Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

Financial Markets and Institutions:

(The Key to Private Sector Development in Kenya)

Abstract

Financial Markets and Institutions – the key to private sector development in Kenya

Building strong financial markets and institutions is key cog in the strategic approach wheel to the
growth and development of sustainable private sector. Research findings indicate that there is
positive correlation between presence of financial markets and institution and private sector
growth. This explains the development disparities between south and north.

China is an example where efforts to install financial markets and institutions has yielded positive
results. Sub-Saharan Africa (Kenya included) is said to be lagging behind in putting adequate and
effective markets and institutions so is its lack-luster performance in private sector expansion.

Financial system must be able to develop and manage appropriate intermediaries and financial
instruments to help mobilize and channel funds for the private sector development. This calls for
installation of transparent and responsible institutions to supervise and regulate operation and
management of markets and markets participants.

Markets and institutions facilitate private investment through various channels and means for both
local and foreign. Foreign Direct/Institutional Investments require predictable markets and
institutions in the local investment scene.

Presence of adequate financial institution accelerate both local and international trade by opening
up new markets necessary for development of private sector. Availability of various financial
instruments makes it possible to raise funds and manage risks encouraging confidence and
growth.

Dynamic education system is necessary to guarantee quality labour-force with continuous

innovative skills to install and manage markets and institutions to steer development in the private
sector, which is backed by synergy between new technology and new knowledge.

It also promotes stronger marketing strategy to help gathers and disseminate market intelligence
for product improvement and new product development necessary to sustain private sector
growth and development.

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

Financial Markets and Institutions - The Key to private sector development

With business trends increasingly changing to financial and money economy across the globe,
there is equal need and urgency to build stronger and dynamic financial markets and institutions.
This has become a key cog in reforms wheel that has created disparities between the nations and
regions.

Financial markets and institutions are powerful tools for mobilizing savings, channeling funds for
private investments, and raising capital for start-ups or expanding businesses in the private
sector. A broad-based financial system is able to induce and sustain credit creation facilitating
multiplier effect through wealth creation to improve quality of life.

Lack of proper financial markets and institutions impedes trade and investment in the private
sector perpetuating prolonged economic stagnation. According to the Research Programme
Consortium on Improving Institutions for Pro-Poor Growth, IPPG (briefing paper 5), Institution &
Economic Growth in Bolivia, indicates the country remains one of the poorest in the Americas. The
issue highlighted to be responsible for the woes are the poor state of economic institutions.

Statistics show that the country has actually seen real income fall in the last half a century (Penn
World Tables) in contrast to majority other countries in the region where real income has typically
doubled since 1950.

Poor legal and institutional frameworks leaving property rights in uncertainty has eroded
investment confidence in the private sector. Institutions governing transactions and financial
markets often fail to provide business and citizens — especially small-scale enterprises and poor
households — with means to save, insure and obtain credit. In a region where financial
transactions rely heavily on the informal system, both local and foreign investors are keen to see
efficient and effective legal redress structures operational. It would require attitude change and
approach to educate the population about the benefits.

This seems to have created a financially illiterate population with less disposable income to invest
or spend to spur growth and development of the private sector.

Africa, especially the Sub-Saharan Africa (SSA) regions, is still bearing the brunt of the least
developed region even after half a century of political freedom because of slow pace to reform
and develop its financial markets and institutions to induce and encourage investment in the
private sector.

Lack of proper ways and means to promote financial literacy has been a big impediment to
business development and financial securities across the world, particularly the developing
nations. Parliament, as the law making body, should play a proactive role by making sure that
there are adequate legislations protecting property rights.
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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

In a versatile market system, the financial intermediaries act as the portal of most business
transactions. Corporate governance, integrity, transparency and accountability are very pertinent
while building strong financial markets. Without which, there is imminent threat to growth and
development.

The United Nations University- World Institute for Development Economics Research (Research
paper No2006/87), on Institutional Analysis of Financial Market Fragmentation in Sub-Saharan
Africa (Risk-Cost Configuration Approach), financial markets have a very limited role in the
mobilization of resources to facilitate growth-enhancing private investment.

The institutions remain largely fragmented with substantial gaps in financing economic activities
by private agent. It also suggested that continuous poor performance of financial system can be
partly explained by the high degree of financial fragmentation (Aryeetey et. al 1997).

