Nairobi - Kenya's commercial banks' decision to raise their base lending rates is set to heap pain on small firms already suffering from high energy costs and wage bills, and hinder economic growth prospects for this year.
Growth more than doubled to 5.6% last year, pointing to recovery taking hold after political violence in 2008, but high prices and exchange rate volatility have dimmed the outlook for 2011, making it harder to keep growth on course for a target of a sustained 10 percent per year rate over the medium term.
Several commercial banks have raised the prime rate by between 100-200 basis points this month after the central bank embarked on a tightening cycle earlier this year to fight inflation and stabilise the exchange rate.
"It is going to increase the cost of doing business. It is going to fuel inflationary pressure onto the market place. There is no need for banks to be hiking their interest rates," said Jaswinder Bedi, chairman of Kenya Association of Manufacturers (KAM).
Small and medium enterprises make up about 60% of the manufacturing sector in the east African nation of 39 million people, a sector that is considered important for growth.
Betty Maina, chief executive of KAM said in May that some firms were considering moving to other countries, due to high energy costs, rising inflation, a weak shilling and political uncertainty.
"I'm worried about the smaller manufacturers who are the largest component of the Kenya manufacturing industry who really have no say," Bedi said.
"What happens with the smaller manufacturers is they get crowded out because the bigger manufacturers have got the clout. They have got the sheer might and they negotiate on Libor (London Interbank Overnight Rate) plus."
Kenyan banks price their credit based on the prevailing Treasury bill rate, which is usually higher than the Libor.
Ndiritu Muriithi, assistant minister at the country's ministry of industrialisation said the banks' move would worsen a situation that is already bad, because lending to the productive sector constitutes a tiny part of total loans.
Like other diversified economies, Kenya leans on small businesses to create employment and drive much-needed growth
"Out of the outstanding banks' portfolio of 1.05 trillion shillings ($11.70bn) in May only 3.3 percent was to the manufacturing sector. Out of that portfolio, only 18-20% was for terms longer than 36 months," Muriithi told a news conference.
Economic analysts say inefficiencies in the credit market is a hindrance to economic growth because firms cannot access long-term funds at reasonable rates for investment.
Matters could get tougher due to uncertainties over a general election due next year, prompting policymakers, who prefer to see private sector credit growth, to lash out at banks that use the tightening cycle as an excuse to raise rates.
Njuguna Ndung'u, governor of central bank said the banks' move is unjustified because policy only has near-term effects.
"When interest rates and inflation were coming down not so long ago, they did not lower the lending rates, so they cannot use the same reasons to raise the lending rates. Monetary policy is short-term and always has short term effects," he said.
Ndung'u, who previously stood by commercial banks in the face of criticism that their rates were too high in a falling of short-term rates and central bank's easing environment, said he will change his stand now.
During that time, he based his support on the argument that rates would fall slowly due to overlapping loan contracts.
Minimal effects
Deposit rates declined drastically at that time, causing the interest rate spread between the lending and the deposit rates to remain at above 10%.
"For the last four years, short-term interest rates and the policy rate (CBR) have declined with minimal effects on the lending rates," he said.
"If commercial banks now want to use the opposite argument to raise lending rates, then I will stand back when the public starts hitting out at them."
Habil Olaka, chief executive of the Kenya Bankers Association defended his members, saying the cost of funds had risen, leaving them no choice but to raise lending rates.
"Wholesale depositors are aware of what is going on in the market and when they demand the higher rate, banks have no options," Olaka said, adding he did not expect all banks to raise their rates.
"It is a matter of competitive strategy. You may decide you want to transfer the whole cost to the borrower in case you are protecting your margin. There are those who may decide I will absorb that increase in order to go for the market share."
Bankers say the cost of credit is also driven higher by risks of fraud and a judiciary that is perceived to be weak and slow, enhancing chances of defaulters getting away with loans.
Geoffrey Mwau, economic secretary at the ministry of finance agreed with that assessment.
"It (weak and slow judiciary) raises the cost of funds. Right now there is a lot of liquidity everywhere in the country but some people might be unwilling to put it in the capital markets because they are not sure that the money is safe," Mwau told Reuters.
"There should be a clear message from the judiciary and the regulator that, that cannot be tolerated. The punishment should be credible."
Still, Bedi of the manufacturers association said action should be taken sooner, to tame the high interest rates, for the sake of economic activities.
"There should be some form of regulation done by the central bank. If you want to charge me 15%, then maybe you should give me deposit at 9% and work with 6%. Average banks in Kenya are working with 10%, which is very high," he said.