Showing posts with label Economics. Show all posts
Showing posts with label Economics. Show all posts

Let Engineers Engineer

Posted by Samora in Wednesday, February 15, 2012

I have been awaken from my deep blogging slumber by an extraordinary statement. In my course of regular reading, I came across the Report by the Parliamentary Select Committee investigating the collapse of the Kenyan Shilling. The basis for their eventual tirade on the banking community as well as the Central Bank Governor is summarised in the following statement;

The Committee received a range of the causes of the fall of the Kenyan Shilling which the committee divides into economic, human and institutional failures. The economic causes such as the wide current account deficit, Euro crisis, large import bill of non-essential commodities, the Arab Spring, are still in place even after the shilling recovered its value in Decemeber 2011. The Committee therefore zeroed on institutional and human failures.

This statement is quite shocking. Let me explain. The currency fell to a low of KShs 107.00 to the dollar in mid October 2011. The key driver was simple, investors stopped believing in the fundamentals that underlie the Kenyan Shilling and quickly began to bet against it. I might confess that I suggested to my former boss that we should bet against the shilling. Nonetheless, these opinions on the shilling were not just based on current fundamentals but also, by forward looking fundamentals. Consider for instance an investor who wants to build a bread factory, his analysis will not only include current demand patterns, but primarily, his analysis will include forward looking demand patterns.

A good investor is one who knows where money is to be made, not where it is being made. 

My point is simple, in December, forward looking projections for the current account balance changed significantly. Banks and investors alike foresaw less dollar demand due to higher interest rates. Therefore, their demand for currency begun to favour the Kenyan shilling. Basing the whole report on that statement is simply garbage in garbage out.

Indeed, the report has some good recommendations including boosting the export base, improving CBK communication with the banks and boosting the CBK's regulatory tools. Nonetheless, the report comes about as more of a witch hunt than an investigative report.

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Capital Gains Tax

Posted by Samora in Sunday, June 19, 2011

Just a thought! In the recently read budget (2011/12), an interesting point came out. Hon. Uhuru Kenyatta mentioned that property dealers were from now on to be paying capital gains tax. The proviso was that if it is stated in the company's articles of association and memoranda that the company actively seeks to buy and sell land and other property for profit, then this profit which is a capital gain would be taxed as regular business income. 

To my lay readers, capital gains is simply an increase in the value of an asset. For example, if you buy a house for Kshs. 1 million and sell it at Kshs 2 million, then you have made a capital gain of KShs. 1 million. In other countries, this gain is usually taxed at a given rate say 30%, so you'd have to give the taxman Kshs 300,000.

Now at first sight, it seemed like a sensible thing to do. If you tax capital gains to real estate companies, it could both reduce real estate speculation, as well as increase government revenue. My issue is, where does it stop? The treasury has just released a can of worms. 

Arguably, capital gains are made by people who are in the business of making capital gains. It doesn't just fall upon some lucky guy walking down the street. Making capital gains is something that businessmen plan for and take advantage of. Therefore, as much as it may make sense to tax real estate companies on their capital gains, the buck, if the treasury is being fair, shouldn't stop there. Asset managers, insurance companies, private equity firms should all be taxed on their capital gains. If the treasury's reasoning on taxing real estate capital gains is to be implemented fairly, then it can be argued that the aforementioned parties are all in the business of making capital gains and as such, their capital gains should be taxed as regular business income. Food for thought for those at the treasury.


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Women Rates...

Posted by Samora in Thursday, June 16, 2011

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After a long hiatus, I thought it prudent to blog once more. It is becoming a rarity these days and for that I apologise to the wonderful people that read this blog. Many of whom are expecting me to blog about the budget, but surely what has not been said? I can't really give any special insights. 

Nonetheless, I only have two issues; Analysts, international agencies and the government are usually first to trumpet Kenya's prudent macro-economic management. In all honesty, our macro-economic plans and commitments are first class and for that, we should pat ourselves on the back. However, the real work lies in our micro-economic management i.e. at the ground level. Until we sort out our public procurement systems, staff our implementation bodies and take other steps that will ensure that we can convert plans, proposals and designs into tangible objects, then no fancy budget will fix our woes.

