Njuguna Ndung'u: Economic and financial developments in Kenya
Speech by Prof Njuguna Ndung'u, Governor of the Central Bank of Kenya, at the Luncheon
with members of the Eastern Africa Association, Nairobi, 21 January 2009.
* * *
The Chairman Eastern Africa Association,
Members,
Distinguished Guests,
Ladies and Gentlemen;
Let me first thank the Chairman of the Association for this opportunity to share my
experiences with economic performance, the conduct of monetary policy in 2008, and the
perspective for 2009.
The experiences of the Central Bank have been vast but I will deal with economic
performance and policy directions in three topical areas:
•
The Conduct of Monetary Policy and Monetary policy decisions
•
Economic growth outlook
•
The Global Financial crisis and Kenya's economic performance
A. The conduct of monetary policy in 2008
The past year has been a difficult one both from a local and global perspective. For monetary
policy at the Central Bank of Kenya (CBK), three challenges emerged;
•
liquidity management in the economy;
• inflation upsurge; and
•
exchange rate volatility
These challenges tended to take monetary policy management to unfamiliar territory. In
order to ensure price stability or fight inflation, the CBK relies on indirect instruments that
affect liquidity in the economy and so the stock of money, which in turn affects interest rates
and prices in the desired direction. The debate on what are the targets and what instruments
to achieve the targets is relevant. Money supply growth was maintained within the target
range for most of the months in 2008.
(i) Liquidity management in the economy
The role of a modern central bank is in general price stability, that is to fight inflation.
However, for the Central Bank of Kenya, stability of the financial system is equally important,
so is the national payments and settlement system. The Bank implemented the first two
objectives with varying degrees of success. While inflation was high we also faced downside
risks to financial stability from the Safaricom IPO. The size and nature of the IPO led to large
shifts in liquidity, and the unwinding process would no doubt have had longer term impacts
on economic and financial variables if not properly managed. The offer attracted Ksh231
billion.
Liquidity was skewed in favour of a consortium of banks despite the mitigation mechanisms
put in place by the banking system. The Bank's approach to this therefore was to mop up
excess liquidity from the banking sector using the Term Auction Deposit and repos and inject
liquidity to accommodate the liquidity shortfalls for banks outside the consortium, through
reverse repos. This intermediation function helped to moderate effects on interest rates, and
thereby ensured financial sector stability.
The Term Auction Deposit is a new instrument we introduced in May 2008 to support liquidity
management. Foreign exchange spot sales or purchases were also another indirect
instrument used.
(ii) Inflation upsurge
The post-election disturbances early in 2008 put enormous pressure on supply networks for
food in most parts of the country. Delayed land preparation and transportation constraints,
coupled with high cost of fertilizer pushed overall inflation rapidly from 12.0 percent in
December 2007 to 31.5 percent in May 2008. Similarly, underlying inflation rose from 5.1
percent in January 2008 to 7.2 percent in May 2008. From the outset, it did seem that
inflation was going out of hand.
The January 2008 effect has taken longer than we had expected to dissipate with inflation in
December 2008 at 27.7 percent. International crude oil prices which had peaked in July 2008
also sustained high inflation but their transmission downward takes a longer period.
A number of factors are also now coming to the fore; weaknesses in the distribution
mechanisms of food in many parts of the country, high world food and oil prices were
passing through to domestic food prices. The process to address these issues has started.
But from the monetary policy side, we derived some measure of comfort in choosing to
manage liquidity in the short term from the fact that inflation was coming from supply
constraints in the economy, specifically supply and distribution factors associated with the
post-election violence effects which caused food prices to increase. Monetary policy
decisions are geared towards controlling the component of inflation that is linked to money
supply and preventing rapid money supply growth - which would ratify high prices from the
supply constraints.
In addition, there are changes to inflation computation relating to the basket of goods and
weights used in major categories of the consumption basket that makes inflation computation
closer to international standards.
(iii) Exchange rate volatility
The foreign exchange market was turbulent particularly from the second half of 2008
onwards. The question we asked ourselves is what a small open economy can do in the face
of portfolio capital flows. My works in the past have produced conclusions which are
important even in the practical work at Central Bank. Stock adjustment, changing risk profile
in the country and arbitrage process all work to warn us to do nothing when portfolio flows
drive either securities markets or the economy. The shilling appreciated following increased
capital inflows for the Safaricom IPO and depreciated as investors took profits and exited the
stock market - a management failure in the IPO process. We have detailed this in the press
release of the Monetary Policy Committee (MPC) of November 2008. We provide Monetary
Policy Committee press releases to share information and even show how to process the
information.
B. Monetary policy decisions
Inflation continues to be a challenge but expectations are that it will come down to its target
level in 2009 of 5 percent. It seems likely that there will be some disinflation in the upcoming
months. The CPI computation has been revised, so is the basket of goods using the 2005/06
household budget survey. The Government is taking adequate steps to address the supply
constraints.
There were indications of a liquidity crunch towards the end of 2008 with short term interest
rates moving upwards. Money demand rises in the festive season and so we used our
liquidity management tools to increase liquidity in order to stabilize the interest rates in the
short term and also hope to sustain a low interest rate regime that would support investment
and growth revival to the pre-crises period. You are aware the MPC reduced the statutory
cash ratio from 6 percent to 5 percent at the beginning of December. To support this, it also
lowered the Central Bank Rate from 9 percent to 8.5 percent to enhance liquidity in the
banking system and to nurture the economic recovery process. So far Repo and interbank
interest rates have declined to 4.8 percent and 5.8 percent respectively. CBK desires to have
a low, stable interest rate environment that encourages private investment. This will support
faster economic recovery from the 2008 shocks.
