Confusion or Desperation - or Both

The Business Daily has an interesting story on the proposed increase in taxes on bank charges. The author of the story, Brian Ngugi, is my friend. He is hard working and often seeks my views on topical issues when he believes that my opinion will add value.

On this one, which masquerades as an analytical piece, he makes three core assertions.

1. That “banks have said they will pass on the additional taxes to customers”. This is trivia. This is a tax on the service so banks are merely collecting it on behalf of the Kenya Revenue Authority.

I thought this should be obvious to a guy who is indicated to be reporting on business and economics.

2. That “this new tax will also affect stockbrokers, fund managers and insurances firms that charge fees for their services”. Actually not; it affects the consumers, not service providers. This is a consumption tax. I thought this should be obvious too. Oh, and these other financial service providers are mentioned just as a by-the-way. 

The core story is about bank  charges and interest rate caps, two aspects that are not at all linked to the tax. But hey, this is the favorite of reporters and editorial writers, whose pretense to expertise on the subject,  is manifest in as many contradicting arguments as the number of stories/editorials that have read over the past two years. 

3. That tax amounts to increase in fees and commissions, which will go to boost bank profits. This is nonsense. See No 1 above.

In the same issue of the newspaper, Brian has another piece on the proposed new tax on mobile money transfer (it is actually not on Mpesa alone as the caption in the story erroneously screams). He correctly sees this as a pain to the consumers (see its equivalence to No 1 above). He does not see this as a possible increase in fees for the benefit of mobile network operators.

This begs the question: how can a guy get it wrong and right on the same subject in the same newspaper on the same day? 

This is either confusion or desperation, or both.

Bad Ideas Are Cockroaches!

Thanks to Paul Krugman, Economics Nobel Laureate, I know that bad ideas are like cockroaches: no matter how many times you flush them down the toilet, they just keep coming back.

Just look at this piece of nonsense (below)! It is not the IMF that is on the spotlight; it is our bad polices. This is basically a distraction from the real problem - a fiscal policy gone haywire.

But as I have argued before, it is easy to seek to blame somebody, anybody; so the IMF it is. But any critical thinker will tell you that all our mess was not a creation of the IMF.

Feigned Thought Leadership

"Eyes on the shilling as Sh152 billion IMF cushion ends ". This is how the Business Daily   screamed today (see picture).



To non-suspecting members of the public, this catchy headline represented deep thinking; it gives the impression that the Business Daily leadership is thoughtful of the fact that of the IMF stand-by facility lapses, as it now seems, the Kenya shilling will be vulnerable.

That could well be the case, as some of us have argued so in the past. Even though the Central Bank of Kenya (CBK) seems to argue that it has sufficient foreign exchange reserves to "defend" the local unit, there is limit beyond which inevitability of depreciation will come.

For those of us who engage in policy research and discourse, the Business Daily is yet again engaging in feigned thought leadership - I have called its editorial pages being a platform for intellectual pretence.

Why do I say so? Because in mid August, the same newspaper that now deeply concerned about the possibility of foreign exchange instability in the event  of the IMF facility lapsing had an editorial to the effect that we may well not need that facility! Oh, I forget; somebody must write stuff that - even when making little sense - can sell a newspaper.

That is why for instance, there is an editorial in  its pages today to the effect that  interest rates capping law - a misguided peace of legislation - is working now that banks are making profits ( a nonsensical argument) while a while back the same pages argued that it was a hasty policy no good for the economy.

It is not that they saw any sense; it is because at that point in time, the Nation Media Group's back was against the wall as its television station had been shut by Government. Now that it is on, it is back to the usual business of taking leave of all logic and donning the feigned thought leadership hat! 

   

 

Nudging Economic Normalcy - "The Animal is Innocent" (A Bit Techical)

I have just finished reading David Pilling's interesting new book (2018) titled 'The Growth Delusion - The Wealth and Well-Being of Nations". It is an easy read with a compelling story on how an economy can be seen, at least by policy makers, to be doing well while that is all delusional (my review of the book is forthcoming). 

If we were to talk matters economic and public policy, Pilling's book is a reminder of two other classics, one by Paul Krugman in 1995 (Peddling Prosperity) and the other is by William Easterly in 2001 (The Elusive Quest for Growth).

But if we were to talk of economic policy discourse in Kenya as propagated - and sometimes actually initiated by a pretentious media - then Pilling's book reminds me of  John Ward's 1993 The Animals are Innocent. I am serious! The book is about the Mr Ward's search for the killers of  his daughter who disappeared while on a trip to Masai Mara. The popular stories about the death that Mr Ward discounts in the book shifted from suicide to "she was killed by wild animals".

If you are wondering how this relates to economic policy, you just need to look at headlines such as Kenyans to feel the pinch as Treasury implements IMF's 'painful' reforms.  If you substitute wild animals with the IMF, then you know what am talking about. As a society, we have become experts in looking for somebody to blame for problems of our own authorship.

It all starts with our misplaced sense of optimism that has blinded us from seeing grave undercurrents (hey, don't get me wrong; I too listen to motivational speakers who tell anybody within their headshots to always be positive!).  Recent episodes illustrates this vividly.

