Mixed signals from CBK confusing the market

The Central Bank of Kenya (CBK) sent out two sharply contrasting signals in a matter of hours on Wednesday, which set the shilling on two wild swings. The banking sector regulator injected Sh15.3 billion into the system through reverse re-purchase agreements, pushing the shilling to an all-time low of 97.50 units to the dollar.

It was the second time in two days that the currency had touched an historic low. The regulator then poured an undisclosed volume of dollars into the inter-bank market in the afternoon, which helped the currency to stabilize at about 96.70 exchange rate- still weaker than the previous record low of 96.20 set on Tuesday. For the third day in a row Thursday, the shilling touched yet another unprecedented low of 98.20 to the dollar, before regaining ground to 97.70 following an announcement that the regulator would not inject any more shillings through the Repo market.

CBK’s decision to flood the inter-bank market with Sh15.3 billion on Tuesday, when it was well aware that the shilling was hanging on a thin thread, would appear to have been reckless at a first glance.

But as Treasury’s borrowing agent, the Central Bank was alive to the biting cash crunch in the inter-bank market, and the cash injection was meant to smoothen government’s borrowing through a two-year bond and six-month Treasury bill. Whatever the merits and demerits of the decision, it highlighted a government borrowing situation that is getting increasingly desperate, as the State struggles between maintaining macro-economic stability and servicing immediate financial needs.

Besides a free-falling currency, CBK is faced with a soaring inflation rate that is way above tolerable limits, and a surge in interest rates that has seen short-term Treasury bills climb to double digit levels. Most critics will agree that Central Bank has little control over many of the factors that have rendered its monetary policy impotent.

It is the mixed signals coming from CBK that have, however, cast an unfavorable light on the institution. The hasty retreat that the regulator beat after a three-week attempt to tinker with the inter-bank rate exposed the soft under-belly of a watchdog that had either hastily implemented a poorly thought out policy, or one that did not have the guts to push through its ideas to a conclusive end.

Wednesday’s decision to sell shillings in the market, which ended up upsetting the currency, only to attempt to reverse this by selling dollars to banks, again exposed a curious indecisiveness at CBK. An uncertain policy stance is the last thing that markets need in times of international economic turbulence.

Kenya must tackle the basics to get economy back on track

Kenya’s monetary policy is at a crossroads, the exchange rate volatile and prices of essential goods on a steady rise. After nearly seven years of relative calm, the economy appears to have been invaded by the forces of destruction that cannot be contained by the known instruments of policy.

Kenya is for the first time in nearly five years back to a point where the Central Bank cannot robustly defend the shilling – its reserves having been eroded to a four-year low even as the trade deficit continues to widen.

Government finances are not in good shape either raising the need for more borrowing. This is the reason that contrary to all expectations, the Central Bank Wednesday released more shillings into the market to ease liquidity as it prepared to borrow Sh10 billion from the same market.

That had the effect of pushing the shilling farther down the exchange rate slope to Sh97.25 to the dollar – the lowest ever since exchange rate controls were removed in 1994.

Adding impetus to the currency troubles are the acute supply shortages in key segments of the economy. A prolonged drought has drastically reduced the amount of cheaper hydro-electric power that is on the national grid, forcing the country to rely on thermal power that has more than doubled the cost of electricity to consumers.

Drought has also caused acute supply shortages of key consumer goods such as sugar, maize meal and milk sending prices to unprecedented levels.

These shortages have to be dealt with through importation of whatever is in short supply using the weak shilling. That adds more pressure on the local currency repeating the circle all over.

A casual look at these challenges may give the impression that they are temporary.

The reality is that they are the fruits of monopolization of the national policy making machinery by a short-sighted elite as is manifest in the annual allocation of resources via the national budget.

