SMEs: PILLARS OF THE ECONOMY

In Greek mythology, the Greek god Atlas holds the heavens on his shoulder. The same thing can be said of SMEs and their support of various world economies, including Kenya’s.

Contribution of SMEs to major economies

China’s economy has grown in double digits over the last few years despite the global recession in 2008. SMEs enabled her stay on course, unlike her western competitors. Mr. Toshiki Kanamoi, a former Director at Asian Development Bank Institute, and others presented a paper addressing China’s SME development strategies on 8^th October 2007. He said that 99% of all registered enterprises, 64% of total output value, 55% of sales revenue and 77% of employment expansion in the industrial sector can directly be attributed to SMEs in the country. SME contribution to the Gross Industrial Output Value was four times its figure in 2005 compared to 2009.

Delivering a speech addressing SMEs on behalf of Dr. Manu Chandaria, Mr. J.W.T Nasirembe referred to Singapore and Malaysia’s SMEs and their contribution. In Singapore, SMEs make up 90% of enterprises and contribute 42% of GDP. The Malaysian government has also recognized the SME potential and has plans in play to have SMEs account for 51% of all employment by 2010.

SMEs in Kenya

With only about 50 companies registered in the Kenyan Bourse, it is clear that SMEs make a bulk of enterprises in the country. Releasing the Kenya Economic Survey 2011, Honorable Wycliffe Oparanya said that of the 503,000 jobs created last year, 80.6% or 440,000 were in the SMEs with the formal sector only contributing 62,600 or 12.4 per cent mainly in building and construction, transport and communications, wholesale and retail trade; restaurants and hotels.

The SME sector faces a myriad of challenges that impedes its growth and contribution to the economy. There is limited access to credit and financial services, a fact that is fuelled by the prohibitive rates of lending to this sector. SMEs are often starved for finance because they are considered too risky. Other factors that pose a challenge to this promising but untapped sector include high cost of energy that is very vital in the running operations of these enterprises, corruption, prohibitive tax rates, and oppressive bureaucracies within the legal and regulatory frameworks that govern this sector.

The Government of Kenya (GOK) is making deliberate attempts to promote the SME sector in various notable ways. The government has realized the vital role played by the sector and is at the forefront of championing the SME sector as a key player in the achievement of Vision 2030 goals. Mr. Abdulrazaq Adan Ali, the permanent secretary in the ministry of trade, had this to say in an editorial piece in a local daily, “SMEs are central in creating a balance between the needs of rural and other disadvantaged areas, where the majority of the poor live thus increasing competition and contributing to a more equitable distribution of income. This is due to the fact that they are the main source of economic growth and employment”.

GOK and the World Bank have also launched a ‘Micro, Small and Medium Enterprise Competitiveness Project’ that aims to provide access to finance, strengthen enterprise skills and market linkages, and provide a favourable business environment. The MSME project promises up to 4 million dollars in grants to be channelled to the sector through financial organisations.

Other government initiatives like the Youth Enterprise Fund are going a long way in enhancing the performance of small and medium enterprises in Kenya.

The private sector also does it part in supporting the sector. A notable initiative is the annual Kenya Top 100 Mid-size company survey, the brainchild of the Nation Media Group and KPMG, a financial consulting firm. The project aims to provide recognition for players in the sector and highlight challenges they are facing with an aim of finding solutions. More support is being given to the program, with the Standard Chartered Bank and Sage Pastel having signed a six million shilling deal to support this year’s Top 100 event.

Various commercial banks are also aiming to expand their loan portfolio by introducing SME banking through which the players in this sector will be able to access loan facilities to meet their financing needs.

In his speech during the 5th anniversary celebration of Fusion Capital, Mr. Kung’u Gatabaki, chairman of the Capital Markets Authority said that the introduction of the Small and Medium Enterprises Exchange (SMEx) in the Nairobi bourse early next year will create a much needed platform for the players in this sector to raise capital and meet their financing needs. This should enable SMEs unlock their full potential thereby propelling Kenya to double digit growth as envisaged in the vision 2030 Economic Blueprint.

Back to Atlas, some versions say Hercules erected pillars to liberate Atlas from the weight. Don’t you think we should do the same by providing support to our SMEs?

                                                                                               

Faith Kalei and Denis Nyanja

MAKING SENSE OF THE SHILLING

When one goes to the market, to buy or sell a product, (s)he always has a means of exchange. In most instances, the medium is usually money. In the forex market, the good to be exchanged is the money itself. Since there is no universal currency for exchanging money, trade in this market is barter, and the universal consideration is the value of the money.

The United States of America is the economic super power of this time, making the US Dollar the most circulated currency in the world. When a country, say Kenya, wants to buy goods from Mexico, they would have to get the Mexican Peso. Since it is difficult to get the Peso, most countries would use the dollar instead, because chances are high that they will trade with it.

Kenya, same as most countries across the world, uses the USD to measure its currency. Being a net importer (imports more than it exports), the country is in a position where it constantly seeks the dollar.

