Have you noticed a change in the way people invest in bonds and unit trusts in this country? There is a subtle shift in how Kenyans are thinking about their money. The proof is in the numbers: a staggering Sh1.4 trillion.
That is how much retail investors like you and I have invested in bonds and unit trust funds over the past few years. This has been a move away from traditional savings, such as under the mattress or in low-interest bank accounts.
This is not just a personal finance trend. It is a seismic economic event. When a significant amount of capital moves from one part of the economy to another, it creates ripple effects that impact everything from the interest rate on your business loan to the amount of tax revenue the government collects.
Let us examine how this substantial investment in bonds and unit trust funds is impacting business operations, tax compliance, and the overall financial health of our nation.
Less Money to Borrow, Higher Costs to Consider
This move by investors is akin to soaking up liquidity. Imagine the financial system as a large lake. The water in the lake is the money available for banks to lend out to businesses and individuals. Any company or individual can borrow money from the bank, depending on their needs, at reasonable interest rates.
When millions of Kenyans and banks decide to invest their cash directly with the government in treasury bonds or corporate bonds, they are effectively taking water out of the lake. The retailers are giving it directly to the borrower (the government or a company).
This large-scale movement of funds has two immediate effects
1. Reduced Liquidity
With less “water” in the lake, there is less money available for commercial banks to lend to small and medium enterprises (SMEs), entrepreneurs, and even individuals seeking personal loans.
2. Higher Interest Rates
The fundamental rule of supply and demand kicks in. If the supply of loanable money decreases while demand remains constant, the price of that money, the interest rate, goes up.
This makes it more expensive for a business to take out a loan to purchase new machinery, expand operations, or manage its cash flow.
Example
Carol, who runs a manufacturing plant in Thika, may find that the loan she was planning to take out to upgrade her packaging line now has an interest rate of 18% instead of the originally planned 15%.
This higher cost may force her to delay her expansion plans, directly affecting her business’s growth potential and, as we will see, her future tax contributions.
The Business Tightrope: Navigating a Tighter Credit Market
For business owners, this environment becomes a balancing act. With credit being more expensive and more complicated to access, operational strategies must adapt.
a. Curbed Project Expansion
Business owners have many projects to undertake. When there is no money in the market to borrow, capital-intensive projects are often the first to be postponed. This can mean holding off on hiring new staff, opening new branches, or launching new product lines.
b. Internal Cash Flow
We have been told many times that cash is king. There is no time when this saying is more accurate than when there is no cheap money to borrow from the banks. When this happens, businesses must become more efficient and rely heavily on their own generated profits to fund operations.
The expense puts a premium on internal financial management. The credit period extended by the business to its customers or clients is reduced, and pending bills must be collected to maintain liquidity.
c. The Rise of Alternative Financing
Many businesses need money to continue operating. Some may opt for more expensive options, such as short-term digital loans or invoice financing. These options can eat into the profit margins.
The collective impact of businesses scaling back or stalling can lead to a potential slowdown in economic activity. When companies are not expanding, they are not purchasing more goods, hiring additional staff, or generating the same level of taxable revenue.
The Taxman’s Dilemma: A Mixed Bag for Revenue Collection
This is where the story gets complex for the Kenya Revenue Authority (KRA). The shift to bond and unit trust funds creates a fascinating push-and-pull effect on different tax heads.
a. The Positive Hit: Direct Taxes on Investments
The most straightforward benefit to the KRA comes from the taxes directly generated by these investments. All transactions are subject to various taxes and fees.
i. Withholding Tax on Bonds
Interest earned from government and corporate bonds is subject to a withholding tax. This means the tax is deducted at source before the investor even receives their interest payment, ensuring near-perfect tax compliance.
ii. Capital Gains Tax
Capital Gains Tax (CGT) applies to a wide range of transactions. If an investor sells a bond or units in a trust fund for a profit, he or she is liable to pay capital gains tax (CGT) on the capital gain. If they do not make any capital gain, there is no CGT to pay.
iii. Income Tax for Fund Managers
Unit trust funds are managed. Asset management companies running these unit trust funds generate fees. These fees are taxable as corporate income for them, as pay-as-you-earn (PAYE) for their employees, and as personal income tax for any person they may pay commissions to.
b. The Potential Squeeze in Indirect Taxes from Business Slowdown
KRA collecting tax from the bonds and unit trust funds sounds like a good idea. However, the potential slowdown in business activity in the country we discussed can indirectly pressure other tax revenues.
i. Value Added Tax
If Carol’s manufacturing plant delays its expansion, it will not purchase the new packaging machinery. That means no customs taxes or duties, or Value Added Tax (VAT), are collected on that major purchase.
Similarly, if consumer spending slows due to tighter economic conditions, VAT collection from retail sales is likely to suffer.
ii. Corporate Income Tax
A business that is not growing is likely to report stagnant or lower profits. This led to a lower corporate income tax bill. If expansion plans are shelved, it also means that no new jobs will be created. This will affect Pay-As-You-Earn (PAYE) contributions.
iii. Excise Duty and Customs Taxes
Many goods and services are imported into the country. Lower production and importation of goods directly translates to lower collections of excise duty and customs taxes. If a beverage company is not expanding, it is not importing new bottling plants or producing more sugary drinks to tax.
A Story of Two Economies: The Long-Term View
This is not necessarily a doom-and-gloom scenario. This tremendous financial shift also has a significant upside. That kshs 1.4 trillion is not vanishing. It is being redirected.
i. Funding Government Projects
When retail investors purchase government bonds, they are directly financing infrastructure projects, such as roads, railways, and ports, that ultimately enhance the business environment for everyone in the long run.
ii. Creating a Deep Capital Market
A robust market for bonds and unit trust funds provides stability, signaling a mature financial system that can attract foreign investment.
iii. Wealth Creation for Individuals
As Kenyans become more savvy investors and build wealth through these instruments, they eventually become a source of greater future tax revenue through higher-value investments and increased consumption.
Example
The same government bond that makes Carol’s loan more expensive today might be funding a new highway that will drastically reduce her transport costs and expand her market reach in five years.
Final Thoughts
Today’s call is to start laying down strategies for navigating the new normal. The movement of Sh1.4 trillion into bond and unit trust funds is a powerful testament to the growing financial sophistication of the Kenyan investor.
While it presents short-term challenges for business borrowing and creates a complex picture for tax collection, it also lays the groundwork for a more stable, investment-driven economy.
The key for policymakers is to foster an environment that allows businesses to continue accessing affordable credit through alternative channels.
This will ensure that the real economy continues to grow in tandem with the flourishing investment economy. For the rest of us, it serves as a reminder that our collective personal investment decisions have the power to shape the nation’s economic destiny.
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