The effect of the interest cap on monetary policy

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This article first appeared in my weekly column with the Business Daily on March 12, 2017

Last year I opposed the interest rate cap before it was approved and came into effect. I opposed it because I knew it would lead to a contraction of liquidity, particularly for SMEs who are often viewed as high risk by mainstream banks. A few months later, the fears I had have become a reality. Last week this paper reported that Kenya’s private sector growth moved towards stagnation in February partly due to a decline in private sector credit. Treasury reports indicate that credit growth slowed down to the lowest level in a decade, partly due to banks becoming reluctant to lend under the rate cap regime.

As this paper reported, Treasury data indicates that lending to businesses and homes grew just 4.3 percent in the year to December, down from 20.6 percent in a similar period in 2015. The 4.3 percent credit increase is well below what the Central Bank of Kenya (CBK) says is ideal loan growth of 12 to 15 percent which is required to support economic growth and job creation

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The irony of this situation is two-fold. Firstly, the interest cap did not expand lending, it contracted it, particularly for SMEs. Strathmore Business School indicates that most SMEs in Kenya struggle to raise capital from banks. With rate caps, refinancing of credit from financial institutions has become even more of a challenge. Secondly, even with the interest rate cap, most SMEs find current interest rates unaffordable. Credit is still too expensive.  So what did the interest cap achieve? Firstly, it has made it even more difficult for SMEs to get access to credit and secondly, it is an effort in futility as credit is still too expensive for most, even with the cap.

This is when monetary policy would usually come in to try and address the situation. In a normal scenario with no cap, a contraction in liquidity would usually lead to a drop in interest rates to encourage banks to lend. However, the CBK would not do this due to two reasons. Firstly, the ongoing drought is already placing upward pressure on inflation; the overall inflation rate for February this year was 9.04 percent, well above the ceiling of 7.5 percent. Thus even in a normal situation, the CBK would likely not drop rates as this would place further upward pressure on inflation. Secondly, this is an election year where billions enter the economy in an almost artificial manner, putting further upward pressure on inflation.

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However it is not business as usual, there is an interest rate cap to contend with. The interest cap has thrown monetary policy into chaos. In the current situation, the CBK cannot drop interest rates to encourage lending as this would engender further contraction in liquidity, shutting even more people and businesses out from access to credit. Lowering interest rates would make banks even more reluctant to lend. So the irony of the situation is that it appears that an increase in interest rates may encourage more lending from banks as it would raise the risk ceiling of those to whom banks are comfortable lending. Kenya is in an interesting position where increasing interest rates may actually expand lending; monetary policy has to work upside down. However, if the increase in interest rates were effected to try and address the contraction in liquidity and worked, it may then exacerbate the inflation being caused by the drought. Even in this upside down world there are reasons against raising interest rates as well as dropping them. Raising interest rates would likely expand liquidity and exacerbate inflation and dropping rates would likely engender a further contraction in liquidity.

The world is watching this experiment with interest rate capping going on in Kenya, and thus far it is making the case against interest rate caps even stronger.

Anzetse Were is a development economist;





Interview with CGTN (formerly CCTV): Kenya’s interbank lending market still fearful, rigid

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Kenya’s 2016 rate caps continued to inflict damage on the wider economy. In its latest assessment of the Kenyan economy, the IMF warns that they could cut growth by up to 2 percentage points in 2017 and 2018 too. The rate caps have added to the sense of crisis triggered by last year’s liquidation of one bank, and receivership of two others. Inter-Bank lending volumes have fallen by about a third, and large banks are extremely reluctant to lend to smaller ones. CGTN’s Ramah Nyang spoke to me to better understand this crisis in the inter-bank market.

Emerging effects of the interest rate cap in Kenya

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This article first appeared in my weekly column with the Business Daily on December 4, 2016

Speaking to businesses over the past few weeks has made it clear that the effects of the interest rate cap are already being felt. And while banks may be experiencing a surge in applications for loans, they seem to be approving fewer than was the case before the rate cap.

As had been my prediction from the beginning, it is the small businesses that are being hit the hardest by the interest rate cap already. Firstly, banks seem to be raising requirements for loans; micro and small businesses have shared with me that they are being told they either need a title deed or log book and that their application is not even considered without at least one of these documents. Yet it is these very businesses that need the credit the most, that do not have the requisite documents. Larger SMEs are getting access to credit but not to the scale prior to the interest rate cap. It seems they too have to make their application risk free to get access credit and even then, not to the scale desired. Very large businesses seem essentially unaffected by the cap because they were getting loans at about the current rate already and often have more options for finance sourcing. (source:

Another negative effect of the interest rate cap is that concessionary lending from banks seems to have become an impossibility. My conversations reveal that previously, projects that stimulated positive social impact some banks espouse such as clean energy would receive competitive rates to encourage the development of that field; such projects are no longer enjoying such flexible lending due to the rate cap. Interest rate variability is a risk management tool for banks and since they do not have access to this tool anymore, it seems that interest rates at below market rate are simply not being awarded anymore, even if such projects previously enjoyed concessionary rates. As a result, some impact focussed businesses are losing out on a key means through which pro-development projects used to be incentivised. Additionally, banks are mitigating loss of income from rate spreads due to the interest rate cap but adding fees and charges to services that were previously free.