The falling Kenyan shilling

During the first term of President Kibaki, the shilling barely touched the kshs 70 against the dollar. The Post Election violence of early 2008 saw it loose ground slightly, and it has struggled to recover since.

However, between August and October 2011, the shilling lost ground from kshs 80 to as low as kshs 107 against the dollar. This is a very sharp drop given the two month period, making the Kenyan shilling the second worst performing currency in the world. Question is, what does the falling shilling do to us?

Consequences of the fall in value

The shilling has resulted to high production costs for businesses that rely on inputs from it. One of the reasons given by telecommunications leader, Safaricom, for hiking its prices was that the equipment they ordered from abroad have automatically increased in value. Companies that had ordered inputs before August will have to absorb such costs, unless they hedged such contracts.

Instability in the currency has also caused inefficiency in budgeting processes. According to the Business Daily, Financial Directors are under increased pressure to revise their budgeting processes to tally with market dynamics.

The economy at large is bound to suffer, since the country imports more than it exports. In the end, this will result in inflation and increased cost of living in the country.

It is however not doom for all players in the economy. Tea and coffee farmers are laughing all the way to the bank, since they receive more money for the same quantity of exports. The falling shilling also provides greater opportunity for growth of local industries, as consumers are bound to prefer cheaper locally made products to the more expensive imports.

Reasons for the falling shilling

Until now, there is no universal reason for the sharp fall in the shilling. In early July, arguments were that the shilling was falling in response to the Eurozone crisis, which resulted to increased demand of the dollar in the global economy. Although most players in the global market called for interventionist policies by the regulator, the Central Bank, its governor was reluctant, claiming that it would soon stabilize.

It defied its predictions, falling further by the day. Appearing before the Parliamentary Finance Committee, Prof Njuguna Ndung’u claimed that the falling shilling was a result of five major banks hoarding the foreign currency. The Treasury has since denied any knowledge of such information.

Latest attempt to stabilize the shilling

This month, the Central Bank claimed that it had done all it could to stabilize the shilling. The onus now was on the Treasury to rescue the currency.

In other levels the government have tried to rescue the shilling, with the President holding a high level meeting to address the crisis and the Prime Minister setting up a technical team to mitigate the effects.

The Minister of Finance, Hon. Uhuru Kenyatta, made a public statement concerning the reactionary measures of his ministry that were received positively, and stemmed the fall. Among them was the plan to take a loan of $600 million to increase supply of the dollar in the economy. IMF chief Christine Lagarde is expected in the country to sign the deal, but she was preceded by a technical team which is currently discussing the specifics with Treasury.

The way forward

The shilling remains at rest at the kshs 107 mark. The market has currently adopted a wait and see attitude in anticipation of the IMF deal, and other measures by both Treasury and the Central Bank. Until that time, our fingers should remain closed!

                                                                                                                Denno Nyanja

THE COST OF WAR

One of the debates brought forward in the Book, ‘The Art of War’, concerns whether a king should sustain the army during times of peace, as of war. The matter is addressed in among others, an economic sense. Fabricio, one of the characters, argues that an army would attract wages in either case, and it would make sense to the Treasury if a majority of them was allowed to return to their occupations during calm times to reduce the financial burden.

Today, just as in ancient time, going to war has a financial tag to it. That is why countries which are able to sustain a war for a long time are more often wealthy ones. Less endowed countries that have lengthened periods of turmoil would most probably end up on their knees economically. Question is, what exactly is the cost of war?

Price tag in other states

One key pillar in President Obama’s 2008 campaign manifesto was the return of troops back home. As at that time, he claimed the war that started in September 11, 2001 had cost his country some 1 trillion US dollars. In 2011, the White House reported that this figure had accumulated to $ 1.3 Trillion, and would increase to $1.4 Trillion in 2012.

A research titled, ‘Cost of War’ sponsored by Brown University, claims that this figure is grossly underestimated. It puts a current price tag at $ 3.7 Trillion, and projects it to hit the $ 4.4 Trillion mark.

According to official budget figures, the People’s Republic of China plans to spend $ 91.5 billion of her military this year. Various international agencies also claim that this figure is grossly underestimated; with the RAND Corporation saying the actual figure could be 40 – 70 % higher.  According to the Xinhua News Agency and the RIA Novosti, Russia plans to increase its military budget from $ 42 billion in 2010 to $ 66.3 billion in 2013.

Some countries have opted for the cheaper end of the stick. Wikipedia lists 12 countries with absolutely no military force, with a further 5 having no standing army but an internal force with paramilitary skills.

Cost of war in Kenya

During President Kenyatta’s era, it was for a moment illegal to know how much was spent on the Kenyan military, so the figures were never declared in the country’s budget. Military spending in Kenya have in the recent past been in the Kshs 40 billion mark despite the country being at peace. Military spending is so highly prioritized that early this year, the government diverted teacher recruitment funds to the military to cover unforeseen immediate jump in costs.

