World Bank backs rate rise to lift forex inflows

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Signage of the World Bank. FILE PHOTO | POOL

The World Bank Group has backed the tightening of the monetary policy stance taken by the Central Bank of Kenya (CBK) to lift forex inflows, which support the exchange rate.

The multilateral lender notes the CBK had been slow to lift the benchmark interest rate with the slack coinciding with the erosion of official reserves.

“While the exchange rate has depreciated playing a larger role in the accommodation of external shocks, the foreign exchange reserves sustained losses, especially in the period when the policy rate was negative in real terms (the Central Bank Rate trailed the rate of inflation),” the World Bank notes in a new report that anchors its recent Sh140.7 billion ($1 billion) disbursement to Kenya.

According to the World Bank, slow hikes in the policy rate alongside unfavourable global financing conditions combined to depress net capital and financial account inflows.

"Portfolio investments turned negative by mid-2022 as international investors rushed towards safe-haven assets, while the recovery in foreign direct investments has been slow.

Together with reduced external borrowing by the government because of unfavourable financing terms, and a negative policy rate, these factors have led to a decline in foreign exchange reserves in 2022 and in the first quarter of 2023,” added the World Bank.

The CBK left its benchmark rate unchanged for two years after the onset of the Covid-19 crisis at seven percent from April 2020 to May 2022.

In comparison, the US Federal Reserve first lifted interest rates in March last year and has comparatively been on a more aggressive tightening cycle which underpinned portfolio reallocations by foreign investors from emerging and frontier economies such as Kenya.

The Central Bank Rate has largely remained negative in real terms for much of the tightening cycle with the benchmark rate only jumping clear of the inflation rate in March this year when the CBK effected a jumbo rate increase to 9.5 percent from 8.75 percent.

While the apex bank tightens monetary policy to primarily manage inflation expectations, monetary policy is widely seen as a key influencer to portfolio flows by foreign investors.

Last month, the CBK effected another jumbo rate increase, setting the CBR at 10.5 percent from 9.5 percent while noting the importance of managing inflation expectations amidst the expected implementation of the 2023 Finance Act.

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