The analogy of a house of cards to me is very appropriate in discussing the recent economic growth circa 2003-2007 and pre-Kibaki growth in Kenya. Economic growth is an ideal every country strives for and is usually the intrinsic mandate of all government efforts. Growth leads to jobs, higher standards of living, higher life expectancies, higher education and even less suffering and misery. However in our case, we have to be very careful as to what factors drive this growth. Here I would like to present a very simple growth model, first posited by an eminent MIT economist called Robert Solow. His model was simple:
Y = f(At Kt Lt)
In this simplified model, he stated that growth in output Y was dependent on At which is a measure of productivity at a given time, Kt a measure of the amount of capital (Buildings, machines, cars, trains) at a given time and Labour at a given time.
From the model, it is the At that we should be interested in. In economic terms, it is referred to as Total Factor Productivity (TFP) and basically shows how much we are getting per worker or machine. If TFP is low in relation to other countries, then our workers and our stock of capital produce less than the same workers and the same stock of capital in other countries. The IMF in a recent study show that Kenya's growth and that of other Sub-Saharan countries has been due to an accumulation of factors rather than an increase in TFP. To better discuss this, I feel an analogy is appropriate. Imagine the economy as a lush field of grass and growth is reflected in how much grass we can cut and harvest off the field. We harvest grass by hiring people armed with sickles to cut the grass. Our growth then in this regard has been as a result of hiring more and more people armed with more and more sickles to cut the grass. The worrying fact is that according to the law of diminishing returns this method of growth is not sustainable.
The law of diminishing returns states that as more and more variable factors of production are added to a fixed factor, production will at first increase at high rate then increase at a decreasing rate before eventually dropping. In the grass case, then production of grass will first increase because of more workers then as workers start jostling for space and arguing over whom gets which sickle, the production will start increasing at a decreasing rate before eventually dropping. TFP in our case would be solved by maybe fertilising the grass so that it grows longer thus justifying the number of workers, buying lawnmowers so as to increase the speed of collection and other such measures.
Clearly then TFP is an important and I would dare say the most important factor in creating economic growth. According to the World Development Report of 2005, between 1960-2000 45-90% of cross country differences in GDP growth were attributable to TFP growth. Added to this, TFP growth in Kenya according to the World Bank grew at an average rate of -1.0 between 1990-2000. Slowing TFP in Kenya has then been the main cause of the massive difference between Kenya's growth and the growth of the East Asian economies. Of the cumulative GDP per capita of Malaysia, Singapore, Korea and Kenya in 1964, Kenya's GDP per capita was 10%. In 2006 this had reduced to 1%.
A study of the factors that affect TFP growth is therefore vital. The IMF in a study conducted in June this year show that good governance, education, good health and inflation are amongst the main causes of differences in TFP.
In terms of governance, it is no secret that the governance in Kenya for the last 40 years has been miserable. Corruption, inefficiency, lack of transparency have been some of the main adjectives used to describe the successive regimes that have ruled the country. Good governance is important as through working institutions and regulations, people can invest in the country and technological and financial innovation can thrive. The poor governance has lead to foreign direct investment flows to Kenya being much lower than those of other countries. FDI as a percentage of GDP in Kenya was approximately 5% in 2006 compared to approximately 18% in Ghana, 28% in Uganda, 30% in South Africa and amazingly 158% in Singapore.
Bad governance has also affected Kenya's exports as a lack of improvement in infrastructure and the tax system has lead to domestic demand exceeding domestic production due to high domestic production costs. This leads to Kenya being a net importer of goods and thus creating a current account deficit. This flies in the face of the mid-term strategy of being a net exporter by 2012. The World Bank usually grade a country's government through six measures namely; voice and accountability, government effectiveness, political stability, regulatory quality, rule of law and control of corruption. Kenya did poorly with voice and accountability scoring approximately 36%, Political stability 15%, government effectiveness 24%, Regulatory quality 45%, rule of law 13% and control of corruption 16%.
If this was your report card after the end of the year, your parents would hang their heads in shame especially for rule of law which should be the cornerstone of any economy that is based on capitalism and allocative efficency.
However as a bright spot, I feel that the current Prime Minister Raila Odinga, has shown commendable leadership taking a strong and often politically unpopular stand on many issues such as the Mau evictions, environmental control and his commitment to improving infrastructure.
In terms of education, it is no secret that our education system needs a lot of work and prayers even. Sound educational policy has been lacking and is reflected in the enrolment statistics and the cost of education in the country. Good education often leads to a higher stock of human capital and thus improved labour productivity. Our education system in my humble view is one that is still based on the colonial role of educating a native population the basics of reading and writing so as to serve in clerical roles for the British. The lack of technological innovation has been a big deterrent to improved TFP. The government has clearly forgotten that early childhood education and technical education are an important part of the educational infrastructure.
My mother who has worked in education all her life always stresses that early childhood education both at home and at school is a make or break time for the child in terms of his/hers approach to learning and knowledge. Between fiscal year 02/03 and 07/08, early childhood education got on average 0.17% of total expenditure on education and technical education got on average 2% of total expenditure on education. Free primary school on the other hand got 52.67%. To make matters worse, of the total expenditure recurrent expenditure was about 92% of the total. Added to this the unit costs of education as a percentage of GDP per capita are high compared to other countries. This means that due to inefficiencies, it is more expensive to educate a Kenyan than it is to educate a South African, Indian or Chinese child at each level of education.
The last factor is inflation. Inflation in terms of TFP usually means that high inflation usually leads to lower investments and savings which are major drivers in TFP growth due to lower real earnings. Kenya has seen high inflation usually due to exogenous (external) shocks that have rendered most wages and salaries useless. According to the Kenya Institute of Public Policy Research and Analysis (KIPPRA), food and beverages contribute approximately 80% of inflation and are subject to extreme shocks such as drought and gross mismanagement of food reserves in the country. Sound policy needs to be enacted to deal with the food issue and consequently inflation so as to improve TFP.
Clearly our economy has been a house of cards, growth has taken it higher and higher but one day when the wind blows or someone bumps into the table, the house will come crumbling down. Governance has to improve through a new proper constitution, improved political good will and leadership and zero-tolerance to corruption. Our education system needs to be ridden of the inefficiency and slack reflected in the high unit costs and high recurrent expenditure on education. Furthermore, the bureaucrats in government need to focus more attention to early childhood education and technical education. Finally the government must realise that monetary policy alone will not fight inflation rather a focus on removing the shocks that affect inflation. Through all these measures, Kenya's growth will finally be sound and stop looking like a house of cards.
