Need for Support of SMEs in Kenya

As much as one would want to believe in free markets where businesses require no support from governments, in a world where there are governments that are already actively supporting their businesses to give them competitive advantages in local and international markets, those ones that fail to support their own businesses are bound to lag behind in terms of growth, or worse, experience exaggerated economic imbalances. These imbalances are in form of widening deficits or a situation where an economy becomes too reliant on specific exports commodities rather than being diversified. Reliance on specific exports means that when those exports under-perform in international markets, the economy weakens which is usually accompanied by rise in unemployment and unrest.

Low unemployment levels are critical in all economies. Employment not only provides necessary accumulation of skill but goes to an extent of even impacting on the next generation through people’s ability to finance their children’s education (that allows for increase in human capital), health services as well as passing on good values. Small and Medium Sized Enterprises (SMEs) are widely recognized on their role in fast jobs creation. In advanced economies, they account for over 95% of enterprises, 60% of total employment and 50% of value added (BIS study paper).

Developing economies especially in Africa have lagged behind on support for SMEs and have instead focused energies on specifics groups especially the youth. Although this is also important in development, neglecting SMEs in general regardless of age groups prevents these economies from harnessing the power of mass talents in the development of the economies. Innovation is not limited by age but rather by ideas and sometimes skill levels. There is great need to extend as much support as possible to these groups.

Some of the barriers that SMEs face when embarking on production of goods and services especially for those involved in exports are well known and are not exclusive to developing economies. These include lack of foreign markets knowledge and the resources that should be devoted to search for markets, being financially unable to wait for delayed payments by buyers of exported goods and services or those ones sold in local markets and need for developing customer base in foreign markets. Advanced economies have country specific export/import banks that fund both buyers in foreign markets and the SMEs, what about developing economies? Are continent specific Exim banks sufficient?

SMEs which report finance as their greatest constraints receive smaller new loans and high interest rates that further constrain their profitability. Policy initiatives that ease these constraints could play a pivotal role in balanced stable long-term growth characterized by high employment rates.

Some of the following measures implemented by the US in support of SMEs should be replicated or debated on their improvement as opposed to current strategy of giving banks funds without onward lending incentives or rate advantage for SMEs.

 

  • Government establishes a team/department/ministry that specifically focuses on SMEs rather than industry in general to study it and give it special attention separate from other enterprises. This team should ensure that SMEs for instance access efficiency enhancing services for free or at very low costs since it might take time before entrepreneurs address this gap. It should also ensure that they are able to access foreign markets and can group small enterprises such as those involved in farming to access external markets that it has negotiated on their behalf collectively.

 

  • Establishment of a rule that prioritizes SMEs that source their goods and services from domestic markets ahead of other contractors as long as price is within reasonable range. This can be in form of target percentages of say 30% of contracts rather than restricting support to youth and women enterprises. Civil servants also need to be educated on the importance of supporting SMEs and the process be made as transparent as possible with easy to use online tendering/contracting platform.

 

  • Special tax treatment for SMEs that gives them a competitive advantage. These may also include employment incentives such as the one in US that gives tax relief to SMEs that employ those who have been unemployed for more than a year and lower taxes.

 

  • Guarantee of risk on loans issued to SMEs by banks without or with insufficient collateral to reduce spreads on savings and lending rates to a level near rates at which established firms obtain financing. These guarantees can be capped at say sh35Billion. Guarantees mean that the government only gets to pay if the SME defaults. If there are a large enough number of new enterprises in an economy where government is aggressively spending and thereby stimulating demand, it will significantly reduce the risks. Extension of funds being in the hands of private banks will ensure more efficient distribution of funds.

 

  • Special funds from government to micro-lenders in form of interest loans. Rate on funds to be inversely correlated amount of lending to SMEs such that the more the micro-lender lends, the lower the rates they have to pay on the special funds. Micro-lenders can be extended to include deposit taking institutions who ordinarily charge high rates on loans.

 

  • Establishment of county level venture funds that match private investors investments in SMEs in counties. This may restrict funding to second stage small businesses such as farming enterprises or those involved in value addition and should offer other support services.

