After a slow start to the year, the economy may be perched on a moderate path to recovery. The economic momentum towards the end of the year could improve thanks to an expected rebound in agriculture following indications of improved weather that will be complemented by a revival in government spending. While this may support the government’s enthusiasm that growth could expand close to its potential of 6.00%, pockets of fragility from a lethargic private sector could dampen this momentum.
Sluggish private sector output has been attributed to constraints in credit markets coupled with cash flow issues that continue to inhibit business productivity. Despite central bank efforts to revive credit to the private sector, growth has stagnated below 6.00%. Subdued private sector credit growth has been attributed to the enactment of the interest rate cap that has challenged commercial banks’ ability to price risk. Despite an evident link between slow private sector credit growth and the interest rate cap, the law could remain in force for a longer period after lawmakers recently opposed the National Treasury’s proposal to repeal it.
The ensuing challenges in monetary policy transmission owing to the cap may then result in an unchanged policy stance. To this end, the central bank rate (CBR) may remain unaltered at 9.00% – at least until clarity on the law is ascertained. Additionally, inflation could remain within target – in spite of the expected upward pressure from higher fuel prices in line with rising global crude prices. Furthermore, calls for the central bank to support the economy may dial back as agriculture activity rebounds in line with favourable weather conditions and government outlays improve following the approval of the Finance Bill and Division of Revenue Bill of 2019.
Meanwhile, positive ripple effects from fiscal stimulus may resume after the standoff between the National and County Governments, which put on hold the approval of the Budget for the 2019/2020 financial year and the Division of Revenue Bill (2019), was resolved. Even then, the available fiscal space remains insufficient to meet expenditure needs. This is due to the lack of momentum with reforms in tax policies and administration that has seen the government consistently miss its revenue targets. While the current war on tax evasion could act as a caveat against further evasion, it may as well have the unintended consequence of further subduing business sentiment and activity – at the expense of overall economic growth.
On liquidity, a resumption of government spending could further bolster the already abundant cash environment. Thus far, the market has over KES 150Bn in outstanding Repo/TAD maturities – which are the surplus funds previously withdrawn from the market. The need for the central bank to streamline liquidity conditions has been in an effort to ward off pressure from the shilling. Because of the aggressive mop-ups, the rate on the 7-day Repo/TAD (=8.97%) edged up higher than that of the 91(=6.315%) and 182 (=7.143%) day papers.
Signals that the interest rate cap will be in force for longer may sustain liquidity allocation towards government securities. Investors are already taking cues from this and are more open to placing their funds in longer-term government debt given lackluster investment opportunities in the market. As a result, the National Treasury continues to issue longer-term debt with the 15-year bond (reopens) issues in the month of September being the most recent.