Frankly, it was utopian for Kenyans to assume that interest rate capping would unleash lending and attendant business and economic growth. Kenyans are now seeing that liquidity seems to have tightened rather than loosened, as some analysts myself included, had warned. Further, the business environment in Kenya is the biggest impediment to business growth in the country, not just access to finance. The introduction of new fees for the movement of goods and branded vehicles by county governments and the high cost of transport and electricity are some of the biggest impediments to business growth in this country and unleashing financing will not solve these problems.


Devolution has made it clear that corruption, not access to finance which the interest rate cap sought to improve, is a key constraint to business and economic growth in the country. Devolution is positive in that it has brought governance closer to the people, but it has also created numerous channels through which unscrupulous public servants can seek rent from businesses. The problem seems most dire at county level where there is limited automation and inadequate scrutiny of county revenue generation and spending. County officials seem to have the greatest leeway to harass businesses for imaginary infractions with no need to account for their behaviour. Unleashing financing won’t solve this problem.

It is not all bad news however; Savings and Credit Cooperative Societies (SACCOs) have become a more attractive financing option particularly given that some SACCOs already provide credit to members well below current bank rates. This may lead to an expansion of this sector thereby broadening financing options for Kenyans. Further, increased difficulty in accessing loans will make it harder for Kenyans to take on credit for consumptive rather than investment purposes. Applications will have to be thought through more rigorously than perhaps previously was the case; this is good news.

Anzetse Were is a development economist;


The effect of raising US interest rates on the Kenyan economy

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This article first appeared in my weekly column with the Business Daily on November 15, 2015

There is an increasing expectation coming out of the USA that the Fed will raise interest rates in December this year. Many African economists have been keeping an eye on the Fed and with good reason as the rate raise is likely to have an effect on frontier markets. The precise effect is hard to determine definitively but there are key elements of which one should be aware.

Firstly, a rise in interest rates will make investment in the USA more attractive after the Fed having pursued a zero interest rate policy for seven years. However, as the Financial Times speculates, because a rate hike has been anticipated for so long, the response to an actual hike may be muted. From a Kenyan perspective there are two ways we could go in terms of our own interest rates to keep Kenya an attractive investment destination. Interest rates could be cut to help the economy grow more robustly and boost domestic productivity, or rates could be maintained or increased in order to deter investors from taking their money abroad.


Secondly, a US rate hike will inform the value of the Kenya Shilling. As has been seen in recent times, a stronger US dollar which will now be backed by higher US interest rates, has tended to place downward pressure on the value of currencies in Africa. Bear in mind that Kenya has been battling a weak shilling for months and the currency seems to have finally reached some point of stability. An interest rate hike in the US may put all the effort put into stemming KES depreciation to waste. Indeed, the CBK should expect the KES to depreciate when the rate hike is announced and will now face a renewed challenge of stemming the KES plummeting having already used most of the monetary policy tricks at their disposal. Further, although some say that investors may not react to a rate hike, there is the real risk that because the hike will strengthen the dollar, this may attract capital away from emerging and frontier markets. In short there may be a severe contraction of US dollars from global markets, especially frontier markets. Bear in mind the emerging and frontier economies as a whole benefited from an estimated $4.5 trillion gross inflow between 2009 and 2013. The thought of that scale of funds leaving emerging and frontier markets, Kenya included, is a daunting prospect.

Thirdly, Kenya has been accruing a great deal of dollar denominated debt and the government has largely been able to do so because of the leakage effects of the very low interest rates tied to the dollar. Rate hikes may therefore present the challenge of making such debt unsustainable. What can be sure is that any future sovereign bond issues by Kenya and other countries will not be nearly as favorable, with regards to interest rates, as was the case even last year. The serendipitous combination of plenty of QE informed liquidity and low interest rates in the US and Europe from which Africa and Kenya has benefited for so long, is not likely to occur again in the near future. Kenya will have to price any debt it offers particularly competitively to attract the scale of funds raised in the recent past.


However, the bottom line is that a rate hike will be a clear signal that the US is well into recovery terrain and thus US investors will be better placed and more confident in investing in general. This particularly good news for Africa, Kenya included, given the challenges the Chinese economy has been facing in the recent past. Also bear in mind that the QE from European Central Bank may buffer Africa and Kenya for a while still as a fresh round of liquidity enters global markets from Europe this time.

