By XN Iraki
The Central Bank of Kenya has finally cut the base-lending rate to 16.5 per cent after keeping it steady at 18 per cent for several months.
The CBK rate is used as a benchmark by commercial banks to set their rates after adding up other costs and a profit margin. CBK uses this rate as the key plank of the monetary policy.
While high rates reduce inflation by checking money in circulation and therefore reducing demand for goods and services, it also slows economic growth.
In the last one year, inflation was CBK’s biggest worry. And thanks to the high rates, Inflation has slowed down. But the soaring rate must now be reduced to stimulate economic growth, by making it easier to borrow money to either invest or consume.
Our only worry is that a reduction in the rate could trigger another bout of inflation because of increase in money supply.
That to a large extent will depend on how quickly banks adjust their own lending rates, which like other prices are “sticky” in coming down, but very smooth in going up.
Adjusted rates
Already, some banks have adjusted their rates downwards.
CBK rate cut is welcome by investors but not by the shilling — whose value decreased slightly after the cut. That was not unexpected; low rates are unlikely to attract lots of money into our economy, which come through bonds, Treasure Bills and even normal bank deposits. High interest rates encourage savings.
That decrease in flow means less demand for the local unit and hence the slight decrease in value.
When CBK cut our rate to 16. 5 per cent, the European Central Bank (ECB) cut the rate to 0.75 per cent (not an error). People’s Bank of China cut theirs to six per cent. The objective of such a cut is similar to CBK: to try and stimulate the economy by making it easier to get credit.
But the ECB rate is perplexing. Why would they put it so low? Economists say risks, such as political uncertainty to default means that Kenya and most developing countries will have high interest rates, while more developed nations will have lower rates. Another argument put forward by economists is that banks use high rates to ration loans, due to scarcity of funds.
The low rate by ECB shows the extent of Euro crisis that centres on Greece. Some economists worry that such low rates may be an indicator that the central bank is running out of ammunition.
Prolonged recession
What happens if the Central Bank can’t cut the rate further, meaning that the monetary policy is impotent? This could lead to a prolonged recession or a liquidity trap similar to the one Japan found herself in for the last one decade.
The crisis in Euro zone should be a matter of concern to us. Europe buys a lot of our exports, and a recession in the region will decrease our exports and reduce our earnings, which will slow down our economy.
This could also slow down remittances from Kenyans in the Diaspora, who might lose jobs, or send less money home because of the inflation that might be triggered by the low interest rates.
Monetary policies are used in conjunction with fiscal policies that include tax reforms. Governments can cut taxes to stimulate consumption and lead to economic growth. Tax cuts lead to budget deficits, which governments plug by borrowing. Such borrowing leads to high rates, which slow down the economy.
It seems economics will take time to become an exact science like Physics, which has its own uncertainties, from the Werner Heisenberg’s uncertainty principle, to the intrigues of subatomic particles — like the Higgs boson.
The inexactitude of economics is what calls for the independence of the Central Bank so that its decisions are not unduly influenced by politics and increase uncertainties.
Euro zone’s number one problem is economic growth and jobs, which made several heads of state and prime ministers to lose their jobs. Economics does not seem to play a big role in our polls beyond the promise of jobs. Yet, it should be the determining factor on who wins.
The current debate in our quest for the next president is being phrased as between reformers and non-reformers. I wish it could between economic and non-economic reformers.
Priority
Economic growth should be our number one problem since the economy will remain, irrespective who becomes our next president.
And in my view, our presidential candidates’ economic thinking and policies are not very clear. They need to come out clearly so that we can make informed decisions. Beyond the new Constitution, we need an economy that is “inoculated” from election cycles.
The next president will have to confront our economic problems particularly joblessness. They need to remember that we ran out of excuses by voting in a new Constitution. Central Banks might do their part, but they will not succeed in their work if politics is not in order. That fact is unlikely to change any time soon.
