Kejetia vrs Legon economics: reality has dawned!

Whenever an economy is strengthening towards stability, there are always gainers and losers. It is fun to speculate over the direction of interest rates and inflation. Sometimes the bold and the beautiful make astronomical gains, but you have to have a heavy risk appetite to play in the game of financial speculation because you cannot win all the time.

Demand and supply works, but only up to a point. The statistical indicators would not continue on the same trajectory forever. Any astute investor must know when the bubble is about to burst and unwind accordingly.

In Akan parlance, we say that “sɛ ehuru sɛn ara a ɛbɛdwo” which literally means that” no matter how hot something becomes it will turn cold at another time.”. The proverb reminds all that no condition is permanent, and the moment when even you realize that the sugar cane is becoming less tasty towards the leaves, something must give- it is time to re-evaluate the sweetness of the sugar cane and the price to be paid subsequently.

Check investors in a pyramid scheme and you would find that early participants tend to gain the most, but one must be sensible to identify the point when one must disinvest to enjoy previous gains. In the strictest sense, a properly organized stock exchange works on similar lines, with some astute investors buying when the market is bearish. Similarly, when the market becomes too bullish, wise investors know when to stop. They feed on the assumption that no matter how dark the night, daylight would appear, but you must have the guts to withstand temporary shocks.

In September 2017, I wrote in this same newspaper …” Today, I have decided to drop all pretence 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”.

I have been forced to re-visit the topic in view of how I consider history repeating itself especially in the real estate sector where the cost of rental accommodation and house prices are generally falling. Speculators cannot win perpetually as long as rational economic thinkers exist.

Last year’s scenario is simply repeating itself to douse speculative tendencies regarding the direction of interest and exchange rates. Gradually, raw speculation is giving way to prudence and conservatism which are core tenets of banking.

Several occurrences in banking and finance in the recent past, have given me the motivation to explain the effects of the current falling inflation rate and the expectation that interest rates should follow sequentially. There is also a visible shift of investor appetite from deposits and treasury bill investments to stock (equity) acquisition which is driving renewed interest on the stock exchange. The government’s borrowing of US$2 billion on the international capital market and the potential effect on exchange rates going forward would be explained.

As usual, I would attempt to use street language (Kejetia economics) to make the majority of readers understand the relationships between the variables and what to expect going forward.

First is the announcement that the government has secured a US$2.billion-dollar bond from the international capital market with the significant characteristic that it attracted the lowest interest rate with a historic 30- year repayment period for half of the borrowing.

According to the Daily Graphic of May 12th 2018,” the bonds were in two categories; $1 billion was raised through a 10-year bond at an interest rate of 7.627 per cent, and again US$1 billion through the maiden 30-year bond raised at an interest of 8.627 per cent. Both were over- subscribed to $5.5 billion which is an indication that the international investors are showing a lot more confidence in the Ghanaian economy and are also responding favourably”.

The paper went on to say that” the government plans to use $750 million to develop infrastructure in the rail, fisheries and aquatic sectors; build roads, silos, rehabilitate warehouses and invest in education”.

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The quotations point to laudable ideas on how to develop the country’s productive capacities and hopefully sustain inflation at a level that would propel further growth in the economy and induce reasonable certainty. What is required is the right governance processes around the disbursement of the funds to promote judicious utilization, so that future generations are not unduly encumbered.

I am not a spokesperson for the government but I dare say to critics who would expectedly comment on the country’s debt stock in relation to GDP, that it is not the absolute figures that matter. It is rather the potential for effective use of these funds to generate incremental wealth that matters most. For instance, according to the MPC report during its 82nd meeting, “the total public debt declined from 69.8 per cent of GDP (GHS. 142.5 billion) at the end of 2017 to 60.0 percent of GDP (GHS.145.0 billion) at the end of February 2018, reflecting a higher GDP base….”

This clearly demonstrates the fact that enhanced economic growth would dilute the proportion of national revenue that would go into subsequent debt servicing, if indeed all the monies go into productive sectors.

In the short term, one would expect that, ceteris paribus, the exchange rate would be stabilized following the increment in our foreign reserve stock, which according to the central bank” stood at USD 8.1 billion (4.4 months of import cover) as at 17th May 2018, providing enough cushion against any potential external vulnerabilities”.

How long this would last would depend, inter alia, on how we manage our apparently unquenchable appetite for frivolous imports, how we deal with corruption regarding over invoicing and under invoicing and how the export sector would be supported to significantly improve future foreign exchange generation.

It is also hoped that the proposed investments in the sectors mentioned would see real implementation to absorb the teeming unemployed youth, including my poor graduate children.

From a finance angle, the other significant factor is the growing confidence in the economy by external partners. This has the potential effect of improving the country’s risk rating which would inure to the benefit of corporate organisations and other institutions who may enter the international financial market for debt and equity, respectively. Perhaps the immediate beneficiaries would be the banks who are under pressure to raise their minimum capital requirement to GHS. 400 million by 31st December 2018. They would also have to contend with new measures on how Basel 11 and 111 implementations would impact their Capital Adequacy Ratios.

