Weak shilling, inflation top governor’s to-do list

If Parliament approves his appointment as the next governor of the Central Bank of Kenya, President Uhuru Kenyatta’s nominee Patrick Njoroge will find a full and rather messy in-tray on his desk, with most matters requiring prompt action thus giving the public a chance to quickly gauge his mettle.

Top on the pile of issues that will demand the governor’s immediate attention is the recent weakening of the shilling against major world currencies and the rising inflationary pressure that is underpinned by weak economic growth.

Besides these short term macroeconomic developments, analysts say the new office holder will need to keep ongoing advancement of Kenya’s financial system that his predecessor started, even as he improves reliability of the Central Bank’s intervention and navigation of the economy.

“The biggest challenge in my view is rising inflation, which will be tough to keep below 10 per cent in the coming months,” said Robert Bunyi, an analyst at Mavuno Capital, adding that besides the short term macroeconomic challenges, the new governor will need to support the uptake of formal banking services, including credit that has topped Sh2 trillion.

Mr Bunyi is particularly relieved that a substantive governor will get the CBK back on track, saying its recent guidance and action on the shilling, inflation and interest rates has been at odds with public expectation.


Dr Njoroge’s immediate focus is, however, expected to be on the sliding shilling and rising inflation given their possible devastating impact on the economy in the short term. The Kenyan shilling has lost about 13 per cent of its value against the US dollar since January last year to trade at 97 units to the greenback.

Razia Khan, the head of Africa Research at Standard Chartered Bank Plc, expects the markets to pay careful attention to decisions that will be taken at the June 9 Monetary Policy Committee (MPC) meeting that has been brought forward from July.

“This will be an important meeting as it will set the tone for the new governor’s tenure at the CBK, and investors will gain an understanding of what they should expect,” she said, adding that the key task for Dr Njoroge in the near term will be to make clear at the outset what he plans to do to stabilise the shilling and deal decisively with any inflation threat.

“The primacy given to price stability over any other goals (financial inclusion perhaps), will be closely monitored.”

Ms Khan said she expects inflation to rise above nine per cent by year-end, driven by the weak shilling, anticipated rise in oil prices in the second half of the year and the pressure on food prices.

A weaker shilling means that imported consumer and capital goods, including petroleum products and machinery become more expensive, worsening the inflation problem.

Inflation stood at 6.8 per cent in May, a marginal decline from the previous month’s 7 per cent which was an eight-month high and largely driven by dry weather that has raised food prices.

Prices of petroleum products, which fell sharply last year on the back of a global oil price crash, have also started rising in recent months.

A weaker shilling is, however, good for exporters who earn more from the same volume of goods and the CBK will need to balance the competing interests.

Some analysts, led by the World Bank, have argued that the shilling is still overvalued at current levels, placing its fair value at more than 100 units to the dollar.

Mr Bunyi, however, reckons that the exchange rate turbulence is a short term and cyclical problem that should not attract undue attention, a view held by former CBK governor Njuguna Ndung’u, who argued that monetary policy is not a remedy for structural weaknesses in the economy, including trade deficits and supply-side shocks.

Should the CBK decide to prop-up the shilling, however, it will need to raise interest rates by increasing the benchmark Central Bank Rate (CBR) and coupons paid on new issues of government paper.

This should bring in more dollars and other major world currencies while simultaneously reducing liquidity and discouraging imports, effectively firming up the local currency and easing the inflationary pressure.

But tightening monetary policy is a double-edged sword that also portends a rise in bank loan interests rates with potentially growth-limiting effects due to reduced consumption and investment.

The CBR has stayed at 8.5 per cent for nearly two years, setting the benchmark for the 91-day T-Bill and commercial bank’s lending rates that have stood at an average of 8.7 per cent and 16.5 per cent respectively in the same period.

The CBK in December 2011 raised the CBR to an all-time high of 18 per cent to rein in inflation that rose to 19.7 per cent and strengthen the shilling that had weakened to 107 units against the dollar in the preceding two months.

It remains to be seen how the CBK will handle the present challenges at a time when a significant tightening could further weaken economic growth.

Ms Khan said she expects the CBR to be raised by one percentage point to help tame inflation and support the shilling.

“We expect the CBK to raise its CBR rate to 9.5 per cent at the now brought-forward June 9 MPC meeting. Any failure to act forcefully would risk the CBK being seen to be behind the curve, and may come at the cost of currency stability,” she said.

The economy expanded by 5.3 per cent last year, relatively weaker compared to 5.7 per cent in 2013 as the slump in the tourism sector weighed down improved performance in other sectors including financial services.

Besides entrenching macroeconomic stability, Dr Njoroge will also need to ensure that the banking sector’s stability seen over the past decade continues.

Current challenges seen among banks include rising stocks of bad debts and serious breaches of corporate governance and prudential rules at Dubai Bank that threaten the interests of depositors and counterparties.