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Monetary policy alone may not stem shilling slide

By Standard Reporter | July 28th 2015
By Standard Reporter | July 28th 2015

Agricultural and manufacturing sectors, respectively. About 40 per cent of the credit went to the central Government. Lending to Government by commercial banks is considered to be a low-risk investment.

These statistics highlight the fact that the banking industry is yet to find a formula that will enable them lend more to the agricultural sector.

Yet, most Kenyan exports are agriculture-based, especially those that go to the European market, while manufactured ones go regional markets.

The agricultural and manufacturing sectors are critical for stimulating exports to generate foreign exchange to support the shilling. But these two sectors are not immune from the likely increase in the cost of credit.

On the positive side, the weakening of the shilling can be taken as a signal to economic agents that exports will be a profitable venture. Thus, they should respond effectively to changes in relative prices to correct structural imbalances that exist in the economy. This should trigger an increase in export and import substitution production in the short run.

However, it may not be possible to increase export volumes or even substitute some imports in the short run because of supply-side and technology constraints.

Structural reforms

Further, the supply-side problems that the economy faces cannot be directly influenced by the intervention of the central bank. Thus, the intervention to stabilise the exchange rate can be expected to only be part of the solution, and a short-term one for that matter.

The management of the exchange rate needs to be accompanied by structural reforms, especially those that could increase productivity, competitiveness and diversification of Kenyan exports.

Kenyan exports are concentrated in a few primary commodities, mainly tea, horticulture and coffee. This has to change, though it reflects the way the economy is structured.

Management of the exchange rate alone may not automatically trigger productivity and competitiveness of the economy. This means that the Government’s fiscal action has to support monetary action.

Without structural reforms in the economy through appropriate policies to enhance productivity and competitiveness, monetary policy alone will not ensure exchange rate stability in a sustainable manner.

Fiscal response has to take into account the fact that Kenya has a devolved system of Government because production will be happening in the counties.

Individual Kenyans also have a role to play. This is because individual consumption preferences cannot be influenced by fiscal and monetary policies alone, for instance, preferring locally produced goods over imported ones in instances where such products are available in Kenya.

The private sector also has to improve the quality of its products to respond to sophisticated consumer tastes, particularly among the growing number of middle-income Kenyans who happen to have a high preference for imported products.

The writers are policy analysts at the Kenya Institute for Public Policy Research and Analysis.

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