The second news item of interest is reported in the Graphic Business edition no. 493 of May 15th-21, 2018 with the caption “Stock Exchange outperforms African peers with 35.3% return”. I am filled with joy and hope to recall how in 2001/2, I made a presentation in South Africa during a conference on Treasury Management and Custodial functions, as the then head of Treasury Back Office and Custody operations in Stanbic Bank Ghana Limited.

My excitement today stems from the unexpected skepticism that greeted my presentation when I reported among others that the Ghana Stock Exchange was at that time, the best performing stock exchange in Africa. My colleagues from other African countries initially refused to admit this until the conference director corroborated my report with additional documents to the rest of the participants. That the Ghana Stock Exchange has repeated the feat in 2018 gives me hope that Ghana would rise again! Believe in Ghana as I do.

The development, though is not far- fetched. Any analyst who understands and sincerely sees what ACTUALLY is happening in this economy and its outlook without political lenses would admit that there is a gradual shift from investment in fixed income instruments like treasury bills and bank deposits into equity instruments, hence the attractiveness of the Ghana Stock Exchange now.

The gradual fall in banks’ base interest rate, following the central bank’s dropping of the reference rate is a welcome development. That inflation is also on a downward trend changes the expectation dynamic. The economy, as it stabilizes, is influencing expectations and by extension, the trends in long term interest rates. I predicted about a year ago that the awkward yield curve we had then would soon be shaven to normality. That is exactly what is trending now; short term interest rates which tended to be higher than long term rates are reversing gradually.

Within that development are lessons for banking and finance practitioners, especially those who failed to cut their losses early in the hope that falling interest rates could not affect them too soon. This is especially the case with some Asset Management companies which are under investigation by the Securities and Exchange Commission.

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Among their charges is that some of them have failed to honour their obligations to their customers. When you over-promise, you must deliver. Their predicament is rooted in the high interest rates that they continued to offer their clients in the face of clear evidence that the high interest rate regime could not be sustained against all the monetary policy and fiscal measures that the central bank and the fiscal authorities have rolled out over the past months.

I was considered “too conservative” when I cautioned a certain medium scale MFI to be wary of depositors who would flock into their office with wholesale funds for placement over the long term at high fixed rates.  Such depositors must have seen the signs on the wall much earlier and would doubtless, look for arbitraging opportunities.

Those who fail to notice this “ominous” sign and embrace high cost deposits would soon find that off-loading the same funds through high interest rates loans would be a mirage. Eventually the mismatch effect would seep through the net interest income lines.

I foresee astute finance managers pulling up their sleeves to re-negotiate their term loans. It would neither be surprising nor difficult to obtain lower rate funding from Bank A to repay Bank B to get some respite over high interest cost in the P & L account of borrowing clients.

Unfortunately, these Asset Management Companies are not the only victims of the falling interest rates. Some banks find themselves in similar straits. The difference is that given the short-term nature of most bank deposits, re-pricing would be relatively easier as the few fixed deposits mature. Banks generally are in a position to quickly mobilize low cost deposits as opposed to Asset Management establishments.

The effect of falling inflation and interest rates would be numerous, depending on who is evaluating the developments on the macro- economic front. Banking commentators find it easy to bash the banks for not responding significantly to the fall in interest rates. The reality is that most banks have adjusted their base rates downwards. What constitutes a significant fall in interest rate is merely relative.

To be fair to the banks, they would love to reduce interest rates as much as possible. The constraint lies principally in their cost components which other commentators do not report on. Among these costs is the non- performing loan ratio of the banks which is still too high by international comparison. Many banks have been bold to write off substantial portions into their P & L over the past few years in the effort to clean up their balance sheets.

The irony is that after the cleaning the balance sheets, banks cannot shut their doors to further loan applicants. But if the banks continue to find themselves in a situation where they pour more loans into a leaking barrel, because the causal factors of the NPLs have not been effectively addressed, then their costs would remain the same or worse. This would inhibit their desire to cut interest rates further.

Banks do not delight in imposing undue hardship on their clients to the extent of weakening their capacity to make loan repayments. Indeed, every bank would relish the time when NPLs would fall into the 5-10% range so that the wheels of credit would be continually oiled for the mutual benefit of clients and themselves.

How soon interest rates would fall and to what degree would be equally determined by how the banks’ costs of operations would respond significantly to the fall in inflation. The nature of banks’ costs of operations, if one detaches the ubiquitous NPLs, are mostly fixed. Examples are personnel and administrative costs, property rentals, judicial costs and delays in the adjudication process, vehicle maintenance and technology cost, loan recovery and taxation. These are not costs that respond easily to spontaneous reductions.

A bumper harvest or some temporary respite in the inflation basket that does not significantly impact the costs listed here, actually impede the banks’ desire to meet customer expectations. It is hoped, though, that however steep bank’s costs of operations are, competition would always lurk in the corner to ensure that excessive charges by way of interest, fees and commissions, would force the banks to listen attentively to their clients.

The writer is a Fellow of the Chattered Institute of Bankers and an adjunct lecturer at he National Banking College, a farmer and the author of “Risk Management in Banking” textbook. Email:  Tel: 0244324181 / 0576436414

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