Secondly, it is worth pointing out that from an operational level, our recurrent expenditure is fully funded from our income sources i.e taxes, levies and earnings from parastatals. We are thus only borrowing to fund our development expenditures. This is a positive development and should be followed up by an improvement in our public pensions systems to ensure that we are not funding pensions from the consolidated fund ala the Portugal Ireland/italy Greece Spain. 

Speaking of borrowing, the only insight I have to share concerns the cost of borrowing/capital i.e. interest rates. Now, a number of people really don't understand what interest rates are. Even brilliant economists can explain them perfectly in economic and financial jargon, however they do not have a tangible grasp on what interest rates are. To explain them, I decided to put them into perspective, using issues that are removed from the financial markets and with the little or no financial jargon. 

To begin with, interest rates are to finance what gravity is to the physical world. Gravity gives objects their weight, whereas interest rates give assets their worth. Whether, it's land, shares, bonds, options, houses and any other productive asset you can think of. Interest rates are what primarily determine their value. The reason this is so stems from the fact that you can invest in an a risk-free asset (T-Bond, as long as its not Greek) and earn a return. This return is the interest you receive from that Bond or Bill. Given that you are earning a risk free rate, then this rate will now determine what you would expect to earn given some risk.

For example, if you earn 12% from a T-bond over say 10 years. Then to take any extra risk, you will require to earn above 12%. In practice, lets say that you want to put up flats to earn rental income. You have Kshs 10 million as capital, if you earn anything less than Kshs 1.2 million per annum as rent, then that is not a good investment given that you can earn the same 12% by investing in a bond. In an efficient market, investors will stay away from the property market and put their hard earned cash into the bonds. This movement away from property will drive property prices down and as such, their worth will have been determined by the 12% interest offered by bonds. 

To explain this phenomena, imagine a world where the only assets in the world are wives. Their worth is determined by only one factor, their beauty. Now, forget about beauty being in the eyes of the beholder and just think of beauty as something standardised. The return an "investor" earns from getting a wife will primarily be determined by how beautiful the woman is. Investors will then try as hard as possible, through charm and wit to get the most beautiful woman alive. 

However, it won't be that straight forward. A few issues will emerge in the investors mind; how beautiful is the average girl? and importantly how many women are there per investor? If the average girl is very beautiful, and almost as beautiful as the most beautiful woman. Then the investor will infer that firstly, there are very many beautiful women in this land and secondly, he won't break his back to get the most beautiful woman. The latter stems from the fact that he will be getting a girl just as beautiful without much effort. In terms of how many women there are, this factor will determine the investor's willingness to either settle for a homely wife or strive for a very beautiful one. If the ratio of investors to women is 3:1 i.e. there are 3 investors for every woman, then investors will be more likely to settle for homely wives. (NB, just so you know, homely is a nice term for ugly). If the ratio is the other way around, then investors are likely to be more picky and will only settle for very beautiful women.

If you can understand this, then you can begin to understand monetary policy, interest rates and their effect on investments. As much as this analogy is dramatically over-simplified, to me it presents a clear way of thinking about things. If the monetary authorities increase the money supply, like the Fed did with their quantitative easing policy, then there is more money in the system (more investors), thus interest rates fall  (investors are more willing to accept homely girls, remember the aforementioned ratios). Given that interest rates have fallen, the demand for alternative assets rises as investors seek higher returns. Prices for commodities, shares, real estate and other assets will rise reflecting more investor demand. In our analogy, our investors become more and more charming and seek all means possible to get beautiful wives. 

Again in our analogy, the average girl ends up determining how hard these investors will work to get a beautiful woman. The average girl being the risk-free rate, you can get her without trying. Now before you invest, always consider how beautiful the average girl is. If she is very beautiful then don't bother getting the most beautiful girl. Secondly, consider how many other 'investors' there are. If there are a number of them, then you should consider upping your game, if not don't bother. Primarily though, don't risk ignoring the average girl to get the more elusive beautiful one if you are not charming enough. If you can follow these principles, then you stand a chance of being a more successful 'investor'.

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Benefiting from the weak shilling

Posted by Samora in Thursday, May 19, 2011

In the last two posts I've talked about the balance of payments and their adverse effects on the Kenyan economy going forward if nothing is done to correct the dwindling trade balances. Note that import cover currently stands at approximately 44% i.e. the proceeds we get from selling goods and services to foreigners can only buy 44% of our imports. This is not an ideal situation, in fact it leads to heavy indebtedness.
Weakening by the hour.

