Celebrating East African Writing!

Financial Calamity in Kenyan Markets by Jaimin S. Vyas.

A free market trader’s point of view of the current market situation in Kenya.

A few years ago I was initiated into free market trading. As a young chap I had no interest in economics as a subject taken at A-levels. A dry; “perhaps out of a young mans context in view of the beautiful young ladies that surrounded his environment”, subject, there were better things to do. I wish I had, as I find practical economics a very interesting subject in present day Kenya.

In the 80’s Kenya was booming. Inflation had just begun with the advent of the Kenya money printing press and Mr. Pattni, and a few other gentlemen had managed to create a bubble which had coincided with certain laws that had provided a conducive environment for  both the public at large as well as manufacturers to have a very profitable period. There was a feel good euphoria all around. A very different scenario to the nineties, we now face a period of desperation in finding income generating jobs. This desperation will perhaps lead to initiative and new business ventures in our society.

Kenya’s history is spotted with such bubbles that have provided periods of artificial economic growth. This is certainly not the creation of our “brilliant minded”, politicians rather we have ended up barging and crashing through our short history with some good luck on the way. While having some laws that date back to the colonial times regarding the limiting of importation helped our fledgling manufacturers who had slowly over a period of twenty years gained confidence enough in Kenya to invest their hard earned money into some medium scale investments, “like a hen having its head chopped off just before its prime”, the “government of the day”, in its infinite wisdom with pressure from the western world not only gave in towards democracy but also opened up the flood gates of open importation.

Open markets are good if the trade is fair; this does not appear so in our case as our products for export were far outweighed by the products to import. A discrepancy that became abundantly clear over a decade. A look at the yearly publications of VAT figures shows us that the VAT figures form importation far out weigh the ones from the manufacturing sector. It is almost double.

This period of 1990’s will go down in history of Kenya as a time where we slaughtered all our Kukus and than began another poultry farm. Indeed the secondhand clothing market which, made billionaires of some but it also added many new paupers too. A classic case of wealth transference!

While employment had been healthy during the manufacturing era, and having cash in hand, the population resulting from the 80’s manufacturing period and high inflation, was euphoric going into the 90’s. We now found that the general population for the shorter term had a purchasing power to double their purchases little realizing that this purchasing power had come from the sale of products by local manufacturers, but the result of that same employee, directly or indirectly was hurting the local industry by purchasing imported secondhand goods, and in effect wealth that should have re-circulated back to the manufacturing sector was cut off. This was all well until the rubber band turned the other way and continues to stretch presently in the direction of importation. As always we have two lines on a graph crossing and once they cross one declines while the other inclines, in the long run these lines criss-cross each other periodically.

What happened next can be considered as a mass murder of the manufacturing base of Kenya. Three major sectors were completely destroyed. It began in reverse with the decimation of the garment manufacturing sector seeing a direct competition with the secondhand imports these manufacturers totaling some 300-400 companies began to shut down or to divert to other ventures. This directly impacted on two different other sectors. The yarn/thread manufacturers and the textile cloth mills. Many of which were parastatals. These cloth mills were dependent on the garment sector and they began to collapse. The result of this was the decimation of the cotton plantations. Literally millions of jobs were lost in this process. The end result was that many had far less than what they began with.

The common man who had been laughing at the prospect of being able to buy clothes at half the normal price was suddenly crying as he found his source of income had been cut off. Desperation set in but there was change in the air. While liberalization had cut off one sector another was about to grow. Another bubble was born. It was a case of buying sukuma wiki from the markets even though we grew it at home.

Out of the 400 odd companies that went down perhaps some 50,000 additional businesses were created. The stitching machines that were now lying unused were bought off by small scale tailors over a five year period and small tailoring units were set up. Another classic phenomenon was the creation of exhibition halls, a question of bending the rules, where tax was not applied to exhibitions.  Others yet continued to find jobs in other sectors. For some, a temporary relief was found in the EPZ sector or export processing zone where a number of garment companies had set up to take advantage of the AGOA trade agreement. This continued for a few years but eventually died off. A bubble had deflated.

The secondhand clothing industry spurred other off cuts such as ironing, cleaning, repairing of torn clothes and the likes.