Due to difficulties in posting tables and graphs I can email the comprehensive article to anyone interested just express your request to my email address at samora365@gmail.com
House of Cards
Posted by Samora
in Tuesday, December 15, 2009
Don't rely too much on the CBK Measure of interest rates
Posted by Samora
in Monday, December 7, 2009
Just as a thought, I would like to suggest to Kenyan's as borrowers or potential borrowers not to over rely on the Central Bank of Kenya (CBK) measure of general interest rates. The reason is more mathematical and I would like you to bear with me on this one. The CBK calculates the interest rates you see in news and in the CBK reports using the weighed average method. The formula is
Weighed interest rate = S(Qi/D)ri
Where, S = Summation over all the loans a bank is making
ri = Rate of interest that the ith borrower pays
Qi - The loan amount for the ith borrower
D = Total loan amounts for all the accounts which is the sum of Qi
You probably will not need to understand the above but it could help. The reason I am putting up this post is to advice or warn that the interest rates given in the news are not likely to apply to you when you go and apply for a loan. They may not even be a good guide as to what rate you may get. The reason to this is that the above formula as sound as it is, will inherently tend to have bias towards bigger borrowers who are usually given loans at below prime rates. An example is that if Safaricom want to borrow to expand their network coverage, they will go to the bank and ask for cash. If the interest rate at the bank is quoted at 15%, then they will get prime - say 3% meaning that they get the loan at 12%. This could be due to the fact that they generate good cash and usually earn their interest many times over. However a small borrower could be quoted a rate of prime + 3 meaning that he gets 18%. This then if applied to the formula will tend to lean more to Safaricom's rate as it will take out a bigger loan than you will.
Therefore, be watchful over such discrepancies when you next go to the bank asking for a loan.
under:
CBK,
Interest Rates
Fuzzy Logic That We Must Live With
Posted by Samora
in Thursday, December 3, 2009
I would like to think of myself as a man of science and the scientific way. That means that I follow reason and logic and maybe that is why I have really hit it off with Economics. However, back home I have found it frustrating to be a man of science. Evermore so in the field of finance and investments. As an amateur student of the Nairobi Stock Exchange, I have been puzzled by the valuations that the market places on some of the companies whose stock is traded on the Bourse. I can comfortably say that the market does not follow any fundamentals and maybe this is the reason that many companies choose not to list on the NSE. I will give a short discussion on the basics of the exchange, the meaning of fundamentals and a short analysis with a locally listed company.
In it's essence, a stock exchange is a financial intermediary. This means that it is a place where people who have money and nothing to do with it at the moment give those who do not have the money but have a use for it. It is like a bank but in this case the depositors decide who the bank will loan. When companies need capital for expansion, investment and other productive purposes, they can sell equity (part ownership) of the company to raise funds. The funds raised will be used for profit making but now the profit will be shared with the new part owners. It is a model that was started by the Dutch with the Dutch East Indian Company a very long time ago. Apart from listing, the bourse/exchange is used for investors and speculators to buy and sell the stock of a company when its underlying fundamentals change either raising or lowering its value. The trading is done with a view of making profits.
Now that I have mentioned fundamentals, I think a paragraph or two discussing this matter is deserved. Often, we hear that word and in most cases followed by a plethora of other financial jargon that confuses most investors and potential investors. Ben Graham who was the intellectual mentor of Warren Buffett reminds us that a stock is part ownership of a company and not a symbol that moves up and down a screen (ticker at the time he was discussing this). Most people think of shares as pieces of paper that people trade like cards, most people detach the share from the company and make hazard guesses on where it is going to be in the near future. What Graham posits and what is true is that when you buy a share, you become part owner of that company. I recommend that you should maybe visit the premises of the company whose shares you have bought to really internalise your position as part owner.
With this in mind, a company exhibits fundamentals when the share price reflects the value of the company. A simple example is needed here. Imagine 10 companies all growing and selling mangoes. When buying a share what would we look for? I would look at the soil fertility of each of the farms, the types of farming techniques used, the farm yields, the selling prices of each mango and the management of farms. The management is very important, imagine a farm whose management eats all the nice mangoes and sells the bad ones to us. Its management is not maximising on its profits and therefore does not offer good returns to its shareholders. The fundamentals are therefore the underlying practices and issues that pertain to the business in its efforts to maximise profits.
Now in relation to the Nairobi Stock Exchange, I state that the market does not offer any fundamentals and is driven by pure speculation and insider trading. The case of Carbacid and Safaricom are good examples. With Carbacid, after its suspension was lifted, it's share price grew phenomenally. However, on Tuesday it suffered a 37% drop and on wednesday it suffered a 7% drop. With Safaricom, speculative tendencies saw many people rush to buy only to see their investment suffer. It is the fuzzy logic that I talk about, from a simple analysis if the greater percentage of retail investors is buying in the IPO to sell shortly after the share starts trading, then wouldn't the resultant supply of shares due to the sell off depress the price and thus nullify their earlier reasoning?
The case of Jubilee Insurance can be given for this speculator syndrome. Jubilee Insurance is an insurance company that was set up in 1937. After growing in leaps and bounds it listed in 1984 on the NSE and is currently the second largest insurance in Kenya in terms of Market Share and it is the Largest in terms of operations in East Africa. Insurance companies make money from the concept of pooling of risk. When many people pay up for premiums, the insurance company through the pooling of that cash can cover some expenses as most of the people who paid the premium will not suffer any loss. Therefore they take premiums and pay up claims for losses suffered. Added to this due to the cash they make upfront from the payment of premiums, they invest this cash and earn investment income. The two main sources of earnings then for an insurance company is the underwriting profit i.e. the difference between premiums received and claims paid & Investment income.
Jubilee Insurance at the end of October was selling for around 5 times earnings, it is now selling at around 8 times earnings. This is below the market average of 13.45 times earnings. This surprises me because Jubilee has registered underwriting profits in an industry where most companies have been forced to close down. It has stayed away from motor commercial (PSV) insurance which has been the main reason for the dwindling profits of the industry. Underwriting discipline is a huge virtue in the industry and it is a good gauge of the management in place at Jubilee. The 2007 Association of Kenyan Insurers (A.K.I) report states that "Insurer's profit going forward will become increasingly dependent on investment earnings as underwriting performance steadily deteriorates". Right now very few companies have seen growth in their investments due to the global recession. However, due to the short term nature of the crisis, not too much attention should be paid to this.
The company has over the years also delivered both consistent and growing dividends that from a dividend growth perspective should see the company being valued higher than it is. Looking forward, the Kimunya Finance Bill of 2007 in reference to the Insurance industry dictates that share capital for general insurance companies should rise from KSh 100 million to Ksh 450 million. This will kick out a lot of Jubilee's competition and make the company more profitable.
The implication is that the bourse through a lack of focus on fundamentals has undervalued Jubilee Insurance and over valued a number of others. Consequently this means that you either stay out or get in with a focus on the fundamentals geared towards long term investing.
Further Details on Blog about Parliamentary control of the Central Bank
Posted by Samora
in Monday, November 30, 2009
If you wish to read further on this matter. The following link gives further details from Ben Bernanke, governor of the U.S Federal Reserve Bank.
Another article by Robert J. Samuelson gives further analysis as to why Central Bank should be free from Parliament.
Enjoy the read.
Innovate or Perish
Posted by Samora
in Wednesday, November 25, 2009
Walking round the Nairobi Central Business District (C.B.D) the other day, I was bemused by just how so many businesses are similar. One is bombarded by cyber cafes, mobile phone shops and clothes retailers. To me it is very amusing that within one bazaar, from out of 12 shops, 7 of them sell mobile phones while the other 5 sell clothes. It is representative of the insatiable entrepreneurial spirit that Kenyans possess as well as maybe a lack of innovation and imagination within society. It could be that low levels of tertiary education and rigid rules concerning small enterprises in Kenya warrant this over indulgence in the aforementioned businesses. They could be thought of as the trinity of businesses amongst I would dare say people who lack a specific personal skill acquired through tertiary education.