The beginning of 2018 has been characterised by an official feel-good sense insofar as the economy is concerned. The extent of such feeling varies, ranging from expectations of modest recovery to a drastic upward swing form the slow growth seen in 2017. If one was to take the Central Bank of Kenya's 2018 output projection of 6.2 percent as the exemplar of optimism of the state of the economy, then one need sot ask oneself: what will it take for the "stellar" growth to be realised?

The answer, I could argue, lies in looking at how far the economy's performance is from its potential - the so-called output gap. Unfortunately, not many analysis - even economists - look for answers from on economic growth or stability from that front. Instead, the preoccupation is on how the economy is "doing better" than the global or continental average - which in itself may look interesting but not very helpful.

There are a few critical things  to appreciate about potential output - which is also referred to as the production capacity of the economy. One is that just like GDP can rise or fall, the deviation of the economy's output from its potential can be bi-directional - it can be positive (meaning actual output is more than full capacity) or negative  (meaning actual capacity I less than what the economy can produce at full capacity).

Either way, an output gap is a pointer that the economy is running inefficiently (either under stretching or over-stretching its resources). While potential output is unobservable, therefore needs to be estimated, there can be tell-tale sign on whether we are on the negative or positive side.

All indications are that we are currently on the negative side, meaning that there is spare capacity of slack in the economy due to weak demand. The fact that core inflation (also called underlying inflation) - which excludes food and fuel, therefore signals demand pressure - is very subdued.

Meanwhile, the headline inflation (overall inflation) has not been consistently low; in instances it has breached the official target and hit double digit levels largely on account of challenges on the real economy (supply side challenges that monetary policy has no tools to directly address).

It is from here that the second critical issue about output gap - the employment gap - enters the equation. Unemployment gap is tightly linked with output and both are central to the conduct of both fiscal and monetary policies.

In order to appreciate this link, one must have an understanding of a situation that economists call the nonaccelerating inflation rate of unemployment (NAIRU). This is the unemployment rate that is consistent with a constant rate of inflation.

In the event that there are deviations of the unemployment rate from the NAIRU,  they point to deviations of the output from its potential. If for argument sake the actual unemployment is equal to the NAIRU, the economy will be producing at its maximum level without straining resources. That will be an economic nirvana - no output gap; no inflation pressure; all good!

Reality Check

But the nirvana in our case can only be imagined, not real. The dipping of real output growth to below 5 percent means that a quick reversal that must confront four factors.

1. Private sector investment needs to be on a positive trajectory. That is not happening; the intuitive sequencing when firms are operating at excess capacity means that there has to be optimal capacity utilisation before demand for new investment becomes a priority.
2. while the dynamics on the investment side represent the supply side of the equation, there has to be a corresponding demand side response. As already noted, demand is muted an inflation - which if low and stable promotes a predictable environment for investment and consumption - is hardly anchored to the target (a recent paper on this subject is my authority here - Hachem K., and Wu J.K., 2017, "Inflation and Social Dynamics", Journal of Money, Credit and Banking, Vol. 48, No. 8, December);  the reality is that inflation expectations could be undertaking econometrician's "random walk". So you can imagine the random walk in the field of sagging consumer confidence (according to a recent survey)!  
3. It is a no-brainer that the public expenditure led growth often runs its course; in our case, the party that has lasted for well over four years has run full cycle. Now its time to pick the tab; such growth having bee a function of a huge fiscal deficit running over an equivalent of 8.0 percent of GDP. Public debt  is now an issue of great concern even to those (IMF - World Bank) who not too long ago argued that "Kenya's risk of external debt remains low, while overall public sector debt dynamics continue to be sustainable" - if you can't take me for my word,  read what they said in December 2016!  Of course, the hot and cold rating agencies do not want to be left out of the loud cry of "fire!" 
4. There is a premature declaration victory on the external sector.  The closure of the current account deficit from double digit levels in GDP equivalent to below 6.0 percent is attributable more to less imports bill than vibrancy of exports. It's hardly surprising that the stand-by arrangement with the IMF remains critical (see here) no matter what a senior advisor loudly muses (see here). We needed the IMF arrangement in March 2018; nothing has changed to make us say we don't need it now. The oil prices are on the rise; add VAT on fuel (what the media is lazily calling the IMF tax while it truly is a lazy response to the need for the necessary fiscal consolidation) and you see how household's disposable incomes are eroded. The downside risks to the global economy have been by the potential dire consequences of the US trade tariffs.

The Delusion

On the back of the foregoing arguments it is easy to see why it is difficult to nudge optimism and think all is well. It is also easy to see why IMF could well be an acronym for "It's My Fault". It is a delusion that we are anywhere close to the nirvana. Unemployment is sky high and wages are low and sticky; we hardly talk of wage inflation in this country. It is a delusion to imagine that reducing fiscal deficit by way of rationalising expenditure is symmetrical to reducing the deficit by way of levying arbitrary taxes. It is a delusion for any proposal -policy or otherwise - to be portrayed as an IMF policy. As things stand, "the animal (in Washington) is innocent".

When Even Reading a Paragraph is Asking Too Much from A Reporter

Recently the Oxford Business Group (OBG) published its inaugural Business Barometer: Kenya CEO Survey 2018 (see report here). I attended the launch event and participated in the deliberations.
Let me quote the first paragraph of the Report:

"While numerous factors have contributed to Kenya's declining GDP expansion rate, one of the main reasons is the slowdown in private sector credit growth as a result of the interest rates cap introduced in 2016. In the inaugural OBG  Business Barometer: Kenya CEO Survey 2018, 89% of the CEOs say than the newly imposed interest rates cap has made it more difficult or much more difficult to access credit".

