Costly loans loom as Kenya’s Central Bank rate hits 12.5%

The Central Bank of Kenya benchmark rate has gone up to 12.5 per cent from 10.5 per cent.
Developing economies including Kenya are paying dearly for geopolitical tensions.
The current US policy rate at 5.25 per cent -5.5 per cent is the highest in 22 years, exerting pressure on economies.

Borrowers in Kenya are facing the prospect of more expensive loans following the country’s central bank’s decision to raise its base lending rate to a near 11-year high of 12.50 per cent. This marks an increase from the 10.50 per cent rate that has been in place since June this year, when it rose from 9.50 per cent due to a rise in non-performing loans in the banking sector.

The hike in rates occurs as Kenya, along with other economies in the region, continues to grapple with the impact of global factors, including elevated interest rates in the United States. The Federal Rate hikes began raising rates in March of last year as part of an effort to check inflation in the US, with ripple effects affecting weaker economies by causing their currencies to weaken against a strengthening US dollar.

The current US policy rate stands at 5.25 per cent to 5.50 per cent, the highest in 22 years. Although the move by the Central Bank of Kenya (CBK) appears to be aimed at curbing inflation and supporting the shilling, which has experienced a decline since the beginning of the year, it is likely to have repercussions for borrowers as banks adjust lending rates, potentially reaching as high as 25 per cent.

This adjustment is expected to impact primarily those borrowers with poor credit scores, who are deemed high-risk borrowers with a greater likelihood of defaulting.

Global uncertainties to blame for costly loans

The Monetary Policy Committee (MPC) of the Central Bank of Kenya, chaired by CBK Governor Dr. Kamau Thugge, announced on Tuesday that the decision to raise the base lending rate was primarily influenced by ongoing global uncertainties. The committee also cited factors such as volatility in international oil prices, a weak global growth outlook, and the escalation of geopolitical tensions, including the Russia-Ukraine war, which began in February 2022.

Over the past year, the Russia-Ukraine war has disrupted the global supply chain, particularly affecting food commodities and oil products. Kenya, being a net importer, has felt the impact, especially with grain imports from these two countries. The recent Israel-Hamas conflict has further added to concerns about potential increases in oil prices, as Kenya sources its refined products from the Middle East. The World Bank, in a recent update, warned that oil prices could rise to as high as $157 per barrel if the Middle East crisis escalates.

Dr. Thugge mentioned that the committee also considered persistent domestic inflationary pressures and the depreciating shilling. The MPC reviewed the outcomes of its previous decisions and measures implemented to mitigate adverse economic impacts and financial disruptions.

Costly loans loom amid rising risk of defaults

The banking sector remains stable and resilient, according to CBK, with strong liquidity and capital adequacy ratios. Nevertheless, the ratio of gross non-performing loans (NPLs) to gross loans grew to 15.3 per cent in October 2023 compared to 15 per cent in August 2023, signaling a higher default rate on loans.

During the period, increases in NPLs were noted in the manufacturing, trade, personal and household, building and construction, and transport and communication sectors, forcing banks to continue making high provisions for the NPLs.

Growth in private sector credit, however, remained relatively stable at 12.5 per cent in October 2023 and 12. (Canadian pharmacy) 2 per cent in September. Strong credit growth was observed in manufacturing (18.4 per cent), transport and communication (16.2 per cent), trade (9.9 per cent), and consumer durables (10.8 per cent).

“The number of loan applications and approvals remained strong, reflecting sustained demand, particularly for working capital requirements,” Dr Thugge said.

The Committee noted the ongoing implementation of the FY2023/24 government budget, as well as the revised budget for the fiscal year, which continues to reinforce fiscal consolidation.

Exchange rate volatility

The MPC noted that exchange rate depreciation continues to exert upward pressure on domestic prices, thereby increasing the cost of living and reducing purchasing power. Of the overall inflation of 6.8 per cent in November 2023, the exchange rate depreciation contributed about three percentage points.

Additionally, the Committee noted that public sector external debt service has risen, offsetting some of the gains made towards the government’s strong fiscal consolidation. Kenya’s debt currently stands at $68.5 billion, with debt obligations on dollar-denominated loans continuing to rise every time the shilling weakens.

“The continued weakening of the exchange rate is contributing to a significant increase in the Kenya shilling value of foreign currency-denominated debt,” CBK noted.

The MPC, therefore, concluded that there is a need to adjust the monetary policy stance to address the pressures on the exchange rate and mitigate second-round effects, including from global prices, said Dr Thugge.