Is the situation any different amongst workers who have attained a university degree or beyond? Probably not, most young Kenyan workers educated both home and abroad mostly engage in similar enterprise. A marketing consulting firm, an accounting firm, a corporate communications firm or a media firm are the usual suspects. The breadth of business ideas is very narrow. This is not to say that the businesses mentioned are not profitable. Among the Top 100 Small and Medium Enterprises (SME's), rated by Business Daily and KPMG 12 of them operate within the fields I have just mentioned. Therefore when run well, they can be very profitable enterprises. In the short run, they can be an investor's best dream as they generate good cash flows and have a high Return on Assets (ROA); this is a measure of the profit gained per shilling of assets. Since the value of the asset is the denominator, it is a measure of how well you use your assets to generate income.
The question then is why is this of any significance to someone who is concerned about our economy? My response is based on an analysis of a perfectly competitive industry.
Perfect competition occurs when there are many buyers and sellers of the same product, selling a homogenous (similar product), within a system that has perfect or near perfect information (where buyers and sellers know everything about each other's prices and output) all leading to a situation where firms make zero economic profits adjusted for risk. An example can be given of the wheat industry in our imaginary province Ungaland. In Ungaland, there is an abundance of land where wheat can be grown. In the province, the population has split itself into two groups; wheat growers and wheat buyers. If one farmer were to start growing wheat and everyone else was buying from him, he would make supernormal profits since he determines his output and therefore price. When other Ungaland citizens take cognisance of this, they will all rush to become farmers so as to also make economic profits. This will happen up to the point where they are no longer making profits as they increased supply will see them sell at a point where the price of the bushel of wheat sold at the market is equal to the cost incurred by the farmer to produce that bushel of wheat.
Here the distinction of economic profits is made because in economics, one has to take into consideration of the opportunity cost. This is the cost of the best alternative activity foregone due to undertaking the farming. The farmer could have become a fisherman or maybe would have put the funds he used to start the farm into an interest bearing account. The benefits that would have accrued from these activities are the opportunity cost. Accounting profit on the other hand just reflects explicit (stated) costs and benefits. From this, the implication is that after adjusting for opportunity costs, the farmers are not being compensated for their foregone opportunities.
If one now applies this to the situation with both "skilled" and "unskilled" workers and I call them that with extreme caution since some of the "unskilled" workers are very skilled at a particular vocation, one observes that the markets for their goods and services are either saturated (especially in the case of the former business trinity) or are going to be saturated in the near future (the case of the firms). They sell a similar product, to many buyers and sellers who are well informed about the demand and supply situations of these firms.
Why then is this an issue if the resulting condition is good for the consumer who will benefit from low prices and bad for the seller who will have to make do with zero profits? It is obviously a good thing for the consumer as he will have cheap stuff. He/she will be able to buy cheap clothes, get a cheap phone, access cheap internet and even have someone do his books for him at a low price. The concern in this article is not for the consumer, it is for the firm and the economy at large.
Low profits will add little value to the economy as in the long run, firms will have no incentives to hire new workers and expand their activities. They will pay less in taxes and therefore add little revenue to the taxpayer. There will then be little income for the government to achieve infrastructure expansion and carry out their mandate.
Furthermore, for me it reflects a failure of our educational system. The clear lack of a stimulating and empowering educational system has two effects. A narrow skill base from which more diverse business ideas can emerge and a monkey see monkey do business climate. The country's business environment needs clear innovation or otherwise many of the existing businesses will have to make do with penny pinching from meagre earnings adding no enterprise value to the economy. Imagine one wanted to buy the businesses; the small earnings will lead to low valuations from potential investors as future earnings are limited. Most business valuations are contingent upon valuing future cash flows so as to get a present value of the business. The businessmen in the businesses and firms therefore lose in their investments from both an earnings perspective as well as an asset growth perspective.
We need more innovation through I suggest better education so that we can have a robust business climate within the country.
New Draft Undermining the Role of Powerful Civil Servants
Posted by Samora
in Thursday, November 19, 2009
Vs
It has been about two weeks since the last article on inflation measurement in Kenya. Since then I have arrived in the land that inspires the blog and gotten more views on the matter. The content of the article is clearly vindicated by the general consensus from Bankers on their unwillingness to reduce their interest rates. It was expected that with lower inflation figures, there would have been downward pressure on bank lending rates as their real interest rates fall.
One positive development since has been that the draft constitution was released to the public on the 17th of November. It has been welcomed with arms wide open and is seen in most circles as a panacea to the woes that have engulfed our beloved country. I will vote affirmatively for it when the referendum comes around as the benefits that it will bring greatly outweigh its shortfalls.
However, after reading through chapter 15 that talks about public finance. Matters ranging from the office of the Budget Controller and the Central Bank if passed as they are will pose both a great threat to the fundamental market system that the country has embraced as well as being a fiscal drain to the budget.
There are some issues that I will raise amongst many others that can be raised. The first is that Parliament is given a great degree of power when it comes to oversight of our institutions as well as the appointment of both the Governor of the Central Bank and the Controller of Budget. It seems a good "democratic" choice to give parliament most of the powers that Treasury and the Central Bank currently enjoy. The rationale is that with parliament, most of these decisions pertaining to Monetary Policy, Budget control and key decisions pertaining to the regulation and oversight of our financial institutions are better handled by the legislative arm that represent the opinions of the populace. It has escaped the makers of the draft that the general populace does not have an informed opinion on a lot of these issues, especially monetary policy and the regulation and oversight of financial institutions.
In the case of monetary policy which parliament will control through the power they wield on appointing members of the Central Bank's board of directors, we are very likely to see very predictable cycles of monetary stimulation. The draft states in Chapter 15, Article 269, part 3, that the authority of the Central Bank of Kenya vests in a board, consisting of a chairperson, the Governor, the deputy governor and not more than four other members who will be appointed by the government and approved by the National Assembly. Clearly then the members of the board are responsible to the National Assembly. With this situation in place, parliamentarians are very clearly going to dictate matters such as the levels of money supply and the setting of tools such as the repo rate and the bank reserve ratios. Political influence over these matters is extremely dangerous. The debate over the autonomy of the Central Bank has been an important one over the years and has even been devoted a whole chapter in many macroeconomic text books. My opinion on this matter is that the boards of Central Banks will be judged on their effect on the economy whereas politicians are looking towards their next election. From an incentives point of view, then it makes sense to give full discretion and independence to the board of the Reserve bank as they are more likely to make dispassionate choices regarding the main mandate of the Reserve bank and that is to control inflation.
