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Borrowing: The paradox of debt and interest rates

Financial Standard
 Credit rating agencies have downgraded Kenya's creditworthiness. [iStockphoto]

Debt has rattled Kenyans in the last two decades, with the belief that the country has over-borrowed.

We heard that during election campaigns last year and on the streets - never mind that we have over-borrowed as individuals. Online lending platforms and shylocks are doing very well. Remember the hue and cry over CRB listing?

Data on debt-to-GDP ratio shows we are way below many countries, but the reality is a bit different. Credit rating agencies have downgraded our creditworthiness. This questions our ability to service the debt.

Add the fact that unpaid bills by counties and national government are not counted as part of national debt. This would raise our debt-to-GDP ratio.

Redefining our debt ceiling as a given ratio of debt-to-GDP is a new development in the debt market. To raise more debt, the economy (GDP) must grow. We hope our politicians will ensure that growth with good policies and incentives for those who go beyond the call of duty.

Why is debt such a paradox? It’s hated and loved with equal measure. Governments and individuals who live beyond their means borrow to bridge the gap between income and expenditure. We love debt because it allows us to live tomorrow’s life today. Debt is loved for another reason - it feels like free money!

Debt is loathed for biblical reasons; read Proverbs 22:7. The borrowers also wonder why they can’t be forgiven yet they lack money in the first place. The psychology of debt is much unexplored. The use of threats from auctions to blacklisting makes it unpopular.

But there is something to celebrate about debt - you use other people’s money. The borrower pays a fee for using someone’s money, the interest rate. It gets better; great ideas are matched with capital.

In Kenya, as Covid-19 demonstrated, debt has another nobler use. It keeps many families alive. With a sick child or no food, interest rate is meaningless. Debt can be life, like water.

The main reason why debt is celebrated is that it’s a business. We make money from it through interest. Banks, shylocks, Saccos and even individuals are in it. Sometimes we do not get interest but goodwill from those we help.

Think of government or corporate bonds or Treasury bills, where you lend money to the government or company at a given interest rate. If you have Sh10 million and buy a bond with 16 per cent interest rate, you will get Sh1.6 million every year as coupon. That’s not bad money!

Finance is very biblical, to those who have more will be given.

This brings us to the next paradox; interest rate. High interest rates are double-edged, they give banks and other lenders more income if the market continues borrowing. How responsive is Kenya’s debt market to a rise in interest rates? High rates also raise the chances of defaulting.

The government through the central bank has another motive in raising the interest rates. It discourages borrowing, leading to less money in circulation, less demand and therefore lower inflation.

The paradox is that lower demand leads to joblessness. What is more evil, inflation or joblessness? It often depends on the experiences a country has gone through.

Compete for credit

Debt and interest rates are paradoxical in another way. They confirm that the government has business in business. Do you recall the interest rate cap?

The government has a lot of influence on our business through debt. We compete for credit with government from banks. We often lose because the government is the only one that reduces the operations cost of the lender. Think of operations cost of lending Sh10 billion to government against lending the same money to 1,000 people.

Crowding effect and lower operating costs have economic consequences; money is more efficiently utilised in private hands than government hands. Do we need to explain why more should go to private hands?

With the government raising or lowering interest rates, we can borrow more or less. This affects the cost of running business. In addition, when rates go up, the wealth held in bonds reduces. The price of bonds is inversely related to interest rates.

I have not complicated your life with jargon like liquidity trap or quantitative easing. We should have added taxation as the third paradox but after the Court of Appeal gave the government the greenlight to implement Finance Act 2023, I will hold my peace for now.

The fact that the government has such a direct effect on our economic welfare demonstrates why we should vote wisely. Does it surprise you that the elite love interest rates and debt? They see debt as a business, the rest of us as a source of suffering. On which side of this economic divide are you? 

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