In view of the findings, the continent’s poor private sector performance could be reversed were
effective markets structures to be installed.

The private sector investors need clear governance and legal structures to give confidence about
fall back mechanism, which could be done by, building new institutions and modernizing the
existing ones to seal off any leakage in the financial system to support and sustain private sector
growth.

For institutional development to penetrate the continent, Africa should be cautiously weaned on
taking along its cultural diversity to generate affinity and acceptance. In the research findings
(UNU-WIDER), in SSA economies, formal institutions co-exist alongside informal traditional
institutions as a result of modern institutional structures being superimposed on the traditional
society, often without necessary adaptations.

The financial markets and institutions in most developing worlds still suffer from imperfect, costly
and incomplete information seen in a plethora of informal bodies hardly worth classifying as
effective and complete.

What is lacking? Let us vaguely call it investment education.

Without requisite education, the private sector ends up with a heap of dead businesses, when
they fail to compete or lose focus. In his book, Economics for a Developing World, Michael Todaro
underscores the importance of human resource. Todaro asserts: “It neither’s the human resource
of a nation, not its capital nor [sic] its material resources that determine the character and pace
of its economic and social development

Financial and business education should be incorporated in the learning curricula of formal
educational institutions to inculcate business orientation and understanding among the learners.
Just as a warning, this should not be tied to the wan method of rote learning, but designed to
equip the interested leaner with knowledge that would make existing business expand and other
potential entrepreneurs, roll up sleeves and work. This education should excite the learner on a
particular segment of business, not the characteristic copious notes for passing theory.
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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

Skills in management and analysis would reverse the trend of too many graduates of business,
entrepreneurship, finance—name it, following few jobs for fear of failing in own business. This
scenario means the private sector is under siege, is shrinking, and slowly repelling because it does
not have success stories.

Investing in human capital is another way to take private sector development a notch higher.
There should be collaboration among nations to enhance free labour mobility across the global
markets to reduce the high rate of unemployment.

There should be a clear policy focus on public and private sector investments targeting education
and on-the-job training to increase efficiency in the private sector and at the same time create
more opportunities. More and better educated labour-force is a prerequisite for rapid economic
growth and social equity necessary for a progressive private sector.

In an enlightened society, capital mobilization, domestic saving and repatriation of capital are
made more realistic to provide more finance for investments. Quality education will guarantee a
high quality labour that can leverage on deepening capital resources and technological innovation
to solve business and economic problem.
This will create a culture of knowledge sharing within and between organization, which will in turn
encourage innovation and competition necessary for private sector growth. Above all it must be
able to equip learners with skills for continuous learning and creating new knowledge through
entire lifetime.

According to Robert B. Kozma’s white paper on ICT, Education and Economic Growth, November
2006 “The synergy between new capital, new skill, and new knowledge creates sustained growth
and an improved standard of living”. He argues that through this synergy, a “the knowledge
economy” can be built. In knowledge economy, new knowledge is not only the input but also an
output of the economy. The creation and sharing of new knowledge feed into the economy to
generate a knowledge–driven, virtuous cycle of sustained growth.

In a place like China where there has not been any serious political governance reforms since the
start of communism in 1949, it has, however, carried out vigorous market reforms since 1979. It
cites how it embraced some international standards and practices. This has, in turn, rewarded it
with a bigger market and put the private sector in the driver’s seat. As a result, China has become
a beneficiary of rapid economic expansion with a sustained growth rate of double-digit figures for
more than a decade.

However, authorities must be wary rampant increase in counterfeit and sub-standards goods. For
instance, there have been various complaints from consumers and standards watchdogs on sub-
standards and counterfeit products from some developing nations. This can serious undermine
the efforts by genuine and innovative private investors and overall economic growth and
development.

Another research by UNU-WIDER (Paper No. 2006/85), Financial Sector Development and
Growth, the Chinese Experience (Iftekhar Hasan and Mingming Zhou) shows that there is positive
correlation between financial sector development and economic growth.
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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

The study examines the relationship between financial development and economic growth in 31
Chinese provinces covering 1986-2002. The research concluded that there is evidence that the
development of financial markets, institutions, and instruments have robustly contributed to
economic growth in China.

Private sector development and presence of working markets to sustain expansion is unique to
and spectacular in China, notwithstanding its political democracy. Meaningful reform agenda
should not consign financial and economic reforms to the back burner.

