Ideas & Debate

Why State spending on infrastructure programmes could cut interest rates

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A construction worker at the trial section of the standard gauge railway at Mtito Andei. PHOTO | JENNIFER MUIRURI

Kenya’s interest-rate environment is set to get a major boost from the government’s ambitious infrastructure spending plans.

First, the standard gauge railway project, whose first phase is expected to link Mombasa and Nairobi, has seen local land owners whose property was acquired to build the new line get compensated to the tune of billions.

In fact, late last year the Transport and Infrastructure ministry had indicated that payments of up to Sh10 billion would be made to individuals and State agencies whose land was acquired.

The 500-kilometre Mombasa-Nairobi portion of the standard gauge railway line is projected to be completed by March 2017 at a cost of nearly Sh340 billion.

Second, the dualisation project for Nairobi Outer Ring Road and additional construction of Nairobi Eastern missing links, which was launched a couple of days ago by the President, is expected to cost Sh8.5 billion.

Third, the Transport ministry is now implementing the annuity programme of financing road construction.

Basically, contractors will now obtain loans from banks to construct roads but get paid back by the Treasury through regular disbursements each year for up to eight years.

It is a design, build, finance and maintain model whereby the contractors will negotiate for financing from banks before submitting bids.

And a contract will be won on the basis of the lowest annuity payments. Under this annuity programme, the government has rolled out an ambitious plan of building 10,000 kilometres of roads in four years with yearly annuity payments to the tune of Sh47 billion for 3,000 kilometres of roads.

These are huge infrastructure projects. But what is the relationship between government infrastructural spending and interest rates? The government is the biggest source of money market liquidity.

Between 2007 and 2014, government injections into the liquidity system accounted for 63 percent of total liquidity injections.

These injections are typically via debt redemptions and payments, both recurrent and capital related payments.

With these additional huge infrastructural spending plans, the market should expect a fairly liquid system on a net basis, especially in the second quarter through to fourth quarter.

In turn, this will translate into lower cost of funds for banks. And remember cost of funds is one of the biggest elements when banks price loans.

Historically, there has been an inverse relationship between excess money market liquidity and cost of funds (generally, cost of funds is reflected by overnight interbank lending rates).

So as the government continues to unveil more infrastructural spending in 2015, interest rates may come down.

However, on the flipside, it is a double-edged sword, to the extent that excess liquidity in the system does not bode well with exchange rates; in fact, the two do not see eye-to-eye.

And so the success will lie in the ability of policy makers to systematically co-ordinate fiscal and monetary policies by ensuring that money creation does not breach monetary boundaries.

Additionally, success will also lie in the ability of banks to pass-on the benefits of the expected low-funding cost to borrowers through downward re-pricing of loans.

The writer is an investment analyst.