Since Patrick Njoroge’s tenor as Governor of the Central Bank of Kenya (CBK), the decision to ease monetary policy has been against a backdrop of stable macroeconomic conditions. Moreover, the need to enhance private sector credit growth appears to be a key reasoning to ease policy with the quantum linked to the need to avoid perverse outcomes.
Below is a summary of the commentary made during past Monetary Policy Committee (MPC) rate cut decisions:
|MPC Meeting Date and Decision||Excerpt from MPC Statement|
|July 2018 50bps rate cut||The MPC noted that inflation expectations were well anchored within the target range, and that economic growth prospects were improving. Furthermore, economic output was below its potential level, and there was some room for further accommodative monetary policy.|
|March 2018 50bps rate cut||The MPC noted that inflation expectations were well anchored within the Government target range, the increased optimism for growth prospects in the economy, and that economic output was below its potential level. Therefore, it concluded that there was scope for easing its monetary policy stance in order to support economic activity.|
|September 2016 50bps rate cut|
|May 2016 100bps rate cut||The Committee noted that overall inflation is expected to decline and remain within the Government target range in the short-term. Therefore, it concluded that there was policy space for an easing of monetary policy while continuing to anchor inflation expectations.|
The MPC is set to hold its last policy-setting meeting of 2019 on Monday 25th November 2019. While there are conflicting views on the expected policy rate decision, majority seem inclined towards a policy rate cut.
Below I present my scribbled reasoning as to why a policy rate cut may not by ideal.
Presently, macroeconomic indicators are favorable:
- Inflation pressures are muted – in October, inflation accelerated to 4.95% though it is expected to remain within target (5% +/- 2.5%).
- Economic activity has remained ‘statistically’ robust. However, GDP growth may likely end the year below potential. In 2019, the economy could expand by around 5.60% – 5.80%.
- Private sector credit growth has gradually expanded albeit at a modest pace. Growth was recorded at 6.30% (Aug-2019). The expansion has been supported by bank-led initiatives to extend credit to MSMEs.
- Local currency (currently) strengthening albeit supported by temporary shifts with respect to fiscal policy. Parastatals have been selling dollars in order to purchase shillings that will be remitted to the government as ‘special dividends’.
Could monetary policy transmission improve in a post-rate cap era?
- CBK/IMF empirical studies show that the interest rate and exchange rate channels are the main channels of monetary policy transmission in Kenya.
- The aforementioned channels feed into the economy in the below manner:
- The interest rate channel feeds into aggregate demand and inflation expectations.
- The exchange rate channel feeds into inflation expectations.
- It is however important to note that inflation expectations (which appears in both channels) are a factor of both aggregate demand and aggregate supply that are both linked to the bank credit channel, which is one of the monetary policy transmission channels.
- In order to stimulate the effective transmission of monetary policy through the bank interest rate channel, there needs to be buy in from CBK regulated lenders (commercial banks, MFIs etc).
- These two institutions are for profit and their ability and willingness to lend is influenced by other competing factors such as liquidity and government debt appetite.
- Liquidity conditions have remained ample so that is not an immediate problem.
- The main issue now is the government’s debt appetite:
- Constraints in revenue collection have primarily fueled the government’s increasing debt appetite.
- Government debt is virtually risk-free so banks may prefer to continue lending to the government over the private sector.
- As the government elevates its demand for debt from the domestic debt market, the rate at which this debt is absorbed becomes a pertinent issue for the effective transmission of monetary policy through the interest rate channel.
- While it is important to appreciate that the government is seeking to consolidate its finances albeit through ‘coercing’ parastatals and SAGAs to remit special dividends, the amounts being remitted are not enough to plug the revenue gap. Therefore, the government’s need for debt will remain.
However… could the CBK be jumping the gun?
- The post-cap era could pose challenges for the central bank:
- Interest rates have suddenly entered into a new phase and the rate-cap repeal could see rates trend higher.
- Already, banks are pricing borrower risk (new loans) higher than the previous rate cap of 13% (CBR at 9% plus a 4% spread).
- Further, investors are already demanding a premium for sovereign debt as uncertainty weighs (T-bill and T-bond yields up).
- This could likely result in a steepening of the yield curve, at least for now.
Could a rate cut be counter-productive?
- If indeed the CBK chooses to cut its policy rate, it will be of interest to monitor how the rate cut filters through to the interest rate channel.
- Moreover, will a decline in the lending rate (Owing to a rate cut) result in a greater quantum of bank credit being extended to the private sector?
- In my opinion, the main issue has largely been the supply of credit not the demand.
- Should credit supply improve (if competing interests are minimized) then this would have positive knock-on effects to the demand for credit which could then amplify the economic benefits.
- Further, will the desire of lower interest rates (because of a rate cut) offset market expectation of higher interest rates?
Like I mentioned before, majority of the market already expects that the CBK will cut its policy rate by at least 50bps to 8.50%.
This largely means that the policy rate cut has already been priced in and as such the realization of a rate cut may not bear much fruit. Thus may not deliver the intended pass through benefits to credit.
Should the CBK choose to cut its policy rate, then it should GO BIG or DO NOTHING AT ALL. I am more inclined to the ‘do nothing at all’ given the aforementioned reasons.
Conclusion: It may therefore be prudent for the CBK to take on a wait and see approach so as to monitor how financial markets behave in an effort to avoid distorting the natural market adjustment.