Central banks are under pressure on two main fronts: easing of currency issuance and regulatory policies; and digital technology. A suggestion published last December was to print currency and ease regulatory policies to address the economic shock of the Covid-19 pandemic.
In Kenya, only the CBK has the power to issue currency. The suggested printing is the “helicopter drop” version of “quantitative easing” (QE) — a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment, itself an instrument of recent origin in major central banks of core industrial countries. It’s a roll of policy dice. Clarity would argue this high-risk advice would escalate Kenya’s weaknesses and struggles with economic policy.
First a policy background.
In times of war, economic collapse, or emergencies, modern economies anchor responses on fiscal and monetary policy mix, a primary template on which economists design successful sector plans and economic recovery, founded on the economic outlook. Kenya under President Mwai Kibaki, 2002-2013, showed this capacity. He revived the economy from Moi’s era of epic mismanagement, even faced off with the 2008-09 financial crisis.
Much earlier, the stark contrast of economic recovery policy frameworks played out in the economic depression of 1929 in the US. President Herbert Hoover attempted austerity, balanced the budget, and reined in public deb with catastrophic results. Gross Domestic Product (GDP) collapsed with mass unemployment and poverty; the public debt/GDP ratio doubled.
President Roosevelt reversed the catastrophe with Keynesian ideas: he engaged fiscal stimulus by increasing public debt and government spending. The GDP rose by 62 per cent over his years to match public debt, with handsome dividends: employment, stable inflation, and decades of prosperity and fair society in the US. He could have cut taxes, but this is less effective than spending. Why? Tax cuts leak into saving, reduce spending potential, and lower the impact of economic stimulus.
Lesson: the debt/GDP ratio is vital in assessing recovery, whether under the business cycle or the complexities of Covid-19. But its implementation must be above suspicion, like Caesar’s wife. If so, a virtuous circle occurs with debt applied under technical disciple to trigger growth because of a mechanism named the fiscal multiplier. The debt/GDP ratio falls. The economy is stronger, more capable of post-recovery tax increases to service tapering outstanding debt, even external, yet leave country and citizens richer. It is even argued public debt pays for itself,
What of Kenya? One often hears leaders misinterpret the macro-policies of the core economies. A popular myth on public debt/GDP ratios cites Japan’s ratio of over 200 per cent. Japan’s debt source is domestic, with a low proportion held externally, while the yen is a safe-haven currency. Few of our leaders worry whether usage of our public debt, for instance for the twin Elgeyo-Marakwet Dams (or even the Eurobond before that, or even Covid-19 funds) is either accountable to citizens and taxpayers or whether zero outcomes matter.
Could money printing replicate perennial questions of corruption, breaching the CBK independence guaranteed in Article 231 of the Constitution? Is it consistent with statutory requirements for inflation at 5 per cent with margins of 2.5 per cent? What if Kenya printed currency, anyway? Of course, appropriate policies coordinated on the fiscal side and the monetary policy can work. They have their “Caesar’s wife” principle.
Over a decade ago, the idea of currency printing was laughed off as inflationary for increasing the money supply of the system, called the monetary base. Today it is a new normal in major economies with accommodative monetary policy. Yet, Kenya has weak linkages in the monetary/fiscal architecture it takes to impact transmission of enhanced money printing to output, employment, and GDP growth.
The pointed failures lie in the debt/GDP ratio and failed public debt policies. They include unsustainable borrowing, leaky usage of revenues and borrowed funds, and a don’t care attitude to development. The Auditor-General regularly reports distaste with Caesar’s wife. The Controller of the Budget (CoB) regularly reports budgeted but unspent development funds and overspending on salaries and remuneration, operations, and maintenance in the two-tier government. Billions lie idle in County Revenue Accounts at the CBK while Covid-19 shocks deepen. The economy will worsen before it gets better, but is printing money to emulate mature economies, such as the US, Japan, a possibility?
Money printing bidden by the government is not a monetary policy. Despite pledges in central banks of advanced economies for virtually unlimited amounts at almost zero interest rates (as with the Federal Reserve in the US now offering ‘QE infinity’), aiming for recovery, we observe multiple risks. It yields patchy unequal impacts.
In QE, the central banks purchase selected assets, much of it private sector-issued debt, to boost liquidity and lower interest rates hoping to boost investment, consumption, and economic management. While this expands central bank balance sheets, the “concessional cash” for lending ends up in financial institutions like banks. To use a metaphor, even with interest rates at sub-zero, or even negative levels, can central banks take the cows to the water, and make them drink? The outcomes vary.
Banks may take liquidity and add their margins to interest rates, or fish for higher returns in emerging market economies (EMEs). This diminishes expected loan uptake, nullifying recovery. Or with low interest rates, financial markets may boom, disconnected from people with no jobs and nothing to eat. Funds could flow to increased stock prices and spur stock markets, enriching the shareholder class, not driving real sector output growth.
To show the disconnect, take a company valued at Sh3 billion, a price/earnings ratio of 40. The numbers mean investors expect only about 2.5 per cent earnings (earnings yield over the short-term) from growth prospects. What matters is long-run investment performance; not Covid-19 or recession.
Can our banking system deliver post-pandemic recovery from the printing? Take CBK’s 2019 Annual Bank Supervision Report issued belatedly. Substantial customer deposits on liabilities in the balance sheets of commercial banks (some 36.9 per cent) are being assigned to government securities at the expense of private real sector loans.
Here is the key difference with central banks of advanced economies issuing QE. A phenomenon called ‘fiscal dominance’ permeates the commercial banking sector, where debt in government securities is large, with marginal private-sector-issued debt. This crowds out the private sector. Uptake of liabilities, when read on portfolios on the assets side, teems with government debt that mops up deposits by customers, including pension funds, NSSSF, NHIF, and other institutional investors.
This kills financial intermediation.
Money printing would thus primarily rope in CBK in expansionary fiscal policy, abandoning monetary policy altogether. It took decades and the Constitution of 2010 to secure CBK’s independence, which is vital for confidence in the Kenya shilling. At-risk would be several other dimensions of the monetary side not mentioned here.
Where did Kenya miss building a fiscal/financial system capable of transmitting monetary policy impulses to the real sector? Some argue 2013-2017 was a Weiji Moment, despite public debt expanding (“Weiji” being the Chinese expression for moments of great peril that also present a great opportunity to leap to the future via transformation). Prepared structural economic reforms in parastatals faltered, including the set-up of Office of Management and Budget (OMB), and policy-led (not market-led) Bank Consolidation. The moment slipped.
Today, printing currency and borrowing could become a bottomless pit devoid of hopes for recovery. It may not pass muster even if with debt support from IMF, and others. And because Covid-19 hits lower-paid workers disproportionately, inflation amid money printing could impoverish most Kenyans.
Further, studies show currencies are not born equal. Convertible ‘core’ currencies transact globally, and ‘peripheral’ currencies are subject mainly to domestic demand. Expansion of the CBK balance sheet could depreciate the shilling. With about 51 per cent of public debt external, we would see an escalation in Kenya shilling’s requirements for debt service. That could destroy the shilling. And the political class would play Article 231 of the Constitution by cajoling the printing presses for pork-barrel projects, for their constituencies, including BBI.
Mbui Wagacha is a former acting chair Board of Central Bank (CBK) and Senior Economic Advisor, Executive Office of the President.