Anyone who's been following the forex markets of late, with particular attention to Kenya, has been dismayed by its depreciation against all major currencies. With the dollar, the shilling has depreciated to Kshs 87.15/ dollar from Kshs 80/dollar at the start of the year. With the pound, the shilling was trading at Kshs 126/sterling pound in January, and now it has hit the 140 mark. In terms of the euro, the shilling has depreciated from Kshs 107/euro to a low of Kshs 123/euro. In percentage terms, the shilling has weakened by 8%, 12% and 14% to the dollar, pound and euro, respectively.

Some blame speculators, for hoarding on to foreign currency, thereby weakening the demand for the shilling. Others, put the blame squarely on the Central Bank's shoulders, as in the recent weeks, the CBK has been a buyer of foreign currency. 

The reason that they have been buying foreign currency is due to their falling forex reserves. By law, the CBK is meant to maintain 4 months of import cover, i.e. forex reserves equal to the value of 4 months of imports. This is roughly Kshs 3.9 billion, as per their estimates. Hence, the CBK at any one time will have to have the equivalent of 3.9 billion shillings in a basket of foreign currency held in reserve. If you go back to the first paragraph, you will read that Kenya's import cover is 44%. 

To make sense of all this data, the key points are simple. The balance of payments going forward will force the central bank to buy more and more foreign currency thereby weakening the shilling. A lack of sound agricultural policy will force Kenya to buy more and more maize, rice and wheat from foreigners weakening our currency. Kenya, faced with a declining export cover, will have to take on more debt from foreigners e.g. the IMF, The World Bank and Chinese lenders so as to finance our imports. The latter may initially represent itself as capital flow and thus demand for the shilling, but the debt payments that will come with it will represent demand for foreign currency, further weakening the shilling. (Notice, I haven't at all touched on the issue of fuel).

In short, my outlook on the Kenyan shilling is rather bearish. Unlike, South Africa, Zambia, Nigeria and other SSA countries, our economy is not based on commodities, therefore our currency is based on Kenya being competitive in terms of our industrial and agricultural output. I don't see these two variables improving. 

What to do? If you are worried about the shilling, like I am. Then the only thing to do is to bet against it, by putting your money in financial assets denominated in foreign currencies. For example, you could buy shares or bonds denominated in the South African Rand, or even in U.S treasury securities (although, the dollar is having its own problems, given that the US has maxed out its credit card). All in all, have a portion of your wealth stored in foreign currency, rather than expose yourself to the weakening Kenyan shilling. Unless, there is a drastic change in agricultural policy, or by mere luck, the rains become more consistent and predictable, then there is little hope for the shilling. 

Nonetheless, anything can happen with regards to currency movements, thereby making a mockery of my predictions. However, if the currency follows the economic fundamentals, then I am lead to believe that it will be a long shot to have a strong currency.

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Capital Account

Posted by Samora in Monday, May 16, 2011

In the last post, I suggested that running a current account deficit is unhealthy. Now, this is not necessarily a bad situation as some would say "the capital that is flowing into the country, will offset any negatives that arise from having a current account deficit". This means that when you sell less than you buy, the money that you borrow to finance this gap can be beneficial. In short, there a lot of intellectually dishonest economists (read IMF and the World Bank) who encourage African countries to run current account deficits and capital account surpluses. 
Picture: Courtesy of The New York Times

In fact, a recently "overquoted' study by the World Bank entitled "Kenya at the Tipping Point" states that "The Overall Balance of Payments position has been positive in 2010 and the outlook remains positive" (Whatever that means) it further goes on to state that the capital account remains healthy. Economists usually use such vague terms such as "positive, healthy, medium term and outlook" when they are making false claims, or worse still, claims that they don't have any faith in. Imagine if your long-term boyfriend/girlfriend told you that their "outlook on your relationship remains positive". I'm sure you'd be puzzled.

Now that I have vented, let me get to the gist of this post. The gist is that in a country such as ours, we can only prosper in the long run if we alter our Balance of Payments and export more than we can import. Further to this, we should export more goods than we do services.

