How financing plays major role in economic development

18Oct 2016
The Guardian Reporter
The Guardian
How financing plays major role in economic development

THE latest report of the Institute of Chartered Accountants in England and Wales (ICAEW) indicate that East African countries have eased monetary policy over the past year while their West African counterparts tightened it in an effort to slow inflation.

There is a large variation in borrowing costs across the continent.

As a whole, Sub Saharan Africa (SSA) performed relatively poorly compared to other regions in terms of access to credit with a regional average Distance to Frontier (DTF) score of 35.9.

The DTF score captures the gap between an economy’s performance and a measure of the best practice across the entire sample – with 100 being the frontier. The lower the DTF score achieved, the worse the access to credit.

The report also shows: Kenya enjoys lower borrowing costs compared to Uganda; now ranks in the top three nations in sub-Saharan Africa for access to credit. However, the accountancy and finance body points out that only Rwanda and Zambia top Kenya for ease of credit financing.

Meanwhile, Rwanda and Kenya have maintained strong growth momentum into 2016, recording real GDP growth of 7.3 per cent year-on-year (y-o-y) and 5.9 per cent (y-o-y) in the first quarter of the year respectively; Uganda recorded a relatively disappointing 3.4 per cent (y-o-y) rate in the same quarter.

Key findings of the report show that on aggregate, SSA performs poorly when compared to other regions on access to finance, but some countries like Rwanda are in very good shape. In many countries, banks are well-capitalised and enjoy healthy asset quality, implying considerable scope for expansion.

There is a large variation in borrowing costs across the continent. Broadly speaking, West African economies face more expensive borrowing costs than East Africa, as authorities try to curtail serious inflation.

This divergence continues when looking at GDP growth in the region. Greater diversification in East Africa should allow stronger economic growth in 2017 and beyond, while the major West African economies continue to suffer the fiscal and monetary consequences of lower oil prices.

Economic risk remains much higher in Africa as a whole compared to other major emerging market regions, but there are a number of bright spots. Botswana, Namibia and Mauritius all fare well by global emerging market risk standards.

Access to finance
Michael Armstrong, Regional Director, ICAEW Middle East, Africa and South Asia said: “Access to finance is a vital driver of economic growth, so this is great news for Kenya. The interest cap enacted in Kenya benefits customers by both keeping the rates regulated, as well as spurring greater competition amongst banks. It could also further incentivise more accurate credit scoring. All of these measures should help Kenyan businesses in the longer term.”

Rwanda has made several reforms to facilitate access to credit in the past 6 years thus pushing up its rank. Kenya too has made gains in access to credit by enacting a law prohibiting banks from lending at rates higher than 4 per cent over the Central Bank rate.

Sub-Saharan Africa (SSA) performs relatively poorly in terms of getting credit compared to other regions of the world, with a regional average DTF score of 35.9 – only the Middle East and North African region does worse.

Credit metrics
According to Making Finance Work for Africa (MFW4A), in 2015 only 23 per cent of African households had access to formal or semi-formal financial services. There is significant variation between countries’ levels of financial sector development. Private sector credit extension (PSCE) to GDP ratios reflects the extent to which banking sectors provide capital to business.

Most SSA countries have relatively low PSCE to GDP ratios, which is indicative of the underdeveloped nature of the banking sectors and the limited availability of private credit in these countries.

Banking sectors still underdeveloped in most of sub-Saharan Africa There is significant variation between countries’ levels of financial sector development.

South Africa and Mauritius have the highest PSCE to GDP ratios on the continent, with South Africa’s figure estimated at 150 per cent in 2015 while Mauritius’s ratio is estimated at around 104 per cent.

Beyond South Africa, the countries with the largest banking sectors in SSA, Nigeria and Angola, have relatively low PSCE to GDP ratios of 14 per cent and 27 per cent respectively.
Turning to financial soundness, a good indicator to assess a banking system’s balance-sheet exposure is the regulatory capital to risk-weighted assets ratio.

Looking at asset quality, Burundi, Ghana and Cameroon perform poorly in non-performing loan (NPL) to total gross loan ratios. While the Organisation for Economic Cooperation and Development (OECD) median ratio is around 3.2 per cent, Burundi, Ghana and Cameroon have figures of 17.9 per cent, 14.7 per cent and 10.5 per cent respectively.

Most SSA countries in the sample have relatively high NPL ratios, with Namibia and South Africa being the only countries with NPL ratios below that of the OECD median.

Another key factor when assessing finance is the cost of finance. In this context, there are important regional differences across sub-Saharan Africa. Through the past 12 months or so, East African countries have eased monetary policy while their West African counterparts tightened it in an effort to slow inflation.

In Kenya, lower inflation allowed monetary authorities to cut rates by 1 per cent to 10.5 per cent. Ugandan authorities, having raised the benchmark rate by a cumulative 6 per cent in 2015, eased policy on two occasions during the first six months of 2016.

Through the past 12 months or so, East African countries have eased monetary policy while their West African counterparts tightened it in an effort to slow inflation.

In August, Kenya enacted a law prohibiting banks from lending at rates of more than 4 per cent over the Central Bank Rate. Commercial banks’ weighted average lending rates were recorded at 18.2 per cent in June, which, when adhering to the new legislation, would be decreased to a maximum of 14.5 per cent.

This could distort credit markets, but on a more positive note could spur greater competition and incentivise more accurate credit scoring.

Both would be positive for access to finance in the longer term. Given that banks will require some time to adjust to the new regulation, and considering uncertainty related to global financial conditions, Kenyan authorities are expected to adopt a cautious approach towards monetary easing.

Uganda still has scope to reverse some of the aggressive tightening undertaken last year, and monetary authorities will be looking to do their part to support economic growth following the disappointing growth figures record in Q1 2016.

The West African monetary environment presents a stark contrast. The inflationary impact of a severe dollar liquidity drought – forcing vendors to turn to the parallel or black market – and administered cost increases, such as petrol price hikes, prompted monetary authorities in
Business implications

Given that the cost of capital is lower in East Africa than in West Africa, firms in West Africa may need to be more creative in accessing finance to support investment and growth. This could be done by using alternative sources to bank finance, or by seeking finance in economies where banking sectors have more scope to offer finance.

Given the pressure for exchange rate depreciation/devaluation in some commodity-producing economies, this could increase financial strain on firms and risks of NPLs for banks.
Exchange-rate risk means that firms in commodity-exporting economies may also experience increasing problems in accessing foreign exchange in the years ahead, until a more sustainable exchange-rate policy is adopted.

As Mauritius pivots even more towards Africa, equity financing will naturally seek out opportunities in East Africa, further driving entrepreneurship and the expansion of maturing businesses. This could further enhance the advantage of firms in East Africa with respect to financing compared to their Western neighbours

Oxford Economics
Oxford Economics is one of the world’s foremost advisory firms, providing analysis on 200 countries, 100 industries and 3,000 cities. Their analytical tools provide an unparalleled ability to forecast economic trends and their economic, social and business impact.

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