It is in plain English!

But this is what Wainaina Wambu of The Standard read (or was told to read):

" Kenya's chief executives give rate cap the thumbs up".

And here is his distortion:

"A sizeable majority (89 per cent) of respondents said the decision to cap interest rates at four percentage points above the Central Bank Rate had improved the cost of borrowing, but had made borrowing more difficult"

This cannot be laziness. It is a case of a reporter (may be a newspaper editor) falling in love with a bad idea and not letting any facts come in between him and his love for the bad idea.

What a pity! It is perfectly understandable to be entitled with your own opinion . But to imagine that you are entitled to your own facts is simply crazy!

Business Daily Editorial Pages - a Platform for Intellectual Pretence

I don't want to make any assumptions regarding what music the editors of the Business Daily love to  listen to. That is why I want to take the liberty of making a prescription, just in case the old rock and roll is not their thing but this one piece may be appealing.

There is a group called The Platters whose hit "The Great Pretender" is an apt description of what I often see in the editorial pages of the Business Daily, especially on matters economic policy where the newspaper unashamedly pretends to take a stance based on knowledge, logic and intellect - and not whim.

It the hit, The Platters croon:

"Oh-oh, yes I'm the great pretender
Pretending that I'm doing well
My need is such I pretend too much
I'm lonely but no one can tell"

It its editorial page today, the Business Daily is evidently miffed (and deservedly so) by the Government's crackdown on media. Its core argument is that the heavy hand on the media is not good for investment.

That is all fine until you read the last three sentences where it asserts:

"Ironically, this is just one of the cases where hasty State action has threatened jobs and enterprises.

From interest caps to anti-gaming war, people with no access to power are sleeping hungry. The government must decide whether ruining the private sector is one of its mandates".

What caught my interest in these sentences is the mention of interest [rate] caps as one of the hasty State actions that threatens jobs and enterprise. Really? Is this a Business Daily editorial?

I had to ask myself these questions because the same newspaper, on the same pages has been playing games that are not so funny.

On June 6, 2017, this is what it had to say: "State should not cave in to pressure to undo rates cap law". I found editorial pretensions and argued as much in a blog post then.

So where is the wisdom suddenly coming from? I would like to proffer an answer. There is a hypothesis that ones level of honesty an level of drunkenness have a positive correlation. The same can be said with the Business Daily and honesty and political siege of its sister or cousin.

And that often makes its editorial pages a platform for intellectual pretence. And The Platters' "The Greatest Pretender"  then easily passes for the official mantra for these pages.

It's "OK" Until Minsky Comes Calling!

There is a strange story in today's Business Daily to the effect that "experts back Treasury's plan to pay debt using Eurobond funds". It's strange in two respects. One, it attributes the views to one expert while giving the impression that some kind of polling amongst economists and other experts was the basis of such assertion.

But two, it seems to suggest that economists are now happy with a Ponzi scheme, for that is what it really is. There is something that in our school is called the "Minsky moment" - named after a great economist by the name Hyman Minsky. This is when there a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressures. Are we courting it?

No expert worth his or her name will call for an unqualified Ponzi programme. Kicking the can down the road will catch up with us.

Financial Illiteracy

Some reporter thinks that the Central Bank of Kenya (and by extension all central banks) is in competition with commercial banks in the profit maximization agenda? Seriously?

This is not some mean joke, but a true story as told by The Standard. Talk of financial illiteracy  disguised as business journalism.

Economic Outlook - Tagging Along with Clever People

There are moments when you find yourself having an interesting conversation.  Last week's engagement - Jan Mikkelsen of the IMF (very cautious), Razia Khan of Standard Chartered Bank (very eloquent), and David Luusa of Standard Chartered Bank (never missing a moment to sell) and yours truly (well, not sure what will be the right description) - was superbly moderated by Aly-Khan Satchu.

The Kenya Shilling - Bobby McFerrin Firmly in Control of Analysis

So the 12th August 2017 edition of the East African (a Nation Media Group publication ) is reporting that the Kenya shilling is unshaken by poll jitters. I am not surprised. Actually I argued two days ago that such pseudo analysis will fill the air as business media looks for content that will make it look serious and analytical.

A better perspective would be reached if one was to take a deep dive beyond what the Shilling is trading at today. But don't bet on that happening; you will lose. Bobby McFerrin is firmly in control with his powerful message of "Don't Worry Be Happy". It worries me!

The Policy Choices We Confront - Some Random Macro Thoughts (A BitTechnical)

Now that Kenya has had a presidential election and the winner is being determined by the relevant agency, every pundit and pseudo-pundit (all expressing their prowess or lack thereof on television) is engaged in what econometricians would call  (for lack of a better word) mock out-of-sample predictions.

The very little time I have spend listening to their "sudden" wisdom, I haven't gotten any reason to imagine that any of them has a "model" to guide their prediction. I am therefore safe to assume that the said wisdom doesn't extend to their evaluation of the macroeconomic policy choices linked to either side once a winner is declared. 