To start with, having a positive capital account is not a healthy situation to be in, especially in Kenya. A study conducted in 2007 by Rajan, Prasad and Subramanian reached the following conclusion about the effect of foreign capital in underdeveloped nations;

"Indeed an underdeveloped financial system is more likely to channel foreign capital, not to potentially-highly productive but hard to finance investments in the tradeable manufacturing sector, but to easily collateralised non-tradeable investments like real estate". They further state that "The financial underdevelopment and underdevelopment more generally, could exacerbate foreign capital's contribution to a rise in costs in the non-traded sector and the possibility of over-valuation". 

These findings are clear to any Kenyan on the street, but are extremely vague to a number of foreign economists living in Kenya. Foreign capital does not find its way into productive segments such as road and rail transport, large scale agriculture and manufacturing. It will find its way into real estate and other easy to exit investments, primarily due to a poor property rights system. Consider that our capital flows are primarily aid and loans to the government, not foreign direct investments. Therefore, these loans and aid flows usually find their way into NGO offices or some lucky government bureaucrats. The NGO people will buy their foreign workers expensive houses or rent the houses at exorbitant rents; the government official will buy a plot!. The money, will not find its way into productive areas. The NGO people will write reports upon reports but will never offer anything towards tangible improvements in our welfare. 

If you consider that only 14% of our road network, spanning approximately 64,000 kms is paved and that not a single rail has been added onto our railway system for close to a century, then it is clear that foreign capital is not doing its job. Further, consider a report by Mars group that found that almost 1/4 of our annual budget, heavily funded  through capital flows, is unaccounted for; then any honest economist or thinker, cannot suggest that foreign capital is doing its work. 

Some will talk about remittances, however, it is almost arguable that remittances are overstated due to a simple fact. As much as people living in the diaspora send money back home, people in Kenya also send money to the diaspora, primarily in the form of school fees and some pocket cash. The CBK statistics show remittances as they are, but do not consider Kenyans sending money to the diaspora to pay for fees and up-keep. If you net these two figures, then the value of remittances would fall dramatically.

Therefore, it is clear that in our case; foreign capital does more harm than it does good. What this means for Kenya is that we should direct our efforts towards enabling a current account surplus. Primarily, this will entail providing for food security and investing huge sums towards agriculture. If one considers that the agricultural sector employs close to 75% of all Kenyans, then it is the only logical thing to do. With a strong agricultural base, then agribusiness and manufacturing will then follow suit enabling an improvement in our current account. Further to this, improved food output will reduce the shocks that have become a norm in modern times enabling steady growth in the economy. In 2008, food inflation in S.Africa, a country with a significant agricultural base was only 1.4%, in Kenya it was well into double figures.

Our policy wonks should steer away from IT and finance as drivers for Kenyan growth. These two form part of the "services" account. IT, finance and Business Process Outsourcing (B.P.O) have what economists call a low multiplier effect. Only skilled employees will benefit from the growth of these sectors and thus income inequality will grow. If you look at the income distributions of India and the U.S.A, they are extremely skewed due to thriving, I.T and financial sectors. The sectors that employ the bulk of the population are not catered for (read manufacturing).

For Vision2030 to bear fruit, approximately 75% of our efforts should be steered toward agriculture. Once we have food, then other things can take care of themselves and the "Perfect Storm" that I alluded to, will be better mitigated. Lastly, improved agricultural production will lead to current account surpluses, and a better balance of payments position.

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Is Safaricom toast?

Posted by Samora in Monday, January 24, 2011

In the little town of "Denial" there was a company called "Denial Meat Company". This company sold the greatest and best priced steaks in town and had generated an almost religious following amongst the townspeople of Denial. They topped off the steaks with sumptuous servings of Ugali and Kachumbari albeit in small portions. The company was so loved and adored that the people of Denial all bought into the company by means of a public offer. The offer was organised by the brilliant manager of DMC Mr. Hope. A year into their purchase of DMC shares, the townspeople of Denial were given a welcome surprise. The little company next door that offered roast meat was bought by a group of foreign investors who were in the roast meat business. Dismayed by the success of DMC, the foreign investors vowed to tear apart DMC's dominance. They did this by drastically reducing the price of roast meat. The prices were so low, that on warm Denial afternoons, the little children of Denial could be spotted carrying bucketfuls of roast meat purchased with their menial savings. It was an oddity for all the Denial men.