It has become clear that the root cause of all this lies in our collective refusal to recognise that no meaningful development will take place in Kenya until we get the basics such as feeding ourselves and meeting our energy needs 

Kenyan shilling slumps to record low for third day

The Kenyan shilling slumped to a record low against the dollar on Thursday on the back of euro weakness and has now fallen 3.3 percent against the greenback so far this week.

The shilling traded at a new low of 98.20 after setting record lows of 97.20 on Wednesday and 96.11 on Tuesday and traders said they were watching to see if the central bank would step in for the second straight day to curb the slide.

"It's still driven by Europe. We can see the euro overnight has slipped a bit, so that's the reason. That's key. It's just in line with what is happening," said Kennedy Butiko, deputy head of treasury at Bank of Africa.

Currencies in frontier markets such as Kenya often suffer when the dollar climbs against other major currencies on the perception there will be increased aversion to investing in riskier markets.

"The shilling is moving on global moves at the moment. We are waiting to see if the central bank will come in. Right now the market needs some liquidity," said Dickson Magecha, a trader at Standard Chartered Bank.

The central bank sold an unspecified amount of dollars on Wednesday to try and curb the shilling's fall. It climbed off an intra-day low of 97.20 but weakened again on the back of importer demand for the U.S. currency.

Some traders said they were a sceptical about whether central bank intervention would be able to stem the shilling's decline, unless it were prolonged.

"There's a bit of fear, caution and market jitters. We have seen wide spreads of as much as 1 shilling," said a senior trader at one commercial bank.

"Intervention did not work, did not yield much, and if they want to contain the market they need to come back again into the market by continuous selling of dollars," he said.

Traders said the central bank, however, may have limited scope to offload hard currency on a sustained basis given foreign exchange reserves at the end of last week stood at 3.53 months of import cover, below a target of four months.

The central bank also injected 15.3 billion shillings into the domestic money market on Wednesday in a bid to avoid a liquidity crunch ahead of government debt auctions.

The extra liquidity did not, however, prevent both a two-year Treasury bond auction and a 182-day Treasury bill sale from being heavily undersubscribed, helping to push yields higher.

Central Bank moves to curb inflation, support shilling

Commercial banks will be required to pay more for every penny they borrow from the Central Bank of Kenya (CBK) following a decision by a key advisory organ - Monetary Policy Committee - to raise a monetary tool used to control money supply in the economy.

The move may signal an imminent reduction in the amount of money doing circulation in the economy and a possible rally in interest (borrowing) rates.

In addition, CBK — which is the lender of last resort to commercial banks — will in the coming months make it clearer to financial institutions what adjustments of any financial control instrument is meant to signal whenever any such changes are made.

These are some of the outcomes of an important meeting called to chat the way forward over raging inflation and increased volatility of the foreign exchange market that has seen the shilling hit record breaking lows against the dollar in the recent weeks.

MPC — the body that advises the governor on money supply matters — Wednesday played along the sentiments expressed by across section of economists in the last couple of weeks by raising Central Bank Rate (CBR) to seven per cent from 6.25 per cent last month, the highest increase since the rate was introduced in 2006.

The MPC decision means that it will be more expensive for banks to borrow from the CBK, a development that is bound to see commercial banks shy away from using the facility in the process reducing money supply in the economy and tame inflation induced by increased money supply.

The move also means that financial institutions that will borrow from CBK will be staring at higher interest rates, meaning that any consumer who borrows from such institutions will bear higher interest rates.

"MPC believes that with these measures and others which are ongoing in liquidity management, the economy will be cushioned from inflationary pressure and domestic prices stabilised while providing a flexible space for banks to manage their liquidity efficiently," said a statement signed by CBK governor Njuguna Ndung’u, who chairs the committee.

On taming erratic volatility of the foreign exchange, the MPC endorsed a recent decision by Finance minister Uhuru Kenyatta to seek more dollars from the International Monetary Fund to raise the import cover and stabilise dollar demand.

