Resetting for growth: What is holding Central Bank?

I spent the week in Cairo at the Africa Peer Review Mechanism’s (APRM) credit rating experts 9th meeting. We spoke at length on credit ratings, interest rates and inflation. In the room were folks from Economic Commission for Africa (ECA), UNDP, and the host, Bank of Egypt. 

Crucially, six leading Africa-based credit rating agencies – Metropol CRA from Kenya, ICRA (Tanzania), CareEdge (Mauritius), Sovereign Ratings (South Africa), Premier Ratings (Zambia), and Agusto & Co (Nigeria) were in the room. Thought of as domestic, these credit rating agencies operate in multiple African countries, and rate corporates, sub-national governments and countries.

The main agenda in Cairo was the establishment of the Africa Credit Rating Agency, proposed by Africa Union Summit in 2017, as a response to the poor credit ratings African countries receive. Because of these ratings, African countries pay 3-4 per cent higher interest on foreign commercial loans such as euro bonds.

To illustrate, this year’s US$1.5 billion-euro bond is costing Kenya US$ 60 million more in annual interest than the one it repaid, the result of poorer rating. That amount can cover the budget of two state departments.

Three western based credit rating agencies have come under heavy criticism for these ratings. They are accused of assigning different meanings to similar data points or observations in Africa compared to other markets. When Cote D’Ivoire was growing strongly, rating agencies did not improve their ratings, judging the growth to be fragile!

When citizens protest in Europe, or America, that is seen as democracy at work, and generally ratings neutral or positive. Citizen protests in Africa however, are interpreted as indicative of just how fragile African democracy is, and therefore rating negative!

Euro bond holders

But actions of African economic managers do add to the negative sentiment. Domestic interest rates are quite high. The spread between foreign and domestic interest rates is a reflection of efforts to control inflation, but also a sort of self-assessment.

Countries have kept domestic rates high to stop inflation from spiraling out of control. But they have also done so, to attract massive borrowing from their domestic markets. When Kenya pays 18 per cent on a domestic bond, euro bond holders will demand 10-11 per cent.

Many officials would like us to believe that interest rates are fully market determined. What then is the market’s conclusion about Kenya, which makes investors demand 17-18 per cent on government securities?

Still, interest rates on foreign loans are less than one third domestic rates. For every shilling that Kenya is paying in interest on foreign loans, it is paying three for domestic borrowing. In Malawi, the ratio is one to nine Kwacha.

Foreign commercial loans can be used for general budget support and have no conditionalities, making them attractive to African governments. They come, however, at a significant exchange risk. When the Kenya shilling lost ground against the dollar on negative sentiment, debt service on the foreign loans increased dramatically.

In the private sector, matching the currency of their borrowing with that of their cash flows eliminates exchange risk is common place. That is why horticulture farms in Kenya borrow in dollars or euros, because they are paid in euros or dollars. Hotels and other tourism operators who have significant volume of foreign tourists can have a portion of their debt in hard currency. 

Reprofile domestic debt

Domestic borrowing increases inflationary pressure, akin to printing money. If it does not raise enough tax revenue to repay, a country can print its own currency. But if you print willy-nilly, your currency ceases to have meaning as happened in Zimbabwe. As your currency is losing value, goods become more and more expensive in that currency and wealth wiped out. Controlling inflation is a fulltime assignment for monetary authorities.

Which leads us to the current developments in Kenya. At 3.6 per cent last month, inflation is the lowest it has been in since 2010. This the result of stable food and fuel prices, increased services exports narrowing of the current account deficit, and the success of many months aggressive interest rate hikes.

But CBK has cut its growth expectations to 5.1 per cent, down from 5.4, and the Monetary Policy Committee (MPC) has once again taken the most tentative of steps, bringing the policy rate down only marginally, to 12 per cent. How is a rating agency to interpret the policy action? The CBK has more data on, and deeper understanding of the economy than any rating agency. So if they are super cautious about future prospects, so too must the CRAs be.

To improve the growth prospects, analysts expected a swift reduction in the policy rate to say 6 per cent, pushing hard to lower all other interest rates. Lower lending rates would give a serious boost to credit to the private sector, crucial because total loans to private sector have been shrinking this past year. A growing private sector will create jobs, and yield taxes, both urgently needed.

Lower rates will give government a window to reprofile domestic debt. With a domestic debt stock of five trillion shillings, a 5 per cent drop in interest rates would yield 250 billion in savings from lower annual interest payments, enough to fund the whole roads program.

The CBK has some of the sharpest minds in the land. They know this story way better than I can tell it. Yet, rather than move with speed to reset interest rates and enable growth, they have opted for a gradual reduction as though inflation will remain low indefinitely. What is constraining their ambitions? Perhaps debate at the Africa Credit Rating Conference in Nairobi at the end of October will shed light.

@NdirituMuriithi, an economist is partner at Ecocapp Capital