Capital Markets

Changes needed in National Fiscal Policy

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This article first appeared in my weekly column in the Business Daily on March 26, 2017

This week the National Budget for FY 2017/18 will be read, and being an election year this budget may indicate how fiscal policy will be approached post-election.

There are three issues with fiscal policy as articulated over the past few years. The first is sub-par revenue generation and unrealistic revenue targets. The economy grew at about 5.9 percent in 2016, yet the tax revenue forecast was raised by 8.7 percent. By December 2016, it was reported that the Kenya Revenue Authority (KRA) failed (once again) to meet its half-year target by KES 20 billion. This is not a new event; revenue targets are routinely not met begging the question as to whether or why unrealistic targets are set; this habit has to change in the upcoming budget. Kenya needs more realistic targets in order to more effectively anticipate debt requirements for the year.

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(source: http://www.capitalfm.co.ke/business/files/2013/11/BUDGET-BRIEFCASE.jpg)

The second issue in fiscal policy is notable increases in expenditure.  Please note that according to the Budget Policy Statement 2017/18 released in November 2016, the government seeks to curb non priority expenditures and release resources for more productive purposes. The BPS states an expected overall reduction in total expenditures resulting in a decline of the fiscal deficit (inclusive of grants) from KES 702 billion to KES 546.5 billion, equivalent to 7.5 percent of GDP. This is positive in that this fiscal deficit should be lower than the 9.3 percent of GDP for 2016/17. However, two problems linger; firstly a deficit of 7.5 percent is still above the preferred fiscal deficit ceiling of 5 percent. Secondly, it is almost certain that supplementary budgets that ramp up expenditure will be tabled over the course of the fiscal year. Just last month the government proposed KES 75.3 billion of additional expenditure for various ministries and government departments. Government has the problematic habit of creating what seem to be artificially narrow fiscal deficits and borrowing requirements during budget reading, only for these to be revised upward significantly over the course of the fiscal year.

Finally, and linked to the point above, government has to rein in its debt appetite. Growing expenditure, partially attributed to a bloated devolution-related wage allowances and benefits bills has contributed to government borrowing aggressively for capital expenditure. The debt to GDP ratio currently stands at 52.7 percent, up from 44.5 percent in 2013 and above Treasury’s 45 percent threshold. To be clear, the debt to GDP ratio in itself would not be worrying if there were clear and demonstrated action to manage debt levels more aggressively. The World Bank puts the tipping point for developing countries at a 64 percent debt to GDP ratio above which debt begins to compromise economic growth. Thus while there is still wiggle room, continued debt appetite juxtaposed with (or due to) subpar revenue generation means Kenya is headed towards debt unsustainability in the near future.

It is hoped that the fiscal policy due to be read will provide detailed strategies on how revenue generated will be stimulated, expenditure cuts effected as well as the articulation of a clear and realistic debt management strategy.

Anzetse Were is a development economist; anzetsew@gmail.com

The effect of the interest cap on monetary policy

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This article first appeared in my weekly column with the Business Daily on March 12, 2017

Last year I opposed the interest rate cap before it was approved and came into effect. I opposed it because I knew it would lead to a contraction of liquidity, particularly for SMEs who are often viewed as high risk by mainstream banks. A few months later, the fears I had have become a reality. Last week this paper reported that Kenya’s private sector growth moved towards stagnation in February partly due to a decline in private sector credit. Treasury reports indicate that credit growth slowed down to the lowest level in a decade, partly due to banks becoming reluctant to lend under the rate cap regime.

As this paper reported, Treasury data indicates that lending to businesses and homes grew just 4.3 percent in the year to December, down from 20.6 percent in a similar period in 2015. The 4.3 percent credit increase is well below what the Central Bank of Kenya (CBK) says is ideal loan growth of 12 to 15 percent which is required to support economic growth and job creation

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(source: https://loanscanada.ca/wp-content/uploads/2014/10/credit-score-scam-1.png)

The irony of this situation is two-fold. Firstly, the interest cap did not expand lending, it contracted it, particularly for SMEs. Strathmore Business School indicates that most SMEs in Kenya struggle to raise capital from banks. With rate caps, refinancing of credit from financial institutions has become even more of a challenge. Secondly, even with the interest rate cap, most SMEs find current interest rates unaffordable. Credit is still too expensive.  So what did the interest cap achieve? Firstly, it has made it even more difficult for SMEs to get access to credit and secondly, it is an effort in futility as credit is still too expensive for most, even with the cap.

This is when monetary policy would usually come in to try and address the situation. In a normal scenario with no cap, a contraction in liquidity would usually lead to a drop in interest rates to encourage banks to lend. However, the CBK would not do this due to two reasons. Firstly, the ongoing drought is already placing upward pressure on inflation; the overall inflation rate for February this year was 9.04 percent, well above the ceiling of 7.5 percent. Thus even in a normal situation, the CBK would likely not drop rates as this would place further upward pressure on inflation. Secondly, this is an election year where billions enter the economy in an almost artificial manner, putting further upward pressure on inflation.