The case of legislative incentives clouding law maker’s judgement can be given. During the sub-prime mortgage boom in the United States of America, a great number of Americans signed up for sub-prime loans. Sub-prime mortgages are loans that are given to people who do not deserve them from a financial point of view. People without employment and with poor credit scores got the mortgages and they clearly lacked the ability to pay them back. House ownership in the States soared and everyone was happy. Senators and congressmen were happy to turn a blind eye to the sub-prime issue because if there voters were happy, the law makers were likely to get voted in during the next elections. Their incentive system disregarded a key economic issue that brought down the world’s economy. Afterwards, they are the ones who tore down Wall Street for their excesses and their insatiable risk appetites. The point to be taken is that a politician’s incentive mechanism will lead to him or her to disregard matters of key economic and financial importance that require unpopular and dispassionate choices because they are incongruent to their political ambitions.
Peering further on this issue, there will be double pressure to disregard inflation and make economic growth the key issue for the Central Bank. Nowhere in the draft does it mandate the Central Bank to actively control inflation. In the current Central Bank Act, it clearly states that "The principal object of the bank shall be to formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices". In the current draft, the Central Bank is mandated to control amongst others the value of the currency of the republic, issue notes and coins, act as a banker and financial adviser of the government and conduct monetary policy aimed at achieving growth. The focus here then shifts from controlling inflation to stimulating growth.
The Central Bank as well as the National Assembly will thus have a focus on growth instead of having a system of balances where the Central Bank focuses on inflation and the National Assembly focuses on growth. Growth with unbridled inflation is merely cosmetic as in the long run, real growth will be stagnant. This debate is rife in South Africa where some sections of the African National Congress (ANC) contend against the Reserve Banks stance on inflation targeting. The results are clear as South Africa has managed to steer away from a meltdown of their financial system and has avoided the disastrous unemployment that their peers in the middle income countries category have suffered.
One final issue is the congruence of some of the key posts that will be affected by the Draft Constitution. These posts are the posts of the Controller of Budget, the head of the Economic and Social Council as well as the governor of the Central Bank. The latter two already exist. Both the Governor of the Central Bank and the Controller of Budget will be appointed by the president subject to the approval of the National Assembly, the former will only have a six year term without renewal whereas the latter will have a five year term with the option of renewal for only one extra term. In terms of the Economic and Social Council, the draft hasn't made any clear guides concerning their tenure, but it has stated that they will follow the same appointment as the Governor and the COB, the only difference is that they will also have to be approved by Cabinet. My issue with the above is that these people will have to work together on many key issues that will require quick decision making in tough times.
They will have to develop a bond and working relationship that will enable this. The incongruence of their working terms is likely to be a hindrance to their proper working relationships. An example can be given of Trevor Manuel and Tito Mboweni in South Africa and Robert Rubin and Allan Greenspan who worked in the U.S.A. Both teams had discretion and avoided political pressures as well as having similar or near similar working terms in regards to tenure, the same luxury cannot be afforded to the likely holders of the aforementioned posts in Kenya.
In the future, we are very likely to see disjointed policy formulation and rigid decision making if the National Assembly is given so much power. As much as former post holders misused their posts especially as governors of the Central Bank, it is a post that will have to be free from political interference. The makers of the draft should go back to address some of these issues now with consultation from the banking industry and other experts. Maybe the draft was written at the wrong time. When the world is suffering from a deep recession and when the country is reeling from the post-election crisis. We cannot afford to slowly turn socialist in the name of trying to be fair to everyone. As the saying goes "too many cooks spoil the broth” and the National Assembly is the perfect example in our analysis.
Further Details
Posted by Samora
in Wednesday, November 4, 2009
Despite it's merits the government has decided that the best way to combat inflation is to change the way we calculate it. Read on the link below...
For opinion and analysis read:
Abbracadabra Inflation
Posted by Samora
in Monday, November 2, 2009
"Inflation is taxation without legislation"
Milton Friedman
This statement is one of the most profound statements ever made by an economist. At its core it speaks of inflation for what it is, a tax on the residents of a country. Furthermore, it is a tax that in many cases is instituted by government action or inaction. Inflation as is defined in any introductory economics text is the continuous increase in price levels.
Recently the National Bureau of statistics in conjunction with the IMF declared that they will revise their inflation measurement tools. This is because they figured that inflation in Kenya as it is calculated, is currently overstated by a factor of two. This means that the current inflation rate of 18.7 percent actually should be approximately 9.5%. The move as they state, will lead to the country attracting investors who are currently put off by the highest inflation figures in the region. Investors will be buoyed by the fact that their workers will not have to negotiate higher annual increments due to the "overestimated" inflation on which they peg their wage negotiations.
So how exactly is inflation measured?. Inflation in Kenya is predominantly calculated through the Consumer Price Index (CPI). The CPI is like a big basket of goods and the aim is to measure the increase in the cost of the basket given fixed quantities of different goods. Added to this, the goods and services in that basket are given weights which could be thought of as measures of importance. The weights reflect how prominent that good or service is in the consumption habits of the population. In the case of Kenya, food is given a weighing of 50.5% of the overall basket (CPI), meaning that on average according to NBS estimates, Kenyans spend approximately 50.5% of their income on food. Alcohol and Tobacco has a weight of 1.7% and Clothing and Footwear has a weight of 8.8%
The main issue with the new move is that for me it seems to be cosmetic and misleading. The key issues for me is that the NBS want to reduce the weighting of food from 50.5% to 40.3% as well as add new items such as mobile phone airtime and internet costs. If this happens, in the next couple of quarters Kenyans should be seeing lower inflation figures. The key thing is that nobody should be fooled that inflation has reduced, all that has happened is a bit of mathematical magic. Reducing the weighting of food under the auspices that people do not spend as much on food as they used to is both misguided and unfair.
The average resident of Nairobi is even likely to spend all of his/her money on food given that primary education has become free. Most casual labourers earn around Ksh250 per day. With flour going for around Ksh80, a packet of milk and bread both selling for 35 each. The total food bill comes to Ksh 150 which is already 60% of his daily income. The new 40.3% weight is more likely to be felt for middle income earners in Nairobi but not for the bulk of casual workers who furnish Kenyan industry with their labour. Added to this, it is a bit misguided to add mobile phone airtime and internet costs to the basket. It is noted that consumers do purchase these items and they therefore warrant inclusion. However, in their state, they are likely to understate the inflation rate. Take airtime for instance, it is very unlikely that Safaricom faced with higher costs will sell Ksh100 airtime for 105 shillings Ksh100 airtime will remain that way forever. They are more likely to increase the charges on their tariffs. So with this in mind, isn't it wiser for the NBS to include a measure of mobile phone tariff charges rather than the cost of airtime?. Furthermore, internet costs in the long-run are more likely to go down than up. It is the very nature of technological products that due to innovation and obsolescence prices in the industry tend to drop.
All these factors summed will obviously reduce the inflation rate that we see on newspapers and hear about in the media, but they will not reduce the inflation that we feel or encounter in our daily lives. Think of it this way, imagine a typical marathon (42Kms). Due to some grumbling from the competitors about the length of the race, the marathon organisers decide to change their metrics. Instead of measuring a meter as 100 centimeters, they ordain that from now on a meter will be 200 centimeters. The effect will be to reduce the length of the marathon to 21kms. Participants will rush in to sign up due to the fact that the race is shorter, but will soon realise that they signed up for a daunting and long marathon. Investors and the general population will be mislead and will make wrong decisions in terms of their investment, saving and consumption patterns due to the new inflation rate.
