Kejetia versus Legon economics
Today, I have decided to drop all pretences of elitism to delve into basic economic principles which I find gradually coming into play with signs of lowering inflation, fairly stable exchange rates, diminishing prospects for windfall profits and how these affect economic agents, especially the ordinary man in the street.
It is easier to understand these indicators and the way they are trending painstakingly towards stabilization if one drops one’s political lenses and focused on basic economic principles.
That inflation is on a downward trend is no fluke. The difficulty for some people is that prices of goods and services are still high. But that is not how inflation is measured in economics. Inflation is not necessarily about higher prices. A proper interpretation of upward inflation is the rate at which such prices rise compared to a stated period in the past, usually the prior year. Thus, on the face of things, prices are still rising but the extent of such rise is lower than what it was a year ago, and this is factual.
The inspiration to write this piece came from two angles. The first is the concept of the current hilarious court room plays titled “Kejetia versus Makola” which defined the title of this piece-such stress relieving video clips! The second is my encounter with my semi-educated brother- in law who came down to Ghana a few weeks ago from Belgium where he has been based for nearly thirty years. Now in his early fifties, he is coming into grips with reality by toning down on his hitherto extravagant lifestyle. He now finds it thrilling to invest in treasury bills whenever he is preparing to return to his base. This mature approach has come from my incessant admonition to put up a house in Kumasi instead of his penchant for smart cars and ostentatious lifestyle.
Our discussions about his disappointment with current lower interest rates on his treasury bill investments have given me the impetus to write this article. Over the last few years, anytime he came down to Ghana, he purchased treasury bills with his Euro savings. Needless to say, he had previously been “impressed” by how much he earned from exchanging his Euros into Cedis and subsequently elated by the high interest rates he obtained from his treasury bill investments.
Then, reality hit him during his last trip to Ghana when he found to his dismay that the Cedi had not depreciated as much as it used to be. In other words, his expectation of receiving higher volumes of Cedis from his Euros was not met, because the Cedi had indeed gained some strength. Then he went to his bank to purchase treasury bills only to find that whereas he used to get over 22% per annum interest rate, now he could get around 12% for the same period.
This realization and the need to explain what had happened to his expectations convinced me that there are many people like him who relish high inflation in view of the associated money illusion. Such people would rather have huge volumes of cash with lower value rather than a lower money supply with higher purchasing power. They are similarly enthused by high interest rates on bank deposits without realizing the associated high costs of borrowing which the banks must necessarily pass on to borrowers, with rippling effects on costs of production in an unending spiral. The government has to step in with anti-inflationary measures through fiscal and monetary discipline.
To assuage my brother-in –law’s disappointment, I simply had to refer him to the relatively low interest rates that he has lived with in Europe over the years (usually less than 3% per annum) and its connection to lower costs of production, lower consumer prices for goods and services which propel economic growth to sustain his employment. These are some of the enabling environmental factors that create employment and a stable outlook for investments. Then he started nodding in agreement when I explained that if the current trends continue, they would lead to increased production of various goods and services and lower inflation, not necessarily that prices per se would be lower (which is possible, though) but that the rate of increases in prices would be lower.
My friend who runs a forex bureau is complaining of lower sales and margins because he has been used to making extraordinary gains when the Cedi was depreciating fast against the other major currencies. Now he finds that it would amount to economic suicide to hoard his foreign exchange or take on too much Cedis with promise of providing foreign exchange for his clients. He sells as quickly as he obtains foreign currency and contends with whatever margins he can make.
Then there was this news item about lower sales of sheep and cattle by vendors at Avenor, Kasoa and other places during the last Muslim celebration. The sellers lamented about lower sales and diminished profit margins after they had brought the animals from Burkina Faso.
It is also noticeable that the over-hyped rents demanded by estate owners/agents for residential and commercial purposes have seen price reductions after apartments and shops have stayed un-occupied for long periods. Talk also to taxi drivers and you will hear cases of sales dropping as commuters begin to re-align their expenditures patterns.
It is clear that the dis-inflationary measures are working, albeit slowly. It is helpful to understand that this trend would continue with new gainers and losers. It is a reflection of an economy that is getting back on its feet after high inflation regime. With lower interest rates and the abolishing of some taxes, other things being equal, entrepreneurs would find it worthwhile to engage in ventures that they previously shied away from because of the earlier high costs and high rates of interest they had to pay. They would bargain well for their goods, knowing that inflation that spurs super profits and arbitraging opportunities cannot be guaranteed. The price wars among beverages (especially soft drinks) and cement producers and distributors are clear examples to note.
