Everything was hunky dory for borrowers until something ruined the party, I explain…

The last twelve months have been characterized by very bold attempts by the Government of Kenya to rein in on high interest rates that have made credit unreachable for many Kenyans. Perhaps the hallmark of which was the debut, and successful, Eurobond in June 2014 that saw the government raise US$ 2.0 Billion (US$ 500 million through the 5-year and US$ 1.5 billion through the 10-year) from the international market. The point was to enable the government to access cheaper credit from international investors thereby lowering its borrowing from the domestic market which typically would help reduce interest rates due to reduced demand from the government

Interest rates are essentially the price of credit. Decreased demand typically reduces the price of a commodity.

Further to this, the Central Bank introduced the Kenya Bank’s Reference Rate (KBRR) the spirit of which was more psychological ─ KBRR would provide a more transparent loan pricing benchmark that would, in essence, enhance borrowers’ capacity for comparing loan rates across various commercial banks and, hopefully, prompt them to opt for the more cost-effective bank. Between June 2014 and end of March 2015, the average commercial bank lending rate declined from a high of 16.9% to 15.5% and all seemed to be falling into plan. I am yet to see any official data on the change in mortgage rates in the same period; my hunch, however, is that they too experienced a downtrend.

When the rains started pounding us…

The outlook for the second half of 2015 is, however, less rosy with interest rates, and indeed mortgage rates, likely to resume an uptrend. Twice now, the Central Bank of Kenya (CBK) has raised its benchmark rate (first from 8.5% to 10.0% and then from 10.0% to 11.5%) which means it is bound to be more costly for commercial banks to borrow money from CBK with this higher cost likely to be transmitted to we end borrowers. At the same time, KBRR was hiked from 8.54% to 9.87%, a clear indication, perhaps, that lending rates are likely to head north in the not so distant future. It feels like, after so much progress, this development has just kicked the can farther down the road and borrowers need to brace for some belt tightening going forward. CBK is raising its benchmark rate in response to rising inflation which has edged up to 7.0% as of June 2015.

Anecdotal evidence suggests banks are already adjusting their loan pricing to the new rates set by CBK. Barclays Bank is reported to revise its rates upwards effective August 2015.

What should we expect?

Looking at the way the shilling has been behaving, inflation is most likely to be heading further up, closer to the CBK upper limit of 7.5%. The shilling has been weakening against the dollar, crossing the psychological 100.0 units of exchange on Monday 6th of July, 2015. What is important to realize is that we haven’t seen the shilling it such lows in about four years with the last episode being in 2011. A weakened shilling feeds into higher inflation since imports become a lot more expensive and importers typically pass the higher cost to end consumers. So depending on how high inflation surges in the next six months, I am of the view that we haven’t yet seen the last of rate hikes from the CBK as far as 2015 is concerned. Between March 2011 and December 2011, inflation surged from 9.2% to 18.9%. In that same period, CBK raised its benchmark rate from 5.8% to 18.0% (Bloomberg Data). There’s really no telling how high CBK will raise its rate this time. What is certain, however, is that the party for mortgage takers, and borrowers at large, has just been ruined.

What this means for Construction

A weak shilling makes the importation process an expensive affair. Like in 2011, it is more likely that the prices of paint and steel will be revised upwards if the Shilling loses value. Paint manufacturers, for instance, import approximately 70% of the raw materials that go into the production of paint. Consequently, these companies might be compelled to adjust prices upwards in order to cushion themselves from reduced profits. Higher prices of paints, therefore, will translate into higher cost of construction. The same applies to other components that are imported for inclusion in various real estate projects, for example, kitchens and sanitaryware. Over time, developers tend to slow down on their ongoing projects or hold back on projects that have not yet started.