At the same time the banking industry took advantage of a vacuum, and laws that allowed private banks to thrive. We saw dangers with the artificial collapse of banks like Trade bank, Bullion bank, BCCI, and the infamous Trust Bank. The manufacturing sector suffered along with this sector as finances were lost in this process. It was a great way to get rid of excess money in the country. Simply wipe it off the books. Perhaps in turn this may have saved the further devaluation of the Kenya shilling. But thousands of depositors lost their hard earned money.

We learn from our mistakes. Today we have the last of these once strong textile companies and the banking sector surviving. The clothes from China, Bangladesh, India, Korea, Vietnam and a host of Far East nations have destroyed our chance to have a very good manufacturing base which would have given us a massive opportunity at wealth creation. What instead we have had is wealth transference. At this same time we had other opportunities too with the flower export market as well as other agriculture sectors. This created jobs but with issues at Lake Naivasha there is a possibility that many of these will also not survive. It really depends on how much leverage they have taken from the banks for their businesses.

When a country has a foreign exchange deficit it is a danger signal. It tells us that our imports are larger than our exports. When a country also happens to have a current balance deficit this adds more venom to an already potent poison. Essentially we have a drain hole that is bigger than our tap that gives us water. This can lead to uncontrolled inflation as a short term solution to the current deficit and to continue with short term economic and infrastructure development. While many will disagree I would consider the practical implications rather than economic theories, and how one can take advantage of such a situation. Such a person would be considered an entrepreneur.

How can we have growth? Real growth? This is a scary situation considering that most of the imports are not machinery and tools but rather consumables. These imports once consumed, never to return. In short we are literally eating through our foreign exchange. So where is the money coming in to buy all these products?

Kenya gets approximately 1 billion dollars every year from various Kenyans living abroad and from other sources outside the country who wish to take advantage of the higher interest rates provided. The base rate in the US is 0.5% while we are averaging at about 11.5% returns. That’s a 2300% rate of return compared to the US. So if your money lies here in a bank doing nothing it gets a massive return and provided the Kenya shilling remains reasonably stable your returns are secured. That is Bubble 1. Even if you borrow at 5% from an overseas bank and deposit the money in Kenya you get a 100% return. Not a bad profit. As a result of this another bubble has inflated to bursting proportions. There is another investment sector that has recently been on a high and on dangerous grounds now. Additionally Kenya continues to borrow and gets foreign government funding through both short term as well as long term loans, which required to be repaid in one form or another.

Real estate is the current bubble that has expanded enormously in the last 10 years as a direct result of the above anomaly. There are several reasons for this. More specific to the major cities and towns of Nairobi, Mombasa, Kisumu, Eldoret, Nakuru, Malindi and Kakamega. The above all have infrastructure in place. A new demand was anticipated with ever larger growing populations in that these cities needed to expand but there is a problem, none of these cities have seen any major infrastructure expansion since independence. What this created were remarkable reasons for the price of properties to go up. Had this been simply based on local demand it would not have increased so dramatically.

Along with inflation we also saw a new much more risk prone middle class begin to emerge. We began to see political stability in this country compared to the inverse in surrounding countries and there began a demand for Non governmental organizations to set up base here. All these organizations had foreign exchange, but they did not have a place to set up. Our citizens saw an anomaly and took advantage of it. “There was demand so let’s supply.”

They did, by replacing a single house on a one acre plot with 5, 10 15, 20 residential. Little did any one realize that while the private sector did manage to build these, the water supply and the rest of the infrastructure would not catch up. Many of these residential developers are using questionable resources as well as in many cases not adhering to safety standards. Apart from this, roads did not expand, neither did water pipes, drainage, sewage or any of the other requirements including telecommunications. What we essentially have is a “Snowball effect”, a case of gathering more snow as the snowball rolls down the hill.