Shocked by the growing influence of this once oblivious roast meat company, the shareholders of DMC organised a meeting with Mr. Hope in the town hall. The key agenda being the next door roast meat company. One shareholder stood up and shouted "Mr. Hope, how will we react to this travesty, all the people of Denial are rushing to the other company to buy roast meat". Mr. Hope stood up, and with unrelenting confidence, he said "not to worry esteemed shareholders, we have a plan" he went on "we will simply increase our servings of Kachumbari and Ugali so as to create value for our customers". Dismayed, the shareholders stared back at Mr. Hope. "You mean we can maintain profitability by increasing our investment in Kachumbari and Ugali preparation?". "Yes" Mr. Hope replied gleefully, "we will simply diversify our product offering to cater for all you Kachumbari lovers". Some shareholders were utterly annoyed by this statement, they headed for the exits of the town hall, each having sold his/her share. They could not imagine the once famous Denial Meat Company now offering Kachumbari and Ugali as it's main product. Some shareholders saw the wisdom of Mr. Hope and continued holding the shares, hoping that one day, DMC would be just as profitable if not more by offering Kachumbari and Ugali.


The above story may sound a tad bit familiar, although the moral of the story is given in the heading of the article.

Bharti Airtel last year introduced what can only be referred to as oligopolistic suicide in the telecomms sector with its entry. The telephony industry works in an oligopolistic structure, what this means is that there are few firms in the industry selling a similar product. Furthermore, the industry has extremely high barriers to entry for any prospective firm. One has to install the physical infrastructure and the organisational infrastructure necessary to run a telecoms company. Given this structure, the only way for firms to gain or increase market share is to lower their prices. If they don't take this route, then the only other way is to collude via a cartel or price fixing. OPEC is the best example of such collusion. However, given that most countries have very strong anti-collusion legislation this avenue is usually shut off. Thus price remains the only weapon in the oligopolists arsenal. However, this weapon is often a double edged sword. Reducing prices may increase the number of your customers, but it will ultimately lead to lower profit margins.

Something must be in place to ensure that you maintain healthy profits.

Surely the abnormal profit margins of close to 60% enjoyed by Safaricom are not those expected of an oligopolist given the preceding discourse on market structures. Well, Safaricom has had an extra weapon that its competitors have lacked. A system that doesn't allow for number portability and M-Pesa. Will these two Knights save Safaricom from the beast from the east. The answer is a simple no. The CCK will from March allow for number portability within the industry, this will enable you to have a 0722 number even though you are an Airtel subscriber. This then means that all those people who didn't want to change to Airtel because they had to change their numbers, will have no reason not to switch to Airtel. The second issue of M-Pesa then seems to be the only Knight in shining armour for Safaricom doesn't it? Well, this could be a fleeting assumption. Tangaza a local company advertised in the newspapers that they have just introduced a service that allows for Money Transfer across all networks, this means that a Safaricom subscriber can send money to an Airtel subscriber. The success of this new initiative is still in the dock, but if successful, then M-Pesa will have no claim to Knighthood for Safaricom.

The future is bleak for Safaricom shareholders, the entrenchment of price wars in an Oligopolistic market structure, the impending introduction of number portability and the introduction of a "universal" money transfer system "tangaza" has shifted the ground for Safaricom. Investment banks heavily dependent on the success of the Safaricom share, will suggest that venturing into Data and internet will provide a cushion against the fall in voice revenue. However, they are like Mr. Hope of Denial. Suggesting that a once great Meat company can generate as much if not more profit by offering Kachumbari and Ugali in stead of meat. This are of course my views, however facts are facts.

A great number of untouchable companies in this industry have fallen at one swoop, AT&T and AOL being prime examples. In a dynamic industry such as the telecommunications industry, dominance and success are far from being granted. Currently, the people shouting at the roof tops as to the greatness and unbridled dominance of Safaricom are like a girl who's just had her heart broken. She goes through the letters, pictures and gifts that her former lover gave her and clings onto the hope that he will come back. Even though her ex is now married with three healthy children to her best friend.

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