Long-drawn war of nerves between CBK and banks turns into a bare-knuckled brawl
Counting money. A bank could borrow money from CBK at 6.25 per cent interest and lend it to another bank overnight for 10 per cent rate, making an extra 3.75 per cent without breaking a sweat. File
For long, the war of nerves between the Central Bank of Kenya and banks has been fought with velvet gloves, behind the scenes, as if both parties were afraid to spill blood.
But of late CBK has come out with barrels blazing, sharply increasing the rate at which banks borrow overnight to meet unexpected withdrawals or higher-than-normal obligations.
This comes in the wake of CBK’s frequent changes in policy that seemed unable to achieve expected outcomes. Banks had discovered that they could easily use the regulator’s cash pile to make their own money. (See: CBK in new move to stabilise shilling)
A bank could borrow money from CBK at 6.25 per cent interest and lend it to another bank overnight for 10 per cent rate, making an extra 3.75 per cent without breaking a sweat. The process is called arbitrage.
The same bank could use CBK’s cash to buy dollars or euros from the market and ship the money abroad. That is why CBK governor Njuguna Ndung’u complained some weeks ago that four banks had wired $260 million (Sh25 billion), only Sh5 billion short of the amount being used to turn the 40-kilometre Thika Road into a multi-carriage way.
The weakening of the Kenyan shilling is partly linked to this trend. The drama on the exchange rate — with CBK and banks as protagonists — was also unfolding in Uganda where the currency has lost 21 per cent of its value.
In fact, management of the two central banks got so agitated between July and August that they resorted to issuing one circular after another.
Inflation spiralled
Try as they might, the regulators were unable to contain the dramatic fall of their currencies as inflation rates spiralled month after month.
The CBK increased the discount window rate — at which banks borrow from the regulator as an overnight emergency facility — every day last week. But the local unit’s exchange rate hardly changed as it stubbornly remains at between Sh92-93 to the dollar.
However, the earlier slide to more than Sh95 to the greenback was somehow arrested. The point was that if the discount rate was raised, it would not make sense for banks to continue borrowing from CBK but would prefer to sell dollars that they were supposedly hoarding in order to meet their demand for the local currency.
That way, more dollars would flow into the market making the greenback less expensive.
But the exchange rate is only one of the issues that CBK is expected to address. Others relate to the interest rate and inflation. And that is what has put Prof Ndung’u on the horns of a dilemma. On the one hand, his role is chiefly to ensure macroeconomic stability, meaning he should maintain low inflation or prices. On the other hand, the central bank must foster policies promoting growth through affordable interest rates.
According to the Central Bank Act, the “principal object of the Bank shall be to formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices.”
By raising interest rates, there would be great interest from foreigners wanting to invest in Kenyan financial markets which means that the value of the shilling would rise. This is because for every shilling invested in the stock or bond market, returns would be higher. Thus higher interest rates would tend to attract the much-needed dollars from abroad to shore up the shilling.
But for sectors like agriculture and manufacturing, higher interest rates would discourage further investment and stunt the already fragile growth for this year. And there in lies the governor’s dilemma. He told journalists two weeks ago that he was having “sleepless nights” over the issue. (See: Central Bank on the spot as shilling falls to new low)
Citigroup, for example, said in an analysis that CBK tends to favour low interest rates thereby blunting its response to the high inflation and volatile exchange rate environment.
“Even if it did want to tighten monetary policy, the reality is that CBK has long had an institutional bias in favour of low interest rates which it feels are crucial to supporting growth. In this respect, it would only want to raise the Central Bank Rate (CBR) gradually if it had to,” said Citigroup.
There are those who see raising of interest rates, even without pumping dollars into the market, as amounting to intervention. “When your neighbour’s house is on fire, you do not go out with a matchbox and fuel. You carry water to stop the fire,” said Prof Ndung’u recently in response to a query on why he was not intervening in the forex market by raising interest rates. He said that intervening in the forex market could aggravate the situation, an admission that CBK did not have enough foreign exchange reserves to fight banks. CBK has about $4 billion which just about covers four months of imports, the minimum under the law, but many foreign banks have enough currency abroad to fight the regulator. The objective is to increase this import cover to six months under the EAC agreement as part of the criteria for progressing the region towards a monetary union by 2012. Prof Ndung’u even mentioned Bank of Uganda (BoU) as having made some interventions. The reality is that regional governors are afraid of carrying out the kind of intervention that BoU governor Simeon Mutebile attempted in June.
