Costly loans, high inflation leave CBK in a tight spot

When the Monetary Policy Committee meets in Nairobi on Thursday morning, it will have to make some difficult, but critical, decisions under the watchful eyes of nervous investors and angry consumers- even as it takes stock of the strengthening shilling.

(Also read Banks extend loan payment periods to avoid mass defaults )

The MPC meeting, which comes one month after the last one that took the unprecedented decision of jerking interest rates up by more than five percentage points, will have to balance its declared war on inflation and exchange rate turbulence against the high cost of borrowing for government, the slowdown in consumption of goods and the danger of stifling growth that comes with it.

To many investors and consumers, the November 1 decision to steeply raise interest rates amounted to a classic failure of the domestic policy making mechanisms to address the real challenges facing its constituency in favour of easy cut and paste solutions from the International Monetary Fund (IMF).

The MPC has for instance come under heavy criticism for staying too long on the loose end of monetary policy, ignoring warnings from partners such as the IMF and independent economists who started pushing for an interest rate increase in April.

“There is now considerable expectation that the CBK has to tighten (monetary policy) more – if not to ensure positive real interest rates, then at least to prevent real rates from becoming even more negative,” Razia Khan, the Standard Chartered’s lead economist for Africa, wrote in a note in March after inflation jumped from 6.5 per cent to 9.2 per cent.

The MPC ignored such counsel and many others in the subsequent months arguing strongly that such a move would negatively affect fragile growth. The decision to stay put in the face of all these signals lay in Kenya being able to internally generate the resources it needed to finance the mega infrastructure projects it had started just before the global economy went into recession in 2007.

And with the onset of the global economic crisis in September 2008, the dogma in the ‘developmental monetary policy’ that Central Bank Governor Njuguna Ndun’gu had chosen to pursue became even more imperative. Interest rates had to be kept low to make borrowing less painful for the government and consumers alike.

That was to help drive consumption in the economy and prop up growth that risked withering in the face of a severe global financial crisis.

The full impact of this policy is, however, that the government used the window to take in huge amounts of domestic debt raising the pile from Sh334.9 billion in 2008 to Sh795.4 billion in September this year.

The fact is, however, that while borrowing from the domestic market has enabled the government to raise billions of shillings for the big infrastructure projects, it has to pay in foreign currency.

Whether it is paying the Chinese contractors, importing the machinery or materials, the currency of payment has been mainly in the dollar, euro or yen – a challenge that many developing nations have managed to overcome only by growing exports.

The value of Kenya’s imports rose from Sh770.6 billion in 2008 to Sh951 billion for nine months to September from export earnings that were nearly static having grown from Sh344.9 billion in 2008 to Sh374 billion in the year to September.

This, combined with acute supply shortages in key areas such as food, is what has hit many consumers in the form of high priced goods, the shilling’s slide from an average of 86 units to the dollar in January to the record low of 107 units to the dollar in October – and ultimately high cost of borrowing.

Though aggressive tightening of monetary policy has since seen the shilling regain more than 10 per cent of its value in the past three weeks, it has remained difficult to explain to a large constituency of the population whose borrowing costs have risen steeply even as the cost of living continues to rise.

Many analysts expect that this morning’s meeting will therefore have to carefully walk the tightrope in the quest to balance its attack on inflation that has began to decelerate and responding to public expectation for a signal that things will begin to look up this Christmas.

That expectation is hinged on the fact that the CBK’s mandate remains to formulate and implement a monetary policy that keeps overall inflation at the official target of nine per cent, while maintaining adequate liquidity in the market to facilitate higher levels of domestic savings and private investment to support economic growth, higher real incomes and increased employment. 

Its recent radical departure from this script has no doubt rescued the shilling from the October battering but its implementation has removed liquidity from the market, and is likely to deliver growth and job creation only if Kenya finds the way to defy all global precedents.