Less domestic borrowing good for stability

Stability in the prices of goods and services, lending rates and the value of the shilling exchange rate is critical for the proper functioning of a market-based economy.

It is out of this realisation that the Government has been doing everything possible to restore stability in the macroeconomic environment, and rebuild confidence among investors and the business community. For instance, rising interest rates, high inflation and the falling value of the shilling against other major international currencies have weighed heavily on the country’s economic performance by reducing consumer and business spending.

Sustainable growth

The trio combined to slow down growth rate in the third quarter of last year to 3.6 per cent between July and September, compared to a 5.7 per cent growth in a similar period in 2010.

Economic experts reckon that price stability is a precondition for achieving the wider economic goal of sustainable growth and employment, given that a price level that does not adversely affect the decisions of consumers and producers encourages long- term investments and economic stability.

However, efforts by the Central Bank of Kenya to fight inflation, which stood at 18.93 per cent in December, through tightening of its monetary policy has only resulted in commercial banks increasing lending rates to over 20 per cent, according to data from the CBK.

The Central Bank Rate (CBR) was raised from 6.0 per cent to 18 per cent in the year, while the Cash Reserve Ratio (CRR) was increased by 0.5 per cent to 5.25 per cent.

High interest rates impact on the levels of borrowing by the productive sector, and increases the default rate, thereby slowing down the overall level of economic activities. The Government has not been spared either.

Efforts by the Treasury to raise Sh119.5 billion from the domestic market to finance its budgetary spending has been hampered by massive undersubscriptions of Treasury bills and bonds.

With interest rates moving up unpredictably and the exchange rate facing unprecedented volatility, investors – mainly local banks and pension funds – were keeping away from participating in the auctions.

It is against this backdrop that the Government’s latest move to borrow from the international markets rather than the domestic market has been highly laudable.

This means there will be less pressure on Government securities and as a result interest rates and inflation would come down.

The Government has since stated that it will borrow $600 million (Sh51 billion) from the international banks and reduce domestic borrowing by a similar amount during the 2011/2012 fiscal year.

poor t-bill subscription

Treasury had previously expected to raise Sh119.5 billion from the domestic market to finance part of the overall budgetary deficit amounting to Sh236.2 billion (7.4 per cent of GDP) during 2011/2012 fiscal year.

But a rise in interest rate disrupted this, as investors kept off Government borrowing market resulting in gross under-subscription in the Treasury bills and bonds.

Consequently, Treasury only raised Sh14 billion or about 12 per cent by the end of December last year. But with Sh51 billion to be borrowed from the external market, the Government will only be seeking to raise 54.5 billion from the domestic market within the next five months. Government’s overall budget for the 2011/2012 fiscal year is pegged at Sh1.06 trillion

The aim is to achieve stable prices – that is low inflation – and to sustain the value of the Kenya shilling.

This is because when prices of goods and services in an economy keep on rising, the value of these goods and services that the currency can buy diminishes.

High rates of inflation lead to inefficiency in a market economy and, in the medium to longer term, to a lower rate of economic growth.

Last year the Government even admitted facing challenges in raising resources from the domestic market to finance its spending programmes because of the instability in the macroeconomic environment.

The Central Bank’s principal object is formulation and implementation of monetary policy directed to achieving and maintaining stability of prices.

Monetary policy is the main tool used in the preservation of the value of the currency in an economy.

It involves the control of liquidity circulating an economy to levels consistent with growth and price objectives set by the Government.