Aggressive borrowing by the government, rising suspicion between banks, and high interest rates are contributing to low circulation of money in the economy, as investors hold onto their cash because of security concerns over next year’s General Election.
This has seen interest rates go up which has, in turn, raised the cost of living.
The credit crunch by government in October last year, which came just two months after the Central Bank of Kenya (CBK) increased interest rates and started mopping up money from the market in order to save the weakening shilling, has been blamed by experts for making banks to prefer lending money to the government instead of individuals, thus denying businesses access to cash.
Worse, the government is spending a huge chunk of its money (a good percentage of it borrowed) to repay debts.
This is as it continues to cut down on spending on development which ideally is supposed to motivate the movement of money in the economy as it is the biggest employer and consumer of goods and services.
Experts have raised concern at the situation, saying it is making the poor poorer as companies cut down costs in order to survive. Others are laying off staff.
“Obviously, the government is struggling to pay its debts which is forcing it to cut down on spending on development. The biggest concern is that all this money is going to China,” Dr Jim Mcfie, a lecturer of accounting and public finance at the Strathmore Business School, told the Sunday Nation.
In the last three months, Kenya has borrowed Sh600 billion from China - which is almost triple the Sh262 billion that Kenya owed the Asian giant at the end of last year.
Data from Treasury shows the government intends to pay Sh250 billion as interest on its debt, which is Sh64 billion more than what the teachers will be paid and Sh221 billion more than what will be spent on health in the current financial year.
Interest on debt is not subject to a vote in Parliament and has shot up by 61 per cent in the last one year and experts say this is undoing efforts by CBK to push down interest rates.
By comparison, development spending has dropped by 9 per cent; from Sh721 billion last year to Sh656 billion this year.
Finance consultants Cytonn Investments say this disconnect between CBK and Treasury has resulted in high interest rates due to uncertainty.
“Both monetary and fiscal policy are supposed to complement each other, however what we see is the two policies moving in opposite directions.
"Monetary policy, which is the role of Central Bank through the Monetary Policy Committee, has taken a tight stance, while the fiscal policy, which resides with the Treasury, is on an expansionary mood,” Cytonn said in a statement.
TAMING INTEREST RATES
On Friday, CBK announced inflation had accelerated this month to 6.4 per cent due to rising food prices. This is, however, below the government’s inflation ceiling of 7.5 per cent.
The cost of maize has been on a seven-month rise with a two-kilogramme packet of Jogoo selling at Sh112, Pembe Sh103, Soko 101 and Hostess Sh148 in most supermarkets.
Worse, the effects of the recent rise in fuel prices because of the introduction of a Sh6 fuel levy a litre will eventually drive the cost of production up which will further increase the cost of living.
“Food inflation increased to 10.2 per cent in July from 8.6 per cent in June. Meanwhile, fuel inflation declined to 0.89 per cent in July from 1.43 per cent in June,” said CBK on Friday.
CBK’s Monetary Policy Committee (MPC) met last Monday and resolved to reduce the Kenya Banks Reference Rate (KBRR) to 8.90 per cent from 9.87 per cent.
This is supposed to be a benchmark rate used by banks to determine how much they will charge their clients for loans.
But this does not always happen and the lenders have been accused of being too quick to adjust their charges upwards when it goes up but not doing the reverse when the KBRR goes down.
Both the regulator and Parliament have admitted that the KBRR, which is adjusted twice a year, has not been effective in determining interest rates.
Interestingly, however, an attempt by MPs to cap interest rates through the passage of the Banking Amendment Bill last Wednesday is being fought hard by CBK and the Kenya Banker’s Association (KBA).
The legislative proposal, sponsored by Kiambu MP Jude Njomo, seeks to limit the amount of money commercial banks can charge as interest.
Parliament wants to cap the interest rate at four per cent above the rate at which banks are loaned money by CBK, which is currently 10.5 per cent.
But KBA argues that will lead to exclusion of a majority of borrowers.
“A majority of individuals and, micro, small and medium-sized enterprises have higher perceived risk of default,” said Mr Habil Olaka, the KBA chief executive.