 

  • Special support for exporters that includes guarantees of close to 100% of export loans so that they are not too adversely affected by delays in payments.

 Conclusion

While encouraging innovations vocally, reducing bureaucracies might actually inspire some people to come up with new concepts or develop on already existing ones, I don’t think that is sufficient to support desired levels of growth. It would be more ideal if we not only harnessed the talent pool of huge numbers of people but also provided support that is at par with competitor SMEs in advanced economies in order to achieve greater levels of growth.

Combating Poverty

I was brought up right in the periphery of a mushrooming slum (everyone was later evicted from the land early 2000) and I believe I had a first-hand experience in understanding the dynamics surrounding poverty and could use the experience to offer possible explanations on why most efforts are yet to completely eliminate poverty and why some might reverse progress made so far. We shared same public schools and other social facilities with the extremely poor (by social facilities I mean slid down the same muddy hills, played same games and swam in same dangerous filthy waters). The saddest bit is that in my former congested class of around seventy pupils, only about ten of us made it past high school and about three of us past the university. Female members were the most affected with a majority starting families prematurely. This is despite serious efforts by donors at providing free lunch (diet that consisted of corn and vegetable cooking oil), water, electricity, books and sponsoring students to raise school attendance (long before the advent of free primary school education).

To begin with, I would like to expressly state that I don’t believe there is a single approach with which we can completely eliminate poverty but rather contend that fighting poverty requires a combination of approaches. For instance even if donors were to hand out money directly to poor families without educating them on good money management practices, the kind of inflation that would accompany such an effort would make the effect too temporary and maybe even aggravate the situation(by making them less willing to work hard, raising crime rate and sponsoring drug abusers/traffickers). Efforts to educate too could be hampered by lack of jobs in the economy; lack of jobs for the skilled labour would discourage unskilled labour to acquire the education they need to improve their human capital. It means, if you have a government that consistently mismanages the economy; poverty is almost guaranteed as a perpetual aspect of the economy. The poor due to possibly poverty induced desperation and low education levels may be unable to regulate the government. Philanthropists recognize this and people like George Soros sponsor whistle blowers who expose incidences of mismanagement and exploitation in governments and private entities. The government too no matter how willing, might be incapable of eliminating poverty on its own without external financial assistance (could be through grants, providing markets for goods, stable external and internal economic environment and very low interest loans).

Education

I recently attended university graduation party of an about twenty six year old girl who had managed to get a degree in education (specializing in geography). In recognizing her efforts we had hoped to inspire other children into following in her trail by providing a visual end result and showing that it is achievable (they too can excel in academics). It was a well-attended ceremony and the local area political leader was present. The ceremony was a big deal for the community because very few girls, if any, in the area have acquired full secondary school education let alone university education. Part of the reason why few girls in the area have taken education seriously is because no one in the community has proved as being distinctly better off in terms of living conditions because they were more educated, showing that there lacked incentives. In fact those who were married off early looked like they were better off than the slightly more educated who were still languishing in poverty some of whom have turned to prostitution. The worrying question about her was; would she be able to get a good job and advance far enough in the society for the rest of the community children to emulate her and to provide enough reason for the parents within the community to push their children into achieving higher education? This is why government support in job creation that rewards more those who are skilled than those are unskilled could be pivotal. Yet some local governments fail in creating reward for effort by discriminating and opting to employ based on relation and or even seeming to prefer those with low levels of education (diplomas rather than university education) thereby distorting the desirable incentives. The only comforting bit would be if the educated were to turn back to their community and enlighten them on what should be the appropriate long-term governance good for the community.

