The jumbo raise on the Central Bank of Kenya’s benchmark rate to an 11-year high of 12.5 percent has expectedly sent shockwaves among households and businesses and triggered a fresh debate on the interaction between monetary policy and financial stability in the economy.
The CBK’s monetary policy team linked its decision to the need to control the weakening shilling against the dollar that has increased debt servicing costs and raised spending on imports.
The decision, however spells discomfort for banks, households, and businesses amid an expected jump in loan defaults.
The Kenya Bankers Association last week warned that any raise on the CBK rate would trigger a further upward review of lending rates in an economy where gross non-performing loans(NPLs) hit Sh615.54 billion in September, marking three straight months of increasing defaults.
The Sh615.5 billion defaults against a loan book of Sh4.10trillion at the end of the period means the NPL ratio is at 15.4 percent and could rise further with the latest raise on CBR.
The CBK move puts its support policy in the spotlight owing to the shaky nature of the economy.
In an environment such as Kenya's today where the CBK is compelled to raise rates and protect the local currency, there is a need for caution to avoid disrupting financial stability.
Extreme monetary tightening could wreak havoc on the financial sector and render the economy vulnerable to even small shocks.
The CBK team should reflect on how monetary policy interacts with financial stability when making such drastic changes. The apex bank should consider an accommodative monetary policy where there is relative predictability through aspects such as smooth price signals in the market.
They should also recognise that there are always trade-offs between their objectives of price stability and financial stability.