The stakeholders of the Kenyan economy and financial markets await the monetary policy with fingers crossed, ahead of general elections when the Banking sector is in improvisation and transformation phase. While the macroeconomic fundamentals are not in bad shape in relative terms to other African countries, the monetary environment and interest rate dynamics do not stay supportive to growth and credit risk appetite of Banks.
The conflicts emerges when the Government urge the Central Bank to ensure availability of adequate system liquidity to fund deficit and at lower cost to cut interest burden on the deficit. On the other side, Central Bank wants the Government to stay prudent in fiscal policies ensuring availability of capital to expand supply side capacity to cut demand-push pressure on inflation. The situation is a bit peculiar now with availability of more than desired liquidity but at high cost. The Banking system have large appetite for Government Bonds with lack of credit risk appetite against cap on lending rate at 14% against elevated sovereign yield of 8.5-14% across 6 month to 10 years tenor. The operating policy rate of 10% and discount rate of 16% gives no room for sufficient margin to cover return on risk adjusted capital and P&L impact from write-off and provision on loan impairment.
The choice here is between the devil and the deep sea. While removing the cap on lending rate is ruled out in the election year, Central Bank cannot take the risk of a rate cut when inflation at current rate is not sustainable when fiscal deficit is likely to worsen in an election year from populist spending targets towards the vote bank. The inadequate supply of credit for capacity building is highly inflationary in the medium term.
All combined, Central Bank monetary policy focus will be on interest rate and not on liquidity. While Central Bank can’t afford to go big-bang on policy rate reduction, there is a case for a marginal rate reduction of 50-100 bps to ensure flow of deposits into credit to cut the risk of slippage in GDP growth momentum to below 6%.
The impact on financial markets will be positive, providing relief recovery in equity markets, improve Banks bottom line from profit on sale of investment portfolio and not so significant impact on exchange rate keeping USD/KES steady at 103.50-106.50. A 50-100 bps rate cut will be great relief for most Banks that struggle for profitability stuck between lending rate cap and high cost of liquidity when credit losses are on the rise.
The lender of the last resort is looked upon to provide resolution to the issues around financial intermediation for which commercial banks exist to provide leverage to capital for economic capacity building which in turn leads to employment generation and social well being of the country. Will the Central Bank bite the bullet? I believe yes, in the interest of the Banking Sector!