ALL EYE ON CBK AHEAD OF SPECIAL MEETING

Unlike in the past where such meetings are held once every quarter, the calling of the Monetary Policy Committee (MPC) meeting comes barely a month after the last one, a clear indication of the urgency of the matters at hand.

Key items giving the CBK team restless nights are the weakening of the shilling and high inflation.

Economists expect the MPC to raise the Central Bank Rate — the rate at which CBK loans banks as a lender of the last resort — to reflect the current economic realities as opposed to the day-to-day juggling of overnight interest rates.

The MPC is also expected to come up with a clear-cut way of stemming the weakening of the shilling once and for all, especially in as far as speculation and arbitrage over the currency is concerned. Expectations are that the bank may agree to periodically off-load dollars into the market to stabilise the shilling whenever dollar demand peaks.

There are also expectations that CBK will come up with specified measures, apparently punitive, on any person who is involved in arbitrage or speculation.

“We will be waiting to see if President Kibaki’s directive that speculators on the shilling be dealt with is addressed,” said Carol Musyoka, a finance analyst.

Last week, President Mwai Kibaki directed financial regulators to deal firmly with speculators, who may have taken advantage of the turbulence in the financial market for selfish gains.

Kibaki—who appears to be reading from the same script as a number of independent economists—reiterated that short-term financial gains could have long-term detrimental consequences on the economy.

Many say that the decision by CBK governor to call for the meeting is meant to save face over the blame that he has received in the last couple of months in the manner in which he has handled the weakening of the shilling.

Past trends have pointed a blaming finger on the CBK Governor Prof Ndung’u and MPC in the lacklustre manner in which they have handled the issue of the weakening shilling with many saying that the two largely sat on the fence as things got out of hand.

The shilling weakened 14 per cent against the dollar this year to a 17-year-low of Sh95.10 on August 9.

Worst Performing

Currently, the Kenyan shilling is world’s fourth, worst performing currency, after neighbouring Uganda’s shilling, the Maldives rufiyaa and the Suriname dollar.

Arguments over what has caused the slide have largely pointed to arbitrage and speculation.

A month ago, CBK issued a statement saying that it had taken an unspecified action against a number of major leading banks over arbitrage and speculation.

The directive was met by scoff from bankers as the shilling continued on its downward spiral with officials in banks saying that the governor has no direct law to effect his directive.

The following weeks saw a number of actions by CBK that have also largely failed to address the weakening of the shilling. This saw CBK resort to other measures to try tame both inflation and the weakening of the shilling.

In mid-August, CBK reviewed the rate at which commercial banks borrow overnight to offset their daily obligations at the clearing house by 509 basis points.

The banking regulator increased its lending rate at the CBK Discount Window to 11.34 per cent from 6.25 per cent. Later, the figure was reviewed upwards to 15.68, meaning that any bank that borrowed from CBK would loan the same amounts at least 20 per cent interest rates to any third party.

The move was seen as an attempt to stop banks from borrowing from CBK and tame liquidity in the process addressing inflation. The operational interest rate for the CBK Discount window was also to be reviewed from time to time and posted on the CBK website on a daily basis by 9.00 am.

CBK had hoped that by revising the rules guiding the operations of its Discount Window would curtail the second round effects arising from fuel prices and exchange rate volatility that have been fuelling inflationary expectations.

In addition, CBK put in place new regulations where any commercial bank lending in the inter-bank market would not be allowed to access funds through the CBK Discount window on the same day.

Similarly, any bank borrowing from the CBK Discount Window is prohibited from lending in the inter-bank market either on the day of accessing the window or on the following day.

The new guidelines also stipulated that CBK considers an individual bank’s foreign exchange trading behaviour over the previous four trading days in determining eligibility for access to the CBK Discount Window (overnight).

Import Cover

But even as CBK took these actions, the Forex market registered no significant change leading to a view that there could be other reasons as to the shilling’s continued weakening.

Those who in the know say that CBK may have had its hands tied over the issue by signing an agreement with the International Monetary Fund over import cover needs.

