Increased private and public loans expose Kenya to interest rates rise

There is a saying that “interest on debt grows without rain”.

The past few weeks, characterised by the rise and fall of interest rates, have revealed that Kenya borrowers are currently much more sensitive and vulnerable to movements in interest rates than ever before.

While most of the focus has been on government borrowing, little has been said about private borrowing (debt accumulated by households and businesses).

Household debt, which currently accounts for 24 per cent of the total amount of loans offered by commercial banks, has more than doubled in the past five years.

Regardless of whether this increase in debt is sustainable, it has important macroeconomic implications for the country.

Indeed the far-reaching effects of high interest rates on private borrowers was the most important factor that contributed to the fall in yields on government securities.

In a space of three weeks, the 91-day Treasury bill rate has plummeted from a high of 22.4 per cent to a low of 9.5 per cent.

Of course, there is the salient factor that at present the government can ill-afford expensive debt.

There are comparisons to be drawn between public and private borrowing.

While government debt has more than doubled over the past five years, so has private borrowing.

And while government revenues have failed to match the growth in public debt, household incomes have barely increased over the past 10 years.

Coupled with the increase in the cost of living over the years, this means that household incomes can barely accommodate higher interest rates on household debt.

When Mr Mwai Kibaki came to power in December 2002, the government’s drive to spur growth led to a reduction in interest rates.

RISE IN INFLATION

The 91-day Treasury bill rate fell from 8.4 per cent in December 2002 to 1.5 per cent in December 2003.

In the same period, lending rates by commercial banks also fell from an average of 18.3 per cent to 13.5 per cent.

Banks became more focused on lending to private borrowers than to the government.

While interest rates were reducing, inflation, which is the increase in the level of prices for goods and services, was on the rise.

It increased to 9.8 per cent in 2003 from 1.9 per cent in 2002, and would continue to peak multiple times thereafter.

The decline in interest rates had two effects on household borrowing.

First, it allowed a greater number of households to borrow.

Secondly, it meant that a household could borrow more with the same amount of income than was previously possible.

The rise in inflation meant that the real value of the loan that one had borrowed was being eroded faster than in the past.

Under Mr Kibaki’s watch, the total amount of loans offered by commercial banks rose from Sh248 billion in 2002 to stand at Sh828 billion in 2010.

Out of this total amount, loans to households grew from Sh18 billion in 2002, to Sh235 billion in 2010, a whopping 1,205 per cent increase.

As though that was not fascinating enough, total loans offered by commercial banks grew from Sh828 billion in 2010 to currently stand at over Sh2.32 trillion.

Out of this total amount, loans to households more than doubled from Sh235 billion in 2010 to now stand at over Sh567 billion.

By September 2015, there were 7,016,378 million loan accounts in commercial banks.

The bulk of these loan accounts were held by households, although the bulk of the total loan amount was held by businesses.

INCREASED INDEBTEDNESS
At Sh567 billion, households currently hold the largest amount of loans by a single sector, representing 24.4 per cent of the total amount of loans by commercial banks.

Other sectors that hold large loan amounts with commercial banks include trade, real estate, manufacturing, transport and agriculture.

These, too, have borrowed heavily in the past five years.

While household loans and the cost of living have been on the rise in the past 13 years, household incomes have barely increased.

According to the Kenya National Bureau of Statistics, in October, 73.5 per cent of the 2.37 million formal sector workers were living on low wages of between Sh10,000 and Sh50,000 per month.

Only 68,676 formal sector employees earn more than Sh100,000 a month, representing 2.89 per cent of formal sector employees.

Wages have grown faster for this small number of formal sector workers at the top of the wage bracket compared with the majority at lower wage brackets, further rubber-stamping our reputation as the country with the highest level of income inequality in the region.

It is, therefore, easy to see how the recent increase in interest rates led to a huge uproar in the country and caused the government to beat a hasty retreat.

Increased indebtedness means the household sector is more exposed to interest rate risk now more than before. And so are businesses.

Increasing interest rates for borrowers was going to make the Jubilee government very unpopular, more so coming barely two years before elections.

High interest rates would mean reduced trade and production, and an increase in already high unemployment levels as companies lay off employees to cut down on costs.

This would translate to reduced tax revenues for a government that is already struggling to meet set revenue collection targets.

POPULAR ROUTE

The government chose the popular route — appease voters, encourage growth and hope for better revenues.

But even as the government puts on a brave face, inflation is slowly rising and the Kenya shilling remains weak.

The Central Bank has made multiple interventions each week to ensure the shilling does not weaken further, which has put enormous pressure on its foreign exchange reserves.

These factors are compounded by the looming effect of a possible rise in interest rates in the US in December.

This past fortnight, key factors in the US appeared to support such a move and the US Federal Reserve is more determined to raise interest rates for the first time in eight years.

This is likely to cause the Kenya shilling to weaken further and inflation to rise.

In addition, the country will experience further capital outflows as investors flock back to the US market.

These developments are likely to trigger a return to high interest rates in the country as the government struggles to tame capital outflows and contain the exchange rate.

Going forward, the increased indebtedness by households implies that household consumption, and hence the economy, is likely to be more sensitive to changes in households’ expectations about the future path of income, inflation and interest rates.

On the other hand, the increased indebtedness by businesses implies that trade and production, and hence the economy, will be more sensitive to changes in business expectations about the future path of interest rates and the exchange rate.