This really reflects the general decay in the Kenyan policy environment and is reflected in the inefficiency of Central Bank Policy in its activities such as fighting inflation and stimulating demand through interest rates. One can check the following link for a deeper discussion about the inefficiency of the CBK and policy makers in general.
Summing up, simply watch out for the new figures and take them with a mouthful rather than a pinch of salt.
The Retailer and his advisors
Posted by Samora
in Sunday, October 18, 2009
I would again like to begin by thanking all the people who have had a look at this blog since its inception about a month ago. I have received nothing but positive comments as well as constructive criticism and I would just like to thank everyone. It has been a great confidence boost to have people who have not the slightest interest in economics and finance, come up to me and tell me that they like the blog and are finally beginning to understand some of the hazy concepts found in economics. One of my aims with this blog was to make such matters understandable. This week's article is about the retail investor and how he should approach investment advice. I hope to give a rational account of the human condition and investing as learned from Ben Graham and others like Warren Buffett and Seth Klarman. I do not claim to be a successful investor, all I am doing is spreading the word from these great men and applying it in a localised manner.
During the mini-boom of the Nairobi Stock Exchange (NSE) of circa 2003-2007, share trading and speculation reached an all time high. The NSE was spoken of at dinner tables, bars, restaurants and even was used as bait for some men trying to attract members of the opposite sex. Stories went around of how people had bought homes, acquired new cars and paid for their children's school fees through their "wise investing" in the stock market. People who stayed away or were suspicious about the gains made in the stock market were ridiculed. I remember my Economics teacher in St. Mary's Mrs. Mwangi in 2006 telling me that the stock market did not reflect fundamentals and it was doomed to drop at some point. Her fellow colleagues at school thought she had gone mad. In the newspapers and on TV, we witnessed mammoth lines of individual investors queuing outside the major stock broker's offices to partake in new IPO's as well as to buy shares that are already trading. It was boom time for the NSE and many other regional exchanges. In fact Zambia's LUSE Index sustained an annualised growth rate of 53% over that same period. This is a remarkable figure for any stock exchange. What drove this growth was an increase in individual/retail investors in Kenya. Many encouraged by the new government and a general feel-good vibe around the country decided that it is time to invest.
With the IPO's some even borrowed so as to speculate and many made some gains. Especially during the Kenya-Re, Eveready and Kengen IPO's. However come 2009, many of those retail investors are questioning their participation. The NSE index has dropped from it's dizzying heights of 5234 in 2007 to 3005.41 as of September 09. I remember at it's height the chairman of the NSE proudly proclaiming that it would hit 8,000 in a year's time. It has shed approximately 40% of its value since. Many of the retailer's as they will be called in this article lost copious amounts of money and some of those who borrowed especially for the Safaricom IPO are in negative equity with their banks. Negative equity occurs when the loan repayment exceeds the value of the asset. An example can be found in the USA. With falling house prices, most people's mortgage repayments exceed the value of their houses. Borrowing to speculate is like a game of Russian Roulette, you risk something that you know and are sure of (your life/ liability) for something that you don't know and are unsure of (an empty chamber/stock price movement). The key then is for future investors and how they should approach financial advice. I will give three sources of financial advice and will analyse each in detail.
The first source of financial advice during the boom, especially for those who were "savvy" and understood some basic accounting elements, were the investment banks and technical analysts. Armed with their deep understanding of technical ratio's and mathematical nuances, many of these analysts had devised techniques of telling where future profit opportunities lay. With acronyms such as EBITDA and PE ratios, they advised the smarter retailers about their stock picks. However one folly lay in that many of these ratio's don't offer any information about the real value of the companies that were being traded. It is vital to remember that a share is a piece of a company and not just a symbol that goes up and down computer and TV screens. A lot of these accounting ratio's are very much a construct of the company that is reporting them and are thus open to legal manipulation. A company can be earning a lot of money but not generating any cash therefore the apparent prospects will be good but the company is struggling. As Warren Buffett says... "Some of these analysts can be compared to a man with a hammer, to him everything looks like a nail". The fact that they have the mathematical and intellectual aptitude to analyse things, they tend to come up with analysis that are mathematically sound but irrelevant. Furthermore, as Ben Graham wisely said "nearly everyone interested in common stocks wants to be told by someone else what the market is going to do, the demand being there, it must be supplied". These analysts are thus providing something that the market is demanding.
It should not be taken then, that these analysts are ridiculous. They are a very important element of the financial architecture, but one should make sure that they are being told relevant details not just a raft of mathematical proofs. The Long-Term Capital Management fiasco is one such example of how brilliant minds can make dumb choices by over relying on sound mathematical analyses. http://www.sjsu.edu/faculty/watkins/ltcm.htm
The second group is the stock brokers. Economics teaches us to study incentives. If one analyses the stock brokerage industry, one soon realises that stock brokers make their money out of commissions charged on trading. For them, then the focus is on volume rather than quality. With this being the case, one can quickly see how one should avoid stock brokerage advice and just use them for what they are, people who let you buy and sell. If you approach a stock broker, he/she will in most cases tell you to buy and sell a certain stock. Added to this will be tips or nudges that the stock in question will do well soon. Rarely will one tell you that you should just sit on the fence and hold your money. Reason being? they make their money out of volume rather than quality. Many of the retailers lost a lot of money by listening to some of the stock broker's tips. Stock brokers then are akin to pharmacists, whenever you go to the local pharmacy with a minor problem, rarely will you be told to just go home and rest. Sometimes, they will even sell you sugar pills because like stock brokers they make their money out of volume rather than quality. Clearly then one should avoid investment advice from a stock broker.
The last source of advice is family or friends. I think this was the biggest motivator for most retailers to enter the stock market. Stories at home, at work and at social gatherings about which hot stock to pick or which one to sell were the order of the day. One's affection for family members and friends as well as the human condition of not wanting to be left out made many follow this advice. However if your family members are not skilled investors and have not had a solid track record of success with their investments then stay away from this advice. The thing is that as human beings we are blessed with the extraordinary gift of story telling, through the years; customs, practices, beliefs and ideologies have been passed from one generation to another through story telling. Oration is then an important part of society. However, stories have no place in financial advice.
Let us take the story of commercial aviation. When Commercial aviation was setting off in the late 50's and early 60's the stories were that the industry would change the way we live and would offer an almost infinite contribution to our GDP's as well as making perpetual profits. However, nobody had analysed the business structure and realised that in the long term the industry would be weakened by increased government regulation, would face perennial uncertainty over fuel prices and even face the risk of terrorism. As I write the aviation industry is yet to turn in a profit cumulatively. Usually the sound information is too abstract for retailers to understand and thus they would rather hear stories. Maybe we should tell stories that are analogous to what the abstract relevant data is telling us. Most of the tips about the stocks to pick are based on almost spiritual beliefs and laced with human over confidence and are in their definition doomed to fail for an investor.
