XN IRAKI
In the last two weeks, down grading of the US government by the credit rating agency, Standard & Poor has dominated the headlines.
Such agencies rate individuals, firms and governments on their creditworthiness, which in general determines the riskiness of a borrower and by extension the interest rate to be charged.
Creditors find it difficult to determine the creditworthiness of borrowers. Without solid credit worthiness, creditors could lose by lending money to people or firms that might never pay back. This is critical for financial institutions like banks.
Without such independent bodies that can objectively determine your ability to pay back, the most uncreditworth borrowers are likely to get loans.
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Credit rating increases the efficiency of the markets, by reducing transaction costs, and reducing information asymmetry.
In Kenya, we have our credit-referencing bureau (CRB), which seeks to share information particularly among banks on our credit worthiness to avoid serial defaulters. That is a great idea; lots of Kenyans never pay back their debts not just to banks, but also even to each other.
Hard Lessons
To us, the rating means that interest rates in the US will most likely rise since lenders to the US government through securities such as treasury bills and bonds will demand high interests to cover up the risk of default.
China, a big buyer of US securities has already raised concerns when the US government was downgraded. Other key holders of US debt are Japan and UK.
Banks’ prime lending rates are highly correlated with Treasury bill rates. Banks and other financial institutions (including shylocks) are likely to raise their rates as well.
This is what should worry us. The high interest rates mean that fewer investors will borrow money and consumers too. Fewer Americans will buy new homes and so will they consume less. This will reduce demand for goods and services and by extension lead to economic slowdown and unemployment.
US may not be our biggest trading partner, but we export to that market. Any reduction in demand will mean less money for Kenyan exporters and fewer jobs too.
The world economies are very intertwined, thanks to globalisation. The effect of the US economic decline and euro crisis could affect us through third parties.
With globalisation, other nations’ progress is our progress and so are their woes. Luckily, the US government downgrading could halt the slide of the shilling against the dollar.
Bad Politics
We need to put our political house in order. US downgrading is a result of political bickering between Democrats and Republicans over US debt ceiling.
The comprise they reached does not seem to go far enough. Politics will never be an exact science despite coining terms like political science. Its main players are human beings with their interests, emotions and weaknesses.
We have witnessed the intrigues in our grand coalition and its effect on the economy. Clearly, the government is a great economic player despite the gospel of free markets.
Some observers will quickly conclude that the stalemate among the US political parties has a lot to do with next year’s general elections. That might not be entirely false. As we prepare for our own elections next year, we expect politics to affect the economy mostly through uncertainty.
The second lesson is that power often rests in some unusual places not just in parliament, judiciary or the presidency. In the American case, Standard and Poor’s (S&P) seemed to wield real economic power.
To some, this is a good check on excess of politicians. To others, however, Standard and Poor’s represents the unaccountable power of unelected bodies. As we implement the Constitution we could see a lot of such entities arise.
The other lesson is that political leaders must be bold in making decisions. One reason why the US downgrade took place is because the US politicians were not bold enough in making fiscal reforms, preferring the Kenyan way of forming task forces.
In 1993, the Canadian government credit rating was cut from AAA to AA+ just like the US. This jolted the leaders into action wiping the budget in four years by making bold steps.
Finally, Kenya’s credit rating by Standard and Poor is B+, a rating that rarely makes headlines…