Fiscal and financial System reform

For faster private sector development, governments should accelerate privatization of the State
Owned Enterprises (SOE). This will require attention to working fiscal policies (for facilitation) as
opposed to direct running of businesses, perhaps based on “the governments are poor business
managers” mantra. Governments had better remain as the regulator and supervisor of the private
sector by setting up appropriate investment and other policy incentives to attract local and foreign
investments.

Take the credit rating as a tool in the financial sector. It’s necessary to have independent multiple
credit rating agencies in the system for the benefit of service providers and users.

Infrastructure is the backbone of sustainable economic growth and development. If all the public
utilities were to be left to the government, like has been the case for a long time, the impact
would be slower and clumsier with the possibility of stopping investment.

Involvement of the private sector in the area could directly spur investment progress. Worrying is
the trend where the entrepreneurs have to contend with poor roads, railways, and
telecommunications everyday in pursuit of profits. The private sector should be allowed to build
roads just like they have done and excelled in telecommunications.

At the policy level, governments should be proactive to open up sector for private investment
because “infrastructure is basic to economic development and improvements in it can be used to
attract industry to a disadvantaged area”. (Bannock G., et al, Penguin Dictionary of Economics,
Seventh Edition.)

As financial markets are experiencing the convergence of the banking, insurance and securities
industries, commensurate legal and financial reforms should be undertaken to accommodate the
changes. This can deepen and encourage private sector to participate in project financing and
development.

A policy to guide the Public-Private Partnership (PPP) arrangement would attract more investors
and at the same time facilitate creation of favourable investment environment. The model Build-
Own-Operate- Transfer (BOOT) can be implemented to trigger growth and development at a
reduced time frame. The model can be used in heavy capital infrastructure like roads,
telecommunication, airport, and electricity generation among others.

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

The arrangement will allow the private consortium finance and manage the project and in return
get concessionary period to operate it to recoup the investment. This policy direction is likely to
add investment opportunities and also acts as an enabler for business in the private sector.

To be left squarely on the heavy shoulders of the government is maintaining and strengthening
role of strategic planning of infrastructure sectors. It, thus, should identify priority areas for
private sector participation and the level of complementary support. Governments should also
zero-in on creating synergy through the Private Finance Initiative (PFI) and Public-Private
Partnership (PPP).

Banking reform:
In the Chinese study, recommended banking reforms included establishing a central bank
(People’s Republic Bank 1994), transforming the urban credit cooperative into commercial banks
(1996-1998), granting licenses to some foreign banks, and to non-state commercial banks.

Others were reducing government intervention in credit allocation, loosing interest rates controls,
recommending standard accounting and prudential norms.

In developing economies, many people do not get access to banking services and instead are left
to the insecure traditional money lenders and pyramid schemes. It behoves governments to open
up the banking sectors to allow more players in the market. However, central banks should
increase the capital adequacy requirement for the commercial banks in pursuit of stable financial
base. Policies should be in place to allow banks to raise finance from the public through capital
markets. Capital adequacy can also be addressed by encouraging small indigenous banks to
merge or go for strategic alliances with foreign banks.

Commercial banks should develop effective methods for their screening process and have
procedures for taking collateral before advancing loans. Related to this should be the setting up of
mechanisms for loan monitoring especially the actual projects in order to reduce high occurrence
of non-performing loans.

Among other gains, this is expected to spur healthy competition within the private sector.
Commercial banks should be allowed and encouraged to open up branches without restriction if
they meet the criteria in order to reach more people through retail banking.

Free interest rates and micro-credits will encourage broader participation which will boost private
sector expansion through market efficiency and excellence of business processes.

Another imminent challenge facing the monetary authorities, particularly in the SSA, is inflation.
Inflation is a challenge to the banking industry and private business especially when sourcing for
raw materials and selling finished goods and services in a liberalized market. Increasingly, the
international trend is to define price stability or the achievement of low price inflation.

An independent Central Banks should act as the monetary authority in a financial system with the
major objective of creating and maintaining stability. Many governments have continuously
interfered with the workings of the Central Bank, erroneously putting them under the watch of the
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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

Ministry of Finance. For instance, Kenya classifies its central as a parastal under the Ministry of
Finance.

