Monetary policy in a tight fix

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This article first appeared in my weekly column with the Business Daily on February 19, 2017

Over the past few months we have seen a severe drought ravage our country. The loss of life and livelihood for so many Kenyans is truly devastating. But what we must realise is that the consequences of the drought impacts the lives of the populations in the domicile counties as well as the rest of us. The reality of the matter is that the drought is not only affecting the lives of our fellow Kenyans, it is also affecting monetary policy.

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(source: https://c2.staticflickr.com/4/3273/2477719111_6b9daa5386_z.jpg?zz=1)

The Central Bank of Kenya (CBK) is in a tight fix with regards to the ramifications of the current drought; there is pressure to increase the Central Bank Rate (CBR). We have a serious drought on our hands; not only will it increase the cost of food, it will increase the cost of electricity. As the drought bites, food will be more scarce and the demand for food will outstrip the supply thereby placing upward pressure on food prices. Additionally, as a significant part of our electricity grid is powered by hydroelectricity, the lack of rain means that the dams do not have a sufficient amount of water to run effectively; as a result the country will have to switch to more expensive sources of power such as thermal power that will drive up the cost of electricity. These factors will drive inflation upwards and will force Kenyans to pay more for basic goods and services. On top of this is the increase in the cost of fuel. So the pressure here is to increase interest rates and the CBR and limit money supply to control inflation. Yet in doing so, the CBK will make money even more expensive.

At the same time, we are witnessing the effects of the interest rate cap; liquidity is tightening. Kenyans are finding that they no longer have access to the loans they used to qualify for. Small and medium businesses are seeing that they no longer have access to the credit lines to which they had access to in the past. Kenyans can no longer get that loan to boost their business or pay for emergency medical expenses because banks have become very risk averse. In a country with a poor tracking system with regards to credit worthiness, banks cannot differentiate between good and bad borrowers. As a result they seem to prefer to just limit lending altogether and restrict the amount of credit they are giving out to individuals and businesses. So what does this mean for the average Kenyan? Well it means that they have less money; and when you couple this with the cost of food, energy and transport increasing, Kenyans are feeling increasingly broke. Kenyans will have to pay more for access to the same quantity of food, energy and transport that they used to access in the past. In short, life is becoming more expensive. But ironically, the best way to address the effect of the interest rate cap would be to increase interest rates to a space where banks feel they can lend comfortably. We are in an interesting space where increasing interest rates may expand liquidity as more people would qualify for credit.

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(source: http://www.aprfinder.com/wp-content/uploads/no-credit.jpg)

So there are several sources pointing for the need to increase interest rates. However, in increasing interest rates, monetary policy by the CBK will make money expensive for Kenyans. In increasing rates to mitigate the drought and address the effects of the interest cap, the government would be doing the opposite of what the interest cap was created to do; give Kenyans access to cheaper loans.

Thus monetary policy is in a tight fix; there is a need to increase the interest rate but in doing so the CBK would engender an increase in the price of credit. It seems the CBK must ride off this season of contradictions and see when a space will open up for effecting monetary policy changes.

Anzetse Were is a development economist; anzetsew@gmail.com

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One thought on “Monetary policy in a tight fix

    Evans said:
    February 20, 2017 at 2:19 pm

    I think the conflicting nature on the effects of interest rates cap and increasing interest rates should be be addressed in both long and short term shortcoming it has to the ordinary Kenyan. The law of interest rate cap seem to have been majorly based on the cost of credit high interest rates exposes the ordinary Mwanachi.

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