Kenya and Uganda central banks have left the benchmark lending rate untouched in their latest review, in the hope of easing the current inflationary pressures which are likely to persist in the coming months.

Kenya held its Central Bank Rate (CBR) — the rate at which the central bank lends to commercial banks — at 8.5 per cent as it voiced concerns about the country’s inflation rate.

READ: CBK maintains key lending rate, worries about inflation

Uganda on the other hand maintained its rate at 11.5 per cent, citing the need to ensure monetary stability in the wake of aid cuts, weak credit growth and a depreciating shilling.

This means commercial banks are likely to maintain their current lending rates, which at an average of 16 per cent in Kenya and 23 per cent in Uganda, are seen to be high, relative to the CBR.

Banks’ laxity to reduce the cost of loans has drawn criticism from financial experts and the public who accuse them of exploiting borrowers to drive profits.

But the lenders have defended their position, saying it reflected the true cost of lending since depositors are still demanding high returns on their money.

The Central Bank of Kenya (CBK) said maintaining a CBR of 8.5 per cent would help rein in inflation, which at 6.86 per cent is above the government target of five per cent. Month-on-month inflation declined from 7.21 per cent in January to 6.86 per cent last month. However, non-food-non-fuel inflation increased slightly from 4.83 per cent to 4.93 per cent.

“Monetary policy measures have continued to deliver the desired price stability. However, overall inflation remained in the upper bound of the medium-term target,” said Njuguna Ndung’u, the CBK governor.

A rise in the inflation rate shows that prices are escalating, piling pressure on household incomes which may not be increasing at the same or higher rate. If this happens over an extended period of time, disposable incomes drop and households spend, save or invest less. This in turn can have a negative impact on the growth of an economy.

The Kenyan shilling on the other hand fluctuated within a narrower range of Ksh86.06 and Ksh86.58 to the dollar in February compared with a range of Ksh85.46 and Ksh86.96 in January.

Global growth outlook

“The improving global growth outlook as well as the start of the tapering of the economic stimulus programme in the US has caused some volatility in the global bond, equity and currency markets. The impact of the spillover effects of this volatility on the stability of exchange rate in Kenya has so far been minimal,” said CBK in a statement released on Tuesday after the rate-setting meeting.

CBK said it has increased its level of usable foreign exchange reserves from $6.1 billion (equivalent to 4.32 months of import cover) at the end of December 2013 to $6.2 billion (equivalent to 4.38 months of import cover) at the end of February 2014.

The build-up in reserves was mainly attributed to commercial banks selling foreign exchange to the CBK. Bankers project lending rates could fall slightly in the coming months.

“Lending rates are likely to decline as a result of increased private sector liquidity and continued pressure to rationalise lending rates,” said Joshua Oigara, the chief executive officer of regional lender KCB.

“A slight weakening of the Kenya shilling is expected, however, this may be gradual and steady with the unit expected to trade within the Ksh85-87 to the dollar.”

According to the CBK, the annual growth in private sector credit stood at 20.47 per cent in January compared with 20.08 per cent in December 2013.

The number of loan applications rose from 94,259 in December 2013 to 111,486 in January 2014, with the number of loan approvals increasing from 85,889 to 102,287 during the same period.

Banks have been relying on a wider net interest margin to grow their profit levels. Kenyan banks have opened a four per cent gap over their peers, data from Uganda, Rwanda, Burundi and Tanzania shows.

While Kenyan banks charging on average 16 per cent interest on loans and Uganda 23 per cent, borrowers in Rwanda and Burundi are paying an average of 20 per cent. Banks in Tanzania are charging at least 21 per cent interest on loans.

READ: Reprieve? CBK team to probe high interest rates

“As market consensus on Kenya was leaning more towards retention of the rate at 8.5 per cent, we do not expect to see drastic changes in equity and bond prices,” said analysts at Standard Investment Bank.

And while the Kenyan shilling is expected to trade within narrow margins for the rest of the year, the Ugandan unit is expected to remain volatile in coming months, pressured by a mix of aid suspension and the country’s widening current account deficit, monetary officials said last week.

Bank of Uganda (BoU) forecasts that the annual inflation will be in the range of 4-5 per cent in the next few months, and increase to between 5.5-6.5 per cent in the next 12 months.

“Nonetheless, there are potential risks of stronger inflationary pressures, including those arising from possible exchange rate depreciation, stronger domestic demand, especially from the fiscal sector, and an increase in food prices on account of the current drought as well as a regional food supply shortfall,” said BoU in a statement.

The Ugandan shilling depreciated 2.5 per cent against the US dollar in the last three days of February, closing at Ush2,538.07, on the back of speculative demand triggered by threats of aid cuts by several western donors opposed to the Anti-Homosexuality Bill that President Yoweri Museveni assented to on February 24.

Norway has already said it is withholding aid, and Denmark said it will redirect assistance to private industries. The World Bank said it will withdraw a $90 million loan in protest against the law.

READ: Sweden freezes Uganda aid on anti-gay law

BoU governor Emmanuel Tumusiimme-Mutebile said the decision by western donors as well as the World Bank to suspend aid was likely to exert pressure on the shilling, and by extension the economy, which is currently struggling to jumpstart private sector lending.

“The magnitude and the timing of the possible declines in foreign aid are also a source of uncertainty for the balance of payment and the economy,” said Prof Mutebile.

As the Ugandan shilling depreciated, BoU injected $47 million into the market.

But on Tuesday, Prof Mutebile said the problem is not entirely down to aid cuts.

“Besides the threats of aid cuts, the ratio of our current account deficit to the GDP is still wide. This has an impact on the exchange rate,” said Prof Mutebile. 

In the financial year 2012/13 Uganda’s current account deficit stood at $1.566 billion which translated to 9 per cent of GDP, while the trade deficit was $2.1 billion.

An analysis by the BoU also shows that in the 2012/13 financial year, Uganda’s exports were worth $2.95 billion against an import bill of $5.1 billion. According to the BoU, the country’s annual export earnings average approximately $3 billion compared with $5.8 billion it spends on imports.

In Kenya, the current account deficit narrowed last year, buoyed by increased growth in exports amid stable international oil prices. The country’s 12-month cumulative current account deficit (as a percentage of GDP) dropped to 8.09 per cent in the year to December from 10.45 per cent the previous year.

The BoU’s decision to hold the rate at 11.5 per cent for the second consecutive month was also meant to influence further reduction in the commercial lending rates which have continued to stay high despite a 12 per cent reduction in the CBR over the past one year.

READ: BoU holds benchmark rate at 11.5pc

BoU director for research Jacob Opolot said the policy plan is to have private sector credit grow by 15.2 per cent on annual basis.

“Private sector credit growth is lagging at 6 per cent which is 9 per cent below the policy target,” he said.

Dr Opolot explained that other rates had declined in line with the monetary policy stance and weighted average lending rates had stabilised at about 22 per cent since September 2013.

“The relatively high lending rates could, therefore, be explained by structural factors such as the high cost of doing business, heightened risk aversion and difficulties in assessing credit worthiness of borrowers by banks,” he said.

However, DFCU Bank managing director Juma Kisaame said that the industry expects lending rates to come down further towards June and this will stimulate uptake of credit by the private sector.

“The credit environment has been characterised by high levels of volatility, but there is stability at the moment due to the neutral monetary policy stance by the Bank of Uganda in the recent past,” he said.

By Martin Luther Oketch and Peterson Thiong’o