It seems so far that I have discredited three main sources of financial advice. There are many others such as your local bank, accountants and independent financial planners. The conclusion is not that we should all just ignore financial advice, a lot of it is useful. The conclusion is that we should be aware of the pitfalls inherent in financial advice. One should know what his aims are and should come up with the fundamental principles that will guide his investments. The conclusion then is that you should let the advisor know your stance about investments and through the ensuing mutual respect, the two of you are likely to make sound financial decisions that are specific to your characteristics and expectations. He/ she should know that you are not easily manipulated and are a focused investor. He is not likely to mislead you if you make your stance clear from the get go.
Dismantling the NSSF: Key to unlocking capital
Posted by Samora
in Saturday, October 10, 2009
I would first of all like to congratulate President Obama on his Nobel Peace Prize, the merits are debatable, but it is a good thing for World Peace that one of it's main drivers gets the award.
It has been a week since my last article on agricultural reform. In that week I have been thinking of what to include in my newest article. It was a tough choice amongst a raft of ideas and even recommendations from some friends and even some lecturers. However, I have stuck on the issue of the National Social Security Fund and it's effects on savings and inevitably capital accumulation in Kenya. My friends and family know that I am a big proponent of dismantling the NSSF in it's entirety and moving the pension system from a publicly funded PAYGO system to a private account system. I hope to give a short discourse on the importance of such a move through its contribution to GDP growth.
The subject of pensions is an important one in any civilisation. Mechanisms need to be in place where employees and workers in general can save some money to avoid old age poverty. Old age poverty is a really regrettable situation in that old people are not as productive as their younger colleagues. Furthermore, after 30 or so years of work, one needs to kick back to enjoy the last years of his/her life without the rigours that have been a constant in their last thirty years of work. Therefore it's a no brainer that pensions and savings are mandatory in any country.
I remember speaking to a friend of mine about the NSSF and its pension system. He told me about his father whom upon retiring went to claim his benefits from the NSSF. To his utter bemusement, he was handed a cheque of 700 shillings ($10) after they processed his case. It took 2 months to process the payment. So, after years of working and two months of processing his payment, he only had 700 shillings to show for it. I remember laughing because after cheque processing fees at the bank, he would only be left with half that amount. Maybe my laughing was tempered by the fact that over the course of his life, he had invested wisely and was even on the board of one of the big corporations whose shares are listed on the NSE. However, if he had just worked and hoped that his pensions would take care of him at the twilight of his life, then it would have been a very sad case. Here, I would like to introduce the concept of replacement ratios. The replacement ratio is the percentage of working income that is received during retirement. Let us posit that he was receiving 500,000 shillings per year (a conservative estimate) during his last few years at work, then this pension would leave him with a replacement ratio of around 0.14%. At this point I would urge you to keep this figure in mind as it may be needed for comparative purposes later on.
Clearly then, the NSSF has failed in its mandate. Further issues arise when we peer further into the system. Its contribution rates are similar to those of the National Hospital Insurance Fund and are pegged to incomes that have yet to be revised since 1988. Therefore, the highest income bracket starts from 15,000 shillings. Clearly the intellectuals at NSSF have failed to keep up with inflation in adjusting its income brackets. The annualised rate of inflation from 1961-2007 as calculated using data from the National Bureau of Statistics is approximately 10% per annum. This means that if you want to maintain your income levels over the years, your employer should be giving you a 10% pay rise each year. However, back to the subject of the NSSF, the administrative inefficiencies that have been apparent over the years eventually leading to the organisation being taken into receivership is a big drag for capital mobility in the country.Furthermore, the minister of Finance Mr Uhuru Kenyatta in his proposed Finance Bill 2010 intends to limit the investments by the NSSF to government bonds and treasury bills. This has been met with opposition from the current head of the NSSF Mr. Kazongo who is the Managing Trustee.
However no amount of reform in the NSSF would improve its efficiency. It is a bureaucratic organisation run by the government "intellectuals". As Milton Friedman would say "Erratic free markets often make better choices than government intellectuals". NSSF has in its portfolio assets worth approximately 90 billion shillings, of which approximately 1/3 is invested in the illiquid real estate market. On top of this, the real estate issue with the NSSF has been a big source of corruption as well connected individuals have benefited from buying the NSSF properties and making clean profits off of them. It is a malignant form of inefficiency that has caused many retirees headaches and eaten into tax payer funds. So what to be done?.
With this in mind, I recommend that Kenya as well as many other African countries take up the Chilean pension reform model instituted in 1981. Chile under General Pinochet who was advised by the Chicago Boys, a group of prominent Chilean economists who had studied under the great economists at University of Chicago, decided that moving from a publicly funded defined benefit program to a privately funded defined contribution program was the best choice to reform its capital markets and improve liquidity which had been a major issue with Latin American economies. Under the reform, new employees had to join the new program and current employees were given the option of remaining in the public system or moving to the private system. It is no wonder that majority of them chose to move to the private program. The public system had proven to be a fiscal drain on the government budget and provided a deadweight loss on the economy. Private administration proved to be much more efficient than the public system.
It is estimated that after the shift, most pension funds averaged a real return of 10% per year. The real return is that adjusted for inflation, in Economics we have to do this to distinguish from nominal/ apparent growth and real growth. What this means for a pensioner is that if you had invested 10000 shillings with them in your first year of work, then after 20 years your 10000 shillings would have grown to 67275 shillings. If we recalculate the above after factoring in the monthly contributions of 1000 shillings, then your money would have grown to about 759,368 shillings after 20 years. Furthermore, economists from the IMF have shown that a change of 100 basis points (1% to the layman) in your real return sustained over your working life would have increased your average pension by 25%. This means that our previously calculated pension would have grown to 949210 shillings if the real return changed to 11%. The statistics are really phenomenal, what's more, stock market capitalisation in Chile grew from 28.4% of GDP in 1988 to about 124.4% of GDP in 2004. Back to the earlier mentioned case of replacement ratios, in the early 90's workers who had worked consistently over their lives enjoyed replacement ratios of 100% meaning that they got their full net annual income at retirement. Compare this with our paltry 0.14% that was handed to our unfortunate pensioner and it speaks volumes. Another issue that could be particularly significant for Kenya is that banks faced with the prospects of increased deposits will have to raise their saving rates to attract the extra cash. This would reduce the interest rate spreads which currently hover at around 13% and increase their supply of loanable funds.
We can really get stuck into the statistics but the picture is clear. Chile's Economy through the pension reform has seen increased capital mobility, better financial systems and sensible savings rates which in turn have lead to Economic growth. The same can be accomplished in Kenya, However for this to be accomplished, Economists from BBVA economic research have shown that policy makers have to ensure that there are strong political and market institutions, sufficient protection of property rights and an adequate and flexible regulatory mechanism for financial markets.
The possibilities for wealth creation and growth would be limitless under such a regime. However factors such as our political climate, erratic and unpredictable labour markets, high levels of informal employment and a lack of strong property protection laws will prove to be a substantial stumbling block to such reform. Too often government intellectuals (a term that readers and followers of this blog will have to get used to) think that they have the best interests of the civilians at heart. However Martin Fieldstein from Harvard University once posited that the industries that are thought to be luxuries and thus left to the market have benefited the poor of those Nations better than the essentials that the governments have kept to themselves. An immaculate example in Kenya is the spread of mobile telephony that has seen more people access the service compared to essentials such as electricity and water. It is clear that erratic markets make better choices than government intellectuals. Pension reform should therefore be seen as a luxury and hopefully the benefits would slowly begin to materialise to hard working Kenyan workers.