That doesn't mean that on the business/economics side there are no quick, if casual, predictions (but those are not on TV, for such stuff doesn't sell at such a time). The easy one, where fake expertise is as always in display, is when people are falling on each other on how the Kenya shilling has been stable even on the verge of the presidential elections. Or that the stock market remains healthy despite low trading volumes.

The other is when an international rating agency is busy telling us the necessary, simultaneously sufficient, for the sovereign rating to be maintained. Reuters reports S&P arguing that Kenya's B+ credit rating and stable outlook won't be affected by its election as long as there is no repeat of the violence similar to the post 2007 vote.  On this I don't have to agonise, for I have my mind clear on how such views are motivated. As I recently argued, these are calculated guesses!

These casual economic observations force me to step back nearly four decades, precisely to 1979, when there was an important occurrence.  Don't get me wrong; I am not talking about the overthrow of the dictator of Uganda, Idi Amin in April 1979. Nor am I talking about Michael Jackson releasing his breakthrough album "Off the Wall" in August 1979.

Instead I am talking about the publication of Paul Krugman's seminal paper titled "A Model of Balance of Payment Crises". Krugman's formalisation of a balance of payment crisis hinges on the coexistence of an expansionary domestic credit policy and a fixed exchange rate regime.

If the central bank's monetary policy is predicated on some measure of money supply (in other words money demand is predetermined) then the only way to sustain an expansionary credit policy is through reducing foreign exchange reserves. But the central bank has a lower limit of reserves that it must hold.

If there is a pre-existing fiscal deficit (in other words the fiscal policy imposing an exogenous constraint), then the monetary authority has to adjust the rate of credit expansion (with, as noted, the effect of lowering the foreign reserves) to balance the budget. If this comes at the breaching of the lower limit of foreign currency reserves, then the foxed exchange rate regime collapses. This is the currency crisis that Krugman likes to joke as having invented (and not the real thing).

How does this relate to Kenya's policy choices at the moment? The lazy and obviously wrong answer is that such theory is at the very least irrelevant. Those with such inclination will no doubt make three arguments:

• One, our foreign exchange regime is free floating. Indeed it is, but if Bloomberg is to be believed, then there is a gag to the nominal exchange rate movement.
• Two, the Central Bank of Kenya's monetary policy is interest rate based. Indeed it is, but as I have argued before, with the re-introduction of interest rates capping the monetary policy tool is rendered impotent.  
• Three, we have adequate reserves and even a stand-by facility from the International Monetary Fund (IMF). True, but if our fundamentals are right, then the facility wouldn't be necessary (in other words, the very fact that we have the IMF facility is a signal of vulnerability). Even the adequacy of reserves needs to be seen on the back of the monetary authority's comportment towards the movement in the nominal exchange rate as reported by Bloomberg.     

Meanwhile, fiscal policy is looming large. The justification is that the fiscal deficit arises from funding necessary physical infrastructure that enhanced the economy's long-run capacity. As I have learned from a recent study published by the IMF (Working Paper WP/17/105 of May 217), the choice is between funding roads and schools.

I don't want to take the flavour from the study, so I will let it speak for itself:

"Why do governments in developing economies invest in roads and not enough in schools? In the presence of distortionary taxation and debt aversion, the different pace at which roads and schools contribute to economic growth turns out to be central to this decision. Specifically, while costs are front-loaded for both types of investment, the growth benefits of schools accrue with a delay. To put things in perspective, with a “big push,” even assuming a large (15 percent) return differential in favor of schools, the government would still limit the fraction of the investment scale-up going to schools to about a half. Besides debt aversion, political myopia also turns out to be a crucial determinant of public investment composition. A “big push,” by accelerating growth outcomes, mitigates myopia—but at the expense of greater risks to fiscal and debt sustainability. Tied concessional financing and grants can potentially mitigate the adverse effects of both debt aversion and political myopia".

 So the shilling may hang on, and S& P may maintain its sovereign rating. But for how long? That is the economic question that the country's political choice may have to be confronted with. And if there is a movement for the worse, it may be swift like a Wile C. Coyote moment - when he is falling down the cliff, it is when he least expects it (see below).

 

When the 'Business Daily' Falls in Love with a Narrative

Yesterday the Business Daily had some “breaking news”! A Citibank economist had proclaimed that interest rate capping is upsetting the Central Bank of Kenya’s monetary policy conduct.

