Last year, calls for monetary policy accommodation were on the rise given the need to prop up economic growth at a time of subdued business activity. However, the Central Bank’s reluctance could have been linked to its aversion towards the protracted electoral cycle and the capped interest rate environment that limited the effective transmission of monetary policy.
A better political landscape and improving macroeconomic variables has since improved investor sentiments towards the economy and could have also paved way for the much needed 50bps policy rate cut in March 2018. This was also complemented by prospects of a healthy global economy, rising commodity prices and a globally weak US dollar (y/y). It also looked more than likely that a policy rate cut would do more good than harm despite the capped interest rate environment.
That said, in its latest policy setting meeting this May, the monetary policy committee (MPC) left the policy rate unchanged at 9.50%. In its statement, the MPC largely emphasized that domestic factors, as opposed to external ones, were determining the conduct of monetary policy in Kenya. However, while country specific factors have become a main determinant of monetary policy, policy makers are keeping a close eye on global financial developments.
The most important domestic factor for the Central Bank is that of inflation. The inflation rate remains mute, particularly that of core inflation which strips out volatile food and energy prices. Headline inflation remains well below the Central Bank’s medium term target of 5.00%, at 3.95% in May 2018, and is expected to accelerate but remain within the statutory target range of 5% +/- 2.50%.
Meanwhile, the stabilization of the Kenya shilling has also helped tame consumer prices over the past 12 months. The Kenya shilling has so far steadied given rising US dollar inflows attributable to improved diaspora remittances and export earnings. That said, the Central Bank’s hawk-eyed vigilance has offered indirect and direct support to the local currency through moral suasion and direct participation in the FX market. In addition to this, the Central Bank’s ample FX reserves continue to provide a buffer from the expected external shocks stemming from a strengthening US dollar and higher crude oil prices.
To this, the Central Bank is expected to maintain its accommodative monetary policy stance as economic growth remains significantly below potential. While the economy proved resilient in the year 2017, there are concerns that a significant rebound could be limited by inefficiencies in bank intermediation. As at April 2018, private sector credit growth was fairly slow at 2.80% compared to double digit growth recorded two-years earlier. While this has been attributed to the interest rate controls, it would be of interest to note that the banking sector is currently well funded. This liquidity has since been directed to investments in ‘risk free’ government securities and as such could underscore the reluctance, and not inability, of the banking sector to extend credit to the private sector.
Nevertheless, the MPC also noted that the 50bps policy rate cut was ‘yet to be fully transmitted to the economy’ thus a further rate cut would be unnecessary – at the time. While this could be true, it isn’t backed by data and as such the vagueness of the statement comes to the fore. Additionally, the MPC lacks clarity in its communication about their expectations of the future path of policy along with the conditions that could warrant a change in its policy stance.
The policy statement also seemed to ignore, whether knowingly or unknowingly, the implications of fiscal policy on the effectiveness of monetary policy. Since macroeconomic variables are in, and are expected to remain in, good shape, it then could have been prudent to provide insights on what could inhibit the effective transmission of monetary policy as opposed to using the interest rate controls framework as the ‘blanket problem’.
Driving economic growth would entail enhancing private sector investment and consumption through efficient bank intermediation. If banks are unwilling to channel part of their excess funds to the private sector with majority of these funds being channeled to government securities, therein lies the problem.
Therefore, for monetary policy transmission to be successful, the government would need to tame its domestic debt appetite so as to induce credit flow to the private sector. However, according to the latest budget policy statement (BPS 2018), the government is doing no such thing. The domestic debt target for the fiscal year 2018/19 is slightly higher than the KES 276Bn target for the fiscal year 2017/18. This could suggest sustained domestic borrowing. This could be aggravated by opposing shifts in global monetary policy in some countries such as the US which is tightening monetary policy (translating to higher interest rates). This could then make the external debt market less attractive for Kenya.
All in all, unless something fundamental changes in the market, i.e. the complete overhaul of the interest controls framework, private sector credit could remain subdued for some time.