Low rates key to reducing cost of doing business

Kenya: It is a universally accepted principle that interest rates play a major role in the performance of an economy.

In general, higher interest rates result in reduced borrowing and hence reduced spending by both households and businesses. Conversely, lower interest rates normally lead to increased spending. We use the term normally as the near-zero interest rates introduced in most parts of the EU and the US did not lead to the desired increased spending.

This can however be attributed to the global recession that followed from the financial crisis in 2007-08. Economic recessions or depressions are hardly normal events, meaning that measures put into place to stimulate the economy usually have a delayed response due to risk aversion by both credit consumers and lending institutions.

Monetary Policy

Kenya is no different, and since 2003, when the NARC government came to power, government made great strides on easing credit accessibility to businesses and the common mwananchi.

Commercial banks have been relatively aggressive in pursuing clients with viable investment plans. Microfinance institutions too have mushroomed all over the country, ready to provide credit to lower income individuals and organisations.

The Monetary Policy Committee (MPC) has consistently tried to ensure that their rates do not stifle business. Although it could be argued that the mandate of the MPC and by extension the Central Bank of Kenya (CBK) is strictly monetary policy and inflation targeting, recent global practice indicates that the role of central banks has evolved.

In the US, Janet Yellen has indicated that the Federal Bank has a dual mandate involving price stability and employment and will thus maintain its interest rates at zero until employment picks up.

The interest rates in EU have also been kept in the lower ranges to boost European economies. The European Central Bank (ECB) has just recently imposed a ‘negative interest rate’ in a bid to spur lending. The MPC is thus well within its rights to attempt to ensure that the interest rates prevailing are business friendly while performing their primary role of inflation targeting.

Lending rate

However, recent attempts by the MPC to reduce interest rates have not translated into much lower bank interest rates. In July 2012 the Central Bank Rate (CBR), which is rate of interest the CBK charges on loans to banks, was 16.5 per cent with the average commercial bank lending rate standing at 20.15 per cent.

The MPC then reduced the CBR in September 2012 and again in November to 11per cent, the average commercial bank lending rate at the same point stood at 18.69 per cent.

There was a further rate cut by the MPC in January 2013 and a final one in May 2013 leaving the CBR at 8.5 per cent. The average commercial bank lending rate ranged from 17.87 per cent to 17.03 per cent in the latter parts of 2013 and is currently at around 16.7 per cent.  Whilst the commercial banks can be commended for reducing their lending rates in line with the CBR, an easy criticism to make is that the bank reductions are not proportionate to the CBR reductions.

A likely defence by the banks is that their lending rates depend on more than just the CBR. The banks have to take into account the high banking infrastructure costs as well as the legal costs involved in chasing after their debts as well as securing them. The high default rate amongst borrowers also has to be factored in.

The high default rate is often attributed to the high cost of doing business in the country which includes legal compliance costs, poor infrastructure, high energy costs, high tax costs and ironically high interest rates. Hopefully during the 2014/15 Budget, there will be some measures put in place to address these concerns.

One of the direct measures is related to the borrowing levels. Domestic borrowing by the Government plays a role in the interest rates faced by credit consumers. The Government borrowed Sh69 billion, Sh117 billion, Sh90 billion, Sh73 billion and Sh106 billion in 2009, 2010, 2011, 2012 and 2013 respectively from the local market alone.

 This search for funds in the local market, keeping in mind the quantity of money required, has the effect of increasing the demand for credit in the economy as a whole and hence increased interest rates. In effect, both the Government and the private sector are chasing for the same money with the Government usually emerging as the victor. This occurrence is commonly referred to as the ‘crowding out’ effect. To keep commercial interest rates down, the Government should reduce its presence in the domestic borrowing market.

The Eurobond that the Government is about to float overseas is thus a step in the right direction. The proposed bond is already generating interest amongst global investors and is likely to do well especially givenKenya’s favourable credit ratings by Moody’s (B1) and Fitch (B+) recently.

Business climate

In addition to the traditional global investors, there is still untapped potential in the form of Kenyans in diaspora. To indirectly aid in reducing the commercial interest rates, Treasury Cabinet Secretary should put in place measures that will improve the business climate and reduce the cost of doing business in the country. Measures would reduce the time spent dealing with construction permits, getting electricity connectivity, registering property, dealing with tax compliance and trading across borders would be most welcome.

The Budget should also contain measures that improve infrastructure throughout the country and encourage energy efficiency. It should also encourage alternative power sources so as to lead to reduce energy costs. Steps to aid Government security network should also be included in the Budget. In addition, the Judiciary should continue in its efforts to speed up the trial process thus making it easier for businesses to resolve disputes and enforce their contracts.

Hopefully, this Budget will see the twin realisation of reducing reliance on domestic debt and increased efforts in making it easier to do business in the country. With that in place the banks will surely have a reason to reduce their lending rates.

The recent announcement by Kenya Bankers Association that banks will be increasing transparency and disclosure around the true cost of bank loans via adoption of the Annual Percentage Rate (APR) methodology as well as the piloting of the Alternative Dispute Resolution Mechanism (ADR) should over time enable customers to choose wisely where to obtain their loans between the banks. Maybe then, we will finally see the achievement of double digit economic growth in Kenya.