Ideas & Debate

Monetary policy: Kenya’s sole bright spot this year

Food has been one of the main inflation drivers this year. FILE PHOTO | NMG
Food has been one of the main inflation drivers this year. FILE PHOTO | NMG 

This has been a difficult year for the Kenyan economy. A combination of the drought, effects of the interest rate cap on the economy and the extensive electioneering period all slowed down economic growth and performance.

However, there has been a bright spot; monetary policy: It has played a crucial role in being a stabilising anchor for the country.

The first means through which this is seen is in the value of the shilling. Given the turbulence of the electioneering period in particular, it was largely expected that the value of the currency would be knocked. However, through practical action by the Central Bank of Kenya (CBK), its value remained relatively stable, hovering over Sh103 to the dollar.

Secondly, is the effect of monetary policy on inflation. While inflation rate was above the preferred ceiling of 7.5 per cent for the better part of the year, it came down to below the ceiling in July and with the exception of August, has remained below 7.5 per cent.

The high inflation was, of course, informed by the drought that pushed up food prices and electricity—the latter which pushed up the costs of production. The management of inflation is particularly commendable given that the CBK basically couldn’t use changes in the interest rate, a key monetary policy tool, to manage inflation.

The introduction of the interest rate cap has fundamentally constrained the CBK’s ability to fiddle with interest rates to manage money supply and inflation. The cap has made the effects of a change in the rate unknown, thereby understandably engendering reluctance to change the Central Bank Rate (CBR).

Indeed, I am of the view that the interest rate cap has turned monetary policy upside down; an increase in the rate may create an expansion rather than contraction in liquidity, as more people would qualify for the higher-rate risk ceiling.

And lowering the rate would likely contract rather than expand liquidity as even fewer people would qualify for the lower-rate risk ceiling. Thus it is not a surprise that the Monetary Policy Committee chose to leave the CBR unchanged.

While on the topic of the interest rate cap, its continued effects are disturbing. Beyond engendering a massive contraction in the growth of credit, it seems the cap may be dampening private sector appetite for credit.

No longer qualifying for credit lines on which they used to rely, businesses have likely changed their models to accommodate this lack of access to credit. Thus, the real test for the economy will begin if or when the cap is lifted, and whether private sector will demonstrate robust appetite for credit, having essentially survived without it for over year.

Again, in the context of a cap, the CBK has played a constructive role in managing the dynamics of the financial sector in two ways. The first is in pushing for a repeal of the cap; the second is in urging commercial banks to price their loans more reasonably.

The CBK is using the opportunity created by the cap to try bring sanity to a sector that is largely seen as extractive, saddling Kenyans with very expensive debt all in the name of profit. These efforts by the CBK should be commended.

Going forward, it is important that monetary policy continues to anchor the economy and buffer Kenyans from volatility in the macroeconomic environment.