There were areas within these cities whose infrastructure was better than other areas and these areas had huge demand suddenly. Within a period of 10 years prices of properties increased 2 fold to 10 fold and in some cases 20 fold where they had infrastructure in place or in the vicinity. A one acre plot in Parklands bought for 11 million in 2000 was now going for 100 million. A plot of land of 6 acres going on Mombasa road for 6 million per acre was now being sold for 35 million per acre. Kenya suddenly had found a new source of wealth and the Kenya shilling remained relatively stable because of the influx of foreign exchange for the same properties. What most people do not realize is that the Kenya shilling has fallen from 7 shillings per dollar to 75 shillings per dollar, over 1000% decline. Inflation in hyper drive! What followed after this has been over speculation. How long can this be sustained? I spoke to a few developers all who seem euphoric based on this lack of infrastructure development. However has anyone lately looked around at how many adverts are beginning to appear for new project sales and discounts, the road and other developments? Keep this in mind as you read on.

If one is to consider not the value of the Kenya shilling but the value of gold as a stable format, it may clarify the picture. The price of gold in the 60’s was controlled. The price per ounce was 35 dollars or approximately KES 2500. A property in South C, in Nairobi at the same time was going for KES 45,000. In gold terms about 183 ounces of gold. That same property is now valued at approximately 20 million shillings, but the price of gold is $1000 per ounce. Equal to KES 76000.  That is equivalent to 263 ounces of gold. That’s a very good return provided  you sell the property.

However, it’s certainly not the massive return that the common public thinks it is on an investment of 45,000. Once you remove the factor of inflation in terms of percentage true gold value the actual value increase is approximately 43 percent. Shocked? It’s not much of an increase in value.

That’s equivalent to an increase of about 1% per annum, does not seem like much does it? The problem is inflation. If you had left it in cash in the bank you would still get beaten because of the devaluation of the Kenya shilling. However some diversification into various trends over this whole period would have seen one make some very good returns. So just this real estate value inflation adjusted is remarkably less. We are under an illusion that we are making money in short we are not. This value has remained par with inflation and in reality we have lost money. If we see gold prices drop as they do fluctuate we would see drops in our price in terms of ounces.

In 2008 I visited Dubai. I was amazed at its growth. I had first been to Dubai in 1986. At the time the airport was literally one hut. There was one duty free shop at the ground floor, a resting area on top of that and the control tower above that. That was the sum of Dubai’s airport. We all know what it is now.

An amazing transformation? Not really. What happened was that Beirut got its self bombed the hell out of courtesy of the PLO, Hezbollah and like minded brotherhoods. Beirut used to be the place to be in the sixties and early seventies if you were anyone. The casinos and the ambience was fantastic. The Monaco of the Arabian Peninsula. When Beirut went down it left a gap which was finally filled by Dubai.

Dubai did not have a natural growth rather it grew on financial steroids, partially financed by the emir’s personal wealth from oil and partially from the other emirates. Followed by blind euphoria. Dubai’s base became a bubble.

In 2004 it’s was at its height, not as most people thought it was in 2009.  The smart investors were already beginning to see the cracks in the walls and realized that the good times were coming to an end. Clever investors realize that they have to cash in at a point when they could cash in. If one does not than one will usually find oneself deflating with the bubble. The reason Dubai began a down fall was because of defaults in the loans. Developers had taken loans and so did the buyers effectively creating a chain. Should one of these links weaken or break than the entire chain breaks.

Usually a good investor will cash in just at the beginning of the height or what we term as euphoria. In 2008 May of that year I visited Dubai, than wrote an article regarding the potential dangers of investing in Dubai. The costs were at all time high, the price of rentals were at all time highs, 25% of the world’s cranes were in Dubai at the time, and there were buildings coming up everywhere. However there was another anomaly. Many of these buildings were completely empty. Devoid of human activity as they awaited tenants at exorbitant rents.  Dubai’s investors had not realized that the price had gone beyond reasonable, I noted this in my little book checked out figures and came to the conclusion that all Dubai needed to drop out of its sky high limits was a little push. That finally came two fold. One with the collapse of Lehman brothers which nearly took the world over the edge and in 2009 the near collapse of the company that was involved in financing the tallest building in the world. At the time no one paid heed to my finds or if they did I do not know about them. To sum it up the buyer told the supplier; “I am not paying”, the supplier told the bank “I can’t pay” and the bank told its account holders it can’t pay. What we had in effect was a chain reaction. (Pardon the pun)

Dubai is literally a city built on sand, a large Disney world for the financial world. It was a mirage and continues to be one with people still in it living within the illusion.  It has no facility for supplying water except through a desalination plant which is fueled by dwindling supplies for natural gas and some oil. No manufacturing base and finally no resources.  Its income from oil has diminished in the past twenty years and the emir realized this and created one of the biggest illusions this world has ever known. A Ponzi scheme that surpassed any illusionist’s production! What exactly is its backup? Nothing! Air I guess.

