Kenya Bankers Association Centre for Research on Financial Markets and Policy

Transcription

1 RESEARCH NOTE NO (RN/ 4/13) Intrductin Kenya Bankers Assciatin Centre fr Research n Financial Markets and Plicy September 5, 2013 Mnetary Plicy Stance: A Temptatin t Juice up Grwth? Highlights In leaving the Central Bank Rate (CBR) unchanged at 8.5 percent during the 3rd September 2013 meeting, the Mnetary Plicy Cmmittee (MPC) f the Central Bank f Kenya (CBK) was very clear n its justificatin: the psitive market utcmes since its July 2013 meeting utweigh the dwnside risks and that there is n demand-driven inflatinary pressure t warrant a change in the plicy stance. As this Research Nte argues, inadvertently r therwise, there is an element f cherrypicking f risks t justify a decisin with the ptential cst being the inevitability t shck the system when the clearly dwnplayed risks crystallise. This is seen in fur key respects: There is a risk that the MPC des nt even acknwledge it exists: the brics hitting the wall! The BRICS as the ecnmies f Brazil, Russia, India, China, and by sme reckning, Suth Africa depicted a tendency f fast grwth fr sme time until it was assumed that they culd grw in their sleep regardless f what happens in the rest f the wrld. One, the pssibility f inflatin vershting the target in the very near term is nw evident and is cntrary t the MPC s stable shrt-run utlk. If this fact has nt escaped the MPC, then it can nly mean that the implicit stance is ne f crssing the bridge when we reach there. Tw, the best bet fr the MPC in ensuring stability in the freign exchange market is hinged n the medium term cnjecture that the initiatives by the gvernment t attract freign investrs and expansin in trade markets will result in increased freign exchange in the future. But there is a risk that the MPC des nt even acknwledge it exists: the BRICS hitting the wall! The brics as the ecnmies f Brazil, Russia, India, China, and by sme reckning, Suth Africa depicted a tendency f fast grwth fr sme time until it was assumed that they culd grw in their sleep regardless f what happens in the rest f the wrld. Three, the path f the internatinal il prices remains slippery than the MPC is willing t acknwledge. Fur, it remains t be seen whether lessns have been learned frm past episdes f delayed plicy respnse. Such learning can nly take place if there is an appreciatin that there is a cst t a delayed plicy respnse if such respnse will entail shcking the system by a drastic adjustment. It may be imprtant t seek t juice up the ecnmy during plitically pprtune mments. But that has its csts. In view f the circumstances, the prspects f ecnmy s real grwth hitting the target f 5.6 percent fr 2013 seem less likely by the day. We therefre see the plicy decisin as a missed pprtunity n the part f the MPC t assert its plicy credibility credentials. We surmise that in the prevailing circumstances, a slightly less accmmdative mnetary plicy stance- which des nt necessarily amunt t a tightening will have been justified fr it culd have sent the signal f vigilance n the part f MPC t secure stability. While it is tempting t seek t juice grwth because that may be ne f the ways f fending ff medium term inflatin, the plicy decisins may end up frustrating the very grwth if they make it inevitable t shck the system s as t have stability.

2 JUN NOV APR SEP FEBR JUL DEC MAY OCT MAR AUG JAN JUN NOV APR SEP FEBR JUL PAGE 2 Intrductin The Mnetary Plicy Cmmittee (MPC) f the Central Bank f Kenya (CBK) decided n its meeting f 3 rd September 2013 t leave the Central Bank Rate (CBR) unchanged at 8.5 percent. The MPC was very clear n its justificatin f nn-revisin f its plicy stance. Its cre argument was that the psitive market utcmes since its July 2013 meeting clearly utweigh the dwnside risks and that there is n demand-driven inflatinary pressure t warrant a change in the plicy stance. Admittedly, this is an interesting decisin if nly in cnfirming the MPC s credentials f cnsistency in pursuance f a shrt-run grwth-prmting agenda. But at what cst? As this Research Nte argues, inadvertently r therwise, there is an element f cherry-picking f risks t justify a decisin with the ptential cst being the inevitability t shck the system when the clearly dwnplayed risks crystallise. It is true that by MPC s decisin time inflatin was within range f 2.5 percent n either side f the gvernment s medium term target f 5 percent (Figure 1). But as we have cnsistently argued in the past, there needs t be be a difference in attitude when inflatin is within target but n a declining trend frm when it is within target but with a clearly cnsistent rising trend. The MPC has been cnfrnted with bth scenaris in the recent past, the frmer btaining between July 2012 t December 2012 and the latter in the subsequent perid Figure 1: Inflatin; CBR Surce: KNBS; CBK Overall Inflatin (%) CBR (%) The pssibility f inflatin vershting the target in the very near term is nw evident and is cntrary t the MPC s stable shrt-run utlk. If this fact has nt escaped the MPC, then it can nly mean that the implicit stance is ne f crssing-the-bridge-when-we-reach-there. And it is easy t see hw the MPC has cut itself sme sizable slack in this respect by asserting that it will cntinue t mnitr the key macrecnmic aggregates and any emergent risks that may impact n price stability.

