The purpose of this Note is to give our thoughts on the likely action of the Monetary Policy Committee (“MPC”) at the upcoming meeting, which is set for Monday March 21st, 2016. The Note gives a quick overview of MPC, then discusses the background leading to the current economic environment, and finally we estimate what MPC may do in their upcoming meeting.
Overview of MPC:
"MPC" is the advisory organ of Central Bank of Kenya (CBK) set up pursuant to section 4B of the CBK Act, Cap 491, responsible for formulating monetary policy. Governor of CBK, Dr. Patrick Njoroge, chairs MPC, and the other members are:
- Deputy Governors: Haron Sirima and Mrs. Sheila M’Mbijjewe,
- Treasury Representative: Dr.Kamau Thugge, and,
- Members: Mr. Charles G. Koori, Prof. Francis Mwega, Mrs. Farida Abdul and Mr. John Birech.
The principle mandates of MPC is to formulate and implement monetary policy to achieve and maintain price stability to create a conducive environment for economic growth i.e. price stability includes inflation levels, currency and interest rates. In order to achieve their mandate, MPC reviews the prevailing macroeconomic environment and formulates appropriate policy decisions to maintain stability. Their tool for maintaining price stability is Central Bank Rate ("CBR"), which is the base for all monetary policy operations. During periods of high inflation or a rapidly depreciating shilling, the MPC raises CBR to curb inflationary pressures and stabilise the shilling. A higher CBR makes it more expensive for consumers to borrow to fund consumption and investment expenditure, which reduces liquidity, in turn reducing inflationary pressures. The opposite is true in a low inflation environment.
There is a set statutory requirement for meetings, with the chairman of the Committee having to convene a meeting of the Committee at least once every two months, and additional meetings are convened if requested by at least four members in writing.
Brief Economic Background:
MPC met several times during the year 2015, and have met once in 2016, with the committee arriving at several decisions, namely:
- At the beginning of 2015, MPC met and maintained the CBR at 8.50%, which had been the rate since April 2013, in a bid to contain inflationary expectations within Government’s target range of between 2.5% - 7.5%. At the time:
- Inflation was at 5.6%, with upward pressures as a result of a strengthening dollar and increase in food prices, which came about due to delays in the long rains season, which negatively affecting agricultural output,
- Currency was at Kshs 90.5 to the dollar at the beginning of the year, depreciating 4.5% to Kshs 94.6 in April. The increased volatility of the shilling was due to: (i) the onset of the dividend paying season for foreign companies, (ii) there was no substantive CBK governor in office, and (iii) forex reserves were declining.
Rates environment for the period January to April was favourable on account of stable macroeconomic indicators such as 91-day T-bill, inflation and CBR except the currency which had weakened 4.5%. Due to the volatility and instability in the economy, the MPC changed their calendar of meetings from bi monthly to monthly to closer monitor the performance of the market. Given the currency depreciation and inflationary pressures, it would have been prudent for MPC to raise CBR.
- In the June 2015 meeting, MPC adopted a tight monetary policy stance by raising CBR by 150 bps to 10.0% in a bid to moderate demand pressures in the economy that were attributed to a weak currency that had lost 8.5% against the dollar YTD to Kshs 98.6, from Kshs 90.5 in January, and inflation which had risen to 7.0%. With the benefit of hindsight, it is clear that MPC should have started raising rates from early 2015 in order to avoid the big 150 bps hike in June.
- In July 2015, after the appointment of a new Central Bank Governor, Dr. Patrick Njoroge, the MPC met and raised the CBR by a further 150 bps to 11.5% in support of the Kenya Shilling, which was rapidly depreciating, having shed 4.3% since the June 2015 meeting and 13.2% from January 2015 as a result of (i) a strong dollar globally, and (ii) increased demand for foreign exchange to finance import of capital goods for Government infrastructural developments. This was a good decision by MPC as they controlled the decline of the shilling.
- The MPC has maintained the CBR at 11.5% for five consecutive meetings until January 2016 on account of (i) stability in the foreign exchange market, (ii) improvement in forex reserves to about 4.5 months of import cover, (iii) a narrowing current account deficit, currently at 6.9% of GDP, and (iv) stable inflation rates, which have been within the target band. Since then, the Kenyan economy has shown resilience, with the FY’2015 GDP growth expected to come in at 5.4%.
Where are we now and what is the MPC likely to do?
Since January, the country has experienced a lot of positive news, starting with the expectations of a high economic growth rate forecast, with the IMF projecting a 6.0% GDP rate growth, Cytonn at 5.8%, and Bloomberg consensus at 5.9%. The currency has remained stable against the USD and other trading partners, and given the U.S Fed’s decision to maintain rates during the March meeting, we see no major risks to the shilling. The money market has remained relatively liquid supported by CBK with their Open Market Operations through reverse repos of Kshs 69 bn since the last MPC meeting. Inflation has remained within target, declining in February to 6.8%, from 7.8% in January, on account of lower oil prices.
Given the favourable environment and positive factors outlined above, there is a possibility MPC may consider lowering the CBR by 50 bps to 11.0%. This could serve as a signal that the interest rates are attractive to the economy at the current levels, and would be in line with CBK Governor’s earlier statement that MPC is working towards lowering rates, anchored by a stable currency and inflation rates.
However, we are of the view that the best move for the economy at this point would be for MPC to maintain CBR at the current 11.5%. This would help (i) the effects of lower interest rates, a stable shilling and low inflationary pressures to consolidate, and (ii) the economy to fully be anchored against any shocks in the near term, driven by the possibilities of:
- A spike in inflation as a result of introduction of excise duty tax, VAT on petroleum products and the possible increase in global oil prices. By maintaining the rate, the MPC would avoid runaway inflation,
- Currency fluctuations as we head into the dividend payment season by most corporates, which may result in an increase in dollar demand by foreign investors, and,
- Financing the Kshs. 200 bn gap in foreign borrowing from the domestic market, which may lead to a spike in interest rates.
In conclusion, the decisions of this MPC meeting are going to be key in shaping the monetary policy environment for the remaining part of the fiscal year 2015/16. We believe it is in the best interests of the country’s economic stability to maintain CBR at current levels, and this combined with the conservatism of Governor Dr. Patrick Njoroge, our call is that MPC will maintain CBR at current levels.