Nairobi is going through a real estate boom similar but smaller in scale. It is financed by another source though it is simply a rumor but the pirates of Somalia provide a steady inflow of cash into these markets. While this continues to thrive it provides a major income if true for the real estate developers. Kenya’s Achilles heel is its interest rate. If the base is 11.5% than the smaller banks and housing finance corporations are bound to provide loans at approximately 5% to 7% above that so 17% to 19%. That is a high rate. In fact unaffordable; developers currently purchasing land at 100 million to build 25 flats. Now how many people in Nairobi can afford that? They are buying! So where did the money come from?  The rentals do not reflect the investment compared against the return in base interest either.

Why the buying that is currently going on? The partial reason is the easy loans available based on the banks premise that the property will continue to move up in value. Good middle class jobs available from various international companies currently using Kenya as a central point to provide supplies and services to surrounding chaotic situations that tend to develop form time to time.

If we look at history this is not the first time  such a phenomenon has occurred. It has occurred in at least the following cities; Tokyo, New York, Hong Kong, Mumbai, and London. Loan defaults simply mean the inability to make payments. Should such a scenario take place in Kenya we will have massive defaults which will inevitably mean the closure and resultant major losses for bank account holders, apart from the various developers going bankrupt. These banks are high risk ventures which have perhaps leveraged them selves as well. It is not feasible to provide such high returns as we have seen in the recent past. So we continue to enjoy until the music stops. However with the developers we may also see many of these banks also collapsing due to over stretched leverage.

It’s Euphoria based on the illusions that prices will not fall but continue to rise. Commonsense has taken leave. Consider that the price of a house in our suburb is almost equated to a similar house in the UK, though this is not quite there it is getting very close and dangerous. While in the UK property rights are held in high esteem, this is not the case in Kenya. (Please read land act- it’s interesting)

Kenya’s property market like Dubai has an Achilles heel. Five things make this venture risky if not more.

1.Political instability- the fact that our politicians can disagree when ever they want, and our current selfish attitude towards property rights in Kenya.

2. The international community will bang the be-Jesus out of the pirates and cut off the supply of easy dollars to Kenya banks.

3. A geographical fault line that makes us venerable to earth tremors/quakes.

4. The increase in interest rates of the dollar will make the avenue of taking risk in Kenya’s property boom less palatable, so those that are taking loans from western banks at 6% and putting it into Kenya will have to not only factor in instability of the US$ and the link of the Kenya shilling but also the interest rate as well as the volatility of the Kenya shilling. This interest rate will inevitably go up. At the same time for more business inducement and liquidity to increase in the market the interest rates currently should come down, however with extra liquidity the bubble will inflate rapidly further.  But with US interest rates going up and ours moving down will provide a perfect scenarios for the influx of foreign exchange to drop. Thus the property market of Kenya will begin to show massive cracks and rapid declines. At this point if I was an investor in property I would be selling not buying.

5. Our constitution does not provide for individual property rights. In essence one can only lease land not own it out right  and more so if one is a foreigner. This is not conducive to investment or stability. Property rights should be a fundamental right just as the right to defend oneself which is also missing within the constitution.

All the above makes it non conducive for a trader such as myself to take unnecessary risk.

So with this in mind how does one save them selves from catastrophe?

Kenya has another anomaly. As mentioned in the beginning we had the collapse of industries, but people have begun to learn their lesson and there is business development geared towards manufacturing beginning to take place. In any event that begins, those that take the first steps usually make the largest and widest profits of all. However the land prices make it difficult to begin any investment at a reasonable price.

Currently the major industries are based around basics. Two industries thrive in these sectors. Grains and Education. The private schools are multi billionaires. Take Oshwal academy run by the Oshwal education trust fund. Trusts are great things they do not pay taxes.

