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

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 scar