Anzetse Were is a development economist; email:

CBK in a tight spot with monetary policy options

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This article first appeared in my weekly column with the Business Daily on September 13, 2015

It is no secret that the Kenya shilling has been tanking, nearing 106 to the US dollar last week. Bear in mind that this is not the lowest the shilling has ever reached; KES reach USD 107 in October 2011. However, conditions now are different and have informed the anxiety about the depreciation of the shilling. Not only does Kenya’s Current Account Deficit remain substantial, the country is racking up foreign denominated debt. As of March 2015, Kenya’s public debt stood at KES 2.5 trn, about KES1.3 trillion (52%) from domestic sources, with the remainder of KES1.2 trillion in foreign borrowing (48%). Yet total public debt is expected to go up to 2.9trn by end year. How much of this will be foreign denominated? This question becomes important when analysing the KES value issue as it adds to the problem of a scarcity of dollars.


The factors that are causing KES depreciation are numerous and include high liquidity in the market after the government released payments to state-linked entities and ministries, a strengthening of the US dollar, Kenya’s high current account deficit which has led to a scarcity of dollars, high imports, and poor tourism inflows the last of which is an important forex earner. Finally, foreign investors have been exiting the Nairobi Securities Exchange taking dollars along with them. So what can and what has the CBK been doing to address these pressures on the shilling?

Well firstly is the direct sale of foreign exchange. However, such a strategy is constrained by two factors. Firstly, Kenya is an import economy, thus by definition, forex is scarce. Yes, the government currently has Foreign Exchange reserves of about $6.4 billion as well as a precautionary facility from the IMF, but these options are limited. Not only must dollars be drained from the economy to make trade payments, lower exports and the poor performance of tourism add a further burden on the CBK’s ability to throw dollars at the depreciation problem. Further, high dollar denominated debt means that the government has to start saving dollars in order to make the repayments that are maturing on this type of debt.


Secondly, the CBK can address the depreciation problem by fiddling with interest rates; and it has. CBK raised the Central Bank Rate (CBR) to 10.0 percent in June 2015 from 8.50 percent, which had been stable since May 2013. CBK then again raised CBR from 10% to 11.5% in July 2015. But there are several problems with raising interest rates to influence the performance of the shilling. Firstly, it often has the effect of slowing economic growth due to reduced investments and consumption. The conundrum here is that the performance of the Kenyan economy will be negatively affected by a hike on interest rates; yet the Treasury’s rosy growth projection of up to seven per cent this year was based on interest rates remaining stable at around the May 2013 levels. Remember that the Kenyan economy is already performing at the subpar level of 4.9% GDP growth in first quarter. Yet interest rates hikes make the prospects of the rates of future GDP growth even grimmer. However high GDP growth performance was based on lower interest rates, the very same lower interest rates government had hoped to rely on to generate the type of economic growth to generate funds that can be used to accumulate revenue as well as build up forex reserves. Thus the irony is that the interest rate increases CBK is using to try and control KES depreciation may constrain GDP growth and thus the government’s ability to accumulate the funds needed to give it wiggle room in controlling interest rates in the future. Difficult conundrum indeed.


Finally, the CBK can reduce the amount of shillings in circulation to control KES depreciation. Indeed, the CBK has sought to drain excess liquidity from the market by offering Sh6 billion in repurchase agreements. But again the CBK is constrained, mainly by political considerations. It is well known that Kenya has a very high recurrent public expenditure bill and thus the government is in a situation where more KES are regularly being released into the market than had been the case for previous administrations, pushing KES liquidity in the market up at regular intervals. But there is no way, as of now, that that public expenditure bill will be reduced; such steps would be too politically acrimonious. Add to this the fact that Kenyan teachers just secured a pay increase. That hike, if calculated up to 2017, will be Sh99.8 billion incurred on teachers’ pay alone. It is also likely that payments to police and other civil servants will rise; thus the public recurrent expenditure is on the rise. Sadly, government’s options in creating the funds to make such payments possible will, again, affect government’s ability to control the depreciation of the KES. How can government pay an ever increasing public expenditure? One by raising taxes which reduce investment and consumption and reduce GDP growth, or additional borrowing by government in domestic markets which crowds out private sector, or foreign borrowing which adds to the problem of additional foreign denominated debt. Thus here, again, CBK’s impact in lowering KES circulation via draining excess liquidity is limited given all these political considerations. Indeed in addressing all these wage demands, government again will be put in the difficult position of very high liquidity in local markets, coupled with taking actions that may dampen GDP growth while also potentially accruing more foreign denominated debt. Again, a difficult conundrum indeed.

Given all these factors, it is clear that the CBK is in a very tight position with regard to the monetary policy options at its disposal to control the depreciation of the shilling. It will be interesting to see the action CBK takes in coming months in addressing what is truly a difficult problem.

Anzetse Were is a development economist; email: