By Gerard Lyons
Are there troubles ahead for the Kenyan economy? In recent years, headline numbers have been relatively strong but now the economy is slowing and the underlying fundamentals appear to be deteriorating. Financial conditions are tough and in the banking sector there has been talk of a crisis in confidence about the policy approach. What should be done?
The outlook for any economy depends on the interaction between the fundamentals, policy and confidence. The fundamentals show that from 2011 to 2016 Kenya’s economy grew at a solid average rate of 5.6 per cent. This was above the sub-Saharan average of 4.3 per cent. The first half of 2016 saw an acceleration to 6.1 per cent.
The external deficit appeared to stabilise, helped by exports of tea, coffee and horticultural produce and helped by tourism and strong remittance inflows, which hit a high in December 2016.
Despite this, a slowdown is now under way. Standard Chartered Bank, for instance, forecast 5 per cent growth this year and 4.8 per cent next.
A slowdown is occurring despite increased government spending ahead of an election in August. In recent years, and compared with most other countries in sub-Sahara Africa, Kenya has enjoyed a high level of public capital spending on its infrastructure. But now, fiscal numbers may warrant closer attention as the election and drought make it hard for the government to rein in its spending. High government borrowing goes hand in hand with the ongoing need to make debt repayments.
The challenge, however, is with monetary and financial policy. Companies across the economy are suffering from the repercussions of a government-imposed cap on commercial interest rates. There has been a dramatic change in the operating environment for businesses, as credit conditions are tough and the liquidity environment tight.
It was only last September that the Banking Amendment Act was implemented. Although opposed by the central bank, the politics of the time forced it through. A cap on loan rates was set, at 4 per cent above the official Central Bank Rate. Deposit rates were set at 70 per cent of the CBR.
Sometimes there are unintended and unforeseen consequences of such policies but when it comes to loan rate caps the lesson from across the globe is clear: they do not work. Banks are forced to confront the challenge of risk versus return. And if price — through the interest rate — is not allowed to determine the market outcome, then credit rationing results.
The losers from such a policy tend to fall into particular categories. These include small and medium-sized firms. Also there are those in riskier areas, such as new ventures and start-ups, who suffer as they are unable to access the credit they need for day-to-day operations. Access to longer-term investment can also be impacted. Unfortunately, this appears to be borne out in practice too, as is now being seen in Kenya.
The Central Bank of Kenya has two main policy goals: price stability and financial stability. On the former it appears to have achieved some success in recent years, but like many other countries it now faces challenges from high food and energy prices. Inflation recently breached the bank’s 2.5 to 7.5 per cent target, hitting 9 per cent. Despite this, it is in the area of financial policy — and the need for a change in thinking towards the banks — where a redirection of thinking would likely help the economy and address concerns of international investors.
Although the central bank has identified correctly the need for a stronger banking sector with increased transparency, the challenge is that there could be a far better approach to achieving these goals and restoring confidence about the future than that being pursued.
Part of the problem is that consolidation appears to be long overdue across the banking sector. The Bank Consolidation Policy sought to address this with fewer, larger, better-capitalised and hence stronger banks. This makes sense. Currently there is a large spread of banks, yet some of the larger ones have lending portfolios to the small and medium enterprise sector bigger than many of the smaller banks combined. The question is whether a market-driven approach may be preferable to the current one where the very visible hand of the central bank seems to be involved. It has taken a hard line with several banks where it had been claimed potential suitors might have been sought.
The outcome is a more challenging financial environment. Non-performing loans are rising. Latest data show they reached 9.1 per cent at the end of September versus 8.4 per cent in June and 5.7 per cent in December 2015. An additional worry is whether some of these figures may in reality be much higher. There have been suggestions that some officials and management may have concealed some loans. In such an environment, where there is so much “noise” about this it is usually best for all concerned if there is an independent analysis to ensure that bank numbers are true and fair, and so address any fears.
Indeed, enhanced transparency and greater accountability are high on the list of priorities of international investors — wherever they are looking to invest. In December, the National Assembly’s Finance, Planning and Trade Committee raised questions linked to the collapse of three banks. These included accusations of collusion between auditors, supervisors and bank executives. Some have suggested that even some of the central bank’s employees were party to this. Even if such allegations prove to be false, it all makes the case for transparency and accountability even greater.
Now with more banks facing challenges — as poor governance and mismanagement are exposed in some — the fear is that a continuation of this approach could trigger a loss of confidence about the regulatory approach towards the banks.
In response to a squeeze in margins, banks are cutting costs, planning to lay off workers and trying to compensate through other levies, which is good for neither lending nor the economy. Credit growth, which is a lead indicator of economic activity, has slowed.
Against this backdrop, a more disappointing outlook for banking sector profits may act as a potential drag for equity-related inflows, making it harder for the economy to service its current account in the months ahead. This, plus possible political uncertainty ahead of the election, may weigh on the shilling. The danger, very quickly, then becomes one of a self-fulfilling downturn.
There are many reasons to be confident about Kenya’s longer-term outlook. It was recognised last year as the third most reformed economy by the World Bank, while Mombasa has been identified by China as occupying a strategic position on its Belt Road initiative. Yet these factors should not divert attention from the need to address issues in the banking sector now.
At the end of last year, the central bank governor spoke of navigating the economy through turbulent times. It is certainly the right topic. Yet one question that merits being raised now is whether the central bank’s approach to regulating the banks is adding to problems rather than providing a solution.
Gerard Lyons is an economist based in London.
This article was first published in the Financial Times