A row between the National Treasury and the Central Bank of Kenya over who is to blame for the rising cost of living after inflation spilled out of the government upper limit of 7.5 per cent last month, has raised fears of an interest rate increase in the coming week.

While the Treasury argues that the Central Bank should be vigilant over all aspects of inflation that caused the cost of living to rise by 8.01 per cent in December, CBK says it can only police risks that arise from excess liquidity in the market or what insiders call demand side factors.

The Central Bank had argued last month after the inflation rate, at 7.32 per cent, came within a whisker of the upper rate that it saw no need to increase the distress rate it levies on banks in distress.

It said that the increase had been caused by what are called supply side factors such as the rising food prices caused by El Nino that made food distribution difficult.

“If you are telling me that we should direct our monetary policy on the price of sukuma wiki and the price of tomatoes, I will tell you maybe you should go and study the sukuma wiki market and then we can talk. In that sense, we know what the underlying dynamics are and we are comfortable because those are weather-related and there is a bit of movement now and then but we know the direction they will stabilise,” said Central Bank Governor Dr Patrick Njoroge.

“The non-food and non-fuel inflation has been coming down quite nicely and it is now below 5 per cent. We are comfortable that there is no indication of pressures from aggregate demand or for that matter from the external sector through the exchange rate,” Dr Njoroge said.

Treasury Cabinet Secretary Henry Rotich, however, took a swipe at the Central Bank for suggesting that it was only responsible for some aspects of inflation.

“It is not a question of who is responsible for what kind of inflation. The debate of headline and core inflation is gone and it is not fashionable today. Monetary policy affects the supply and demand sides of inflation,” Mr Rotich told The EastAfrican.

He said he was expecting the Central Bank to write to him and to the Finance, Planning and Trade Committee of Parliament explaining why inflation had deviated from the 5 per cent target by more than 2.5 percentage points, the measures the bank was taking, and when the rate was expected to return to the preferred range.

The report would be in line with a notice Mr Rotich issued in June last year to then Central Bank governor Njuguna Ndung’u who was replaced by Dr Njoroge two weeks later.

“The inflation rate target for monetary policy shall be five per cent. This is the target for which the bank is accountable for to the government and the general public. We have provided a flexible margin on either side of the inflation target to cater for effects of external shocks such as oil price variations and domestic weather related shocks,” Mr Rotich said in the notice.     

This is the second major dispute that has arisen between the Treasury and the Central Bank since Dr Njoroge was shortlisted to be the Central Bank governor. During public interviews with the Parliamentary Committee Dr Njoroge said he did not see the need for the minimum capital of banks to be raised fivefold to Ksh5 billion ($50 million) by 2018. Instead he advocated niche banks and risk based supervision.

READ: Kenya Treasury urges rise in banks’ minimum capital

He seems to have won that one, with commercial banks now increasing their capital base for business rather than regulatory reasons. This has consequently delayed consolidation in the sector with the merger between I&M Bank and Giro Bank, the only one announced so far.

While this one largely spoke to stability in banks and ability to handle big ticket projects in extraction and infrastructure sectors, the outcome of the current dispute has implications on the ability of businesses, especially SMEs, and individuals, to borrow.

If the political pressure prevails, the policy rate is likely to be reviewed upwards when the Monetary Policy Committee meets on January 20, making loans more expensive at a time when sectors like real estate are struggling to secure project funds.

On the flip side, a stronger shilling and higher interest rates would be good for net importers (manufacturers) and bad for net exporters (horticulture) in local currency terms while encouraging savings and investments.

While a single inflation figure is the global trend now including in the European Union (1.5 per cent above the average of three members with the lowest rates) and the East African Community (8 per cent), a cross-section of economists said co-ordination between Central Bank’s monetary policy and National Treasury’s fiscal policy is critical in taming inflation.

“These two institutions need to talk to each other and balance the two sides of the macroeconomic policies. CBK might be doing the right things but if the behaviour of the fiscal side is not properly managed then there is a challenge,” said Thomas Kibua, a senior economist at the African Development and Economic Consultants Ltd (ADEC).

According to Dr Kibua who is also a long-serving Deputy Governor at CBK, the government’s decision to increase taxes (VAT and Excise) on commodities coupled with increased public spending have added to inflationary pressures.

“You realise that the government is going on a spending spree because of the forthcoming elections and so a combination of all these factors impacts prices of goods and services,” he said.

Dr Samuel Nyandemo, a senior lecturer at the University of Nairobi School of Economics said high energy costs, increased taxes, high interest rates and increased cost of doing business have made manufacturers to adjust prices for their goods upwards.

Positive investments

“The major issue is the slower rate at which the economy is growing resulting into demand outstripping supply. We need to see growth driven by positive productive investments. We want to see CBK regulate commercial banks in terms of lending and interest rates,” he said.

According to Scholastica Odhiambo, a senior lecturer at the School of Business and Economics at Maseno University, higher taxes and the depreciation of the shilling against other foreign currencies is partly to blame for the rising prices of goods and services.

“Taxation should be reasonable and should not be done in a manner that is injurious to other segments. CBK should also stabilise the exchange rate by mopping up cash from the market in a moderate manner that will not entice banks to raise their lending rates,” said Odhiambo.

Dr Joy Kiiru, a lecturer at the University of Nairobi School of Economics said  CBK is likely to tighten its monetary policy (increase rates)  to cushion the economy from overspending  usually associated with elections.

“Politics is likely to go against economics and the responsibility is likely to fall on the shoulders of the CBK Governor to cushion the economy,” said Dr Kiiru.

What goes down

However some analysts are divided on whether the Central Bank Rate (CBR) and Kenya Bank Reference Rate (KBRR) should come down or up as inflation surges.

“My thinking is that CBK is putting pressure on commercial banks to lower lending rates to spur economic activities in the economy. I think this is a good time for them to bring down the rates so that there can be more borrowing and lending because the current inflation is not being driven by money supply,” said Amish Gupta, Director of Investment Banking at Standard Investment Bank (SIB).

However, KBRR is likely to go up because the average rates on the 91-day Treasury bills for November and December was above 11 per cent.

KBRR — an average of the mean TB Rate over two months and CBR — is reviewed every six months and was last adjusted in July 2015 to 9.87 per cent from 8.54 per cent. On the other hand CBR is reviewed every two months and currently stands at 11.5 per cent. Industry data suggests the KBRR could be raised to about 10.8 per cent.

KBRR was introduced in July 2014 as an instrument that would ensure that lenders are transparent with respect to the cost and pricing of their loan products.

But there have been concerns over the effectiveness of the policy instrument in reducing the cost of credit, with both CBK and commercial banks agreeing that, taken in isolation, this instrument cannot bring down lending rates.

“The success in bringing down the level and spread of interest rates will depend on the implementation of the raft of measures agreed upon by the stakeholders including the implementation of KBRR and hence KBRR alone is not the panacea,” said Habil Olaka, chief executive, Kenya Bankers Association (KBA).

“The real concern has always been the fact that the two variables used to derive KBRR — Central  Bank Rate (CBR)  and 91-day T-bill rate — may not be fully representative of the business environment, such as cost of funds,” said George Bodo, head of  banking research at Ecobank Capital Ltd.

“I think what commercial banks have done so far is to frontload the entire balance of risk premiums into K, since KBRR, as currently formulated, tends to underprice business risks (especially the wide swings in cost of balance sheet funding).