How high will interest rates go?

CBK Governor Kamau Thugge. [Boniface Okendo, Standard] It was least expected that the Central Bank of Kenya (CBK) would hike the interest again in two months. But they did. CBK Governor Kamau Thugge added a twist to it - he said the shilling has gone beyond its equilibrium rate. Fascinating because the equilibrium exchange rate is unknown. What does the shock rise in rates mean to the Kenyan economy, and to Wanjiku? How high will the rate go? Kenya is raising interest rates steadily just as the West did after post Covid-19 recovery. The key objective in the West was to tame inflation. Covid-19 was tamed faster than expected, leaving excess liquidity and inflation by extension. Disrupting supply chains and reduction in labour supply too contributed to inflation in the West. High interest rates mean less borrowing, either for consumption or investment. The reduced money supply means less demand for goods and services leading to a fall in inflation. But loss of jobs as the economy slows. Our inflation is within the targeted band, 2.5 to 7.5 per cent. It's at 6.85 per cent in January 2024, according to CBK. I do not think inflation is that high to warrant such a drastic hike in interest rates. Besides, our money has been taken by increased taxes and levies. We have less to spend, less demand for goods and services and a reduction in inflation is expected. But I doubt if that was the government's plan. The key reason for the hike is to shore up the depreciating Kenya shilling. It's wreaking havoc on our debt. A weak shilling is also driving inflation. We are a net importer and a weak shilling leads to costly imports (including oil). That's reflected in high local prices for goods and services. The fact that the shilling gained after the shock 200 basis points rise might have convinced CBK that a further rise would work! Digression; economists use jargon to keep their jobs and prestige. The 200 basis points is simply two per cent. Let's get real. Was the 200 basis point rise anticipated muting its effect? Do you recall one bank selling bonds just before the 200 basis points hike? Some observers think CBK - read government - is overusing monetary policy tools compared with fiscal policy. That is not surprising; monetary policy is easier to use. Just increase or decrease the interest rate. It's more like lengthening the jail terms to deter crime instead of creating jobs which would reduce crime in the long run. Fiscal policy is trickier; think of raising taxes or reducing government expenditure. That will be felt by the voters immediately. Who has not felt the effect of new or higher taxes? Reduction in government expenditure would mean job losses, at the county and national levels. In a country where unemployment is high, the political cost would be very high. Enough lamentation: what are the intended and unintended consequences of this raise? In general, anyone seeking loans will have to dig deeper into their pockets. Banks raise their rates as cued by CBK. I am told they simply add more time for you to pay back your old loans. New loans could have fewer takers. A decrease in credit is not good for the economy. But given a choice between a slower economic growth rate and a stronger shilling, the government chose propping the shilling. It's expected that high interest rates will attract the dollars and shore up the shilling. What of bond owners? Their prices will go down. Tried selling bonds lately? Remember the inverse relationship with the interest rate? How will the banks holding such assets react? Their capitalisation will go down. See where I am heading silently? Two questions have left my head spinning. One, how high will the interest rate go up to get us to the expected equilibrium exchange mentioned by the CBK governor? Exchange rate New policies take time to be felt, or in economics, their effects are felt with a lag. Why did not we give the 200 basis rate hike time to take effect? Why did we think it needed enhancement? It's like keeping on adding salt to food without tasting it! Two, if we knew the equilibrium exchange rate, we could model how far the rate would rise to get there. Can CBK give us the targeted equilibrium exchange rate? The unknown equilibrium exchange has left me thinking. Can we also ask for an equilibrium tax rate? This would give us maximum tax revenue with minimum suffering for Kenyans. What of equilibrium national debt and expenditure? Where do we go from here? Economists should celebrate the frequent policy shifts. They are free experiments. We can check the effectiveness of both fiscal and monetary policies. Will interest rate hikes lead to the appreciation of the Kenyan shilling? Is the rate hike equally effective in Kenya compared with other countries? Are we getting more tax revenues from more taxes or higher taxes? Would a VAT of 18 per cent give us more taxes than say 12 per cent? Academics may celebrate their experiments but Wanjiku will not. All she wants is money in her pocket. She has no time for economic romanticism.

How high will interest rates go?

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