Cost of money rises steeply as Kenya bows to IMF demands
Posted Tuesday, November 1 2011 at 20:34
The Central Bank of Kenya on Tuesday raised its policy rate by the highest margin ever, in a surprise move that marked the IMF’s return to the centre of Kenya’s monetary policy.
A statement released by the bank at the end of the Monetary Policy Committee meeting said the Central Bank Rate (CBR) – the principal instrument that the CBK uses to transmit its decisions – is to rise by 5.5 percentage points, marking a steep tightening of monetary policy to reduce inflationary pressure and stabilise the shilling.
Njuguna Ndung’u, the Central Bank governor, also said the Cash Reserve Ratio (CRR) or the money that commercial banks must keep with the Central Bank as a bulwark against their operations would rise to 5.25 per cent in another measure aimed at limiting the amount of money in circulation.
The twin decisions marked the greatest influence that the International Monetary Fund (IMF) has had over Kenya’s domestic policy in nearly 10 years and came after the country’s recent engagement with the Bretton Woods institution for foreign exchange support.
The MPC’s decisions were a carbon copy of the IMF’s recommendations made public a day earlier and which rooted for a tightening of monetary policy to limit credit to the private sector and to stop further slide of the shilling.
“Monetary policy will be tightened to bring down the rate of expansion of credit to the private sector to levels that can be sustained and to reduce the demand for foreign exchange,” the IMF said in a statement released at the end of its mission in Kenya on Monday.
A rise in interest rates was one of the key conditions that the IMF gave Kenya for access to a new foreign exchange support loan that Nairobi had asked for to stabilise its besieged currency.
In agreeing to take the IMF medicine, Kenya appears to have given up its pursuit of growth in favour of inflation control and currency stability – the twin factors that are seen to make the economy unattractive to foreign investors because of their negative impact on the value of investment.
A rise in the CBR – the rate at which commercial banks borrow from the central bank as the lender of last resort -- by 5.5 percentage points means the rise in lending rates that began in earnest with last month’s increase of the CBR to 11 per cent will intensify, taking the average base lending rate above 22 per cent from the current 19 per cent.
The IMF expects that at this level, the interest rates will discourage private sector borrowing, reduce demand for foreign exchange and restore stability to the shilling.
“Kenya needs to reduce the pace of the growth of private sector credit that is fuelling the rise in demand-pull inflation,” said Domenico Fanizza the head of the IMF mission that ended on Monday.
In September alone, private sector credit grew by 36 per cent compared to the same month last year a development Mr Fanizza said was not sustainable.
“Consistent with the monetary policy stance taken by the last MPC meeting, there is therefore a need for further tightening of monetary policy to tame these inflationary pressures and stabilise the exchange rate,” Prof Ndung’u, who chairs the MPC, said in a statement.
MPC had last month promised to gradually tighten the policy rate to curb inflationary pressures from exchange rate turbulence. As a further measure to tighten demand-driven inflation, the IMF expects the Treasury to reduce government spending in the next couple of years.