As bank loans dry up, small and medium businesses fight for life

NAIROBI, KENYA

Few Kenyans may have noticed a small advertisement that Victoria Commercial Bank ran in the Daily Nation of Friday June 8, 2012. “We are pleased to announce that our Base Lending Rate will be reduced to 22.5% p.a. with effect from 1st July 2012,” it said.

To ordinary readers, there was nothing special about it. Yet to businesspeople like Steve Kiruri the message was significant. Any information on the cost of credit is big news for businesses. With banks charging interest rates of up to 25% since late last year, the high cost of credit has seen many businesses adjust their strategies.

Like the owners of SMEs in Kenya, Mr Kiruri is just struggling to survive now, a victim, he says, of a government policy that has kept interest rates high for over a year. “We have temporarily suspended borrowing for other purposes other than (essential) needs,” says Mr Kiruri, the founder of Petty Errands Ltd, a courier services provider based in Nairobi. “We have looked at operational expenses that we can reduce or do away with so as to get better margins.”

Banks increased their rates in two waves – June/July and October/December 2011 – after Central Bank of Kenya launched an aggressive monetary policy in an effort to stem rising inflation rate and a weakening Kenya shilling.

Inflation, which measures the cost of living, rose to a high of 19.72% in November 2011 though it has eased to 12.95% in May 2012, while the shilling plunged precariously to a historic low of 107 units to the dollar in October 2012. It has since gained ground to average 85 units to the dollar.

By raising the Central Bank Rate (CBR) to 18%, Central Bank’s Monetary Policy Committee signaled banks to raise the cost of credit and limit the amount of cash in the economy to calm inflationary nerves and strengthen the shilling. They took the cue and raised their rates to between 23% and 30%, locking out many small businesses.

Experts say what is happening to Mr Kiruri is happening to small companies all over the country, as many of the 3 commercial banks that such businesses relied on have priced loans out of reach of many companies.

Prof Tabitha W. Kiriti-Nganga, head of economic theory at School of Economics, University of Nairobi, says Mr Kiruri’s reaction is normal since high rates are good for portfolio investments, which do not really help the economy because they are very volatile.

“High interest rates are not good for the economy because they make the cost of borrowing money for investment very expensive and this of course discourages investment with negative consequences on economic growth,” she says.

For people like Mr Kiruri, therefore, the ad was big news because Victoria Commercial Bank was the third bank in as many months to cut its cost of lending including Citibank and Kenya Commercial Bank.

“We will be glad if it triggers a downward adjustment of the (interest) rates across the industry,” he said. Ranked 35th in terms of market share, Victoria Commercial Bank’s cut was very marginal – a mere half percentage point – to have an impact.

This was within the range set by Citibank, ranked ninth by CBK, and the topmost bank in Kenya KCB, which cut their rates from 25% to 22.5% and 24% to 22% respectively effective June 1, 2012. Victoria Commercial Bank’s decision came only two days after the Monetary Policy Committee (MPC) retained its signal rate at 18% for the seventh month running.

MPC said the global foreign exchange markets witnessed a resurgence of turbulence in May 2012 mainly attributed to the instability in the Euro Zone, justifying to leave the CBR high.

“As a consequence, the US Dollar has strengthened globally as investors shift from Euro to US dollar denominated assets. Several emerging market currencies and those in the region, including the Kenya shilling, weakened against the US dollar as a result of these developments,” MPC Chairman and Central Bank Governor Njuguna Ndung’u said.

This shows the banks are not in a hurry to bring down the cost of credit with the lending rates now ranging between of 19% and 25%. Even where banks like Equity, ABC, Consolidated and I&M have signed agreements with international institutions to finance SMEs, the rates are only slightly lower than the prevailing market rates.

Only the banks’ most valued customers, especially corporates and high net-worth businesspeople, are charged the base lending rates with the others paying more depending on their individual risks.

Hence, with a base lending rate of 25%, interest rates can go as high as 29%. Prof. Kiriti-Nganga says the high cost of borrowing will have negative consequences on production and business expansion.

“Those who have already borrowed find it difficult to service their loans and this leads to an increase in non-performing loans,” she warned. There’s little doubt that the loss of credit is hurting small businesses, contributing to Kenya’s troubles by raising unemployment and cutting tax revenues, making it harder to finance its high budget.

The credit loss hits particularly hard in a country where 70% of the economy, and 80% of the jobs, come from small and medium-size companies. These effects are beginning to show in business where entrepreneurs are scaling down or shelving expansions.

“We have put on hold expansion plans until after the next elections, when we think the economy stabilise, and the cost of borrowing reduce,” says Mr Kiruri of Petty Errands, echoing sentiments of a number of other investors.

Besides, the high rates negatively impact on the cost of goods and services and thus erodes consumers’ purchasing power, hurting manufacturers and service providers.

“Consumers who may have borrowed my find it difficult to service loans and especially if the loans were for consumption, school fees, and so on,” Prof Kiriti-Nganga says.

This could not have come at a worse time. The government has warned that the high interest rates, which might constraint credit to the productive sectors and result in loan defaults, could slow down East Africa’s biggest economy.

“The domestic economy is likely to maintain a positive growth but at a decelerated rate of between 3.5% and 4.5%,” said Mr Wycliffe Oparanya, the Minister for Planning, while launching the Economic Survey 2012.

Kenya’s economy slowed down to 4.4% in 2011, down from 5.8% in 2010, pulled back by escalating oil prices, a weakening of the Kenya shilling that led to widening of the current account deficit, high inflation and erratic weather conditions, which triggered a food shortage.