Was MPC too optimistic when it cut the Central Bank Rate?

By Morris Aron

Did the Monetary Policy Committee (MPC) turn a blind eye to the political and economic risks associated with an election year when it reduced its key rate?

Was the looming food price increment totally forgotten?

What of the already boiling global petroleum prices and the potential threats to the economy? According to a number of analysts, the potency of such scenario is high. Were these matters considered?

According to a number of analysts who spoke to Business Weekly over the issue, it is possible that such threats have materialised after the market regulator reduced the Central Bank Rate — which signals which direction interest rates are going — by a whooping 3.5 per cent last week.

Looming increase

Interestingly, MPC made no mention of election year risks or the looming increase in food prices, save for acknowledging that petroleum prices is a potential risk to the latest move.

No investment analyst had expected the CBK to make such a strong gesture so soon given that it had struggled for months to contain runaway inflation and a volatile foreign exchange market. In fact, analysts had anticipated that the CBR would be reduced by between two per cent and 2.5 per cent.

And now analysts say that the drop in the CBR could be another case of  ‘too much too early’, following the ‘too little to late’ move, when the momentary policy committee raised the CBR to 18 per cent and maintained it at that level for six months at the expense of the economy.

A recent report by Renaissance Capital entitled, ‘Kenya: Weak 1Q2 GDP Growth’ indicated that the real economy in the first half of the year grew at its slowest pace since quarter one of 2008 when it was at a standstill.

Strong environment

While releasing the rate cut, a statement signed by CBK Governor, Prof Njuguna Ndung’u indicated that dropping inflation, a stable exchange rate and strong fundamentals from the banking sector had led to the decision.

“The country’s policy environment remains strong as depicted by the latest sovereign credit rating by Fitch Ratings, which affirmed Kenya’s rating at “B+ with stable outlook”,” said Ndung’u.

“The MPC Market perceptions survey conducted in August showed that the private sector expects inflation to continue declining, the exchange rate to remain stable, and the economy to be resilient.” And many analysts who spoke to Business Weekly agree with the market regulator on the three issues.

But there is, however, a growing concern that Monetary Policy Committee — the body that advises the CBK on the such issues — took the risks that come with an election year — including inflation and political risk — too lightly while depressing the effects of increasing prices of oil and a possible rise in food prices in the coming months.

Internationally the prices have being rising, and such increases would immediately spark inflation and reverse the gains that lead to the signalling of interest rate. Inflation is also bound to come about as a result of increased spending during elections.

 Money supply

There are projections that in the short to medium term interest rates are bound to rise by between two and three per cent due to increase in money supply, brought about by elections. Moreover, it is estimated that politicians will spend up to 20 per cent of Kenya’s Gross Domestic Product (GDP) — the total market value of all final goods and services produced in a country in a given year —  on elections.

On its part, MPC recognised that there are still risks facing elements relevant to monetary policy in maintaining macroeconomic stability. “These include vulnerability to international oil prices and any likely impact of drought affecting world food prices. The slowdown in global economic growth was also noted to have a dampening effect on both domestic growth and the balance of payments,” said the statement.