Interest rates in unprecedented dip

Kenya has since the beginning of the year been grappling with a very unfamiliar problem - that of low interest rate. For almost a decade and a half, the country in the wake of reckless monetary and equally imprudent fiscal regimes had only known double-digit figures for interest rate, a scenario that has all of a sudden reversed, leaving everyone bewildered.

At the close of July, the benchmark 91-day Treasury bill rate stood at 30-year lows of 1.4 per cent, a far cry from the early 1990s, during the Goldenberg Affair, when it nearly hit a hundred per cent. Generally, it is clear why the rates are coming down. For one, there are high expectations that the international financiers will resume funding of the government budget next month.

That this is not far from a foregone conclusion has not been bothering anyone. But what has happened is that the Treasury has taken advantage of the feeling to offer lower rates on its short-term borrowing and relatively lower rates on its medium-term notes (bonds).

The 91-day Treasury bill is the benchmark for all interest rates in the country. Government though is working on a new benchmark following criticism that its domestic market borrowing rate is not a good indicator for the markets.

It is also thought that some capital, which had fled ahead of the general elections in December is returning. In part, this is a good measure of the confidence the new government is enjoying. The confidence factor, in the beginning of the year, was crucial in the appreciation of the shilling, which has effectively halted as the interest rate drops to historical levels.

There is though one perturbing reason why the rates are coming down: lack of effective demand for credit due to a recession that has been biting since 1997 when government in earnest fell out with the multilateral donors led by the International Monetary Fund.

Banks have excess liquidity and with a non-performing economy and default rate estimated to top almost 40 per cent of the total loans portfolio, they are not in a hurry to lend outside the safe circle of blue chip firms.

Base lending rate, the indicative benchmark over which banks put a mark-up according to the customer risk profile, currently stands at between 10 to 19 per cent, the lowest since the liberalisation of the economy 15 years ago.

What has upset conventional thinking is that interest rates can go that down without government controls. In 1999, a little-known opposition legislator went to parliament seeking control of the interest rates charged by the bank. Mr Joe Donde's law officially called Central Bank (Amendment) Act 2000 easily passed in the National Assembly but was later bogged down in the judiciary system in a curious legal rigmarole.

Treasury last June tried to reintroduce some of the aspects of the law, only to be met with a straight NO from the IMF and has since done a quiet retraction. Its domestic interest rate repayments have nevertheless remained low.

To a large extent, the 45 commercial banks, dominating the market in the absence of credible long-term lenders and capital markets, are the biggest losers. Ever since the government became the largest borrower in the domestic market, most of them have abandoned their core business to concentrate on financing the deficit.

Much of the nearly Sh300 billion ($4 billion) domestic debt is owed to banks and other financial market players. Now that state is paying peanuts for their money, some of the major institutions have panicked and are scrambling for the few good retail and corporate borrowers. Their huge exposure to interest income from government securities is expected to show at the end of the year.

Little wonder that the so-called financial experts have been quoted saying the rates are not sustainable. It is estimated that an average of 70 per cent of bank's income emanates from interest rates and most of it from government borrowing.
The situation will be more explosive once the financial needs of the Treasury are reduced if a good part of the deficit - estimated at Sh62 billion ($820 million) - is covered by external resources.

Last year, banks made some Sh6.7 billion ($89.3) million) against a background of recession. The amount was 1.5 per cent betterment over the previous year.
More interesting is that most of the money was made by the clearly unpopular subsidiaries of transnational corporation.

Barclays Bank of Kenya made Sh2.5 billion ($33.3 million) and Standard Chartered chalked up Sh3.2 billion ($42.6 million). Both are listed subsidiaries of the UK firms. The other big taker was Citibank, a subsidiary of Citigroup New York, which made Sh1.2 billion ($16 million).

On the other hand, indigenous institutions were either in the red or made very poor showing. The largest such institution, Kenya Commercial Bank, made Sh4 billion in losses. KCB is in a category of six state-owned banks, mismanaged for years by cronies of the ruling elite, and dominating the bad debts scenario in the industry.

At the end of the day, some of the weaker banks could fall by the wayside as their non-funded incomes are close to nil. However, it is hoped that with new economic growth figures put at an improved 1.4 per cent, the excess liquidity will be absorbed and the banking sector redeemed. But with restructuring to fit the new realities on the cards, short-term instability is not ruled out.

Central Bank initial figures, however, are showing good performance by the whole industry for the first six months - presumably because lower losses by KCB and National Bank, which last year provided well for their non performing exposure, are losing less money.