In the community I was brought up in, it was observable that most of those who attended high schools that had boarding facilities managed to complete high school education compared to those who attended day schools most of whom dropped out for a variety of reasons. I believe it still plays a role in poor communities. It is difficult to get all children into boarding facilities but as an alternative, there have been commendable efforts by people from outside these poor communities to mentor young people still within the vicious poverty cycle and even taking them away from the community into well-established universities for tuition on weekends and holidays. This is helping introduce the boarding school effect being promoted in certain poor states in the US. Children from poor families especially in slums are different from those in middle or high income families since they face distinct distractions/challenges. Some of those I watched drop out of school dropped out mostly because of influences from members of the communities and problems within families. For instance a former classmate had to drop out after the sole bread winner in his family, step-father, died alone in the house from cancer. If he had been taken away into a boarding facility, he would probably have not felt the need to quit education to provide for the mother and siblings. Others get affected by uneducated people they interact with who introduce them into drugs and have lacked mentors or the opportunity to have the proper incentives for working hard in education.

Some of these problems in education could be solved by continuously encouraging children from these communities to go through formal education, creating visible incentives, having people from outside the communities mentoring and interacting with them, providing support in terms of education and books. I do not think free education alone would be enough to raise skill levels in way that can attract investments that absorb skilled labor from these communities.

Misconception around community currencies in slum areas

I have nothing against innovations that seek to improve the welfare of a community but at the same time I believe that it is appropriate for these innovations to undergo high levels of criticism so that they do not end up creating bigger problems in the long-run. Personally, I had done studies around the subject and feel I could contribute to the debate around their viability.

Community currencies are simply an alternative means of exchange other than the main currency accepted in a sovereign that seeks to allow community members to utilize ‘idle resources’ through a system of credit extension. A grocery that could have wasted perishable goods such as vegetables, they argue, would be able to benefit by giving out the vegetables on credit to a person who runs a hotel (the grocery receives the alternative currency as a measure of the quantity exchanged), in turn the hotel instead of wasting away excess food could sell to the grocery thereby balancing out and smoothing cycles. It all seems perfect from there and is a well-intentioned scheme. Statistical data has shown that there has been increased level of profitability for businesses involved. The rise in profitability makes sense because members are able to consume more than they otherwise would have, member businesses also have guaranteed customer loyalty since they would tend to purchase from each other goods and services. But is it really beneficial in the long-run? I doubt.

From my understanding of slums and most poor clustered communities, they are net spenders (they consume more than they are able to generate from within the community). Most of the goods and services are either sourced from outside or involve components that have to be sourced from outside the community. This means that the system would be creating a wrong incentive, instead of encouraging saving for investments in opportunities some of which are outside the community; it encourages members to live beyond their means. The grocery spends more in buying foods from outside the community because it is able to generate more sales and it has to use the main currency to do that. Isn’t it in effect promoting certain members of the community into earning a lot more at the expense of pushing other members deeper into poverty? Wouldn’t it erode progress made within the community in learning how to manage personal finances? Wouldn’t it be better if instead alternative programmes that seek to create skills that generate revenue within the communities and marketing products from the community to outside markets were encouraged?

Having a community currency also means that it could close out the community from the rest of the economy. The currency is usually not accepted outside these communities. Users of the community currency would tend to use facilities within the community that accept the community currency. They would use medical facilities that are poorly equipped and attend schools with poor quality education within the community. Without interaction with other social classes, poor people interacting with only poor people, it might create less incentive to work harder in order to escape poverty thereby enhancing the vicious poverty cycles rather than eliminating them. Members may also be unwilling to venture out, invest and relocate to areas with better jobs, of the community outside where community currency would not be acceptable.

On a broader perspective, these communities are still part of the economy and are even worse affected by downturns in the economy. Central bank monetary policy tools that seek to control certain aspects such inflation could be hampered since even if they tighten money supply, these communities would be able to sustain demand through the alternative currency meaning that during episodes of high inflation, rates may have to be raised higher than they would ordinarily have. This is besides other factors such as the community currency use reaching a point where it creates enough incentive for fraudulent individuals to start creating counterfeit currencies.

The subject of community currencies which was introduced in the country for experimental purposes needs to be extensively debated and abolished if seen not to be beneficial to the economy just as some developed countries have banned crypto-currencies.

Conclusion

There is no magic bullet for fighting poverty. It needs combined effort from donors and community members both within and outside affected areas as well as a supportive government. It is important that efforts aimed at alleviating poverty be carefully weighed so that the fight continues to be progressive rather than regressive.