A wonderful way to make serious money. Currently each child averages a fee of 60000 per term there are 4000 children approximately made up of Nursery, Primary, Secondary, Senior Secondary, and College.  A total turn over of 240 million every four months. Approximately 720 million a year. Their costs are less than 200 million a year so a net profit of about 500 million. Not a bad little thing going. All tax free off course. As long as there is easy money around.

The other industry is grains and basic food. The costs  of grains have been going up world wide and the grains industries have been cleaver and using world prices to increase theirs. However the local demand has nothing to do with the overseas price. They use the excuse that they are subsidizing their supplies with imported grains. It’s wonderful. Their profits are extremely hot. At least those that are in the private sector.

However a new bubble is on its way. The general manufacturing bubble is coming back. This is big because of all the connected sectors that will be able to take advantage of this and the current road infrastructure development. With roads transport becomes cheaper and faster. I also see the railway structure being overhauled in the future and this will add benefit to cost reductions.  Government think tanks have begun to think and may realize that they have a foreign exchange deficit that may increase in the near future to a point where it is unsustainable. This may bring back the import license quota and the protection of local businesses. Without a manufacturing base it would be difficult to sustain employment at a national level.  They are after all the ones that can employ a majority of Kenyans. This is a major problem for Mr. Kibaki, and a key part of his agenda to winning the previous elections. Above all Mr. Kibaki intends to move out of the presidency with his reputation intact and respected. Vehicle importation was at an all time high in 2008. We now have over saturation in this market, and when this happens the decline in supply follows as an example until equilibrium sets in. With the above neighboring markets begin to reopen providing additional clients.

Manufacturing and agriculture are the only two sectors that have potential to expand exponentially in this country. These are the bubbles that have enormous growth potential and long term sustainability. The problem lies with our local investors to take the risk in something that they do not understand.  The local population has been slow to invest in areas where there is perhaps cloudiness over how the business works. With real estate its simple math and you know where you stand.  With a little more work the manufacturing sector can perhaps give you ten times what your money earns in the real estate sector. Keeping one ahead of inflation. However it requires finesse, marketing, skill and desperation to become something. Essentially intangible skills.

The anomaly is that there are several industries in Kenya that are up for sale at perhaps the cost of one of the real estate investments that look so lucrative to the uninitiated. They are so low in price because no one has realized the beginning of a bubble. However most people look for a turnover or the financial status of the market as ingrained at Universities by theoretical professors such as perhaps my self. A rather naïve and stupid attitude if I say so myself, because Professors regurgitate information from books not knowledge acquired from the field itself. In terms of these investment opportunities one has to really look past the books and gauge the real stuff. Management, capital investment, machinery stocks etc. There is no business right now so what  are the books going to show?  In venture investments one really has to open their eyes and look beyond at the future potential.

Some of these industries are sitting on huge plots of land, some of them are sitting on fantastic manufacturing basis and, some of them require a small push to make them boom. Some of these assets can be separated and sold off to redeem the initial finance. Some will need it for future expansion.

I came across a small company that is not in the lime light. A company that has the potential to target, the educational, shoe, garments, transport, printing, medical, entertainment, and a host of other sectors as clients including taking major orders for the armed forces and other sectors. The company used to export but for some reason they lost zest and suddenly came to a standstill. Their potential margins are phenomenal. We are talking about products with profits of anywhere between 500% to well over 2500%. Incredible. If this company was running in full force their turnover would be in the region of about 100 million per annum. A billion shilling industry. Now you venture capitalists think about this. You need the next wave, well here it is. The company is going for as little as 35 million. To boot it all it has a quarter acre plot of land that goes with the company for free. So what does this company require? Well it requires one to market the products and have a fresh approach. Good management, and the company’s present owners are willing to provide technical support for a period of  6 months to get you on your feet.  This company has the potential to either go public or to be sold in five years reaping huge profits on investment. There is a catch!

Off course there is. It requires hard work to market and bring out the full potential. Some ones giving you the gold mine, but surely you do not expect them to give you gold which is mined and sitting in the stock room too? Do you?  You have to dig a little to get to the gold but its there.

Such companies bought at the bottom will mean real entrepreneurship and a potential to make some serious money in this country at the same time help develop the backbone of this country. A minimal risk at the present price. It will also create the all important phenomenon of wealth creation. It will mean other sectors will begin to  also join as confidence returns to the related or needed sectors. We could see a return to the cotton industry too. Eventually companies like this will have competition but eventually having an initial boost should see them create a good management and infrastructure enough to place it on the NSE.

