High interest rates will hurt SMEs and economic growth prospects

SMEs are an important pillar of Kenya’s economy. PHOTO | SHUTTERSTOCK

The latest interest rate hike by the Central Bank of Kenya (CBK), raising the central bank rate (CBR) by 50 basis points to 13.0 percent, risks substantially damaging small and medium enterprises (SMEs) and broader economic growth prospects, outweighing the intended benefits of tighter monetary policy.

In its statement, the CBK highlighted the need to anchor inflation expectations among the reasons for its decision. However, considering the vulnerability of Kenya's economy, aggressively tightening policy could prove severely misguided.

With commercial banks likely to tack on an additional 5-6.0 percent onto lending rates based on the new CBR benchmark, credit will become cost-prohibitive for many SMEs already dealing with liquidity crunches, high input costs, and weak consumer demand.

As the backbone of the economy, contributing over 40 percent of GDP, squeezing SME capacity will reverberate across sectors to severely hamper Kenya's economic prospects. With consumer demand weak and many SMEs already struggling financially, excessively raising the cost of credit could have severely deleterious consequences. An accommodative policy that keeps rates moderately stable would limit the shock dealt to this crucial sector.

Rather than focusing narrowly on projected inflation, the CBK should take a more balanced approach that considers vulnerabilities such as struggling SMEs and average citizens’ reduced purchasing power. Protecting their financial health and income growth will sustain broad-based economic expansion over the long run — essential as Kenya looks to realise its aspirations for inclusive development.

The CBK has several tools at its disposal beyond interest rate hikes for managing inflation risks like foreign exchange market interventions to smooth excessive currency fluctuations that drive import price inflation.

With oil prices projected to stabilise and agriculture rebounding locally, headline inflation may moderate without aggressive policy tightening.

A more prudent approach would be to keep moderate interest rate levels largely unchanged over the near term as previous hikes work their way through the economy. The CBK can wait and judiciously assess their impacts before considering further rises.

Rallying rates ever higher risks inflicting disproportionate damage on SMEs that form the heart of the economy.

Rather than an outright war against inflation, the CBK should pursue a nuanced balancing act that stabilizes prices while safeguarding the real economy. Kenya’s SME sector and broader growth prospects are important to the economy. With care, it is possible to make progress on stated inflation goals without severely harming the engines of economic progress.

The writer is a management and development specialist. [email protected]

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