Should we celebrate falling interest rates

Central Bank of Kenya’s monetary policy committee (MPC) has cut the interest rates in the last 10 meetings. [File, Standard]

The Central Bank of Kenya’s (CBK) monetary policy committee (MPC) has cut the interest rates in the last 10 meetings. Its latest rate is now 8.75 per cent. Why does this matter? 

It’s expected that with low rates, banks will take the cue and lower their lending rates. We shall borrow more money to invest or consume.

That will stimulate the economy and lead to growth and jobs. That would be political good news.

Economics has become the new face of politics. Who said the government has no business in business?

The MPC statement does not mention the 2027 polls, but economic growth and jobs thereof will matter. Wait for the campaign speeches.

The big question is whether the interest cut by CBK will be transmitted fast enough through the economy to be noticeable before 2027. Will banks reduce the lending rate? Shall we borrow more money by extension? 

Banks don’t lower rates immediately; they do so with a lag. I have heard CBK complain about that.

There are many other factors banks consider in setting their interest rates, beyond the CBK rate.

One is the risk profile of the borrowers. That does not change overnight, whether it’s an individual or an institution.

Do banks incorporate our credit rating in pricing the loans?

Two is the economic prospects. We borrow with a firm belief that we shall pay back and possibly make some profits.

If you borrow Sh100,000 from the bank at 15 per cent, we expect you to make a higher return than 15 per cent.

That will depend on the performance of the economy. 

If the growth prospects are good, there will be demand for your goods and services, leading to profits and the ability to pay the loan.

Online lending

How are the growth prospects beyond the official statistics? How do ordinary Kenyans feel about it?

Borrowers, from their experience, decide how much to borrow, when and for how long.

Clearly, interest rate is not the only factor in borrowing. Do you recall when the interest rates were capped? Did we get queues outside banks? 

Why are shylocks and online lending platforms doing so well despite their high interest rates? That is the best evidence that lowering rates will not necessarily lead to more borrowing.

Add the many Kenyans who borrow money with no intention of ever paying back. There is a hidden belief that debt is a “gift.” No wonder banks have to provide for non-performing loans. The government also owes citizens lots of money through pending bills and tax refunds.

Confidence in the growth of the economy is a key consideration of the borrowers; they often have a keener sense of the economic prospects than CBK as they deal with the reality.

Cutting rates frequently could have a counter-effect. Borrowers might interpret that as a sign that the economy is not doing well and needs intervention.

They may avoid borrowing and spending. Sentiments matter in the economy. Ever heard of the liquidity trap? I am not a pessimist. 

Cutting rates has other consequences. It reduces the cost of government debt. Remember T-Bills and Bonds?

At lower rates, we want to borrow less from the government, while bond prices go up as coupons fall. 

Lower interest rates on deposits shift us to alternative investments and enhance the stimulative effect of lower interest rates.

We can invest the money in projects that create jobs instead of keeping it, or spend it because the rates are too low. We do all that if we have confidence that tomorrow will be better than today.

We can shift our money to land, gold or other assets with higher returns. That is the beauty of affluence! The rest?

Let’s not forget that low inflation is cited as one of the reasons for the interest cut. The low inflation is interpreted as a sign that we have no money to spend. We hear that in the streets and hamlets.

Monetary policy, best espoused by changes in CBK rate, could be more effective if its cross pollinated with fiscal policies; tax cuts and targeted government spending.

Tax cuts have been sticky in the last three years, but government spending is picking up. 

High inflation

Will more cuts come in the remaining part of the year? My hunch is unlikely. As we head towards 2027, inflation will be fought using any arsenal at our disposal.

Remember, lots of money is going out through Nyota and other projects.

Pre-election spending is a reality. That could be inflationary.

Add the prospects of subdued rain, and inflation is a real threat. 

Is Philips curve still applicable? What would the government choose, low inflation and fewer jobs or high inflation and more jobs? The government has reduced inflation by “taking money” from us through taxes and levies.

Has it created jobs? That is the missing link. No wonder the focus on giving youth startup capital and internships.

One question at the back of every economist’s mind is, if the CBK rate has been falling, why is the shilling not weakening when the fundamentals suggest it should?

The next MPC meeting is in April 2026. Let’s watch and wait for the direction the interest rates will take and the stimulative effect on the economy.