Instead of the banks retreating from the market after BoU intervened by injecting $100 million into the forex market, they called his bluff and the Uganda shilling sunk to historic lows from which it has not recovered. The banks bought all the dollars in the market and hoarded them causing the shilling to plunge.
As a result, Uganda has the worst turmoil in the forex market in the EAC region. In Kenya, the currency is down 16 per cent while in Tanzania it has shrunk by 11 per cent between January 3 and now. In Rwanda and Burundi, the depreciation has been negligible.
CBK’s position has been at odds with that of market players and analysts. “The central bank has missed the point completely. They have raised interest rates but we have not seen much change in the value of shilling. The thinking is that this higher rate will stop banks from buying and hoarding dollars. The assumption is that banks are only buying dollars which is wrong,” said Fred Mweni, a member of the informal CBK advisory group comprising of top traders in government securities.
He said preoccupation with the value of the currency was causing turmoil in both long and short-term rates. In the August 25 auction, the 91-day t-bill stood at 9.71 per cent, which is quite close to the 9.75 per cent yield of the eight-year infrastructure bond sold last year. In the August 15 auction, the 182-day t-bill rose to 10.31 per cent while the 364-day was at 11.06 per cent — showing that it was more lucrative to invest in the paper than in nearly all infrastructure bonds.
“Setting of the CBR as a signalling tool has been inconsistent and the overnight peg to the interbank is a forced marriage to correct the situation,” said Alexander Muiruri, a dealer in fixed-income securities at Africa Alliance Investment Bank. Two weeks ago, CBK pegged the discount window to the interbank rate. On any trading day, the window rate will be 300 basis points (bps) above the previous day’s interbank rate. When the interbank rate is equal to or below the Central Bank Rate, the window will be 300 bps above the CBR.
Liquidity squeeze
“The peg enables a quicker response to current macro conditions, which these days seem to have gone against any move the regulator has come up with,” said Mr Muiruri.
However, by Monday, the CBK had yet another change on the discount window, but retaining the interbank rate as the basis. It further indicated the policy dilemma the CBK is in and the jury is still out on whether the action will arrest the lack of liquidity in the market and the weakness of the shilling and consequent spillover into inflationary pressures.
University of Nairobi senior economics lecturer Samuel Nyandemo said CBK was mismanaging the monetary policy, which needed to be corrected for confidence to be restored in the market and the economy. “We don’t see the central bank managing the monetary policy in the proper manner. That is why it is moving the CBR up and down without a clear direction. I would call that mismanagement of interest rates. What does CBK really want to do for the country? Inflation is rising and we don’t have a clear direction on foreign exchange as well. Yet oil price is rising,” Dr Nyandemo said.
Stanbic Investment Management Services senior investment manager Kenneth Kaniu said causes of the shilling’s weakness were in the rising import bill, global dynamics involving a shift to safe havens, inflationary pressures, and market expectations.
Mr Kaniu’s analysis showed that there was a correlation between high international oil prices and the weakening of the shilling. He said cash in circulation was growing rapidly. This has in turn caused prices of goods and services to rise as there is “too much money chasing too few goods”, the classic definition of inflation. The import bill has also been rising such that Kenya has a major current account deficit. The situation is not made better by negative interest rates considering that inflation stands at 16.7 per cent and t-bills and bonds are below this rate. Only the interbank and discount window now beat inflation. ]
Joe Donde, who introduced regulations to tame banks, said the central bank was unsure of how to deal with the crisis on interest and exchange rates allowing banks to have a lot of leeway. Mr Donde said Kenya Bankers Association (KBA) should sort out the issues concerning the foreign exchange and the discount window with CBK. “It appears that there has been no dialogue between bankers and the central bank. That is why everything appears to have gone out of control. It is a total mess now,” said Mr Donde.
He said banks should decide on whether to pass on the high cost of cash they were receiving from CBK to customers. He said banks did not pass on the benefits of lower interests rates to customers and so he did not see why there should be a direct relationship between what the CBK was asking for on the overnight window and the lending rate to the private sector.
Mr Donde recommended that some rules be put into force to define relationships in the financial markets because CBK was giving conflicting signals about interest rates.
The tug of war between banks and the regulator gives the impression that there is no dialogue between them. But former KBA chief executive John Wanyela said CEOs of banks met the regulator regularly. “In my era, we had meetings with the central bank every quarter to get briefings on the Monetary Policy Committee decision, but we didn’t have the type of issues that have now arisen,” said Mr Wanyela.
