Opinion & Analysis

IMF shouldn’t hijack monetary policy

CBK governor Njuguna Ndung’u with  Prof Terry Ryan at a Monetary Policy Committee meeting last month. Kenya needs economic tools that encourage growth.  File
CBK governor Njuguna Ndung’u with Prof Terry Ryan at a Monetary Policy Committee meeting last month. Kenya needs economic tools that encourage growth. File 

A rate increase by the Central Bank of Kenya (CBK) last week was always on the cards and the Central Bank Rate (CBR) raise by 75 basis points didn’t surprise the markets. So far, inflation was being driven largely by food and commodity prices and CBK rate could have little effect.

Inflation had, within the year, been inching up in spite of the few hikes in the policy rate. The CBK had to take small steps to express concern and readiness to act. So long as inflation was seen as a supply side constraint, there was no point in CBK displaying its killing spirit.

The context has, however, changed where commodity price inflation has spread to non-food, non-fuel type and from the Wednesday’s Monetary Policy Committee (MPC) statement, it now registers at more than seven per cent. Couple this with food price inflation, and there is the risk of a wage-price spiral. Given this, it was time to deal with inflation, before it gets out of control and hence CBK’s step.

Developing nation

Apart from the expected higher lending rates, a more important message was clear in the move taken by the regulator: CBK will not tolerate increased inflation and further action is possible.

According to the MPC statement, the CBK will pursue the inflation objective through a continuation of the gradual tightening of monetary conditions. The interest rate policy, according to the MPC will be “designed to deliver an outcome that is purely based on the Net Domestic Account (NDA) target”. The movement or adjustment in the CBR will always be consistent with the NDA target and the CBR will move in line with these targets. If NDA is above the target, the policy rate will be raised, and vice versa. So, CBK, unlike in the past, will directly target inflation in a preset manner.

This is not good news for economic growth. There is always a tradeoff between raising interest rates to fight inflation and economic growth. As a developing nation, we cannot ignore growth and become obsessed with inflation targeting. No doubt, in the war on inflation, growth can sometimes wait, but only to a level the economy can live with.

What is that level? What is the limit beyond which the rate should not be pushed to protect growth? It looks as though the CBK has given away its freedom to answer these questions.

I don’t think the CBK is adopting this approach on its own volition. This has got IMF written all over it. The MPC statement in fact states that “tightening will be implemented by adhering to quarterly Net Domestic Assets (NDA) targets as agreed under the IMF Extended Credit Facility (ECF) supported programme.” The IMF approach to central banking unfortunately does not focus on economic growth or employment generation; instead promoting formal ‘inflation-targeting’, where keeping a low rate of inflation— in the low single digits — is an obsession.

This approach normally emphasise market-based instruments such as short term interest rates, as the primary and often exclusive tool of monetary policy. This is in contrast to quantitative tools often used by central banks including credit allocation methods and other ways to direct credit to priority economic goals.

The MPC says: “The Committee will explicitly show the precise way in which the CBR is indeed the policy rate governing the levels of other rates”. It indicates that all other monitory policy tools will be relegated as CBR counts.

The IMF is not one to worry aboutour economic growth or Vision 2030. Its major concern is whether it will get back what it lends. That is why it has imposed on us monetary conditionality that consists of limits on monetary aggregates. That is also why it has forced us to set a ceiling on the net domestic assets and establish a floor for the level of net international reserves (NIR). They usually call this financial programming.

They give you support but you get “programmed” to act in a particular way. Their typical programme connects balance of payments constraints, the government fiscal deficit, and central bank policy. Under such an arrangement, target ceilings are set for central bank monetary and credit expansion and floors are established on net foreign reserves. The idea is to put in place domestic credit ceilings and limit the amount of credit the CBK can create and also establish net reserve floors to preserve a minimum level of international reserves.

Our priority

If net domestic assets are too high or if international reserves are too low then the policy calls for tightening monetary policy, usually raising the CBR. It doesn’t matter even if the economic growth rate is at one per cent as the bias of this programming is highly contractionary. By agreeing to this, the government has lost the leeway for expansionary monetary policies, even in a situation of slow growth and high unemployment. Reducing inflation into the single-digits is key to the success of this”programing” and hence the reason the IMF needs to dictate the nature of the monetary policy framework. We don’t need this.

To the contrary, we need to encourage more expansionary monetary options that enable domestic firms and consumers to access affordable credit for expanding production, employment, and increased contributions to the domestic tax base. Monetary policy should thus maintain low real interest rates, rather than ineffectively trying to keep inflation low with high interest rates which dampen aggregate demand and growth prospects.

Furthermore, some countries have grown for long periods with persistent inflation of 15–30 per cent. This approach was tried in other countries such as Ghana with little success in bringing inflation down. Instead it limited economic growth.

There was nothing wrong with the flexible monetary policy we had. We should be free to consider all of our options regarding monetary policy and priorities, and not be locked into the IMF’s preferred ideological straightjacket. Our priority should be growth.

Mr Wehliye is a banker.