A sound banking system would be a distant dream without an independent commission to find out
on, introduce, implement, and nurture international norms and standards — for regulation.

Such a body would also be apt for harmonizing regulations and supervisory procedures by
encouraging more co-operations between commissions and monetary authorities to improve
exchange of information.

Microfinance:

In SSA, financial services revolve around personal relations and reputation in the market. A
number of informal institutions lend to members only and cannot mobilize savings from non-
members. As a result, many people in low income bracket lack access to financial services.

These are due to challenges in contract enforceability and weak monitoring. Though they also
play significant roles in the private sector development, many are blocked by informal sector and
collateral required by commercial banks. A specific product for this constituency of microfinance
would be necessary for the market.

Microfinance will empower the poor population to get out of the yoke of poverty and hopelessness
to possibly become important stakeholders in the economic developments. Availability of
microfinance can increase the disposable income that eventually creates market for goods and
services.

Micro-finance institutions (MFIs) would thus expand and start offering investment education to
their borrowers and the potential members. Why? Many people have practicable business ideas
but lack the muscle to approach financiers, for fear of failing to service the loans.

A stable market for the “unbanked” private sector offers business opportunities.

Applied by the Grameen Bank of Bangladesh, it is true that it’s not only an effective tool for
fighting poverty, but also a means to a dignified life for private sector development.

Capital markets:

There should be a deliberate effort to develop capital market to include swap market, bonds
market and equity market. Capital markets are a tool to mobilize and influence application of
financial resources in favour of private sector development activities. Accordingly, private sector
requires predictable and transparent financial system to thrive. Well functioning, secure, efficient
payment systems are an intrinsic component of the operation and development of financial
markets.

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya

There should be separation of the running and management of the securities and exchange
markets from their supervision and regulation. Capital markets authorities should take the role of
supervision and regulation leaving the operations and management for the stock exchanges.

To ensure harmony that creates synergy of purpose, a dynamic financial system needs to focus
on developing the market supervisory and regulatory authorities. The institutions will coordinate
and enforce transactions and expectations of investors.

Capital Market Authorities should be instituted by law, run by independently appointed and
mandated professionals, and endowed with independence to effectively supervise and regulate
markets and participants.

Notable progress in this direction has been achieved in Securities and Exchange Commission of
the US, Securities and Exchange Board of India (SEBI), Capital Markets Authorities (Kenya)
among others countries.

A vibrant private sector will require efficient settlement and clearance of transactions. Central
Securities Depository (CDS) is a financial infrastructure linking the capital markets and to the
central banks to enable secure and efficient payments within the capital markets. CDS facilitates
sound and efficient modern payment systems, and incorporating new information and
communications technologies (ICT), which are the technological determinants and enablers of e-
banking, e-finance and more generally, of e-services.

ICT has completely changed the way business is run across the globe because it is a key pillar
that supports markets for easy coordination and management. Going by this, using the latest
technologies in finance would pass greater benefits to the private sectors for development. ICT
has affected the transfer of finance and financial services to different markets to support private
sector development.

The automation of trading systems implemented in various stock exchanges across the globe has
given more people access to investment opportunities and as a result, private companies are able
to raise more capital and/or invest in other organizations. The implementation of the
dematerialization has tremendously boosted the private sector through faster and safer
investments procedures.

Stock exchange is one of the key markets, especially for equity, investors are keen on predictable
entry and exit options for fair competition, dictated by the laws of demand and supply. Such a
market should be demutualized as a matter of priority to increase the level of transparency and
accountability. Financial systems should allow multiple stock exchanges to facilitate healthy
competition of free market economics, which will champion the interest of the investors.

A robust stock market generates positive vibes in the private sector. The performance of private
sector also comes on the spot when market fundamentals are adhered to. The trading activities
will reflect confidence investors have in the traded corporations. Equity market should embrace

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya
professionalism and integrity and strongly shun speculation and illegal trade practices to build
reputation, trust and instill investor confidence.

Exchanges should be operated like private entities to ensure, among other things, international
competitiveness and the introduction of new technology and financial products.

For an open economy to remain competitive it is necessary to develop a strong swap market to
build and maintain stable and fixed income markets.

This will also help to mitigate the risks associated with lack of market depth for local currencies
and reduce legal hurdles. This will encourage the use of cross currency swap to complement
offshore borrowing.

