CBK must go beyond taming inflation

NAIROBI: The conduct of monetary policy by the Central Bank of Kenya (CBK) has been guided by price stability objectives.

CBK currently formulates and conducts monetary policy with the aim of keeping overall inflation within the allowable margin (currently 2.5 per cent) on either side of the target prescribed by the National Treasury after the annual Budget Policy Statement.

‘Inflation targeting’ mostly ignores the impact of monetary policy on other economic variables such as poverty, employment, investment or economic growth. The next Central Bank Governor and the Monetary Policy Committee (MPC) of the CBK should therefore revisit the current policy framework and initiate debate on whether we should retain it or whether we should adopt a framework that prioritises growth, scaling up of public investment and employment creation.

Former CBK Governor Prof Njuguna Ndung’u and the Kibaki administration, which appointed him to office, were indeed pro-growth.

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They resisted the implementation of the current inflation targeting-based monetary policy, until recently when the IMF forced it down our throats as part of a loan agreement.

The current IMF-favoured inflation-targeting regime as a formal policy stance is neither feasible nor appropriate for us for a number of reasons.

First: In a developing economy such as ours, the Central Bank should not focus exclusively on inflation oblivious of the larger development context.

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The CBK cannot escape from the difficult challenge of weighing the growth versus inflation trade- off in determining its monetary policy stance.

Inflation is a result of demand expanding at a higher rate than supply.

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In a poor and growing economy such as ours, where the policy objective is to raise the consumption levels of the majority, it does not make sense to curb private demand as a measure to correct the demand-supply mismatch.

That just hurts those who are already poor, as it effectively implies slowing down the economic growth rate and reducing job creation.

As an inflation-targeter, the CBK, for example, would be biased in favour of a strong shilling as all our imported intermediate inputs (fuel and capital goods) and the final consumer products would become cheaper.

This helps in keeping inflation down. But a strong shilling is bad for export earnings and attracting tourists, both of which are labour and employment-intensive sectors.

The CBK will therefore tend to sacrifice employment opportunities for price stability when the objective should instead be to rapidly expand supply capacities in anticipation of demand.

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Unfortunately, more often than not, inflation targeting-based monetary policy limits capacity addition at a time when we need it most.

We should learn from the Chinese, who sustained a double growth rate for three decades with few – and far in between – major inflationary episodes through expanding their supply capacities in anticipation of demand.

Second: Does our current framework even work? For inflation targeting to be effective, an efficient monetary policy transmission has to take place.

In Kenya, monetary transmission is very poor.

Although the CBK policy rate has seen a steady decline from the 18 per cent it was in December 2011 to the current 8.5 per cent, effective interest rates charged by the commercial banks have not witnessed much decline, with several factors inhibiting the transmission process.

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Among them is the fact that bank lending rates are not being determined by only inflation and the CBK policy rate but also high risk profile of most borrowers, Government domestic borrowing and other rigidities in the financial markets.

All these factors dampen the efficacy of monetary signals and complicate the adoption of an inflation-targeting regime in our case.

Third: CBK has little control over supply side constraints which generally are the drivers of inflation in Kenya and monetary policy is an ineffective instrument for reining in inflation emanating from supply pressures.

Given our low income levels, food items have a relatively larger weight in our consumption basket compared to the more advanced economies.

So, whereas inflation targeting has some rationale in advanced economies because food’s contribution to the CPI and consumption expenditures is less significant and agricultural markets are far more organised, it hardly would be effective in our case as food and non-alcoholic drink component makes up almost half of our inflation.

Remember late 2011 when our monetary policy tools failed and could not contain food inflation, with inflation hitting almost 20 per cent?

If monetary policy can’t change this major component, then what is the use of the framework so designed?

No country has ever prospered simply by controlling inflation. Economic growth, expanding employment and tackling poverty are far much more important to Kenyans today than reducing inflation.

We need a feasible, flexible and efficient homegrown macroeconomic policy framework whose central component should not aimed at just keeping inflation within some arbitrary range but one that is also flexible enough to help us tackle the ills of poverty, unemployment and slow economic growth.

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CBKNjuguna Ndung’u