Steep price rises loom as shilling defies CBK action

The shilling Wednesday stayed relatively unchanged against the US dollar, a day after the Central Bank of Kenya (CBK) shocked the market with a second raise in the policy lending rate in as many months to stop its slide.

Market data showed that the Kenyan currency stayed above 100 units to the dollar, setting consumers up for life in a difficult macro-economic environment that is underpinned by high cost of living.

Commercial banks on Wednesday traded the shilling at 100.59 to the dollar when markets opened, lower than the previous day’s opening price, making some analysts to conclude that the Kenyan currency could slide to 101 units to the dollar by the close of the week.

On Tuesday, the shilling stood at 100.21 units to the dollar at the opening of markets. Reuters yesterday noted that the local unit could be headed for 101 units to the greenback.

If the shilling remains at current levels against the dollar or continues to slide, the combination of a weak currency and high cost of credit is expected to cause a general rise in the cost of goods and services— pushing the inflation rate beyond the policy range of 7.5 per cent.   

Consumers are expected to start feeling the initial pangs of the pain associated with high cost of living next week, when the Energy Regulatory Commission (ERC) announces new petroleum prices.

Pump prices are expected to rise significantly, saddled by the weak shilling ultimately increasing the cost of transport throughout the economy.

The CBK said on Tuesday that its decision to raise interest rates was partly informed by the fact that credit expansion rose above target in May, risking a general rise in prices on the account of too much cash chasing few goods.

Oversupply of money also has potential of increasing demand for imported goods that would consequently increase the demand for dollars and pile additional pressure on the local currency.

Though many market watchers said the decision to raise interest rates further had come as a surprise, some analysts reckoned that the 1.5 percentage points rise in the benchmark Central Bank Rate (CBR) to 11.50 per cent and the 1.33 percentage points increase in the Kenya Banks Reference Rate to 9.87 per cent is not adequate to stop the shilling’s slide.

Jibran Qureishi, an economist at CfC Stanbic Bank, said the CBK needed to supplement the interest rates increase with high yields on government paper to attract dollar inflows and keep the local unit stable.

“Investors have indicated that they will come in at a one-year (364-day Treasury Bill) rate of at least 13 per cent,” said Mr Qureishi.

READ: Njoroge hits borrowers hard to save the shilling

Razia Khan, chief economist for Africa at Standard Chartered Bank, said that whereas CBK governor Patrick Njoroge had tabled his “hawkish credentials” early in the day to calm markets, there are concerns that the weak currency would still exert pressure on inflation in the coming months.
“For now CPI inflation remains within the CBK’s targeted band. However, there are concerns that pass-through from a weaker forex rate may pressure inflation in the coming months,” said Ms Khan, adding that the minimal increase in the base lending rate may not reduce private sector borrowing enough to prevent an overheating of the economy.

“With the Kenya Banks Reference Rate (KBRR), which is reset every six months, raised only 133 basis points [1.33 percentage points] from its January level to 9.87 per cent, the authorities may need to do even more to prove their willingness to cool a potentially overheating economy,” said Ms Khan.

Without disclosing the figures, the CBK’s Monetary Policy Committee (MPC) said in its Tuesday statement that the private sector borrowing had run ahead of target by the end of May. Cash in circulation was also ahead of target, creating the potential for inflation.

Robert Bunyi, an analyst at Mavuno Capital, said the MPC’s decision showed its readiness to act to rein in depreciation of the shilling.

“This is a strong signal from the MPC that it is willing to pay the price of containing inflation and stabilising the exchange rate, which is a slow-down of the economy,” said Mr Bunyi.

Higher interest rates— which effectively make borrowing more expensive — would discourage importers from placing more orders. Besides, high rates should rein in the widening current account deficit as importers are most likely to get discouraged from placing more orders.

The current account deficit rose by 59 per cent to Sh101.5 billion as at the end of March compared to the same month last year – amounting to an increase of Sh37.7 billion.

The deficit is close to 10 per cent of the gross domestic product and has been the constant among the many factors causing the shilling’s slide.
The Kenya National Bureau of Statistics (KNBS) has attributed the huge deficit to the rising value of imports relative to exports.

Tourism, which has been one of Kenya’s main sources of dollar inflows, remains in the doldrums, beset by the threat of insecurity arising from frequent attacks from Somalia-based terrorists.

“All the sectors of the economy recorded positive growths of varying magnitudes except the hotels and restaurants whose growth contracted.

This was the fifth consecutive decline in growth, which is mainly attributed to low hotel occupancy rates arising from insecurity concerns mainly by international visitors,” said the KNBS in its latest report.

In line with the related hotels and restaurants sector, the activities of accommodation and food service recorded negative growth for the fifth consecutive quarter.

The sector is estimated to have contracted by 7.5 per cent during the first quarter 2015 with the bed occupancy rate in the coastal beach hotels estimated to have shrunk by 21.9 per cent during the same quarter.

If the CBK is forced to raise benchmark rates further, it will only fuel the cost of money in Kenya and further constrain economic growth. In the first quarter of the year, GDP growth was 4.9 per cent, marginally higher than the 4.7 per cent of the same quarter last year.

Consumers face further difficulties with the possibility of fuel prices being increased next when the ERC reviews them. The rising cost of imports, through the local currency depreciation, could force authorities to jerk up fuel prices.