On a normal day, the stock market never favors high-interest rates in Kenya. The higher the interest rate would lead to an increased cost of company products and services. There is no doubt that an increased cost would further lead to lesser profits and lower stock prices here. On the contrary, the impact of rising interest rate on stock market in Kenya is advantageous as it reflects a positive trend in the economy.
However, before we know how the interest rates affect the stock markets, let us have a look at how stock markets came into existence.
A History of the Stock Exchange
To start a new business, a person needs to pool their savings and have co-owners, as no single person can ever start a business alone. A unit of ownership represented the contribution to the company; it was what is known in today’s time as shares.
The trading, known as hawking began in the streets of London. As the volume of shares increased with more companies floating shares, the demand for a proper marketplace for exchange was raised. Eventually, the traders would meet at the coffeehouse where they used as a marketplace. With time, they renamed the place to Stock Exchange in 1773, and the first stock exchange known as the London Stock Exchange was found.
After this, the financial intermediaries including brokers, fund managers, investment advisers, investment banks, etc. and bonds followed suit. Nevertheless, there is no doubt about the impact of an increase in interest rate on stock market in Kenya.
We will now understand how the stock exchange in Kenya function does.
The Nairobi Stock Exchange
The stock exchange is a market, which offers deals in exchange of shares of publicly quoted companies, government, corporate, and municipal bonds among other market instruments for money. The Nairobi Stock Exchange, formed in 1954 was established as an organization of stockbrokers and is one of the active markets of Africa at present. The NSE has assisted people in making the right choice when it comes to investing their money on a stock.
The Nairobi Stock Exchange is located on the first floor, nation center, Kimathi street in Nairobi. As a capital market institution, NSE plays a vital role in the economic development of the country. However, those who are new to how it functions, we will share a few insights.
- It helps mobilize domestic savings thereby bringing about reallocation of financial resources from dormant to active agents.
- Long-term investments are made liquid, as the transfer of securities (shares and bonds) among the participating public is facilitated.
- The Exchange has also enabled companies to engage local participation in their shares ownership, thereby giving Kenyans a chance to own shares of reputable firms.
- Companies can also raise new finance essential for expansion and development. To raise funds, a company (issuer) issues additional shares; an issuer publishes a prospectus, which gives all pertinent details about the operations and prospects of a company, while at the same time stating the price per share of the Issue.
- A stock market also enhances the inflow of international capital.
- Stock markets also facilitate government’s privatization programs.
Now we will learn about the impact of an increase in interest rate on stock market in Kenya, both its pros and cons.
The Positive Impact
The slow rise in interest rates would have a positive impact on stock market prices. These rates increase when the economy is functioning to its best. For example, in 2018, the Federal Reserve Board stated that during the present economic conditions, the increase in rates would be advantageous. We recommend that you have financial goals to retire without any worries.
One needs to understand that when the economy is expanding in such a direction, companies earn a profit. The cost might rise a bit if the interest rates increase, and the profit level would go ahead of the charges. In short, a higher profit would lead to increased stock prices. The industry to benefit the maximum from rising interest rates is the financial service industry. For example, the banks earn profit from paying depositors fewer rates. Thus, the impact of increasing the interest rate on stock market is beneficial.
The Negative Impact
Higher interest rates also increase the cost of borrowing for companies. It reduces corporate earnings and stops the company from taking on debt for capital expenditure. Without a proper option for expansion, interest rates make it harder for companies to increase their profits.
The treasury bonds in the US are a risk-free asset. However, if the interest rates increase to the point that an investor can have a risk-free rate of 6% on Treasury bond, then the investor would choose Treasury bonds over the stock market. Although the stocks have a higher and long-term return, they have a higher risk than Treasury Bonds. In short, fewer buyers would mean less money to increase stock prices.
Thus, we can deduce that any effect on the interest rate on stock market in Kenya has its pros and cons in Kenya.