IMF says rates capping could erode Central Bank autonomy

Control of interest rates may compromise the independence of the Central Bank of Kenya (CBK) since it will set the base rate with consideration of public or political interests, the International Monetary Fund (IMF) has said.

The multilateral lender said it feared the CBK’s decisions on monetary policy have been captured by politics through the control of the price of money.
The CBK makes decision on the Central Bank Rate (CBR) through its independent organ Monetary Policy Committee (MPC), which normally meets every two months.

With the CBR now declared the base (lowest) rate for lending rates, the MPC will be meeting knowing the rate they set will be much more closely followed because of implications on actual price of loans.

“Linking deposit and lending rates to the central bank’s policy rate may compromise the independence of the central bank, and hamper its ability to enact monetary policy towards achieving its main objectives — that is to maintain price and financial stability and to support the economy,” said IMF deputy managing director Mitsuhiro Furusawa.

Mr Furusawa made the remarks at the CBK symposium called in Nairobi on Tuesday to discuss the place of central banking in Kenya in the past 50 years.

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The meeting is among the activities the CBK has lined up as part of celebrating its 50-year history.

The IMF deputy MD said politicisation of monetary policy may lead to risks in the financial system and credit access since some borrowers would be highly underpriced at the current 14.5 per cent maximum lending rate.

Locking out many borrowers

“The politicisation of monetary policy bears well-known risks — for the soundness of the financial system and for credit access, notably higher-risk borrowers,” said Mr Furusawa.

The IMF fears that the control of interest rates could end up locking out many borrowers, especially those perceived to be high-risk such as small and medium enterprises, farmers and consumers.

“International experience suggests that, in many cases, interest rate controls may actually end up reducing access to the banking system for small borrowers — such as farmers, SMEs and consumers — and may also revive informal lending at much higher cost for borrowers,” said Mr Furusawa.

The IMF was concerned about the extent to which the credibility of the monetary policy — especially the achievement of inflation targets — may be compromised by a lack of independence.

However, Mr Furusawa said Kenya had done well in relation to being prepared for shocks by keeping its forex reserves at a high level — currently above five months of import cover — and also ensuring inflation was at most times within the target of 2.5-7.5 per cent.

“The good news is that many of sub-Saharan Africa’s central banks have built adequate international reserve cushions. This includes Kenya, giving the CBK greater room for manoeuvre, and reducing the risk of a sudden reversal of capital flows in the first place,” said the CBK governor’s former workmate.
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