Raising interest rates ‘was a necessary evil’

October 27, 2015
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The Central Bank of Kenya on Haile Selassie Avenue, Nairobi.
The Central Bank of Kenya on Haile Selassie Avenue, Nairobi.

, NAIROBI, Kenya, Oct 27 – Despite ongoing concerns over increased interest rates in the past one week, the private sector sees the move as inevitable.

Former Kenya Private Sector Alliance Chairman Vimal Shah termed the move as a necessary evil that has curbed the shilling from falling further against the United States dollar.

Shah, who is the Chief Executive of Bidco Africa says the move was a delayed action and has borne fruit as the shilling is now trading at a mean of Sh101.66.

“The Kenya shilling had gone up to Sh106 levels; Central Bank of Kenya had no choice but to increase the interest rates and Treasury Bills rates, when the shilling is high, petrol prices go up, we experience high energy costs because we are largely an importing country,” Shah told Capital FM Business, adding that he sees the rates dropping in the near future.

The interest rates environment in Kenya has witnessed volatility over the last calendar year, with a sharp increase in rates being the trend.

This can be evidenced by the 91-Day Treasury Bills rising from a rate of 8.6 percent in December 2014, to 22.5 percent in last week’s auction.

The Central Bank of Kenya lending rates have also increased by 300 basis points to stand at 11.5 percent.

According to Cytonn Investments, the high interest rates environment was as a result of:

Aggressive Government Borrowing

According the fiscal budget for 2015/16, the government is expected to borrow Sh219 billion from the local market. The government has been lagging in terms of its borrowing locally, which was brought to the forefront during the first quarter for the fiscal year, where the total domestic borrowing was in fact a net repayment of Sh14.4 billion.

Notably, the government is carrying out mega infrastructural projects such as the Standard Gauge Railway, and concurrently facing labour wrangle challenges, which may result into an increase in recurrent expenditures towards the civil service sectors.

As a result of this and in a bid to step up its borrowing and meet its obligations towards financing the budget, the government has been borrowing expensively from the domestic market, which has seen yields increase drastically, resulting in the 91-Day T-Bill rates increasing to 22.5 percent as at October 2015.

Unrealistic Tax Revenue Estimates

The current budget was based on aggressive Gross Domestic Product estimates of about 7 percent, Actual tax collections have been below target. Revenue estimations below budget coupled with aggressive spending means more borrowing, which can only increase rates

Policy Disconnect

Both monetary and fiscal policies are supposed to complement each other; however, what we have seen in Kenya, and especially during this fiscal year 2015/16, is two policies have been moving in opposite directions.

Monetary policy, which is the role of CBK through the Monetary Policy Committee, has taken a tight stance, while the fiscal policy, which resides with the Treasury, is on an expansionary mood as they continue with significant expenditure. The disconnect between the two in public policy has resulted into high interest rates in Kenya, due to interest rate uncertainty.

Liquidity Levels

The money market has been relatively illiquid as most investors tie in their funds in higher yielding assets. With the uncertainty in the interest rates environment observed in Kenya recently, and going with the meaning of liquidity highlighted above, there is low appetite for risk as few investors are willing to undertake risk. This results into these investors demanding higher premium, which leads to a high interest rates environment.

Currency Support

Given the expectation that interest rates were to increase in the United States, investors started moving their funds to safer currency which is the dollar. This lead to a significant depreciation of most emerging market currencies and Kenya was not spared. To maintain Kenya as an attractive investment destination, the central bank increased the Central Bank Rate by 300 basis points to 11.5 percent, and also a series of mop up activities to reduce the supply of Kenya Shilling in the money market.

So what should be done to contain high interest rates?

Shah says the government needs to contain its expenditure and live within its means.

“If you were employed and receive a salary of let’s say about Sh100,000 then your salary is cut to Sh50,000 what do you do? You cut on your leisure, you probably move in to smaller house, you start using public transportation if you owned a car? Why can’t the country do the same? Cut on excessive travels, expenditure that doesn’t necessarily add any value to the country,” Shah said pointing out that the government also needs to enhance revenue collections to reduce over reliance on domestic and foreign borrowing to finance the budget.”

Cytonn Chief Executive Edwin Dande says the government needs to moderate Infrastructural project saying the financing factor modalities of such mega projects need to be relooked at.

“The government is currently carrying out mega infrastructural projects such as the Standard Gauge Railway (SGR) and LAPSSET project, which are very expensive. The projects can be spaced out and at the same time look for cheaper ways of financing them other than higher reliance on debt,” Dande said.

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