CBK braves forex trouble to hold policy rate at 10 per cent

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The bank’s monetary policy committee (MPC) argued that inflation will stay within the preferred range of between 2.5 per cent and 7.5 per cent while the country’s current account deficit has narrowed, easing pressure on the shilling.
The base rate retention means the interest rates charged on loans by commercial banks continue to be capped at 14 per cent, in line with State-backed banking policy that caps rates at four per cent above the policy rate.
The bank said the improved current account from a deficit of 6.8 per cent in 2015 to 5.5 per cent last was helped by lower import bills for petroleum products, machinery and transport equipment.

The Central Bank of Kenya (CBK) Monday defied turbulence in the currency market to hold the base lending rate at 10 per cent, a move that some analysts saw as risking a steep increment sometime later in the year.

It was widely expected that a weakening shilling would push the CBK’s Monetary Policy Committee (MPC) to respond by raising the Central Bank Rate (CBR).

The Kenyan shilling has lost 1.4 per cent of its value to the US dollar since the beginning of the year and is currently trading at a 15-month low of 103.95 units to the greenback.

The CBK said Monday that the forex market remains relatively stable, citing a narrower current account deficit and a sizeable foreign reserve war chest it can call upon in case of major shocks.

“The foreign exchange market remains relatively stable. This is supported by a narrowing of the current account deficit, from 6.8 per cent of GDP in 2015 to an estimated 5.5 per cent in 2016,” CBK governor Patrick Njoroge said in a statement.

The statement further added that the CBK’s foreign exchange reserves currently standing at $6.94 billion (4.5 months of import cover), together with the precautionary arrangements with the International Monetary Fund (IMF) continued to provide an adequate buffer against short-term shocks.

Keen observers of Kenya’s monetary policy space will, however, remember that the CBK has in the past used similar arguments to delay its response to currency market turbulence with grave consequences for consumers who had to bear a sudden and steep rise in interest rates by more than 10 percentage points in just four months.

That happened in the last quarter of 2011, when delays in reacting to a depreciating currency left the CBK playing catch-up that resulted in the sudden increase of CBR from 6.25 per cent in August 2011 to 18 per cent in December of the same year.

The shilling opened the year at 102.50 to the dollar, but high demand, especially from importers, has seen it rapidly depreciate to the 103.90-104 level forcing the CBK to intervene through sale of dollars in the market to control volatility.

READ: Shilling outshines currencies but exports costlier

The bank has lately deepened its intervention through liquidity withdrawal from the market.

In holding the rate, the CBK also said that it expected inflation to remain within the target range of five per cent plus or minus 250 basis points in the short term.

The decision means borrowers have been spared an increase in loan servicing costs as it keeps the maximum rate chargeable on bank loans at 14 per cent for the fifth straight month, being four percentage points above the Central Bank Rate (CBR) as per the law.

The CBK also suspended the Kenya Banks Reference Rate (KBRR) as a loan pricing tool, saying it had been rendered irrelevant by the law capping interest rates.

“In view of the adoption of the new law capping interest rates, the CBK decided to suspend the KBRR framework,” said the MPC statement.

When the capping law came into force last September, there was some initial confusion over whether the base rate to be applied would be the CBR or the KBRR, which had been put in place to provide a transparent credit pricing framework.