How exchange losses affect a cheap dollar loan
The Sunday Nation
Nairobi,
18 November 2012
Christopher Kangethe has received an offer for a dollar denominated loan from his bank. The interest rate charged is 10 per cent per annum which is much better than the 20 to 25 per cent levied on Kenyan shilling loans. For that reason, Christopher is wondering where the catch is.
Unfortunately, he has not given me the relevant terms and conditions of this loan, therefore I can only restrict myself to financial comparisons. Nevertheless, I suspect that the bank only allows the customer to use the dollar funds for importing goods and services in dollars.
Christopher gave me a copy of the repayment schedule for various dollar amounts ranging from US$1,000 to US$48,193 in multiples of US$1,000. The table gives the results for different loan durations starting from 6 to 60 months (5 years)
Now I found that last figure (US$48,193) rather curious so I decided to test it on my self-designed loan analyser. If you borrow this amount on a 60-month duration, the bank’s table says that you will pay US$1,024 per month. My calculator agrees; it gives US$1,023.96.
But I still can’t help wondering why the bank picked on that rather awkward figure of US$48,193. Perhaps it is because the rounded-off monthly instalment is US$1,024. While most people will see just another random series of digits, computer geeks will immediately recognise the number: 1,024 bytes make a kilobyte (kB); 1,024kB make a megabyte (MB); and so on. May be that’s what the bankers had in mind.
What is more important, however, is that there is a significant difference between a shilling and a dollar denominated loan in terms of interest rates. So the question that Christopher is asking is whether it makes sense to borrow money in foreign exchange.
The catch is that the exchange rates fluctuate all the time and the general trend is that the Kenyan shilling is continuously weakening against the currencies of the industrialised countries. Five years ago (November 2007), the dollar was exchanging for about Sh65. Today it is hovering between Sh85 and Sh86.
If Christopher had taken this dollar loan five years ago, the US$48,193 would have been equal to Sh3,132,545 and the US$1,024 instalment would have come to Sh66,560. Today, the repayment would be equivalent to Sh87,040. So, while the interest rate charged is low, he would lose money as the shilling weakens.
To get the exact amount of foreign exchange losses that he would incur, we need to look at the exchange rates on a month by month basis. That is not a worthy exercise for a hypothetical and historical situation. However; it is good to note that the final instalment of Sh87,040 is the amount that one would pay far a Sh3,132,545 loan charging 22.275 per cent interest.
But all this is based on the past performance: who knows what the future holds – especially after the discovery of oil in Turkana? I don’t!
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