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(source: https://i0.wp.com/covered.co.ke/blog/wp-content/uploads/2017/02/sme-banking-e1479992621937-1024×857.png?fit=810%2C678&ssl=1)

However it is not business as usual, there is an interest rate cap to contend with. The interest cap has thrown monetary policy into chaos. In the current situation, the CBK cannot drop interest rates to encourage lending as this would engender further contraction in liquidity, shutting even more people and businesses out from access to credit. Lowering interest rates would make banks even more reluctant to lend. So the irony of the situation is that it appears that an increase in interest rates may encourage more lending from banks as it would raise the risk ceiling of those to whom banks are comfortable lending. Kenya is in an interesting position where increasing interest rates may actually expand lending; monetary policy has to work upside down. However, if the increase in interest rates were effected to try and address the contraction in liquidity and worked, it may then exacerbate the inflation being caused by the drought. Even in this upside down world there are reasons against raising interest rates as well as dropping them. Raising interest rates would likely expand liquidity and exacerbate inflation and dropping rates would likely engender a further contraction in liquidity.

The world is watching this experiment with interest rate capping going on in Kenya, and thus far it is making the case against interest rate caps even stronger.

Anzetse Were is a development economist; anzestew@gmail.com

 

 

 

TV Interview: State of the Nation with a focus on the economy

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On Monday February 27, 2017 I was interviewed by Citizen TV on the State of Kenya’s Economy.

TV Interview: The economy and upcoming elections

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On Sunday February 26, 2017 I was part of a panel that was interviewed by KTN on the economic issues that ought to be addressed by political aspirants.

Monetary policy in a tight fix

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This article first appeared in my weekly column with the Business Daily on February 19, 2017

Over the past few months we have seen a severe drought ravage our country. The loss of life and livelihood for so many Kenyans is truly devastating. But what we must realise is that the consequences of the drought impacts the lives of the populations in the domicile counties as well as the rest of us. The reality of the matter is that the drought is not only affecting the lives of our fellow Kenyans, it is also affecting monetary policy.

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(source: https://c2.staticflickr.com/4/3273/2477719111_6b9daa5386_z.jpg?zz=1)

The Central Bank of Kenya (CBK) is in a tight fix with regards to the ramifications of the current drought; there is pressure to increase the Central Bank Rate (CBR). We have a serious drought on our hands; not only will it increase the cost of food, it will increase the cost of electricity. As the drought bites, food will be more scarce and the demand for food will outstrip the supply thereby placing upward pressure on food prices. Additionally, as a significant part of our electricity grid is powered by hydroelectricity, the lack of rain means that the dams do not have a sufficient amount of water to run effectively; as a result the country will have to switch to more expensive sources of power such as thermal power that will drive up the cost of electricity. These factors will drive inflation upwards and will force Kenyans to pay more for basic goods and services. On top of this is the increase in the cost of fuel. So the pressure here is to increase interest rates and the CBR and limit money supply to control inflation. Yet in doing so, the CBK will make money even more expensive.

At the same time, we are witnessing the effects of the interest rate cap; liquidity is tightening. Kenyans are finding that they no longer have access to the loans they used to qualify for. Small and medium businesses are seeing that they no longer have access to the credit lines to which they had access to in the past. Kenyans can no longer get that loan to boost their business or pay for emergency medical expenses because banks have become very risk averse. In a country with a poor tracking system with regards to credit worthiness, banks cannot differentiate between good and bad borrowers. As a result they seem to prefer to just limit lending altogether and restrict the amount of credit they are giving out to individuals and businesses. So what does this mean for the average Kenyan? Well it means that they have less money; and when you couple this with the cost of food, energy and transport increasing, Kenyans are feeling increasingly broke. Kenyans will have to pay more for access to the same quantity of food, energy and transport that they used to access in the past. In short, life is becoming more expensive. But ironically, the best way to address the effect of the interest rate cap would be to increase interest rates to a space where banks feel they can lend comfortably. We are in an interesting space where increasing interest rates may expand liquidity as more people would qualify for credit.

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(source: http://www.aprfinder.com/wp-content/uploads/no-credit.jpg)

So there are several sources pointing for the need to increase interest rates. However, in increasing interest rates, monetary policy by the CBK will make money expensive for Kenyans. In increasing rates to mitigate the drought and address the effects of the interest cap, the government would be doing the opposite of what the interest cap was created to do; give Kenyans access to cheaper loans.

Thus monetary policy is in a tight fix; there is a need to increase the interest rate but in doing so the CBK would engender an increase in the price of credit. It seems the CBK must ride off this season of contradictions and see when a space will open up for effecting monetary policy changes.

Anzetse Were is a development economist; anzetsew@gmail.com

Interview with CGTN (formerly CCTV): Kenya’s private sector credit growth falls to lowest in a decade

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More data is coming in pointing to the damage being done by Kenya’s interest rate caps. Inter-Bank lending has fallen by a third. 6 small banks, accounting for about 7% of sector assets, are struggling with non-performing loan ratios of over 20%, while the sector average was 9.3% by end October. Private sector credit growth has fallen to levels not seen in nearly a decade, at 4.3% in December. Earlier on CGTN’s Ramah Nyang spoke to Anzetse Were, one of the economists who had argued against these rate caps. I asked her if the data available now vindicates her position.

Interview with CGTN (formerly CCTV): Kenya’s interbank lending market still fearful, rigid

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Kenya’s 2016 rate caps continued to inflict damage on the wider economy. In its latest assessment of the Kenyan economy, the IMF warns that they could cut growth by up to 2 percentage points in 2017 and 2018 too. The rate caps have added to the sense of crisis triggered by last year’s liquidation of one bank, and receivership of two others. Inter-Bank lending volumes have fallen by about a third, and large banks are extremely reluctant to lend to smaller ones. CGTN’s Ramah Nyang spoke to me to better understand this crisis in the inter-bank market.