The Central Bank of Kenya has embarked on measures to reduce liquidity in the market by enhancing repos to suck shillings from the banking system and raise interest rates, among other fiscal policies. File
The Government has agreed to implement measures meant to control inflation that could lead to higher borrowing rates and reduce credit available to firms and households.
In a letter to the then acting IMF managing director John Lipsky seeking release of $29.4 million, the State has agreed to suck liquidity in the market to check demand for goods and services.
“Monetary policy in 2011 will be geared at keeping inflationary expectations under control,” says the letter signed by Finance minister Uhuru Kenyatta and Central Bank governor Njuguna Ndung’u.
Inflation topped 14.49 per cent last month after months of upward pressure. It is expected to remain high even as crude oil prices ease, owing to a weak shilling bound to be reflected in food and energy import bills. The letter already reveals the section of the population set to be covered by the relief food programme will rise from 2.4 to four million.
Both food and oil imports are expected to widen the current account (export-import gap) deficit besides importing production and consumer inflations.
Among the measures mooted to reduce liquidity in the market is enhancement of the repos to suck shillings from the banking system and raise interest rates and the repayment of the government overdraft at Central Bank of Kenya.
“These actions will bring the rate of growth of credit to the private sector to levels that can be sustained while providing adequate support to economic activity,” says the letter.
On Wednesday, macroeconomist Mbui Wagacha faulted the focus on domestic credit saying the government should persist in its bid, initiated in the last Budget, to reduce supply side shocks instead of tinkering with interest rates. “I can see a bit of struggle here because there is no problem with net domestic assets (NDA or credit). If you tighten credit and increase rates I do not see how you are going to help the economy,” he said.
Dr Wagacha says the only non-compliant bit is the Net Foreign Assets where CBK is struggling to meet the agreed benchmarks — and has asked for waiver of criteria. As the Central Bank shrinks the stock of the shilling available in the interbank market, it has also agreed with the IMF to increase the currency reserves in the market to four-month import cover. The statutory cover has fallen to 3.65 month or $3,894 million level as Central Bank embarked on a limited market action to shore up the value of the shilling by releasing hard currency into the forex market.
The shilling has fallen to an all-time low of Sh90 to the dollar causing a lot of pain to the importers but gifting exporters a windfall. However, even exporters have moaned about the net negative impact because of the cost of inputs. “We will step up efforts to accumulate international reserves through regular purchases of foreign exchange…but the pace of reserve accumulation will need to take into account the impact of the external supply shocks that has created instability in the foreign exchange market,” says the document.
Central Bank appears to have explored alternative ways of raising the reserves and is currently crafting a strategy to net hard currency from the Kenyan Diaspora through selling them part of the Sh36 billion infrastructure bonds and raising $600 million by year-end.
Accumulate reserves
This in part according to the governor would minimise the instability associated with CBK participating in the currency market.
“When the CBK accumulate reserves the market watches. So getting from Diaspora and building reserves and also from the IMF, the CBK and the Government will be in a stronger position to deal with balance of payments pressure and to keep the market in check,” Prof Ndung’u told the Business Daily.
Kenya Commercial Bank acting Treasury head Jeremiah Kendagor praised the CBK effort to stay out of the interbank market but pointed out how to tap Diaspora remittances sent directly to bank accountholders and directly to households needed further clarification.
“Tapping donor and remittances is a bright idea because CBK intervention in the market has had negative impact. This will help stabilise the shilling,” he said but noted the $29 million IMF injection was unlikely to help the shilling significantly. Besides monetary affairs, the government agreed to reform the tax system through simplification of the code following the appointment of the Tax Reform Commission. The measures, including a review of value added tax exemptions, are expected to maximise revenue collection and compliance.