The Kenya Shilling was volatile and followed global developments; appreciating against the
US dollar and the Sterling Pound but depreciating against the Euro and the Japanese Yen.
Against the US dollar, the shilling has lately been oscillating around Ksh78 to the dollar. But
most spectacular were the effects the dollar had on the Pound and Euro. Between
September 2, 2008 and January 12, 2009, the US dollar has appreciated by 7.7 percent and
16.5 percent against the Euro and Pound respectively.
There were also "flight-to-safety" concerns in the wake of the global financial crisis as banks
dumped asset backed securities and preferred US Bills and Bonds. The global liquidity is
increasingly being measured in US dollars and so scarcity of the dollar when global banks
were not lending to each other led to this depreciation and continues to sustain it even today.
The road CBK took was a bit bumpy in that it accepted to live with some exchange rate
volatility in the hope that they would soon soften once global banks started trading with each
other.
The current trend in imports and exports is expected to be sustained in 2009 with the current
account deficit expected to widen. This deficit will be financed by capital and financial inflows
as has been the case in the last few years. We are taking a cautious view on private capital
flows. We will monitor the current account and the deficit to ensure its sustainability. But so
far, most imports have been inputs and machinery equipment - so signalling firm growth and
expansion in the future.
C. Economic growth
The economy was buffeted by internal and external shocks in 2008, thus performing below
potential throughout the year. During the third quarter of 2008, the Kenya National Bureau of
Statistics estimates the economy to have expanded by 2.1 percent compared to 6.3 percent
in the corresponding quarter in 2007. The recovery from the post-election violence has been
fast although agricultural performance lags behind. The shortfall in tourism receipts from
January 2008 has also narrowed down and a catch up is expected during the next prime
season.
Fiscal side
The shocks that have taken place in 2008 and continuing food supply constraints have put a
strain on the budget and a risk of overshooting the fiscal targets. The Government intended
to borrow Ksh54 billion from the domestic market in the current fiscal year. This, so far has
not changed. The Government delayed issuance of the sovereign bond of about Ksh34
billion, to await stability in international financial markets. But the Government in the coming
weeks will float an infrastructural bond for Ksh18.5 billion to finance major infrastructure
projects. I am encouraging corporates like yours to commit funds for this important bond.
D. The global financial crisis
Starting as a global financial crisis it is now an economic crisis. For those countries that are
less integrated in global financial markets, there is need to look at some of the risk factors.
•
Capital flows: Short term capital inflows which had increased substantially in 2007
flattened out in 2008 above US dollars1.1 billion. Short term capital outflows which
have been far less substantial have increased, and we know the dangers and
destabilizing effects of these flows.
• Fiscal risks: Expenditures have been below target due to delays in implementing
some projects. There may also be some diversion of expenditure to cater for famine
relief and other recurrent expenditures. However, with respect to revenue, the
Government is on target despite the fact that the benchmark was on the basis of a
more optimistic growth path. Current figures from the Kenya Revenue Authority
(KRA) on the last quarter show tax revenues overshooting their target.
•
Export risks: Global growth is expected to decline from 2.5 percent in 2008 to
1 percent in 2009. Although demand for some of Kenya's exports is expected to
remain robust, recent trade statistics indicate a slowdown in export volume growth.
International commodity prices are also expected to decline. However, the impact of
the global crisis on Kenya's exports may come from reduced aid flows to regional
trading partners.
•
Remittances: Remittance receipts through formal channels increased from US
dollars574 million in 2007 to US dollars630 million in 2008 despite reductions
beginning May 2008. The decline could persist with reduction in incomes in source
countries. Remittances are predominantly used for smoothing consumption and for
investment in real estate. But they are also pro-cyclical and tend to follow events in
the economy. So their trend may not reveal much.
•
Liquidity risks: While global banks are not lending to each other, local banks are.
However, Government access to global financial markets may be constrained by
weakening of these markets. The postponement of the sovereign bond is a pointer
to this. The latest upgrade by Fitch rating agency for Kenya is improving the country
ratings and once global financial markets are stable, Kenya's entry will be
significant. But more significant will be the target enabling projects targeted to be
financed by this bond issue.
•
On the domestic banking sector, the expectation was that due to the global crisis
and the political crisis in 2008, the banking system's net non-performing loans
(NPLs) would rise. However, net NPLs as a share of total loans have come down
from 2.9 in March 2008 to 2.2 in November 2009. This is due to improved
provisioning and a decline in net NPLs portfolio.
The CBK is tracking these risks to assess their likely impact on macroeconomic stability.
Nevertheless, the economy is expected to weather first round effects of the global crisis. This
will be supported by productivity growth from improved business climate and improved policy
frameworks. In 2009, we expect a modest recovery and a rebound to the growth trajectory in
the medium term in line with the country's long term development strategy.
Our efforts to sustain macroeconomic stability will bear fruit.
Ladies and Gentlemen, let me thank you for your attention, and invitation to this auspicious
occasion.
Thank you.