EDITORIAL: Find a way out of market distortion in loans pricing

Customers in a KCB banking hall. Experts now say the CBK made a mistake in picking CBR as the applicable base because that decision has hampered monetary policy. file photo | nmg 

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Summary

• Citigroup economists say capping of interest rates has rendered the monetary authority incapable of acting with speed to stimulate liquidity or fight inflation whenever it arises.
• The reality is that there has been a substantial reduction in credit advanced to the private sector since the interest rate-capping law came into force last September.
• Indeed the MPC has argued the current high inflation is all related to the dry weather conditions and related food shortage that is subject to rapid change.

In the wake of Parliament’s decision to pass a law capping interest rates, the Central Bank of Kenya (CBK) as required by the same law picked the Central Bank Rate (CBR) as the base rate referred to in the Act for purposes of fixing the applicable rate. It had the option of picking the Kenya Banks Reference Rate (KBRR), which takes into account both the CBR and the prevailing Treasury bill rates.

Experts now say the CBK made a mistake in picking CBR as the applicable base because that decision has hampered monetary policy. Citigroup economists say capping of interest rates has rendered the monetary authority incapable of acting with speed to stimulate liquidity or fight inflation whenever it arises. The reality is that there has been a substantial reduction in credit advanced to the private sector since the interest rate-capping law came into force last September.

But that is not the whole story. Poor corporate performance has affected companies’ ability to borrow. Commercial banks have, however, made it all look like the rate cap is solely to blame for the slowdown – a position that some Kenyans have seen as an attempt to arm-twist the country into removing the caps sooner. There is no reason why the MPC should be unable to raise the CBR in the face of high inflation, unless it sees this as temporary. Indeed the MPC has argued the current high inflation is all related to the dry weather conditions and related food shortage that is subject to rapid change.

Inflation has indeed begun to fall going by the latest data.

The monetary authority, however, allowed inflation to cross to double digits for three consecutive months without moving the CBR, leading to the current accusations that it is hamstrung by the law and is intent on being politically correct, especially as the General Election draws closer.

The capping of interest rates has only added a new layer of market distortion in the pricing of loans making things difficult for the CBK, but it must find a way out.

The reality, however, is that removing the caps demands that all other distortions are dealt with at once. A measure such as the recently introduced annual percentage rate (APR) is a good starting point, but even this one needs time to see how it works in practice.