CBK controls inflation in three ways; regulating the supply of money (liquidity) in the market, trying to keep the exchange rate at desirable levels, and controlling interest rates.
Higher interest rates deter individuals and companies from borrowing which results in less consumer spending.
The ripple effect, however, is it deters investment which in turn slows down economic growth.
CBK data shows that the rate of growth in lending to the private sector has slowed down to 14.3 per cent in April compared to 19.8 per cent last October.
Being a pre-election year, Rich Management CEO Aly-Khan Satchu says the effects of high interest rates are being magnified as investors shy away from investing due to fear of an outbreak of violence further slowing the flow of money.
“Economic activity will lessen because typically World Bank data has shown that the economy slows by up to 1.7 percentage points in an election year. We have not had a great track record in the matter of handling of elections. Hence investors tend to turn defensive,” he explains.
World Bank data reviewed recently by Nation Newsplex shows that out of the 10 elections Kenya has held, the economy slowed or failed to grow in three of the five multiparty elections and in two of the five single party elections.
The effects are already being felt at the Nairobi Securities Exchange (NSE), where companies have lost Sh300 billion of their value resulting from a 13 per cent drop in market capitalisation from Sh2.3 trillion in January last year as foreign investors sell their stake.
Manufacturers, too, say they have been pushed to scale down operations and fire staff due to increased costs of production, high interest rates which makes loans expensive and delays in government payments.
“By and large, the money from government is not coming through as expected - which is pushing companies to borrow money in order to finance their operations. So there is an overall scale down of economic activity in several sectors and the ripple effects are worrying,” Kenya Association of Manufacturers chief executive Phyllis Wakiaga told the Sunday Nation.
She said: “This is something all of us have been feeling in the economy and as manufacturers, the sector ranked fourth last year with a loan allocation of only Sh85 billion. And for a capital intensive sector like that you expect the money to be there at the top. That indicates that we are not borrowing as expected.”
The government has ramped up spending to build a modern railway, roads and electricity plants, driving up borrowing from both the local market and international partners to plug its budget deficit amid rising tax shortfalls.
This has seen the country’s public debt rise in the last three years by 66 per cent from Sh2.1 trillion in November 2013 to Sh3.5 trillion by the end of March.
But while experts argue that the country’s GDP to debt ratio, which stands at 49 per cent, is still manageable, government’s increasing appetite to raise money locally is denying investors and individuals access to cheap credit.
Also, the collapse of three banks in quick succession has reduced interbank lending as banks fear to loan each other money.
The collapse of banks has also seen depositors taking their money to the more established banks.
“The spike in interest rates which we witnessed around October last year has taken time to unwind. This plus the uncertainty in the banking sector has been a catalyst for a wave of deposit flight to quality which saw deposits flee the Tier 3 banks and park in the Tier 1 banks,” says Mr Satchu.
“But instead of lowering their rates, the Tier 1 banks, “flush with liquidity”, have parked these funds for the most part in GoK securities,” he said.
SOUND AND RESILIENT
The average interbank rate (the rate at which banks lend each other money) stood at 4.79 per cent.
Banks lend each other money all the time to fund their operations whenever they fall short, a phenomenon known in banking circles as overnight lending.
However, the rate at which they do this, which acts as a barometer of liquidity in the market, is at its lowest in three years as lenders seek the safety of government debt.
“The moment you put your money in the bank they will immediately put it into a government bond which, though has a low interest rate, has an assurance that it will be paid back than if the bank lends it to one of its customers or other banks,” says Dr Mcfie.
CBK insists that Kenya’s financial sector is sound and resilient, supported by strong macro-economic fundamentals.
According to an annual assessment of the banking sector released by the regulator, asset base grew by 5.6 per cent from Sh3.6 trillion in June 2015 to Sh3.8 trillion last month signifying a growth in deposits and loan issuing.
“This has been driven by increased lending. The liquidity ratio for the sector has improved to 40.4 per cent as at the end of June 2016 from 38.7 per cent in June 2015. This is above the statutory minimum limit of 20 per cent,” said Dr Njoroge.
But as the experts argue their points, many Kenyans are decrying the lack of money and rising inflation.