Kenya is currently on the offensive, dubbed operation Linda Nchi, against the Al Shabaab in Somalia. This should automatically translate to increased costs on the military. There are no figures to attach to this offensive, and maybe the figures won’t be available in the foreseeable future. How much then does this current war cost?

The cost of not going to war

To answer this question, a different approach should be taken. Question should be, ‘how much would it cost the country not to go to war?’ A starting point would be to look at the Tourism sector, which is greatest hit by the terrorism menace. The sector projected that revenue figures would jump from kshs 75 billion in 2010 to kshs 100 billion in 2011, this not even counting the increase that would result from the weakening shilling against the dollar. Any shortfall from this figure would be the cost of not going to war.

Factor in the loss in investment in other sectors due to the reduced security rating that the country would attract by ignoring the Al Shabaab. Above all, Wanjiku entrusts on the state the duty to make her feel secure, including from external aggression. The peace of mind of a nation’s people is priceless, and the state should not spare cost to ensure that her people enjoy this right.

The math on the cost of war in the Kenyan case is simple. Summing up these and other factors not mentioned, the product is that WE GO TO WAR, as the benefits far outweigh the costs. In the words of Moses Wetangula, the minister of foreign affairs, ‘The duty to defend oneself is not limited to the rich, even the poor must defend themselves.

                                                                                                                                        by Denis Nyanja

 

INDEPENDENCE: BEDROCK OF THE AUDIT ENVIRONMENT

The European Commission’s Green Paper on Audit Policy has generated much debate. The paper hopes to address apparent cracks in the audit profession, revealed by the 2008 financial crisis. Matters highlighted include expectation and communication gaps between auditors and clients, matters of independence and conflict of interest, and the regulatory burden faced by SMEs.

The greatest interest lies in question 19 of the paper, which targets dual audit and consulting roles of the Big Four. In an article published in the Financial Times, KPMG Global Chairman Michael Andrews vows that the firm will never split its audit and consultancy businesses. Roger Acton, Director of ACCA Europe, describes any regulation meant to downsize the Big Four as inappropriate.

Lessons from the past…

The argument about audit firms venturing in and providing non audit services is not new. Following a previous split the consulting wing in audit firms reemerged in the second half of the last decade. Pundits argue that such a systematic arrangement shakes an auditor’s independence, which is described as the ‘unshakeable bedrock’ of the audit environment. Question is, does it?

Arthur Anderson is accused of ignoring SOS signs in Enron, largely because of the USD $27 million consultancy fees that came with the $25 million audit fees. Consulting does carry with it big numbers to audit firms, and from the management point of view, it would be a bad idea to separate audit from consultancy. From an employee’s point of view, the marriage of the two provides an avenue for exposure and experience. That way, the auditor gets to know how a client can solve her problems, after making recommendations in the management letters. What of the client’s point of view, which is most important. Does he get value when the two wings stay together or when they separate?

The client gets value through audit quality she receives. The audit quality is a function of many factors, including the auditors knowledge, experience and ethical qualities, among them independence. The expansion of services offered by audit firms is part of the natural intellectual progression of man. Auditing is about identifying issues, advisory acts on such issues. To curtail such progress would be inhibit knowledge generation in the profession. It is also logical that the auditor gets greater experience when the firm has both functions than when it has one. What awaits clarification is the independence bit.

Independence; the main issue…

What is an auditor without his independence? Independence is the cornerstone of profession, and auditors themselves appreciate this fact more than anyone else. If there is anything learnt from the Anderson saga, is the bigger one is, the harder one falls. Breach of independence can make giant audit firms fall hard!

For this reason, the audit profession has set for itself robust regulations to ensure that the auditor is not compromised. Among the rules is the categorization of non audit services that an auditor can provide to the audit client and those prohibited. These have been assimilated in national regulations and internal firm mechanisms.

At KPMG, independence is given priority in approving an engagement with a client. Before an audit team goes out to an assignment, the engagement must be run through a global independence database system called Sentinel, and an approval given. The approval procedure is detailed and intensive, taking into consideration the historical and emerging independence issues all around the world. The process is so serious that should the approval process fail, the firm declines to take up the engagement.

The firm also ensures that its people have independent frames of mind. Annually, employees have to take independence tests, to refresh the concept in their mind. Before every engagement, all auditors have to sign an independence declaration form to disclose any matters that could impede their judgment. The firm also has a standing risk management department, which ensures that independence and integrity are always the top agenda of the firm. The long and short is that auditors in the firm eat, drink and sleep independence.

The answer; not to separate…

The auditor therefore has many lines of defense before he loses his independence. Regulations prohibiting provision of advisory services by audit firms with an aim of assuring independence would have little effect on whatever safeguards have been built. On the contrary, the provision of both audit and advisory services by audit firms would ensure increased audit quality, which translates to heightened value delivered to the client. After all, that is what we are about!

Denis Nyanja
Appeared on Msafiri; a KQ publication; December 2011 issue