The result of which is the availability of sufficient finance for the private sector without increasing
the public debt obligation. This instrument will only require credit rating without a sovereign
guarantee, which ultimately promotes macro-economic stability.

Particularly, the system should encourage the use of corporate bonds to create more investment
opportunities. The more private sector use more financial instruments, the more dynamic and
versatile the markets become. This also reduces the overall cost of doing business enhancing an
accelerated private sector growth.

Venture capital is another instrument that can be traded in the capital market to ensure that any
viable business ideas are transformed into practicable business models. Research shows that
many potential business projects in developing countries are not implemented because of the lack
of venture capital due to weak markets and underdeveloped financial institutions.

Trade and Investment

Trade has been identified by some experts from developing world as the new way out of the dwindling
economic reform package urging for fair trade practices and not just a mere grant and financial
aid. The private sector lacks the muscle to have a go at the international trade, as the door to
bigger markets.

Trade facilitation was identified among “Singapore Issues” by World Trade Organization (WTO) in
1996 as major concerns and better means of accelerating globalization. The issues refer to four
working groups set up during the WTO Ministerial Conference of 1996 in Singapore, namely
investment protection, competition policy, transparency in government procurement and trade
facilitation.

This has been one of the thorny debates between the North and South, with many research
findings indicating that investment would help build sustainable economies of the developing
countries as opposed to aid and grant. Concerned countries should act fast to accelerate market
reforms favourable to local and foreign investors.

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya
For private businesses to thrive there should be comprehensive measures to address competition
laws and other trust related legislations. There should be in place simple and complete dispute
settlement mechanisms and procedure. Though disagreements existed at the 2003 Ministerial

Conference in Cancun, Mexico, largely between developed and developing economies, the
contentious issues are modalities and procedures.

In July 2004, WTO Members formally agreed to launch negotiations aimed aim to enhance
technical assistance and capacity building in this area and to improve effective cooperation
between customs and other appropriate authorities on compliance. This is likely to encourage
opening up of more markets and more investment opportunities in the private sector.

Though the international business community still expresses concern for greater transparency,
efficiency, and procedural uniformity of cross-border trade, markets and institutional reforms have
attracted huge foreign investment in China, India, and Brazil among others.

There is also a synergy that can be created when appropriate focus is directed at import and
export especially on cultural items and goods from micro and small businesses. International trade
procedures, insurance and financial requirements, electronic facilities, and evaluation are some of
the areas of markets and institution that call for urgent attention. The simplification of
documentation requirements; official procedures; automation and use of information technology;
transparency and consistency; and modernization of border-crossing administration, would bring
to the fore private sector extended market base.

Foreign Direct Investment (FDI) comes with the benefits of technological advancement to the
host country and in return the investors get the local market. This goes a long way to create
employment opportunities for the locals, which is akin to a win-win situation.

It is imperative that the world over, the spirit of market economics is embraced and used as
double-edged sword: allowing the rich to make money and at the same time empowering the
consumer. In the process, poverty is reduced as it is in the interest of all stakeholders. This will
not only ensure stability in the developing countries but global peace and prosperity.

Foreign Institutional Investor (FII) is known to have the ability to boost local economies.
However, there must be prior adequate and predictable market institution to cater for both their
interest and that of the local market they participate in. FII would be keen to see the issues of
capital and current accounts convertibility streamlined- making entry and exit less strenuous but
controlled in a manner not to destabilize the local investment scene.

Private sector development would also be a notch higher if joint marketing and branding of
products and services were taken as prerequisite for export.

This will help assure of the quality and also disseminate adequate information on goods from
small and micro business. Franchisee model could be a strategy for the small and micro business
set ups to help pass the message across to different cultures and regions. This will eliminate huge

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Jackson Barngetuny-ag CFO Ministry of Nairobi Metropolitan Development, Kenya
cost barrier that hinder this sub-sector from getting their premium value in the international
market.

In Kenya, the government invited private investors into tourism industry while undertaking to
brand the country’s tourist facilities. The Kenya Tourist Board (KTB) reported that the initiative

has yielded significant returns and was the fastest growing sector in the country’s economy in
2006. Kenya is today one of hottest global tourist destinations. The private sector could take the
cue to use the power of marketing to create markets, facilitated by specific policies.

…THE END….

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