The economist – David Cowan – knows what he is talking about; and his observations in the research note that underpins the story are entirely valid.
What is interesting, at least to me, is the timing of the decision by the Business Daily to give the story prominence.
First, it is not breaking news. When the Monetary Policy Committee (MPC) of the Central Bank Kenya (CBK) said as much in its communique of March27, 2017, it wasn’t news worth of Business Daily’s prominence.
 Instead, all we got was the nonsensical argument that the decision to retain the policy signalling rate – the Central Bank Rate (CBR) – which is also the base for capping at 10% was a reprieve to borrowers.
My colleagues and I have elaborately argued twice [here (March 2017) and here (June 2017)] that, if for no other reason, the capping of monetary affects monetary policy consequences; and the consequences of that is damning to the well-functioning of the money pricing regime and the economy as a whole.
But I guess I have been around the block enough to know how masquerade to thought leadership in newsrooms operate: it is not about the logic and the merit in the argument; it is who makes the argument and as a consequence how will it sell the newspaper for a day.
Second, it is a reflection of the thinking that is compartmentalised – monetary policy is now hamstrung is one compartment and banks are engaging in blackmail through reducing credit to the private sector is the other.
I must be quick to excuse such thinking, to the extent that it happens in the newsroom; the reason why I do so is because I do not expect a “general equilibrium” way of thinking – where one looks at all possible connections – to happen there.
If I am right is so arguing, then it is easy for me to see why people are now making the lazy argument of there being a nexus between banks’ decision to rationalise their branch network and the “blackmail” conspiracy theory.
What I know for sure is that the decision by a bank to open (and close) a branch or extent credit is tough to make than that of wring a careless newspaper story or a pretentious editorial like today's where there is an assertion that “removing the caps demands that all other distortions are dealt with at once”. 
One wonders whether there is really an understanding at the Business Daily of (a) what the distortions that they are talking are (b) whether it is practical to imagine that those distortions can be dealt with “at once” (c) how it doesn’t make any economic, even logical sense to start putting a sequencing (more accurately a condition) that the removal of the distortionary caps needs at happen once all the other distortions have been removed “at once” – why not remove all of them “at once” then?
 But hey, I am not naïve to expect a newspaper that has fallen in love with a narrative to let soberness come in its way.                    

"Inflation: Both Sides Have a Point"

What comes to your mind when you read the Business Daily's Friday 3, 2017 splash about how poor households are skipping meals in order to beat inflation? What was the essence of seeking the views of the Chris Kirubi and Donald Kipkorir?

This is what the duo had to say.

Kirubi: "It's the small people that the government needs to step in and cushion from rising costs".

Kipkorir: "I even don't know the price of fuel, food and such. I am never bothered by these price changes as they don't affect me".

When I saw the quotes attributed to the duo, I couldn't help but recall a column written by Economist Paul Krugman nearly 17 years ago in the New York Times where he said thus:

"If a presidential candidate were to declare that the earth is flat, you would be sure to see a news analysis under the headline "Shape of the Planet: Both Sides Have a point".

In other words, the story above was looking for balance in giving  the duo a chance to gloat about why the inflation thing is not about them - I naively used to imagine that business people need a stable operating environment as assured by low and stable inflation!

Crazy!

The Trageddy of a One Day News Cycle

On January 31, 2017, I published a Research Note that made some policy makers unhappy. In the Note, I observed thus:

"We therefore observe that the decision by the MPC to hold the CBR at 10.0 percent as justified
by the Committee’s argument that inflation is within the target range and previous decisions
need time to work through the economy was anticipated. While on that account the MPCs
decision seems justified, its assessment of the immediate term risks on price stability and other
macro  parameters  are  of  less  candour.  Consequently,  this  reflects  the  MPC’s  inability,  or
unwillingness, to provide forward guidance in its monetary policy signalling".

At that point in time, everybody who has an opinion on such matters - especially the pretentious business media - was fixated on the cost of credit, terming the MPC decision a reprieve to borrowers.

To many,  it didn't matter then that the capping of interest rates had dampened credit expansion as many of us had forewarned and that the main worry was macroeconomic stability.

It equally didn't matter that the MPC - in its wisdom or lack thereof - decided to hold its meeting a few hours before the release of  inflation numbers - the core policy target; this meant that the Committee chose to make a decision without the benefit of one crucial piece of information.

Fast forward to February and as I had anticipated Inflation hit the roof, busting the official target. Now everybody is wise. The editorials are roaring: "Inflation rise a wake-up call for policy makers".

The next MPC meeting is scheduled for March 27, 2017 - curiously three days before inflation numbers are published.

If the MPC does the right thing and adopts a tightening stance, the same wise people will predictable start talking about the cost of credit - as if that is all that matters!

While this is a tragedy of the one day news cycle syndrome - that coincides with the editorials' short  memory - is vindicates my argument on the folly of the CBK's choice of the Central Bank Rate (CBR) as the benchmark rate for capping  lending rates.

For those curious, the CBR is a policy signalling rate meant to balance the inflation gap (actual vis-a-vis the target) on the one hand and the output gap (actual output vis-a-vis potential output).

The CBR therefore has no business being linked to credit pricing. It is role is to signal policy intentions, and then be operationalized by a market rate (be it the interbank rate, repo rate, or even the Kenya Banks Reference Rate (KBRR) - which the MPC chose to suspend).

That is funny stuff right there!  

Yours Truly as a Talking Head!

Courtesy of the CFA Society of East Africa, John Randa (World Bank ) and I had this interesting conversation.

