Kenya: Interest Rates Present Tricky Challenge For The Central Bank

By Anzetse Were more info

After the government announced that it had acquired a two-year, Sh77.43 billion ($750 million) syndicated loan, some banks raised their interest rates. This raised questions about what happened to the billions raised via the Eurobond and the implications of rate hikes on the economy. However, the truth of the matter is that there are several compounding variables with which CBK has to contend; variables that put pressure to keep rates high as well as pressure to lower rates.

In terms of the pressure to keep rates high one need only remember that the CBK raised the Central Bank Rate (CBR) to 10.0 percent in June 2015 from 8.50 percent and then raised it again to 11.5 percent in July 2015. These hikes were done in an attempt to stem the depreciation of the shilling and control upward inflationary pressure. This act was arguably warranted given that Kenya is an import economy and has to service foreign denominated debt which currently stands at about 50% of total debt. Therefore, if the KES depreciation is not managed, import bills will become more costly and foreign denominated more expensive to service. These are real short to medium term pressures that the government has to manage.

Of course the problem with raising interest rates is that it often has a dampening effect on economic growth due to reduced investments and consumption. Therefore in keeping rates high further strain will be put on economic production and GDP growth. This will happen in the context of economic performance that has been so anemic that both the World Bank and the government revised GDP growth figures downwards. High interest rates will likely exacerbate the subpar performance of the economy and government will fail to generate the revenue required to pay import bills and service debt. Therefore in this scenario, CBK has to tussle with keeping rates high to stem KES depreciation and control inflation while contending with the negative consequences of doing so.

At the same time, there is pressure to lower rates. As mentioned, high interest rates tend to dampen economic growth and Kenya cannot afford this. So there is good reason for rates to be lowered, clearly the economy needs it. Lower rates will enable economic productivity, support economic growth and allow government to generate much needed revenue. However, if interest rates are lowered it risks prompting the devaluation of the shilling and enabling upward inflationary pressure. A weak shilling will mean import bills are more expensive and may make servicing foreign debt unaffordable. High inflation will raise the cost of living which will mean that basic goods such as food become more expensive for Kenyans. This is when the politics of economics comes in; no government wants to be in power when basic goods become unaffordable as social unrest usually ensues. Therefore, although there is pressure to lower interest rates, the potential negative consequences of doing so are not phenomena with which any government would want to contend.

In short there are good reasons to keep rates high and there are good reasons to lower rates; so what should the CBK do? In my view, given the fact that there is extra incentive to raise rates due to heavy domestic borrowing by government, the CBK should lower rates. This is because government borrowing has prompted rate hikes beyond what CBK had orchestrated. Therefore, a lowering of the CBR will buffer the economy and Kenyans from the recent hike in rates.

However, the situation the economy is in right now has made one thing clear; Kenya’s economy cannot continue to be structured as it is. There must be concerted and deliberate action by government to plan a fundamental reorientation of the economy in which more forex is earned. This can be done through increasing exports and diversifying our export profile, as well as supporting forex earners such as tourism.

This article first appeared in my column with the Business Daily on October 25, 2015

Anzetse Were is a development economist based in Kenya and a weekly columnist for the Business Daily.  Twitter:@anzetse, email: [email protected]