Reaffirmation
Posted by Samora
in Monday, October 5, 2009
It seems that the people at the KNBS have affirmed my earlier assertion that agriculture should be given more prominence than IT.
Follow the link below
Agricultural Reform: The Blind Visionaries
Posted by Samora
in Wednesday, September 30, 2009
When one looks at the vision 2030 strategy papers and feels the current sentiment of the policy makers and implementers in Kenya, one realises that there is a strong focus on ICT investments and a dream to make Kenya a high-tech Nation that will be well placed to be a trend-setter in the ICT industry in Africa. This in turn, they hope, will lead to improvements in internet banking, internet shopping, Business Process Outsourcing and other IT related benefits. The scene set is very appealing especially to a young Kenyan like myself, when I think of the myriad of ways I can make money due to the impending IT boom. However, upon closer inspection I have realised that we can't be more misinformed about the focus of our vision 2030. They say that you must learn to crawl before you can walk, the vision 2030 program with its focus on the IT sector wants Kenya to run a marathon and we are not yet even born.
The models and poster boys of sustained economic development are the East Asian Tiger economies. Their platform for growth as they obtained independence and transformed into capitalist societies was focused on labour intensive industries. China through Deng Xiaoping reformed the agricultural industry by removing the state controls that were recently set by Chairman Mao. These reforms under Mao, especially the Great Leap Forward led to droughts and mass starvation. Under the reforms, Deng Xiaoping introduced capitalist incentives as farmers were allowed to sell their produce privately and keep the profits, of course after giving the government its share. This led to companies like Nestle moving into the country to buy milk from the farmers. Most farmers bought extra cows and of course saw their incomes rise.
The same platform was achieved in other countries like Malaysia, Thailand and Singapore. From a strong agricultural base through good government support, these countries were able to raise their average incomes for the greater population. From this, the increased incomes lead to demand for manufactured goods which then lead to the growth of the manufacturing industries in these countries. A chain reaction then occurred as rising incomes lead to the diversification of their economies. China these days produces cars, laptops and other high-tech equipment. Hong Kong used to produce plastic toys, tyres and other basic goods in the 70's, but now they produce high-tech medical equipment and other sophisticated goods. On another note the advertising bill for companies in China is second only to that of the USA, reflecting both a diversification of the economy and an increase in incomes.
Conversely, India decided to take the route of improving technological infrastructure without greatly investing in Agriculture. This has lead to a stagnation of the economy and is evident from the statistics, India has one of the largest gini coefficients at 36.8%, the gini coefficient is a measure of income inequality. Furthermore, the richest 10% of the country earn 31% of GDP while the poorest 10% earn a paltry 3.6%. With the booming IT sector, it is a sad fact that only 1% of the population is working in this sector. The GDP per capita stands at $2,300 and is lower than that of Djibouti and Swaziland. Furthermore, India has one of the toughest regulatory mechanisms in the world. These ubiquitous controls have earned the nickname of "license raj". The situation is eerily similar to that one in Kenya and its why I have decided to write this. If an economy is to prosper, the majority of the population should be earning respectable incomes, it is usually a standard that the poorest should be earning at least 2$ a day.
These facts lead me to my beloved country and its fascination with running the marathon while we are still embryos. Kenya's agricultural sector contributes towards 80% of the employment in the country, it contributes to about 27% of GDP and yet it only receives 5% of the budget allocation. Furthemore of this 5% a great deal about 68% is used as recurrent expenditure, these are mostly administrative expenditures. Proper estimates by the ministry of agriculture put recurrent expenditure at 17 billion shillings and development expenditure at 8 billion shillings. This under allocation to agriculture is akin to a businessman underpaying his best salesman while he overpays his worst salesman. If he continues in this way, it is more likely that the good salesman will become disillusioned and probably not work as hard as he can because there is no incentive to do so.
The government needs to support the agricultural sector and commit itself to this aim. The infrastructure system in terms of irrigation, roads, water, sanitation and even aviation need to be thoroughly upgraded. Most farmers in Kenya find it very expensive and inefficient to transport their produce to the market, this often leads to waste and a loss of money on the farmers side. It is evident from the weekly commodity prices that transport is a big impediment for farmers. The theory of arbitrage suggests that when there is good information and mobility of factors, prices for a similar product within an economy will level out and be the same. What this means is that if District A is selling fish at 50 shillings per kilo and District B is selling at 70, profiteering merchants will buy from district A and sell to district B, the resulting supply and demand situations will lead to a leveling of prices at say 60 shillings per kilo. From the weekly price list, a 90kg bag of maize in Bungoma sells for 1,600 shillings while the same bag sells for 2,700 shillings in Busia. Clearly merchants would rather not buy from Bungoma and sell to Busia because the transport costs will wipe out all their potential gains.
The tax system also needs to be addressed so as to benefit farmers, the 2009 Economic Review of Agriculture and the medium term strategy paper for Agriculture both produced by the ministry of Agriculture define the multiplicity and complexity of the tax system as major impediments to agricultural productivity within the country. Farmers are faced with expensive fertilisers, farm inputs and fuel expenses therefore making it very expensive to farm. These factors have led to many of them sub dividing their farms and selling them to property developers. Government should in form of either tax cuts or direct subsidies make it extremely cheap for these farmers to benefit from their farms. . The case of Malawi, which has become a net exporter of food is a good example of what a country can achieve if it subsidises its farmers. Andrew Daudi from the Malawian ministry of agriculture says that it is a long term trend in sub-saharan Africa that urban dwellers are prioritised over rural dwellers, he goes on to say that we need to reverse this trend if we are to achieve growth.
There are many other issues including land reform, scientific research and others that can improve the agricultural sector. However, the main aim of this article is to stress its importance as the bedrock for economic growth in Kenya, it is a lesson that is to be learnt throughout the world. Peter Hartman the director general of the International Institute of Tropical Agriculture in Nigeria neatly says that the "continent's intellectuals thought that agriculture was just a phase that they could skip on their way to industrialisation" referring to the poor state of agriculture in the continent. The continent's intellectuals as it turned out were and are not so smart after all. The "intellectuals" in Kenya responsible for the vision 2030 are also in my view extremely misinformed.
In conclusion, the only way that we can achieve sustainable growth and prosperity both as a continent and as a Nation is to greatly invest in Agriculture as it is where the majority of people work. This in my view will lead to a substantial economic chain reaction akin to an economic atomic bomb, a benevolent one at that. If we continue to invest in the ICT sector and disregard agriculture, we will be in a situation analogous to that one of a teenager who after being told to clean his room, decides to sweep everything under the bed. When the mother comes in to inspect the place it will look nice and clean, however upon closer inspection, the room will still be the rotten mess that it was. Let us take the East Asian Tiger model rather than the Indian Elephant model. Please leave your comments and opinions on this matter.
