Consensus must have been hard. The Monetary Policy Committee (MPC) must have contemplated the impact of their decision in the current interest rate regime and realized they are no longer an independent organ of the Central Bank of Kenya (CBK), but rather, captives of the political class and the Banking industry. Their decision can no longer only be based on research and economic fundamentals on the ground, but must be tampered by political and industry sentiments.
The MPC is an arm of the CBK tasked with maintaining price stability in the country. This includes ensuring that the Monetary policy in the country is sound and addresses issues around inflation, money supply, stability of the shilling and even the availability of credit.
At its disposal, there are several instruments that it can deploy to maintain this stability. They include, Cash Reserve Ratios where banks are expected to hold currently 5.25% of their total deposits at the CBK and this can be varied to impact the money available to banks for lending, overnight lending at a penal interest rate and just going into the market and issuing or buying debt and FX securities to reduce money supply in the economy.
However, the most powerful instrument comes as the Central Bank Rate (CBR) which is the minimum or maximum rate depending on whether it is buying or selling that it uses to influence the direction of interest rate and signals tightening or loosening of the monetary policy. The MPC determines this rate bi-monthly and by just observing its direction and magnitude, the financial sector is able to adjust albeit poorly in the past to the direction of the rate. If the rate is headed south, that means the CBK wants interest rates to come down in order to expand credit while when they are headed north, the interest rates should rise and curb inflation.
Now, here in lies the problem. This rate is expected to be a guide and not a peg. By denoting this rate as a peg, the political elite effectively killed the autonomy of the MPC. This rate is supposed to be changed six times during the year, does it mean the banks change their rates six times in the year. What happens to stability of the sector?
The MPC may want to use this rate to move the rates in a certain direction by gradually changing it a few basis points at a time until an equilibrium state is achieved. This has been taken away from them and I won’t be surprised if they are castigated for creating turmoil in the sector buy frequently changing the rate. They are now pure captives of the political elite from today henceforth.
What about the Banks. Are they supposed to expect revisions every two months? Are they supposed to sign new banking facilities with customers every two months? What room do they have to plan and raise their funding, be it mobilizing deposits and or just raising capital? Wont the MPC be compromised to a point of saying, “let’s not just change the rate again so we don’t cause trouble in the sector?”
And Wanjiku, what happens to her? If the rate is moved every so often, can she plan her loans and repayments anymore?
The CBR has been effectively rendered useless and the MPC effectively rendered toothless to manage the prices in the economy, since the CBR was a broad brush instrument that could be used to manage several facets of the monetary policy and by making it a peg, it cannot be used as so anymore.
There is no easy way out of this. Both the political elite the CBK have committed themselves up to the neck, and have set the expectation that the interest rates cannot go up above 14.5% per annum. What if the monetary decision requires that the CBR be raised to 13% or more as we saw last year, what happens?
A back out of this rate capping policy is not completely impossible, the government only needs to issue a gazette notice and reverse this draconian law and let the economy determine its own prices and occasionally intervene when things seem to be getting out of hand. Leave prices to market forces and concentrate on policy, that’s what governments are for.