Kenya rates set to tumble if cbank refocuses on growth

NAIROBI (Reuters) - Kenya's benchmark interest rate looks set to fall if the central bank takes advantage of slowing inflation to attack the eye-watering commercial lending rates stifling growth.

A year ago inflation was ripping through the economy and even global Twitter streams were humming with protests at policymakers' slow response.

Now, with inflation tempered, the question is whether those same policymakers are being too slow to refocus on promoting much-needed growth for fear of undermining the shilling currency they have toiled so hard to support this year.

The outcome matters because Kenya, which struck oil in March, is East Africa's leading economy and a popular destination for yield-and-growth-hungry foreign investments.

It also matters to Kenya's 40 million population ahead of a presidential and parliamentary election next March.

Memories are still fresh of the violence which followed the last election in 2007 after which more than 1,200 people were killed in widespread fighting. The health of the economy is vital to the country's stability.

Many market participants say the central bank could now cut rates boldly and scale back its efforts to prop up the shilling, which it has been doing by tightening the number of shillings in circulation.

Its continued support for the currency has driven up yields on short-term government securities recently and kept commercial lending rates at punitive levels.

The really bad news was that quarterly growth fell to its slowest since 2009 in the second quarter of this year as growth in the key agriculture and construction sectors nearly ground to a halt.

The slowdown may be attributed in part to less demand for the flowers Kenya grows from debt-crisis Europe, and to fewer European tourists.

But the main cause, analysts say, was the rapid jacking up of Kenya's benchmark lending rate to a record 18 percent last December when the central bank was scrambling to shore up the shilling, which had plunged more than a quarter to 107 per dollar last October, when inflation peaked at 20 percent.

The medicine worked though and the shilling, one of the most heavily traded in Africa with average daily volume of $350 million in the foreign exchange market, has since stabilised at 82-85 per dollar for most of this year.

Inflation also tumbled, to 5.32 percent last month, allowing policymakers to cut rates by a total of 500 basis points over two meetings since July to 13 percent today.

Some analysts say this is still too high and is stifling growth. But the central bank has shown that currency stability remains its number one goal by actively absorbing liquidity from the market, causing yields on short-term government securities to rise at auctions over the last few weeks to around 9.0 percent from 7.5 percent.

AHEAD OF THE CURVE

The central bank's fear is "the likely weakening of the currency but at some point, they have to sit down and say, 'what is it that matters?'" said Duncan Kinuthia, head of trading at Commercial Bank of Africa.

Last year's currency slump and the subsequent surge in inflation, especially of imported goods like oil, caused widespread anger and a failed attempt by lawmakers to remove central bank Governor Njuguna Ndung'u from his post, after they blamed him for the currency woes.

It also spawned a mocking Twitter campaign. The hashtag #thingsstrongerthanthekenyashilling went viral, with one tweet likening the shilling to "wet toilet paper".

"The central bank was traumatised by events of last year and hence are exercising undue caution," said Aly Khan Satchu, an independent trader and analyst.

A year ago the Kenyan central bank was blamed for dithering in its policy response because of its preoccupation with growth.

The policymakers had since righted their wrongs, Satchu said, creating ample room for them to champion growth again.

"We are ahead of the curve once more," he said, now that inflation had been wrestled down.

Consumers lost out when businesses passed on inflationary costs and they are losing out now as businesses said they pass on their high financing costs.

"The developers are passing those costs to the buyer so that makes housing unaffordable," said Daniel Ojijo, chairman of Mentor Holdings, a real estate firm.

In the Mombasa Road neighbourhood of the capital Nairobi, where investors set out to develop affordable homes for 2.7 million shillings each, they were now selling them for 5.5 million shillings apiece, Ojijo said.

EYE-WATERING RATES

Although inflation has fallen dramatically this year, commercial banks' lending rates remain stuck above 19 percent. Policymakers will have their work cut out to narrow the spread between interest rates and inflation.

"Policy choices are all about tradeoffs. So the key is striking that balance that is consistent with economic growth," said Mwangi Kimenyi, senior fellow of global economy at The Brookings Institution in Washington.

Kenya's ministry of finance says the ideal exchange rate is 80.00-85.00 per dollar, which may explain the central bank's reluctance to let it slip past those levels.

A strengthening past the 80 level per dollar leads to complaints from exporters due to erosion of earnings while a slip past the 85 level has the same effect on importers who have to dig deeper into their pockets.

A significant weakening of the shilling could however be avoided even if the central bank went for a decidedly pro-growth stance, some argue.

"Kenyan shilling stability is also helped by having healthier levels of FX reserves in place," said Razia Khan, head of research for Africa at Standard Chartered in London.

At $5.13 billion or just over 4 months worth of import cover, the bank's foreign exchange reserves are at record highs, after it built them up in the first-half of this year.

The bank could use the reserves to smoothen any volatility in the foreign exchange market, keeping the shilling stable, the argument goes.

The discovery of oil in the northern county of Turkana in March by British explorer Tullow Oil also pointed to the country receiving significant foreign direct investments into the oil and gas sector in the months and years ahead.

Those inflows should assuage any worries that a resolutely economic-growth-friendly stance by the central bank could usher in another round of exchange rate volatility, traders said.

"Policymakers have re-established their inflation fighting credentials. Now it is time to stimulate growth," Satchu said.

Source: http://news.yahoo.com/kenya-rates-set-tumble-cbank-refocuses-growth-140415194--business.html

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