Your "Dream Home" Myth or Reality
Posted by Samora
in Saturday, September 26, 2009
As a hopeful future home owner, the subject of Real Estate is one that is close to my heart. Owning a home is a dream that almost everyone harbours and is not a reserve for teenage girls. As it is a matter that is of significance to me, I am worried about the current prospects for home ownership in Kenya. A look around property websites and magazines will reveal that a typical first-time buy in an area like South B, South C and Langata or even a first time apartment in Kileleshwa, Kilimani or Parklands will put you back around 10 million shillings. This is a round figure and is not reached at by any statistical analysis. The question is that is this affordable?
This can be answered in two ways, if one was to pay straight upfront cash then ofcourse it wouldn't be affordable to first time buyers. In this case then, is it affordable through a mortgage? My own analysis confirms that even through a mortgage this is still too much to pay. Why? you may ask. Given an interest rate of 15% on a 20 year mortgage, then your monthly payments would have to be Ksh 131,700. As most banks and mortgage lenders usually prescribe that you pay a third of your salary, then this would mean that you should be earning a net salary of Ksh395,100 before tax. If one includes taxes which in Kenya would mean a base tax of 6,761 plus 30% of 395,100 which is the marginal rate. This information was obtained from the latest Kenya Revenue Authority (KRA) PAYE guide. This would add up to a total tax bill of Ksh125,291. When we add these sums up, it would mean that you need to earn a gross salary of Ksh 520,391 to afford such a house. The worst part is that after you have finished paying for your house 20 years down the line, you will have paid Ksh 21,602,949 in interest alone.Clearly this leaves a lot to be desired as starting salaries are far from 520,391 for the vast majority of urban citizens. The 2009 Economic survey carried out by the ministry of planning puts the urban average income to be about Ksh23,000. This makes for gloomy reading for many of us who would want to buy a house.
These factors are made worse, when one realises that the average age of Kenyans according to the CIA world factbook is 18.1 years. This means that the core mass of potential homeowners is yet to reach a home buying age. Therefore, 10 - 14 years down the line, there will be a huge surge in home demand as this critical mass seeks shelter adding to the upward movement of house prices. This housing problem is evident in the statistics, from the 2009 FinAccess Review carried out by FSD Kenya, only 17.1% of the urban population live in their own houses. Furthermore, a third of homeowners acquired their homes through inheritance. Therefore Kenyans are not a home buying people.
So why then are houses so expensive? and why is it so hard to afford one. I have hypothesised in the past in casual conversations that a weak transport infrastructure is a big part of why houses are expensive. Most housing areas in Nairobi lie within a 6 km radius of the city center. These include areas such as South B, Eastleigh, Langata, Runda, Ridgeways, Muthaiga, Westlands, Kilimani, Kileleshwa and others. This proximity to the city center and other areas such as industrial area are a major factor in the high prices. If one was to take the same radius in a city like London, then Piccadily, Kensington Gardens, Fulham and Grosvenor Park would be their equivalents. These are traditionally very expensive neighbourhoods in London. If there was a good transport infrastructure, then people can easily commute to the city center from areas such as Kitengela, Athi River, Ngong and Ong'ata Rongai in 20 mins. My university Campus is approximately 20 kilometres away from the city center in Johannesburg and it only takes 25 minutes to get to the city center. A good transport infrastructure would lead to developers building decent housing communities targeted to high income families in areas such as Kitengela and Mlolongo. I for one wouldn't mind buying a house in such an area if I was guaranteed easy transport to the city center and some security. However, the government seems to be taking positive steps towards this by their recent heavy investment in infrastructure.
Another issue could be the fact that Kenya has very weak anti-money laundering legislation if any at all. A look at the latest key economic indicators published by the National Bureau of statistics puts the aggregate value of the council building approvals for residential houses in 2008 to be 18,749 million shillings, if one compares this with the amount of credit advanced towards building societies in the same year approximately 681 million shillings by half year, you would notice a big discrepancy. Of course this is a very bold claim as credit was advanced to non-building societies for residential purposes. However, the point to be made is that there is a significant cash aspect in both the construction and acquisition of homes in Kenya. Stricter money legislation in the country would maybe leave a significant amount of these buyers and developers at bay. As Warren Buffett says "you only find out who's been swimming naked when the tide goes out".
This is an important issue as with any economy, resources should be directed to their most efficient use, if people are spending too much on housing, then areas such as education, research, and even domestic tourism are not invested in therefore reducing the value added to the economy. I am sure there are a number of other factors that affect house prices in the capital. Please share with me your opinions and give me feedback on any of the issues raised here.
The OTC market in Kenya
Posted by Samora
in Thursday, September 24, 2009
The Over The Counter (OTC) market is a greatly untapped market in Kenya. As it currently is in Nairobi, the market is veiled in secrecy and thus a great majority of the potential participants are unaware of it. OTC markets are exchanges in which small and medium sized companies can trade their shares. Examples all over the world include the MESDAQ in Malaysia, AltX in Johannesburg, NASDAQ in the USA and the AIMS in UK. The most appealing in this case are the pinksheets which are found in the USA one can check them out at http://www.pinksheets.com/pink/index.jsp. However, the AltX in Johannesburg would be a good template (http://www.altx.co.za/) due to its proximity.
A study commissioned by the Capital Markets Authority (CMA) and carried out by Vas Consultants found that 63% of individual investors and 67% of potential OTC companies were aware of the presence of the OTC market. However, these stats have their shortcomings as the studied sample size was not large enough to warrant any inferences. It should be noted that a good number of both individual investors and potential OTC markets are unaware of this presence. So why should they be aware? and why should they even care?
One of the biggest benefits to small and medium sized companies is that they can raise cheap capital. Currently, the interest rate environment in Kenya makes it very costly to raise capital. The latest CBK monthly bulletin puts commercial bank lending rates at around 14.7%. Furthermore, their informal means of raising capital are usually tested in such economic conditions. The fundamental thing about business is the cost of capital and cheaper capital would be welcome news for everyone involved. The capital raised can be used for expansion and investment. Hopefully this will also lead to banks lowering their rates as they try to compete for capital. This would lead to a robust monetary climate that would benefit the Kenyan business community.
However, personally the greatest benefit would be to investors. I have always been of the belief that the best companies in Kenya are unlisted and can be considered to be medium/small companies. For investors the ability to buy into these companies would offer enormous chances for wealth creation. My time working in Industrial area albeit for a very short time exposed me to the real face of Kenyan business through seeing companies like Double White, Lino Stationers, Kenya Grange Vehicle Industries and others. These very profitable companies would be the potential OTC participants. Furthermore, the same study by VAS consultants found that a formal OTC market would offer an exit route for investors who no longer want to have part ownership of the company. As it is, the informal market makes it hard for investors to sell of and move on. Finally, the formal market would lead to increased quality and responsibility in financial reporting that would offer a sense of safety for investors.
As this blog is mainly concerned with chances for capital accumulation, I strongly recommend that the CMA expedite their creation of the formal OTC market so that potential investors can participate and own part of Kenya. Please leave your comments and suggestions on this issue.
Feeds
get latest updates on news and subscribes to our feeds
Member of
Member of