“This will ensure that inflationary expectations remain anchored, while setting inflation on a firm downward path towards the 5.0 percent midpoint of the target range. Therefore, the MPC decided to raise the Central Bank Rate (CBR) from 10.50 percent to 12.50 percent,” he said.

He added that the MPC will closely monitor the impact of the policy measures as well as developments in the global and domestic economy and stands ready to further tighten monetary policy as necessary to ensure price and exchange rate stability are achieved, in line with its mandate.

Global growth is expected to decelerate from three percent in 2023 to 2.9 percent in 2024, reflecting the impact of high-interest rates in advanced economies and weakening demand, particularly in China and the Eurozone. The heightened geopolitical tensions are expected to continue weighing down on economic activity.

Additionally, headline inflation rates in advanced economies have continued to ease but remain above their respective core inflationary targets. Global food prices have declined from the peak levels witnessed in 2022, except for a few items such as sugar and rice.

Inflation in Kenya

Kenya’s overall inflation remained broadly unchanged at 6.8 percent in November 2023, compared to 6.9 percent in October, but has stayed consistently in the upper bound of the government’s target range since July 2023.

Food inflation declined slightly to 7.6 percent in November from 7.8 percent in October, largely due to lower prices of key non-vegetable food items, particularly maize and wheat flour. This follows improved supply attributed to ongoing harvests and government measures to zero-rate key food imports. Nevertheless, prices of a few vegetables, particularly onions, tomatoes, and carrots, remained elevated in November due to reduced supply.

Fuel inflation increased to 15.5 percent in November from 14.8 percent in October, reflecting the impact of higher international oil prices and depreciation in the shilling exchange rate.

Non-food non-fuel inflation declined modestly to 3.3 percent in November from 3.6 percent in October.

“The risks to inflation are elevated in the near term, reflecting the impact of second-round effects of the rise in fuel inflation and pass-through effects of the exchange rate depreciation,” the Governor said.

Central Bank surveys on economy

The survey of the agriculture sector conducted ahead of the MPC meeting revealed that prices of key food items were expected to decline due to improved supply, thanks to the ongoing rains.

Nevertheless, respondents expect prices of some consumer goods to rise in the coming months due to higher transport and energy costs, attributed to the increase in fuel prices and a rise in import costs due to the depreciation of the exchange rate.

The GDP data for the second quarter of 2023, however, indicates continued strong performance of the Kenyan economy, with real GDP growing by 5.4 per cent compared to 5.2 per cent in a similar quarter of 2022.

This performance reflects a strong rebound in the agriculture sector and a resilient services sector supported by robust activity in information and communication, transport and storage, financial and insurance, and accommodation and food services.

Leading indicators of economic activity show continued strong performance in the third quarter of 2023.

“Despite global uncertainties, the economy is expected to continue to remain strong in 2024, supported by a resilient services sector, the rebound in agriculture, and the implementation of measures to boost economic activity in priority sectors by the government,” Njoroge said.

Market perceptions

On the other hand, the CEOs’ survey and market perceptions survey, conducted ahead of the MPC meeting, revealed tempered optimism about business activity for the next 12 months.

Respondents expressed concerns about weakened consumer demand and increased costs of doing business, attributed to the weakening of the Kenyan shilling, taxation, and higher energy costs.

Nonetheless, respondents remained optimistic that economic growth would remain resilient in 2023 and improve in 2024, supported by increased agricultural production. Goods exports declined by two percent in the 12 months to October 2023, compared to a similar period in 2022.

Receipts from chemicals and manufactured exports increased by 5.1 percent and 13.9 percent, respectively. The increase in manufactured export receipts reflects strong regional demand, according to the CBK.

Imports declined by 14.9 per cent in the 12 months to October 2023 compared to a growth of 14.7 per cent in a similar period in 2022, mainly reflecting lower imports across all categories except food.

Tourist arrivals also improved by 34.1 per cent in the 12 months to October 2023, compared to a similar period in 2022. Remittances totaled $4.16 billion in the 12 months to October 2023 and were 4.2 per cent higher compared to a similar period in 2022.

The current account deficit is estimated at 3.7 per cent of GDP in the 12 months to October 2023 and is projected at 4.1 per cent of GDP in 2023 and 4.2 per cent of GDP in 2024.

The CBK foreign exchange reserves, which currently stand at $6.746 billion (3.62 months of import cover), continue to provide adequate cover and a buffer against any short-term shocks in the foreign exchange market, as noted by the CBK.