Treasury’s appetite for cheap loans to crowd out private businesses

Domestic debt from local investors increased by Sh115.5 billion between July and October 2019

The fight between the public and private sector for cheap loans has started in earnest, with the government gaining some ground against businesses and households.

Latest data from the Central Bank of Kenya (CBK) shows that the government has increased its appetite for domestic debt even as the private sector, particularly small and medium enterprises, continue their elusive quest for financial independence.

With the private sector going through a cash crunch, an over-borrowing government has been blamed for the problem that has seen some businesses close shop even as others have fired employees in droves. 

And it looks like the government is not about to exit from the local credit market. Kenya’s total loans climbed back to Sh6.02 trillion after the government added Sh60.7 billion to its stock of debt.

This means that in the first four months of the current financial year ending June 2020, the debt jumped by Sh220 billion as the National Treasury borrowed more than it repaid.

In the same period in 2018, public debt and guaranteed loans increased by Sh151.4 billion.

But it was the share of domestic debt that grew the fastest during this period. Debt from local investors - banks, insurance companies, pension schemes or individuals - increased by Sh115.5 billion between July and October 2019.

The increase was more than double that of the same period in 2018, when domestic debt went up by 2.3 per cent (compared to the current increase of 4.1 per cent), or Sh56.9 billion.

While domestic debt, denominated in local currency, is less risky (technically, according to economist Tony Watima, a country cannot default on a local debt, it can just negotiate with the creditors for a rollover), its accumulation is at the expense of credit to the private sector.

Already, the high demand for government papers - Treasury bills and bonds, short-term and long-term government debt respectively - has been reflected in the increase in the average interest rate of the 91-day Treasury bill.

Yields on the three-month paper edged up to 7.2 per cent Friday from an average of 6.3 per cent some three months ago.

Indeed, for a while last year, if you put your money in a fixed deposit account, you got better returns than if you put it in Treasury bills. This has been flipped in favour of government paper.

Mr Watima fears that with better yields on Treasury bills, the government will continue crowding out the private sector. Banks’ preference for government is that they are sure the State will pay them, but small businesses might default.

“Liquidity will continue to go to the government despite the removal of the rate cap,” said Watima.

Towards the end of last year, Parliament repealed a provision in the Banking Act, which had placed a ceiling on interest rate banks charged on loans. 

Banks were not allowed to charge interest at more than four percentage points above the Central Bank Rate, the rate at which the financial regulator lends money to banks for onward lending to the private sector.

President Uhuru Kenyatta, while calling for removal of the rate cap, noted that the law - which was meant to help Kenyans access cheap credit - had been counterproductive with small businesses being locked out of the market.

He added that the rate cap had interfered with CBK’s role of regulating the supply of money in the economy.

There were fears that even with the removal of the rate cap, the government’s high appetite for debt would drive up the interest rates.

CBK Governor Patrick Njoroge last year downplayed the effect of the government’s huge appetite for domestic debt on the growth of private sector credit, noting that because government borrowing in a year is fixed the impact would not be major.

External debt has not grown as fast as domestic loans. During the review period, external loans increased by 3.4 per cent as Treasury, under acting Cabinet Secretary Ukur Yattani, added another Sh104.5 billion to the stock of its foreign loans.

The country’s total external loans as of October stood at Sh3.1 trillion compared to domestic debt of Sh2.9 trillion.

Between July and October 2018, external loans increased by 3.6 per cent, or Sh94 billion.

Reginald Kadzutu, an investment and economics professional at financial group Zamara, says the government’s appetite is not shifting from the external market.

Borrow in shillings

He says the time is just not ripe for Treasury to plunge into the international credit market, and availability of foreign loans as well as the need for repayment will determine the uptake.

Mr Kadzutu reckons that much of the foreign loans uptake will be informed by the need for the country to refinance a number of external loans that will be falling due between now and June.

One of the external loans that the country will be paying by end of February is Sh35 billion for the standard gauge railway (SGR).

“You also realise that KRA has been missing its targets for Kenya Shillings expenditure. As a result of the shortfalls, the government is forced to go into the local market to borrow in shillings to pay in shillings,” said Kadzutu.

And with close to 50 per cent of domestic loans maturing this year, the government might have been forced to restructure most of the maturing loans, he added.

The National Treasury, having foreseen the removal of the rate cap, might have decided to take advantage of the cheap loans before the taps closed in November, according to Kadzutu.

In a rate-cap-free regime, he says, interest rate caps are certain to go up unless the CBK governor succeeds in using his muscle to threaten banks to keep rates low.

The Monetary Policy Committee (MPC) - CBK’s organ responsible for the formulation of monetary policy – lowered the Central Bank Rate to 8.5 per cent last November, down from nine per cent.

This set the stage for cheaper loans weeks after the interest rate cap was repealed. CBK cited the government’s austerity measures as one of the main reasons for lowering the benchmark rate.

“The MPC noted that inflation expectations remained well anchored within the target range and assessed that the economy was operating below its potential level.

“The committee noted the ongoing tightening of fiscal policy and concluded there was room for accommodative monetary policy to support economic activity,” said Dr Njoroge in a statement.

Besides tightening fiscal policy, the MPC also attributed the rate adjustment to an economy operating below its potential. The Exchequer has moved to aggressively implement a raft of austerity measures aimed at reducing borrowing.

The World Bank has, however, noted that the decision by the CBK to cut the key rate will take time to counter the effects of Treasury’s austerity measures and have the desired results.

The reduction was meant to open the tap of cheap loans with banks expected to on-lend to consumers at a lower rate.

“In Kenya, growth is expected to remain solid, but soften somewhat as the accommodative monetary policy does not fully offset the impact of a fiscal tightening,” said the World Bank in the latest Global Economic Prospects.

Nonetheless, besides CBK unveiling a mobile app, Stawi, aimed at deepening financial inclusion, a few banks have also indicated that they will shift to lending to the private sector.

Equity Bank, the second largest bank in asset size, is just one among an increasing number of lenders that have indicated that they will switch from government lending to private sector.

Equity said it had lined up Sh150 billion worth of Treasury bonds which they want to channel to small enterprises.

“We are saying that Sh150 billion needs to go back into the real economy, to the micro-businesses and individual consumers,” said Equity Group Chief Executive James Mwangi at a press briefing last year.

“We are using the reduced cost of lending and reduced cost of infrastructure to be able to lend to the whole population at 13 per cent.”

Barclays Bank also indicated that it would reduce its lending to government in favour of the private sector.

Banks pocketed at least Sh122 billion from the State coffers last year as they rushed to profit from a cash-hungry government.

Earning from Tbills

The income generated from lending to government reflected an increase of 14 per cent from Sh107.1 billion that the lenders received in the previous year, according to an analysis by The Standard last year.

The seven largest banks were the main beneficiaries of the windfall, sharing out Sh79.3 billion, or 67 per cent of the total haul, among themselves.  

Kenya has also since moved the public debt ceiling to Sh9 trillion from the previous arrangement where it was pegged on the gross domestic product.

However, commercial bank loans to the private sector in October increased by 4.4 per cent compared to 17.4 per cent to government, meaning banks are still lending more to the State.  

Credit to firms and households has been picking up after it slowed to an all-time low of less than one per cent in 2018.