Fake Intellectualism

I have no idea who coined the catchphrase "fake it until you maker it". Whoever it is, the subject was obviously not the attitude is the Business Daily at a general level towards what passes for good economics and at a specific level the appreciation of how the financial system works beyond the usual scandals (real or imagined).
But the Business Daily has made it almost a preoccupation to come up with an hypothesis, accept it without testing (by the way researchers never accept an hypothesis; they only fail to reject the null hypothesis!).
Before the new law capping interest rates was enacted, anybody with a basic understanding of financial economics warned that it will lead to shrinking of credit. This is because if the caps (obviously determined arbitrarily) are below the price that a bank will lend to a risky borrower, the decision will be not to lend to such borrower.
The official attitude at the Business Daily was that those making such argument are scaremongers, and that lower rates will translate to high credit (as if the credit  market is the same as the potato market).
While it is still early days, evidence has started trickling in that indeed what some of us anticipated as a consequence of this new law is playing out.
But trust the Business Daily to waffle when faced with the evidence. First, it reports the evidence of shrinking credit with a twist that it is the private sector that is shunning credit from banks - this of course being totally a nonsensical argument - see 'Businesses cut credit uptake as rate cap uncertainty bites' (Business Daily, 15th November 2016).
Then in quick order, there is realisation that the banks (villains in the Business Daily hypothesis) need to take the entire blame. So the great minds in Business Daily pen an editorial the following day to put the blame 'where it belongs' - see 'Change lending strategy' (Business Daily, 16th November 2016).
The editorial makes three arguments, all of which entrenching what I often call an attitude in search of justification.

• One, banks are deliberately starving the private sector of credit. So was the Business Daily  reporting of the previous on the subject wrong and was the editorial seeking to correct it? No; this is textbook waffling.
• Two, the stringent screening by banks has led to more investments being channelled to government securities. So does the Business Daily understand the zero-sum argument? No; game theory is not thought in its school! More seriously, nobody there cares to know the difference between crowding out through the quantity channel and through the price channel. I presume that it is the obsession with interest rates (the price channel) that the Business Daily does have the guts to simply report the evidence that it is the quantity channel (the government's unquenched appetite for funds from the market) that carrying the day here.
• Three, what obtains is a betrayal of the spirit of the law capping interest rates. So does the Business Daily imagine that the spirit and the reality are one and the same? Oh well, let me take this opportunity to welcome everybody in that house to the real world!

All said, I believe in consistency of thought in any debate. On this one, I see lots of shifting of arguments in a desperate quest to fit a preconception. That is the definition of fake intellectualism.

Interest Rate Capping: Muthoni Thang'wa an Innocent Victim of the Dunning-Kruger Effect

One of the luminaries in Kenya’s financial sector recently wittily quipped that on the subject of interest rate capping “everyone and his/her cat” has an opinion. And he was right.  Ms. Muthoni Thang'wa has very strong opinions on the matter as expressed in her Op-Ed in today’s Daily Nation.

Ms. Thang’wa’s short bio in the Daily Nation indicates that she “works in the heritage sector, specialising in culture and enterprise”. That does not deny her the right to have an opinion on this subject. It however makes one wonder whether she knows what she is talking about when she asserts thus:

“It has been proven, economically and mathematically, that banks will make profits on loans at the current regulatory rate of 14.5 per cent, yet they charge up to 11 per cent more than this rate. This greedy difference is what this law seeks to regulate”.

On this I can only ask one question: where is the study? I suspect that there is no study she or any person of her persuasion has done of the matter. If there was such study, she could have been all over town with it.

But then again I know how those who earn a living out of pontification operate. They simply take leave of logic and reason if that will come between their preconceptions. In other words they have attitudes that they desperately seek to justify through sounding profound but not making any sense.

It gets juicier when Ms. Thang'wa argues thus”.

“All the players in the financial sector take the public for granted; none of them had any research or data that supports any of the claims they used to oppose the Bill, including inefficiencies in the credit market and credit rationing”.

Really? No studies? I argued yesterday that there is a group of people whose arguments on this subject can be characterised as “accidental expertise”. If Ms. Thang'wa is the reading type, she can see the link on my blog post to a World Bank Paper that could easily rubbish the arguments in her Op-Ed.

Let me make it easier for her by saying that the financial sector knows a lot on this subject than she imagines. And that knowledge is based on experience and, yes, research.

Let me not speak to experience because that is a subject on its own that portrays Ms. Thang'wa’s attitude seeking dubious justification. Such attitude is such that:

(a) she knows more on the subject than the Central Bank of Kenya (CBK) which has opposed the capping of interest rates as a way of addressing the structural issue of high interest rates
(b) she knows more than the National Treasury, on the subject whose view on the matter is the same as the CBK’s
(c) she knows more on the subject than the Deputy Managing Director of the International Monetary Fund (IMF) who recently argued that “Another challenge facing many African countries is the persistence of very high spreads between the interest rates offered on deposits and those charged on loans. This has led to understandable frustration among borrowers about the cost of credit, and has produced political pressure for interest rate controls. However, the politicization of monetary policy bears well-known risks—for the soundness of the financial system and for credit access, notably higher-risk borrowers. International experience suggests that, in many cases, interest rate controls may actually end up reducing access to the banking system for small borrowers—such as farmers, SMEs and consumers—and may also revive informal lending at much higher cost for borrowers”.       

Instead let me speak to research conducted by the financial sector in Kenya.

·         We know through research that the Kenyan banking industry exhibits strong competitive attributes. So if interest rates are sticky at high levels it has less to do with competition and more to do with exogenous factors such as huge government fiscal deficits financed through domestic borrowing. That study is available here.

·         We know through research that the challenges that exists in the interbank market (yes, no assumptions here that Ms. Thang'wa knows that there is a credit market amongst banks!) are structural and could be compounded by capping of interest rates. That study is available here.

