LIKELY IMPACT OF HIGH INFLATION ON THE NAIROBI STOCK EXCHANGE

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The past couple of weeks have witnessed a dramatic decline in the value of the Kenyan Shilling against the U.S Dollar among other major foreign currencies. This has set rolling fears that inflation is set to soar to levels last seen when the global economy was in the doldrums during the Global Financial Crisis.

The high inflation stems from a number of reasons among them the high fuel prices. If the Kenyan Shilling weakens against the U.S Dollar (which is used in most international transactions) Kenya will for the same amount of money buy less goods than they could only a couple of months ago. And with oil prices still high, we will spend quite a big chunk of our money on oil imports.

Not to forget the impact of drought - which seems perennial to our country (and is it me or are harvests usually “below expectations” every single time?) In order to ensure the people do not starve, The Government will either have to pick up the tab on grain imports or allow maize to enter the country without duty (also providing a few well placed waheshimiwas the opportunity to make a killing)  

Interest rates are also likely to head north as banks begin to act defensively (like they did a couple of years back). T-Bill rates are already breaking new ground.  

So what does all this mean for our beloved Nairobi Stock Exchange? What follows is my opinion of what will go down across the different sectors if the high inflation rates persist for a while. Note that I give opinions on the performance and not the share prices. Plus the article is based on country-specific (Kenya) analysis

Commercial Sector

These companies’ performance depends on the disposable incomes of consumers. In a period of high inflation, disposable incomes reduce and consumers spend less.

Retailers particularly don’t do that well during periods of high inflation. Uchumi Supermarkets, recently back on the bourse after a long hiatus, may see its recovery stifled.

CMC will also be hit if the high inflation persists. Let’s face it, in hard times a car is not the number 1 priority. Luxury car sales were recently reported to be up, but you can bet this feat won’t be a regular if the current tough environment holds up. C&G falls in this category too

I see no major effect on Safaricom. The telecom industry is still on a growth curve and the data market is begging to be exploited

Kenya Airways is well diversified into other markets (44 destinations in Africa) for it to be affected by events in Kenya. Passenger numbers were up as a result of a host of new routes that were incorporated during the year under review. The airline is also likely to get more shillings as their services are priced in foreign currencies which have strengthened against the Kenya Shilling.

Of course all this is assuming the global economy does not tank like it did in 2008

As high inflation is generally associated with a slowdown in consumer activity, other sectors will also record reduced growth. Thus, media and companies will generate less business. Advertising revenue will be hit hard as companies cut back on expenses.  

TPS Serena will record a reduction on the number of domestic tourists, but will get more shillings from foreigners.

Financial Sector

Banks turn defensive during times of high inflation. This is to say that they prefer ‘riskless’ profits, such as bonds, to lending to businesses which might default. Interest rates will also rise to reflect banks’ unwillingness to lend to those who they consider to be ‘high risk’. This has already happened with The Commercial Bank of Africa (CBA) raising its interest charge on loans to 14.5 per cent from 13 per cent effective from July 11.

A high cost of credit is an impediment to the growth of businesses. Default rates will go up if the cost of living continues to rise.

With treasury intent on mopping up excess liquidity from the economy, Treasury Bill rates have shot up in a short span. The 91-day Treasury bill is trading at 9% while the 182 day bill is at 9.9%

It was recently reported that commercial banks’ purchase of government securities has jumped by Sh20 billion. This shows that lenders are not that confident of lending to the private sector. Plus who would blame the banks for buying government securities when the rates have risen as they have.

It is even being reported banks are borrowing money from the CBK and putting the same money into T-Bills. If true, this goes to show the level of uncertainty that lenders have about the private sector’s ability of repaying loans.

Banks also face the risk of losing customer deposits to the high interest Government Securities

Though banks will not repeat the performance of 2009 (where Equity grew by 5%, Co-op  11%, and KCB 5%) they are also highly unlikely to repeat last year’s stupendous performance.

Insurance companies which are limited to the local scene will also suffer the same fate as they usually use their float to make investments, many in the NSE.


Industrial Sector
To be honest, I don’t feel that the inflation level will put a dampener on housing prices which are high as a result of excess demand coupled with thin supply. Cement thus is likely to be consumed in more quantities, albeit at a lower price with the entry of more capacity by year’s end

Flour miller Unga Holdings may experience less demand for its products as the biting inflation forces Kenyans to change eating habits, in favour of cheaper foods. Flour has maintained its high price thus forcing consumers and their tight purses to find alternative foods.

Utilities KPLC and Kengen deal in energy which is essential and demand for their services are unlikely to fluctuate much. As demand for electricity is set to rise over the years, their revenues will follow suit.

Oil marketer KenolKobil will weather the storm due to its heavy presence in the region and in Southern Africa. In fact, management expects very strong growth, thanks in no small part to its diversification strategy.
I cannot say the same for Total Kenya

Agricultural Sector
With the weak shilling partly contributing to inflation, the agricultural sector presents a mixed bag. While they earn more money from exports as a result of the cheaper shilling, expenditure will also rise as costs such as fuel increase.

If oil remains stable and the Kenyan Shilling further weakens, these companies can grow their revenues. Sasini Tea & Coffee is in the process of adding value to its products and be involved from production to the market place.    

Kakuzi is highly diversified

The agricultural firms also rely on biological gains from revaluation of land and property, thus the downside, if any, will be limited

All in all, inflation affects the raw material cost of companies. Cost of producing a good goes up due to an increase in inputs like labour, land, raw material, petrol, transportation, etc. Thus the profit margins of most companies reduce. To cover up for the reduced margin, companies hike prices of the goods and services they sell. As it is always not possible to hike prices for fear of losing customers, companies’ margins will be reduced and thus growth prospects of a company will reduce

It was recently reported that fund managers were shifting their investments from shares to fixed deposits and T-Bills to tap rising interest rates and check erosion of their portfolios by high inflation and a weakening Shilling.

Thus, it is not an improbability that the Nairobi Stock Exchange will further slide. I look at this favourably though as I believe a host of opportunities of purchasing chasing strong companies at discounted prices will be realised from this.

The high inflation has resulted in Kenya’s GDP growth for this year cut to 4.8 per cent from 5.3 per cent by the World Bank.

 

Fuel prices were lowered by the Energy Regulatory Commission in its latest set of prices

Let me end with this quote from the Central Bank Governor, Prof Njuguna Ndung’u:

“Continued high inflation is bad for growth and bad for the poor, too. The poor tend to pay a higher price in a crisis like this.”