The argument goes that the CBK is not allowed to off-load dollars into the market to ease off the dollar demand as the arrangement requires that the country maintains a four month dollar equivalent import cover.

As if understanding the precarious situation that the country is in, last week, it was President Kibaki asking the International Monetary Fund to release additional funds from its Extended Credit Facility to help deal with a weakening shilling and surging money-market rates.

In January this year, the IMF approved a three-year arrangement under its extended credit facility for Kenya equivalent to about $508.7 million, with an initial disbursement of $101.7 million.

An additional payment of $65 million was approved in June. According Ragnar Gudmundsson, the IMF’s representative in Kenya, Kenya’s request for more funds will be considered when an IMF team arrives in the country in October to do a regular review of the existing program.

According to President Kibaki, who seems to have taken over the issue of the weakening of the shilling and liquidity in his own hands, the decision is to be taken along with other unspecified measures to ensure “orderly trading in the money markets for liquidity and foreign exchange”.

Kenya wants its next IMF disbursement to be paid early “to ensure ample supply of foreign exchange to finance required imports without putting pressure on the shilling.”

And so as MPC sits to chat the way forward on taming inflation, the volatile Forex market, economists will be watching closely if actions of MPC will be in line with the expectations of many.

CBK cuts overnight rate to ease cash shortage

The Central Bank has cut sharply the rate at which it gives overnight loans to commercial banks, easing a cash shortage that had raised fears of a fresh surge in the cost of loans.

The regulator quoted the discount window rate at 17.87 per cent yesterday, putting it below the interbank lending rate of 19.25 per cent.

The discount window rate is ordinarily supposed to be punitive and higher than the inter-bank rate, and CBK’s action signalled a resolve to ease the biting cash crunch in the banking system.

A formula introduced by the regulator about two weeks ago for calculating the discount window rate triggered a rally of both the interbank rate and the discount window rate, prompting an intervention by Treasury which said the high rates would strangle economic growth.

“Money has found its way to banks,” said head of markets at Citi Bank, Ignatius Chicha.

Banks had found it increasingly hard to maintain minimum cash balance requirements by CBK as the discount window rate shot to 31.4 per cent from 6.25 per cent on August 12 while the interbank rate peaked at 27.72 per cent.

Barclays Bank on Wednesday announced a one percentage increase in lending rates to 14.75 per cent, raising fears that it would set off another wave of increases similar to another one in July.

Bankers said the easing of the two rates was being helped by new CBK guidelines issued on Friday relaxing the rules on cash reserves that the lenders are supposed to maintain as a ratio of deposits.

Mr Chicha said the government has also increased its spending, injecting money into the banking system.
He said the rates are expected to continue declining.

CBK restricted commercial banks from borrowing at the discount window mid last month, accusing them of using the money to speculate on the shilling. According to CBK it led to depreciation and banks were lending the money to other banks at higher rates.

Commercial banks also used the funds to invest in Treasury bills which pay higher returns than the cost at which they were borrowing from the CBK.

The regulator introduced a new formula for calculating the discount window rate, which included 3 per cent penalty on the previous day’s average interbank rate.

The banking sector regulator also said that it would consider an individual bank’s foreign currency trading behavior over the previous four trading days to determine whether it would allow it to access funds at the discount window.

On Friday the regulator said the bank’s cash reserves will now be based on a monthly average and commercial banks were allowed to deviate from the 4.75 per cent rate requirement on a given day but not fall below 3 per cent- provided that the overall average for the month will be at least 4.75 per cent.

Commercial banks quoted the shilling at 93.95/94.05 to the dollar yesterday morning, a weakening from Tuesday’s close of 93.65/75.
The move by the banking regulator to restrict commercial banks from borrowing using CBK overnight lending rate was also supposed to force them to lend to each through the horizontal repurchase agreements.

Tight liquidity

The Central Bank, which had also stopped publishing the overnight lending rate a week-and-a-half ago, started publishing it again on Thursday.