·         We know through research that banks are strategically positioning themselves to support capital markets deepening through their investment banking subsidiaries; therefore strategically they are diversifying away from interest income towards entrenching transaction and advisory based income. That study is available here.

·         We know through research that the challenges of SMEs are wider than financing, although Thang'wa et.al. would want to make it appear that finance is the only problem of SMEs. That study is available here.

I can go on and on and on about the studies on matters finance, banking and economic policy by researchers in the financial sector, but I guess it cannot help persuade Ms. Thang’wa to move an inch from her jaundiced view. I need to say this though. The fact that she doesn’t know about the existing research does not excuse her empathic assertion that there is no body of knowledge on this subject and more.
What it does it bringing out the possibility that Ms. Thang’wa could be an innocent victim of the Dunning–Kruger effect, which is a perception bias whereby low-ability individuals suffer from illusory superiority, mistakenly assessing their ability as much higher than it really is.

Interest Rate Caps, the “Accidental Expertise” and Our Version of Donald J. Trump

In April 1999, economist Paul Krugman published a small book with a big message. The book is titled “The Accidental Theorist and Other Dispatches from the Dismal Science”. I recommend it to anybody keen on understanding why in economics and in business, relationships are not always linear.

I have my doubts though that many of those who this small book (yes, it is only 204 pages) should realty help could even touch it because it has the world “Theory” in its title.  I guess it is because they consider themselves to be “practical”.

My understanding of practical men is shaped by Lord John Maynard Keynes who, in the last Chapter of his Magnus Opus – The General Theory of Employment, Interest and Money – noted thus:

“The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist”.

 The “practical” men and women are now telling us that all will be fine with the interest rate capping, and that they have done “their research” which points them to a WorldBank report that concludes that the practice is all over. Their inference is therefore that the practice must be beneficial. If only that was true! But it isn’t. The report says exactly the opposite; but then who – among the “practical" people – cares about the truth in this logic-free, fact-free interest capping regime? Indeed who cares to read a 40-page paper whose main conclusion is contrary to ones prejudiced position?

That is not where it ends. The “practical” people are telling us that the “greedy” banks (remember Gordon Gekko in the movie Wall Street?) will do all they can to keep their levels of profitability. In other words, their greed will push them to lending more; in any case, they argue, with low margins banks will be “forced” to lend much more.  In other words, to them the credit market is like the potato market.

If I was talking to my fellow “’non-practical” people, I would say that the “practical” side assumes that credit demand is price elastic. And they are wrong. Consider this: walk into The Junction Mall in Nairobi and see two banners. One of the banners is by a bank – pick any, for there is NIC Bank, Commercial Bank of Africa, Standard Chartered Bank, etc. – and it says that you can get credit at 14.5%. The other banner is by Nakummat Supermarket and it says that you can buy one kilogramme of potatoes at Kshs14.50.  

With Kshs14.50 in your pocket, you can walk to Nakummat and stroll out with your bag of potatoes. Just as you find that the price of potatoes in Nakummat is competitive, you would be on the idea that credit is now competitively prices thanks to the capping law. With your potatoes in hand, walk into the nearest bank and apply for credit.

It may not take as short a time as buying the potatoes, but the bank will make a decision either way. If the appraisal process shows that your credit risk is larger than the cap, then the bank will make the decision of not lending to you.  Under no capping, the bank will make an offer of a rate that matches your risk profile; but what the capping law does it make it illegal to lend to people of a certain risk profile!

I guess being “practical” simply means that you ignore even the very basic truth that many households and small business are constrained more by access to credit than the cost of credit. This by no means suggests that cost is irrelevant; it simply means that if you come up with a blunt tool such as capping to address costs, you may end up frustrating access.

Will the low margins mean increased credit so that Mr. Gekko can quench his greed? The answer is in a document that many “practical” people  haven't read – while posing as experts in matters banking when in fact their lives revolve around the equation Assets = Capital + Liabilities – ; that document is called the Central Bank of Kenya Prudential Guidelines.

For those too busy being “practical” to read the Prudential Guidelines, they provide for how much a bank can lend for a given level of capital. So more lending demands more capital, if price is restricted. But what happened when the capping law was signed tells anybody careering to look at this matter intelligently that capital was the first variable to quickly move – the listed banks’ stocks simply crashed.

So therein lies the “accidental expertise”. It doesn’t surprise me therefore that leading media houses wrote celebratory editorials about the capping law even as the bank stocks where their staff pension funds are invested collapsed. Nor does it surprise me that even respected business newspapers such as The Business Daily is treating its readership as if it all have a one-day memory on this matter.

 If not having a Donald J. Trump mentality of switching positions daily, what can explain the following switch?

July 28, 2016 Editorial: “The Kenya Banks Reference Rate (KBRR) for example was a brainchild of intense the banks lobby as it sought to calm MPs who were at the time baying for the lenders’ blood. The widely discredited rate again did not move a needle on the interest rate charts, but has been used as political tool to appease any critics of the high interest rates”.

September 14, 2016: Editorial:  “For instance, the CBK waited till the very last minute to speak to the key issue of the base rate that would be applicable in the pricing of loans as the new law requires. When it did, it chose the Central Bank Rate (CBR), an instrument set by armchair economists in boardrooms instead of the transparent and market driven KBRR – and felt no obligation to tell Kenyans what informed that choice”.

