Central Bank’s move to mop up excess cash has reduced inflation. Photo/ File
The Central Bank of Kenya’s severe restriction of cash supply to banks has led to the sudden drop in the inflation rate to single digits, data released by the regulator shows.
The mop-up of cash effectively stopped the phenomenon of having “too much money chasing too few goods,” even as the ease in international oil prices helped to reverse the increase in costs of consumer goods.
The move to limit money supply also supported the banking sector regulator’s decision to raise the benchmark rate at which banks borrow from CBK as a lender of the last resort to 18 per cent last December.
The CBK data shows growth in cash available went down to as low as 1.4 per cent in March this year, the lowest increase since May 2009.
Cash within and outside banks grew by only 1.7 per cent to Sh616.1 billion as at May, lower than the growth of 6.1 per cent in April this year.
This was from a trend of double digit growth — mostly more than 20 per cent in any single month — in money supply between July 2009 and November last year.
“I think the CBK has done well to mop up liquidity in the market to restrict money supply. The increase in interest rates has been reflected in the stability of the shilling but we also have to appreciate that food and oil prices have come down and played a key role in reducing inflation,” said John Kamunya, market analyst at Sterling Investment Bank.
AlyKhan Satchu, head of data vending and financial advisory firm Rich Management, said the CBK had “re-established their inflation busting credentials and have felt the collar of the inflation rate, which was in danger of turning into a runaway train last year.”
But given the lower inflation and slowing economy, Mr Satchu said he would recommend that the CBK take “a much more activist monetary policy” and cut rates as quickly as it brought them down.
To play its role in reducing inflation, the CBK bank targeted the stock of cash technically referred to as M1 which is money used in transactions in banks and among consumers of goods and services.
The cash moves around frequently and has the most significant impact on price escalation, justifying CBK’s concern with its amount.
Overall inflation rose to 19.72 per cent last November, the highest levels since the geometric method of calculation was introduced in early 2009, causing concern with the depreciation of the shilling cited as the major contributor.
The severe restriction of money supply is also noted by analysts as having contributed to the more stable macroeconomic environment.
“Large twin deficits, combined with strong credit growth, rapid inflation and a sharp depreciation of the exchange rate raised serious doubts about macroeconomic stability during 2011. Volatility was exacerbated by the slow response of monetary policy,” said the Fitch report on Kenya.
Due to the slow response, several opinion leaders including MPs called for the resignation of CBK governor Njuguna Ndung’u.
The role of the CBK in taming inflation, even if belatedly, was however recognised by analysts.