Case for Continued Weakness in Kenya Shilling

There are distinct aspects that make it difficult to predict local currency trend over specific time duration. For instance the market does not have large enough number of participants, is not an international currency and its rate is often managed by the central bank through interventions. Despite this, I still hold my contention that the present downtrend is likely to persist over the medium-term especially with the widening twin deficits (budget and current account deficits) and high inflation (and inflation expectations). In the long-run unless there is significant changes made on the fundamental factors(boosting tradable goods sector), any interventions  will tend to not only aggravate situations but postphone volatility. The longer strong exchange rate persist, the more speculative capital accumulates and the more the speculative capital accumulates, the worse the volatility that accompanies peaks of such currency strengths when ‘fundamentals’ (not motivated by total return) and speculative capital move in the same direction.

It is generally accepted by central banks that speculative capital flows have an inherent exchange rate destabilizing effect (exchange rate fails to reflect prevailing ‘fundamentals’) and there is enough evidence to support the same. Markets cannot be relied upon in establishing their own equilibrium. Some central bank tends to mitigate that risk through capital controls and interventions on the basis that it is much easier to control capital when it is moving into an economy that when it is moving out (Philippine central bank collapsed while trying to defend the currency).

Deteriorating Exports

The data I have is unreliable at the moment and much of my views are impressionistic and partly based on conjectures. Commodity prices have been falling and are expected to continue trading at low prices in the medium term. The past few weeks have had a large Tobacco exporter close shop alongside a fluorspar mining company both of which cited low prices as being largely to blame for the exit. Although they represent a smaller fraction of the exports sector, it could be indicative of the likely stress the tradable goods sectors will undergo. The government is trying to slow rising trade balance by restricting sourcing of materials in government projects to local businesses. It is not clear whether it is possible to enforce this rule in practice and on whether the local spending in actual effect will result in further imports to support demand created by the rise in incomes.

The shilling strengthened slightly on nominal (not adjusted for inflation) basis against the dollar immediately after the central bank raised interest rates but has since resumed downtrend albeit at a much slower pace than before the rate hike. The government is still maintaining its aggressive spending stance and running a possible large budget deficit relative to GDP as per the last budget reading. It is also likely to push banks into lending to fund infrastructure development, a money creation process that could result in inflation and further exchange rate depreciation especially if the tradable goods sector is not supported and funds are invested inefficiently. It is also not clear whether government investments will attract much needed longterm capital investments with ongoing allegations of misappropriation of funds and inefficient non-transparent costs investments.

At the moment the economy is experiencing a widening current account deficit that could continue pressuring the shilling. Stronger shilling would have been okay with inflation differential advantage, but inflation at the moment remains higher than in its trading partner economies (whose exchange rates are also depreciating) making it a vicious cycle of high inflation leading to weaker exchange rate and weaker exchange rate leading to high inflation.

External shock risk

At the time of writing, the world’s gaze is focused on the events unfolding in Europe as Greece negotiates with its creditors on a last minute bid to avoid default. Greek default presents a significant market risk in the immediate future alongside possible US rate hike within the year.

In the event of an external market shocks such as Greek exit or US rate hike, international markets are likely to respond indiscriminately towards frontier and emerging market economies that benefited from low interest rates and QE, this could trigger acceleration in loss of shilling against the dollar. Yellen remindee Asset managers that she had already warned them of possible risk in rate hike, they are particularly prone to herd behavior and would be predictable that they could reduce capital investments in these markets. After the initial market shock, differentiation is likely to come on the basis of for instance economic strength judged on fundamentals presented in each economy. Economies with low inflation, strong external and fiscal accounts, more reserves and sound financial sectors are likely to experience less market reactions. At the moment, the country’s biggest advantage lies in predicted high growth rates on fiscal stimulus. Holding adequate reserves is particularly important because interventions will be critical in dealing with the temporary bouts of volatility that will likely arise.

 

Conclusion

Based on my hypotheses, shilling is likely slide towards 2011 lows on RER and nominal basis in the near future especially with anticipated dollar rally from US rate hike. It would be better for regulators to err on the side of caution in inspiring investor confidence and preparing markets for possible shocks.