Central Bank of Kenya exerts pressure on banks to cut lending rates

The Central Bank of Kenya’s decision to maintain the central bank rate and lower a key figure used by banks to determine interest rates is a calculated move to tackle inflation, the local unit and cost of credit in the short to medium term.

Economists, bankers and investment analysts who spoke to Weekend Business said the Monetary Policy Committee (MPC) —the body that advises CBK on inflation, exchange rate and cost of credit—is keen on lower interest rates and single digit inflation of below 5 per cent.

“(The decision by MPC) ... sends out two clear messages. One is that the CBK’s monetary policy is alive to the fact that inflation needs to be anchored and therefore it is premature to change the monetary policy stance as signaled by the CBR,” said a statement from Kenya Bankers Association.

“The second is that the money market conditions have been characterised by slight reduction in the Treasury bill rates on the back of the government’s external borrowing programme that has influenced the extent of resort to the domestic money market.”

On Wednesday, MPC set Kenya Bankers Reference Rate (KBRR) at 8.54 per cent from 9.13 per cent in July 2014 while maintaining the CBR rate at 8.5 for the seventh consecutive time—a move that shows no change in the monetary policy for the next couple of months.

The decision, analysts say, is a pointer that CBK will remain active in its open market operations--a monetary policy tool used by central banks to increase or decrease money supply by buying and selling government bonds in the open market—as one of the mechanisms of ensuring stability in the foreign exchange market.

According to data from the CBK, the average bank lending rate declined from 16.9 per cent in July 2014 to 15.9 in November 2014 while the spread between the KBRR rate and banks’ lending rate declined from 7.8 per cent to 6.8 since introduction of KBRR framework to inculcate transparency as to how banks price credit.

Lower oil prices

With the KBRR framework, banks are expected to price their flexible loans using KBRR as the base rate and any deviation from the KBRR be disclosed to both the respective borrowers and CBK. “As anticipated the CBK has left its key lending rate unchanged in the face of falling oil prices. With fuel costs being one of the largest consumer and business costs the decision of OPEC to keep the pumps flowing in a race to the bottom with US Shale, Kenyan inflation has been suppressed.

The Monetary Policy Committee of the CBK is still targeting a 5 percent rate of inflation,” John Foster, Head of Africa Debt Capital Markets, Debtwire CEEMEA – The Mergermarket Group (UK) said.

Going forward, manufacturers and retailers stand to lose out from the deflationary cycle and may have to cut prices to shift stock –seeing the shilling is depreciating – or falling in value – against the US dollar.

Also, importing goods paid for in USD will be more expensive for Kenyan companies if the shilling’s value continues to fall.

“Falling retail prices and rising costs – that’s a bad thing as it turns profits into losses which means some firms working on thin margins will go out of business and have to sack their staff – and then things can start to snowball.

Fundamentally MPC’s announcement is a good thing. But the CBK can’t take it’s eye off the ball,” said Foster.

Razia Khan, the Standard Chartered’s Head of Africa Research concurs, viewing the foreign exchange rate and its likely impact on future prices as the key reason for CBK to exercise caution. “Interestingly, recent Kenya Shilling weakness is still viewed much as the consequence of ‘temporary’ USD strength. Against other currency pairs, the Kenya shilling exchange rate is seen by the MPC to be more stable,” Khan said.

She said of concerns are more long-term. “Given Kenya’s rising external debt obligations, we need to see an enhanced export performance to mitigate debt service risks.

Even though Kenya will clearly be a near-term beneficiary of lower oil prices, the effect of lower oil on its import demand may well be offset by rising capital goods imports to support its infrastructure build,” she said. “In our view, risks remain, and the authorities are correct to adopt a relatively cautious approach to monetary policy.”

Even so, she said with the resetting of the KBRR to reflect lower T-bill yields, Kenyan borrowers will still benefit from a lower interest rate environment. “Increased external borrowing has capped the level of domestic borrowing that is required, helping to lessen the pressure on short-term yields.

As a result, the KBRR is reset to 8.54 per cent for the next six months, from a previous 9.13 per cent. This should continue to support Kenya’s economic acceleration,” Khan added.