Bankers said that failure to publish this information led to a widening differential between the rates at which the commercial banks were lending to each other.

Duncan Kinuthia, a senior dealer at the Commercial Bank of Africa said that the high differential was caused by lack of information and tight liquidity in the market.

On Tuesday for instance, some banks were lending to each other at 10 per cent while others were borrowing at 29.5 per cent, a differential of 19.5 percentage points.

“We are coming from a period when there was very tight liquidity and I also think that there was some information asymmetry,” said Mr Kinuthia.

He said there would be a “natural correction” of the interbank lending rate.

Think-tank opposes extension of sugar industry safeguards

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Yako supermarket in Kakamega has restricted sugar purchase to one packet: Kesref says extending the Comesa safeguards will hurt the economy. 

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A government think-tank is opposing the extension of the safeguards protecting the local sugar industry from duty-free imports being fronted by the Trade and Agriculture ministries.

The Kenya Sugar Research Foundation (Kesref) says the country is losing Sh4 billion annually because of inefficient milling.

Local millers are protected by the Common Market for Eastern and Southern Africa (Comesa) safeguards initiated in 2007, which limits the amount of sugar that can be imported from these countries besides imposing a 10 per cent duty.

“Therefore, opening up of trade will reduce prices of sugar and save consumers income which could be directed to other areas.”

But Kesref says the protection has made sugar millers, save for Mumias, inefficient, leading to expensive sugar and lost earnings for farmers and the millers. “This translates to an average loss of $43.64 million per annum since the protection policy was introduced in Kenya,” says Kesref

Sugar prices rose from an average of Sh75 per kilogramme in January to Sh200 this month as cane shortage forced most of the millers to operate below capacity, causing an acute supply shortage.

Local sugar millers, led by the largest and most efficient player Mumias, said they expect high prices to continue into next year, adding fresh impetus to inflation that is running at 16.67 per cent.

The protection of local millers is expiring next March, opening up the local sugar industry to cut-throat competition from imports from the bloc whose members produce sugar at half the cost of Kenyan millers.

Poor planning, corruption, and red tape have reduced efficiency, making the factories weak competitors.

The Trade and Agriculture ministries want Comesa to keep on hold the 10 per cent duty beyond next March, arguing that millers were not strong enough to compete with the region’s least-cost producers. [Read: Sugar hits Sh200 per kilo as supply shortage persists]

“We expect to communicate the extension request very soon. We are certain that the local sugar industry has not reached a stage where it can compete freely with imports from efficient producers in the region,” said Trade permanent secretary Abdulrazaq Ali.

Kenya’s production cost of Sh45, 000 per tonne is higher than that of rivals within Comesa such as Swaziland, Malawi, and Zambia whose average budget is Sh20,000.While the rivals plant the bulk of their sugarcane, Kenyan millers rely on independent farmers whose cane pricing is regulated by the Government, which owns at least five of the sugar firms.

Kenya has been opening her sugar market to imports from Comesa at the rate of 40,000 tonnes annually, on top of the 220,000 tonnes agreed on in 2007.

Duty on the imports has also been coming down, from 100 per cent in 2008 to 40 per cent in 2010 and 10 per cent this year before attracting zero duty from next March.

Kesref reckons that lack of competition has made local millers, especially State-owned Chemelil, Nzoia, South Nyanza (Sony), Miwani and Muhoroni lax, arguing the inactivity has led to reduced sugarcane and obsolete equipment.

Poor planning

The planned upgrade of the plants by, among other things, reducing the amount of cane used to produce a tonne of sugar has been delayed.
Sugar millers have cut production and are laying off workers as they struggle to cope with shortage of cane.

Chemelil, Muhoroni, West Kenya, and Kibos are operating at less than half their capacities due to cane shortage, while Mumias Sugar Company is producing less than it did last year.

The Kenya Sugar Board blames supply drop on poor planning.