Baptism of fire for CBK chief as shilling hits 100 to US dollar

Dr Patrick Ngugi Njoroge, the Central Bank of
Dr Patrick Ngugi Njoroge, the Central Bank of Kenya governor. PHOTO | DIANA NGILA |  NATION MEDIA GROUP

The shilling has plummeted to a three-and-a-half-year low against the US dollar, underlining the Herculean task before the newly appointed Central Bank of Kenya (CBK) governor Patrick Njoroge as he chairs his first Monetary Policy Committee (MPC) meeting Tuesday morning.

Traders priced the Kenyan currency at 100.15 units to the dollar, breaking the psychological mark a second time in a decade and setting Dr Njoroge up for a baptism of fire.

Besides the shilling’s slide, Dr Njoroge and his team of monetary policy wonks must confront the unrelenting rise in the cost of living in recent months that left inflation standing at 7.03 per cent last month from a low of about five per cent at the beginning of the year.

The regulator already reacted to rising inflation and exchange rate turbulence with a 1.5 percentage points raise in the benchmark Central Bank Rate (CBR) to 10 per cent but that only had a temporary impact on the exchange rate, which has since the June 9 MPC meeting continued to slide.

Analysts said the MPC could react to the market realities with another increase in the policy rate during today’s meeting when they are also expected to set the new Kenya Banks’ Reference Rate (KBRR).

The KBRR, a credit pricing tool that the CBK introduced late last year, is the average of the CBR and a two-month weighted average of the 91-day T-Bill.

It is the interest rate banks are expected to charge risk-free borrowers, and on to which the lenders attach a premium “K” to reflect each borrower’s risk profile. The KBRR is set every six months.

The KBRR was last set in January at 8.54 having moved only slightly from the previous 9.13 per cent. The MPC is expected to raise the benchmark lending rate having raised the CBR to 10 per cent last month.

The move should lead to a general rise in commercial bank interest rates — which currently stands at average of 15.5 per cent — and open a new cycle of tightening similar to what followed the shilling’s slide in 2011.

Dr Njoroge, however, has to balance the fight against inflation and exchange rate fluctuation with the economic growth, which the Treasury has set at between 6.5 per cent and seven per cent this year but would be harmed by a high interest rate environment.

Higher interest rates ordinarily have the impact of reducing investments and consumption, the two key ingredients of growth, making it imperative for the MPC to strike a balance between maintaining economic growth tempo and reining in the cost of living.

Razia Khan, the head of Africa Research at Standard Chartered Plc, said she expects the CBR to rise further “if it should become necessary to safeguard the exchange rate.”

The MPC said last month that the decision to raise the CBR to 10 per cent was particularly informed by rising fuel prices and the strengthening of major world currencies, which the committee feared would have had a lasting negative impact on the prices of domestic goods and services.

The cost of living has risen further since that meeting, and analysts said the CBR increase was yet to make an impact on the money markets where it was expected to tighten liquidity.

Year-on-year inflation rose to a 10-month high of 7.03 per cent last month, largely driven by higher food prices arising from a supply shortage associated with inadequate rainfall.

A weaker shilling has also adversely affected the prices of goods and services with an import component, including electricity which is partly generated using imported fuel, and foreign currency-denominated debt.

Fuel prices have been on the rise, recovering from a major decline last year when oil producers like Saudi Arabia precipitated a global oil price crash that more than halved crude prices.

The latest monthly fuel price review, covering June 15 to July 14, saw the maximum price of petrol, diesel and kerosene rise by an average of Sh4.39, Sh3.97, and 2.54 per litre respectively and the resulting pricing pressure has led some analysts to forecast the CBR rising to at least 10.5 per cent by December.

“Given the upside risks to inflation from strong growth — we see CPI inflation above 9 per cent before year-end — we forecast at least another 50 basis points rise in the CBR to 10.5 per cent in the fourth quarter 2015,” Ms Khan said.

Should the CBK decide to strengthen the shilling, however, it will need to raise interest rates by adjusting the CBR and coupons paid on new issues of government debt paper even higher.

This should bring in more dollars and other major world currencies while simultaneously reducing liquidity and discouraging imports, effectively firming up the local currency and easing the inflationary pressure.

Such a move will also push up interest rates on loans from banks and other lenders who take their cue from the CBK — potentially having growth-limiting effects by reducing consumption and investment.

The latest 91-day T-Bill auctioned stood below the benchmark rate at 8.16 per cent coupon, indicating that the CBR rise is yet to impact the market.

Ms Khan said the phenomenon of short-term treasuries yielding less than the official rate will have to change to stabilise the shilling.

The CBK predominantly lets the market to set the interest rates on government paper using bids from investors to arrive at an average and the current coupons are deemed to signal that liquidity is still high in the money markets.

Commercial bank lending rates are, however, expected to rise effective today as the June CBR increase feeds through a newly introduced formula for pricing loans.

Kenya’s GDP expanded by 4.9 per cent in the first quarter of the year compared to 4.7 per cent in the same period last year, driven by improved performance in construction and financial services that will now be vulnerable to higher interest rates.

Despite the risks of dampening growth, analysts said the tightening imperative has gained momentum in the wake of the government’s increased reliance on external borrowing.

The government last year raised $2.75 billion (Sh275 billion) by selling dollar-denominated sovereign bonds to global investors.

Treasury secretary Henry Rotich said the government will raise a further Sh340.5 billion from external financing to help plug the budget deficit in the current fiscal year.

A weak shilling means the government’s debt burden rises significantly as more units of the local currency are needed to pay investors their interest and principal in dollars.

“In our view, Kenya’s greater reliance on external borrowing will intensify the effort to maintain [the shilling] stability,” Ms Khan said.