Obviously there will be casualties along the way to stable economic growth. The biggest casualties will be some micro finance institutions and even some mainstream banks who used to take in deposits at very high rates. They would soon realise, (if they have not already done so,) that they are carrying a portfolio of high cost deposits which they may not necessarily be able to offload to borrowers at the same higher rates; and they cannot find solace in low yielding treasury instruments either. They will end up sitting with expensive liquidity.
In any free market economy, correction of imbalances in the system naturally causes some casualties. Anybody with a basic knowledge of assets and liability management in banking would appreciate that the hardest hit institutions would be those who carry high cost of deposits which they took at astronomical rates. Their dilemma would be compounded where these deposits were long term or fixed deposits which they may find hard to re-price, but which they cannot also offload at higher rates because competitors are now advertising lower rates.
As the Central bank continues to lower the prime rate, the banks would follow in tandem and in due course even reduce their risk margins. Naturally, borrowers are impatient to see a sharp drop in the rates of borrowing offered by the banks. This cannot however come abruptly as the banks are still grappling with high costs of funds and have not effectively crossed the threshold where non-performing loans ratio would come within acceptable levels, currently averaging 15% against international norms of about 5%.
Competition and a stable macro-economic environment would however ensure that bank interest rates and some charges generally would continue to fall. Increased capitalization would also enhance liquidity which must be carefully managed if return on equity is to be maintained.
Customer loyalties begin to break down when borrowers realize how much they are being fleeced by their existing bankers. Matters would become worse with the Central Bank also advertising comparative interest rates of competing banks. Rational borrowers then have the liberty to move to banks offering competitive rates by borrowing from these lower rate banks to repay existing high rate loans, penalties for early loan repayment notwithstanding. The net effect would be a dwindling asset base, diminishing interest income and ironically, high or fixed costs of routine operations which cannot be neutralized with economies of scale.
In a stable macro-economic environment, expectations play a key role in the direction of future interest rates. There is gradually emerging a noticeable trend where long term interest rates are becoming more rewarding to compensate for uncertainty as against short term rates. Little wonder that investors are taking keen interest in the Monetary Policy Committee deliberations to gauge future trends. Over the last decade and a half, we witnessed a peculiar curve where short term interest rates were higher than long term rates. This had the effect of entrenching short- termism, creating a disincentive for long term investments. With a portfolio of huge short-term deposits across the industry, any astute banker would be wary of lending for long term investments in view of the risk of mis-matching. This had the effect of strangulating infrastructural growth which should otherwise propel further economic growth, especially in the roads and housing sectors.
In view of the apparent correction of the yield curve, there are prospects for long term investments as evidenced even in the comparably lower rates for the bonds that the government floated recently. With a diminishing public-sector appetite for borrowing, hopefully funds at lower rates would be freed to enter the private sector to spur growth. Gradually the mortgage market would be stabilized and middle-income earners would be able to afford mortgage loans with reasonable prospects of paying up in view of stable interest and exchange rates, especially for dollar denominated mortgages.
The published financial results of the banks at the end of the first half of the year (2017) already showed signs that the banks’ windfall profits would suffer by the close of this year. Non-performing loans have been cited as the biggest impediment to bank performance as customers have been reeling under high costs of operations in an inflationary environment, leading to defaults. The government itself has been a prime culprit in this scenario by not settling its debts as they fall due. Already some banks have collapsed, others are wobbling; and yet others are busily strategizing with cost reduction measures manifesting in staff lay- offs and branch rationalisation with little publicity and ingenious explanations, lest they court negative goodwill from customers and other stakeholders.
It is said that the darkest part of the night is the period before dawn. This statement also holds true for an economy that is gradually recovering from stagnation. As the economy progresses, economic agents would realize that it is becoming more and more difficult to obtain super profits from economic ventures. Efficiencies in the operating environment would begin to catch the attention of producers so that they would be able to remain in business.
The government is continually under pressure to meet its debt obligations to the banks, contractors and others. It can only oblige through disciplined fiscal measures, including plugging income leakages (the ports!) and unnecessary expenditures that do not promote productive capacities. More and more actors would hopefully enter the productive arena because it would become relatively easier to assess loans from financial institutions. The banks themselves would begin to chase customers with loans at reasonable rates as borrowers begin to have various choices. The ordinary man in the street would gradually find that the cedi has gained value and he would not spend recklessly.
The writer is a Fellow of the Chartered Institute of Bankers and an adjunct lecturer at the National Banking College, a farmer and also author of “Risk Management in Banking” textbook.
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