Mess in money market needs clearing up

It is emerging that the Central Bank of Kenya (CBK) has failed miserably in its duty to protect the Kenya Shilling from undue pressure and instability.

Apart from failing to discipline commercial banks, that are considered the most dominant players in the local foreign exchange market, the CBK has also failed to provide clear signals on where this economy will be in the next one year.

Next year’s elections are round the corner and like all previous periods, the financial sector is unstable and economy is stormy waters.

All the while, the CBK, which is the top monetary policy organ has been shifting its tools up and down, commercial banks largely ignoring its policy actions.

Resorting to desperate options such as selling dollars directly to key importers such as oil firms, though the move has been withdrawn reflects poorly on the leadership of CBK.

The fact that CBK officers routinely spy on currency dealers in the banking system is not only illegal but unprofessional.

Apart from failing to salvage the shilling from speculative attacks, CBK has also not delivered when it comes to providing this economy with the confidence levels it needs.

For instance, why tighten availability of credit in an economy that is suffering from supply-side constraints?

Local answers

While investors are keeping a wary eye on what appears to be sustained stress in the money markets, more instability is expected as the country enters 2012, another election year.

In the light of a rise in cost of living, a falling local currency, and shortage of essential items such as sugar, a team from the International Monetary Fund (IMF) is already in the country to issue its verdict.

But it will not be prudent for mandarins at the Treasury to simply wait for prescriptions from the Fund and swallow them wholly without also using our own home-grown solutions.

While CBK has raised the Central Bank Rate (CBR) at which it lends to commercial banks, these institutions are still very liquid and are likely to ignore the hike. A few could respond by raising their base lending rates, pushing individuals and small business out of their loan portfolios.

Activity on the Nairobi Stock Exchange (NSE), a key barometer of how the economy is performing, has been waning.

Most investors borrow from the banks to invest in equities. So when credit becomes expensive, the stock market suffers. Further, investors are shifting their attention to Treasury bills and Bonds and other interest-bearing assets as the NSE 20 share index takes a plunge.

Even further, the expected rate of return from stocks must be greater than the short term interest rates for investors to consider stocks.

What the equity market is going through is really a change in the investment outlook. And even on both the corporate and personal level, rising rates often translate into rising costs; whether it is working capital borrowing or adjustable mortgage rate payments, increase in short-term rates have a negative effect on net income and by extension on confidence.

The market is in a primary bear run and this week will be an extension of the same.

We hold the view that while CBK has been deploying its monetary tools, what is needed is a balance of this with fiscal policy to ensure stability.

For instance, dealing with inflationary pressures in the economy will also require such fiscal tools as import duty waivers, imposed on certain food items. Monetary tools alone cannot be used to deal with supply problems and heated demand. In other words, it is not enough to worry about what CBK can do but also the Treasury.

Urgent measures

Although the economy is expected to grow this year, it will do so at a decelerated rate, probably between three to four per cent.

This is why policy makers, bureaucrats and State actors need to find solutions to rapid fluctuations in the exchange rate, especially against the US Dollar.

Urgent measures are also needed to deal with the prevailing high cost of living, expected to reach up to 20 per cent by the end of this year.

Although it is another season of short rains, this precipitation is still inadequate and not sufficient to bring food supply back to normal. This is not to mention the uncertainty surrounding 2012 as the country goes into another competitive election period.