A Mechanical Tool for a Structural Problem - ICPAK Edition

My first economics lesson in high school decades back was on the subject fancily referred to as "market structures". My teacher, Mr. Stephen Mugenyi, started by telling us that there are three types of markets - monopolistic (one market player), perfectly competitive (many players), and oligopolistic (in between the two extremes).That was a mouthful.

The following day, he went on to tell us the features of each of the three. A monopolist has total market power and plays in a market with entry barriers. A monopoly makes 'abnormal profit' based on the ability to restrict output and therefore charge high prices.
In a perfectly competitive market there is free entry and exit, and market players make 'normal profit' as the market dynamics enable prices to adjust to a common level.

As I came to learn later (as I grew to become a professional economist), monopoly and perfect competition are two extremes - what we later used to call "corner solutions". The real world is somewhere in between, and that is the oligopolistic structure. [there is also monopolistic competition; I didn't learn this from Steve]. In an oligopolistic set up, there are either few players or a few dominant players.

If one wants to move the market towards perfect competition, one needs to look at one variable: number of players - not simplistically increasing such number but ensuring that that market dominance is not by few players (in other words expand the top).

Even this will not lead to perfect competition; it can only approach but not attain perfect competition status (we used to  romantically refer to this as an "asymptotic process"). You cannot move an oligopolistic market towards perfect competing through attempting to fix the price. That is because, the reason you have oligopoly is "structural".
Now, the Institute of Certified Public Accountants of Kenya (ICPAK) leadership has chosen to argue that price controls will address a structural issue. They argue that the banking industry is oligopolistic, therefore cap interest rates will just do the magic.

This brings three things to mind.

• One, things that are expected to be obvious to some a group of professionals who are expected to be thoughtful and knowledgeable aren't usually so.
• Two, playing to the gallery is  very very tempting. I can't see the motivation though when it comes to ICPAK leaders on this issue. Is it politics? Well, I don't know. What I know though is that it is not economics!
• Three, there is a huge difference between simple solutions (carefully thought through but easy to implement) and simplistic (looking at which side of the debate is noisy and assuming that they have a point). ICPAK leaders present a typical simplistic solution. Not that there is a simple one when it comes to interest rates; but one expects logic in any conclusion and I see none of that in ICPAK's assertions.

Illiteracy in Basic Economics - Once Again!

When I saw the Daily Nation tell us today that the IMF calls for  interbank rate control in Kenya, I wouldn't help but recall that in the recent past I have asked (actually twice - here and here) whether the Nation Media Group has an economics editor. I guess I would have to go easy on the question and surmise that clearly they do not need one.

Why do I think so? Because the author of the piece hinges his sweeping observations on a recent IMF Working Paper. I happen to have read the said paper three days before the Daily Nation story was published. I would like to argue that:

• One, my reading was very careful because the paper is very technical but well written for a trained eye to enjoy [I didn't expect the Daily Nation reporter to understand what the hell the exponential generalized autoregressive conditional heteroskedasticity  (E-GARCH) specification is all about!].
• Two, the paper's conclusion - written in plain English nowhere suggests for a control of the interbank rate.
• Three, the habit of picking statements from a technical paper with the objective of fitting a particular narrative is very addictive in the media, especially when there is a desperate endeavour to appear knowledgeable on a subject where the reality is the exact opposite. 

I have a strong feeling that either the author doesn't - or chooses not to - understand  how the interbank market operates. So let me make no assumption here and observe as follows:

• First, the interbank market is an overnight market whose price (the interbank rate) is influenced by the overall liquidity in the market. 
• Second, the other money market rates such as treasury bill rates are a reflection of liquidity situation in the market and therefore have an implication of what the interbank rate could be.
• Three, (and this is for those technically inclined) the E-GARCH methodology allows for the determination of the direction of influence between the interbank rate and the treasury bill rate; and such influence can be dual (meaning the two influencing each other). The IMF paper indicates that such influence is strong from the interbank rates.
• Four, the interest of ensuring a smooth interbank rate that is coordinated by the policy rate (the Central Bank Rate[CBR] in this case) is such that the central bank could use the interbank market as an operational target for monetary policy - the CBR is the signal rate and the interbank is the operational rate
• Five, there are merits in the central banks creating a band around the CRB around which the interbank rate could fluctuate (the paper calls it a corridor). The narrower the corridor the better it is to manage volatility in the interbank market given that the CBK does not fluctuate frequently.

Does the proposal for the creation of a corridor amount to a call for controlling the interbank rate? Definitely not. The central bank can only seek to influence, but not control, the interbank rate. That is why, to let the IMF paper speak for itself, 

"by announcing a rate that it wishes to prevail in the overnight interbank market and ensuring its implementation through day-to-day liquidity operations, the central bank aims to influence and stabilize longer-term rates, important for overall level of prices and real economic activity. Likewise, the central bank’s ability to reduce volatility of overnight interbank rates should matter for monetary policy because interbank market volatility may

affect funding costs for longer-term financing".       

So where is the Daily Nation coming from with its screaming assertion about the call for interbank rate control? I do not know. I suspect it is a function of the implicit sympathy to have money market rates controlled - aligned to the silly proposal by the a section of the legislature - that the media house is shy of directly asserting.

But it all amounts to illiteracy in basic monetary economics.