Real estate is not what it used to be. We are at the summit and people are still buying but it’s a question of when the music stops who will be holding the parcel? Who will be lacking a chair in this financial game of musical chairs? This game is about transferring wealth as quickly as possible to the next player. This game is up and it would make sound sense to look at the manufacturing basis up for sale. That is the new game in town and it has potential.

Take the example of another company. This company was part of the EPZ based on Baba Dogo Rd. It borrowed about KES 1 billion from a well known bank and the bank based on risk was gaining returns of approximately 20% every year. By the end of five years the company had returned the initial amount loaned to them and spent the next five paying interest. Eventually the company could not sustain. It gave up its premises to the bank and took off. The premises are huge. On 11 acres, with a built up area of about 250,000 square feet now lying in the banks hands. While this may look very attractive it is difficult to figure out what one would do with it  unless you have a lot of extra cash lying around and a sound idea for returns. Essentially its real estate at peak prices.

The first company is smaller but with a much quicker return potential and less risk. The second is a potential money pit.

There is change in the air and we are about to hit a crisis if we are not careful. We could be involved in one way or another. If you are cleaver and have the initiative consider picking up whole companies which have capital invested in machinery, and stocks but have no loans or debts outstanding and perhaps only relevant property is not factored in valuation. There are some around and you will have to dig deep to find them but they are there. With a minimum capital investment you will be ahead in the bubble and be in a position to make some good returns. In a nutshell, the real estate game is over or will be soon. It is inevitable. The industry bubble has been deflated too long and is in an oversold position. Get out of the real estate one first and get into the second.

The second method I would apply is to invest in gold. While the precious metal does not earn any interest it works well as a hedge against inflation and holds well with one major advantage over properties in that it can be sold easily on the open market. I do not advocate jewellery or coins as each of these variations has a premium over the value of gold which may or may not be redeemable when selling the asset. There are other precious metals that have done extremely well in the recent past such as palladium and platinum however though geared towards ornaments, their recent hike in price is more to do with their connection to the motor industry. You may prefer to have some of these too as a further hedge.

This provides a safe bet as long as you purchase gold over a longer period of time and wait patiently for prices to come down. Gold trades on various metal exchanges including the NY metals exchange as well as London metals exchange. The price you actually see are what we call futures which means the price factored is usually 1 month to 1  year ahead of the current date for delivery. However this is the price that may be used as the spot price. I am assuming there are a lot of  ladies out there who are smiling after reading this. When purchasing gold please ensure that the ingot or disc is 99.99% pure, has a reputable hallmark and is purchased from a reputable dealer. Rings and ornaments are not pure gold and have little more value than sentimental and are not suitable for investment purposes. It is strongly advised that one rents a safe deposit box prior to making such purchases and is not recommended to keep in residences. Gold is a hedge against inflation and cannot be considered as an investment. In order to redeem value one has to sell it at some point in the future when prices have become too high to be sustained provided it is low when you buy it. Gold is near all time highs for the present, it would be prudent to wait for the price to come down or begin to show a tendency to move up before one purchases.

A combination of both solutions will be a better long term solution to capital preservation.

© Jaimin Vyas 2010.

The author has been in free market trading and economics for the past twenty years. His specialty is on the various world stocks and commodity exchanges. He has been a keen student of technical analysis on the movements of stocks and commodities on various markets around the world and lectures on free market economics and trading as a guest lecturer to various organizations companies and universities.

If you would like this piece to be the Story of the Week, please vote below on a scale of 1 to 10, with 1 being weak, and 10 being excellent. The numbers will be tallied on Friday and the story with the highest figure shall be Crowned Story of the Week. Be sure to fill in your name and verifiable email. You can include your critique/comment after the vote.


2 comments on “Financial Calamity in Kenyan Markets by Jaimin S. Vyas.

  1. Pingback: Storymoja Blog – Interview them! :: Storymoja

  2. Pesa
    November 18, 2011

    Very timely,insightful and relevant.Unfortunately too many people are too blind too see the bubble


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