Low money supply is straining the economy

Ken Gichinga is Chief Economist at Mentoria Economics.

The balance of evidence paints the picture of a Kenyan economy that is straining under low levels of money supply. Indeed, many established corporates are citing a “tough operating environment” as the key contributor to their poor earnings.

The latest reports from the capital markets tell the story of a bloodbath at the bourse as the share price of 17 Nairobi Securities Exchange listed firms have fallen below Sh5 per unit and 5 of the stocks are trading below one shilling!

This effectively has pushed the NSE 20-Share Index to a 10-year low. How can this be happening at a time when government is making major investments in infrastructure particularly in road and railway? The new SGR stations between Ongata Rongai to Suswa are a sight to behold and a marvel of architectural brilliance.

Many roads have also received an impressive facelift and one cannot find a road these days that in not undergoing construction. So why is this policy orientation towards public spending not translating into more money for the ordinary citizens?

The answer is simple.  While Kenya’s economic strategy has emphasized fiscal policy through government investment in infrastructure, it has been weak in creating an environment for solid monetary policy, which is the most important tool for increasing money supply.

This has ultimately resulted in the strange situation in which Kenya finds itself, whereby the country has improved roads and railways, but the ordinary citizen has no money to be able to take advantage of these new infrastructure developments. The statistics bear witness to this reality.

The total currency in circulation in Kenya is Sh540 billion shillings and for a population of 50 million people, that comes to a paltry Sh10,800 or USD 108 per capita. Contrasting this to a currency per capita of USD 9,516 in Switzerland or USD 5,241 in Singapore or USD 1,677 in Saudi Arabia.

This is a serious indictment on those charged with the country’s economic planning for failing to observe that if there is any lesson to be learnt from the last one hundred years of economic history, it is that monetary policy is far superior to fiscal policy when it comes to generating long-term economic growth.

During the Great Depression – the worst economic downturn in the history of the industrialized world – several theories emerged on how to restore growth. The ideas of John Maynard Keynes gained popularity, particularly on the importance of government spending as a way of pulling the economy out of the depression.

This was the moment that Keynesian economic thought took a foothold in policymaking circles informing the move towards more focus on government expenditure as has been witnessed here in Kenya, which has an infrastructure deficit.  In the world of the Keynesian economist, increased public spending can boost aggregate demand and restore growth.

The dominance of Keynesian economics led to the elevation of fiscal policy as a tool for generating growth. However, it quickly begun to emerge that the ideas of John Keynes not only applied just in the short-run, particularly during recessions, but also could have negative long-term effects of failing to prevent stagflation- a period of high inflation and unemployment.

It was at this moment that the world shifted attention to the powers of monetary policy as the critical economic stabilizer. Indeed, this was the golden age of economics with ground-breaking work conducted by Milton Freedman at the University of Chicago. His book -A Monetary History of the United States- which he co-wrote with his wife Anna Schwartz, effectively brought home the point that monetary policy, through raising or lowering of interest rates by Central Banks can play a critical role in determining whether an economy prospers or stagnates. It is, arguably, the most important book in economics.

It is unfortunate that these crucial learnings have not been harnessed here in Kenya to unlock the potential of monetary policy. If anything, the Central Bank of Kenya - the sole institution charged with monetary policy- has found its mandate has been effectively usurped by parliament.

Through the interest-rate capping legislation, MPs have disrupted the transmission mechanism of monetary policy in Kenya ultimately creating perverse reaction in the market. When the CBK reduces the benchmark interest-rates, instead of the expected result of higher money supply, the reverse happens, and liquidity conditions tighten.

There needs to be a meeting of minds between the economic policy technocrats and their legislative counterparts before the situation gets out of hand. Anything less will mean a more difficult future for Kenyan businesses.

The writer, Ken Gichinga, is Chief Economist at Mentoria Economics; Twitter: @kgichinga