3 04/01/ /01/ /02/ /02/ /03/ /03/ /03/ /04/ /04/ /05/ /05/ /06/ /06/ /07/ /07/ /08/ /08/ /08/2013 PAGE 3 Beynd its inflatin utlk which, as we have alluded, even against all dds the MPC assumes t be stable in the near term, we see sanguine attitude whse realism needs t be established. In the MPC s cnsidered view, all is well in the freign exchange market; the gvernment brrwing prgramme has been within target and therefre nt exerting pressure n interest rates; and the strng cnfidence in the ecnmy as reflected by the activities at the Nairbi Securities Exchange can nly mean that the prjected grwth target f 5.6 percent is attainable. In shrt we are depicted t be living in the wrld f musician Bbby McFerrin and the fficial mantra may as well be Dn t Wrry, Be Happy. The Bbby McFerrin Stance Hw Realistic? When yu cnsider the perid July August 2013 as the MPC has, yu bserve a sense f stability in the freign exchange market. Which the market cnditins buttressed by a weak external psitin characterised by a current accunt deficit equivalent t abut 10 percent f GDP, the relativestability is mre a functin f the depreciatin trend that cmmenced in May 2013 (Figure 2) starting t cnstrain imprts as ppsed t the exprt impetus picking Figure 2: Nminal Exchange Rate (KES/USD) Surce: CBK The best bet fr the MPC in ensuring stability in the freign exchange market is hinged n the medium term cnjecture that the initiatives by the gvernment t attract freign investrs and expansin in trade markets will result in increased freign exchange in the future. We call this a cnjecture advisedly; the MPC des nt define the future against which it hinges stability in the freign exchange market. It is the endeavur by the MPC t hinge its market stability expectatins n expansin in trade markets that brings ut the fact that sme clear risks are being dwnplayed. These are principally the external risks. The nly external risks that the MPC explicitly acknwledges are the challenges f the Eur zne and the Middle East and Nrth Africa Challenges; in the case f the latter it is nly t the extent that it influences the price f il.

4 PAGE 4 But there is a bigger risk that the MPC des nt even acknwledge it exists: the BRICS hitting the wall! The BRICS as the ecnmies f Brazil, Russia, India, China, and by sme reckning, Suth Africa depicted a tendency f fast grwth fr sme time until it was assumed that they culd grw in their sleep regardless f what happens in the rest f the wrld. Unfrtunately that attitude led t a bubble f cmplacency that is nw being ppped brutally. As bserved by The Ecnmist (July 27th August 2013), these ecnmies are experiencing the great deceleratin and even thugh that may nt necessarily imply the beginning f a burst, it is a turning pint fr the wrld ecnmy. The challenges f the brics did nt emerge with the US s Federal Reserve Bank signalling the intentin f re-lking its mnetary plicy stance in its tapering talk. Sft patches started being bserved as far back as Octber Prir t that perid and subsequent t the beginning f the glbal ecnmic crisis, cnventinal wisdm divided the wrld int tw: the BRICS and the sick (the EU and the US). But then, it is nw emerging that fr all the talk abut decupling, the BRICS are affected by the weak Western ecnmies. In ther wrds, the MPC is lking at the leading emerging markets in its expansin in trade markets bservatin as the refugee in repairing the current accunt. Unfrtunately, this cmes at a time when the brics are als lking sick. The MPC is sending the signal that the usable freign exchange reserves currently at an equivalent f 4.11 mnths f imprt cver will adequately allw the CBK t intervene as apprpriate in the event f vlatility. The sense f freign exchange stability that we earlier bserved meant that if there were any market interventins by the CBK, they were mild. But this des nt take away the fact that the current accunt is increasingly relying n shrt-term capital inflws, and this has attendant risks in the event f a reversal. In anther respect, the MPC s inadvertent penchant t be implicitly backward lking as ppsed t giving frward guidance withut necessarily giving away the game has tended t shrud in the mney market. The MPC s indicatin that the gvernment dmestic brrwing prgramme was within target and was therefre nt driving r exerting pressure n interest rates needs t be cnsidered alngside the fact that while delayed gvernment expenditure as the new gvernment was settling in may have resulted in tight liquidity, the resumptin f expenditure may be accmpanied by challenges f meeting gvernment revenue cllectin targets. Therefre, t assume away the pssibility f a simultaneus dmestic adjustment at the fiscal frnt and the external adjustment in view f the glbal develpments we utline abve will be sweeping a majr risk under the carpet. Similarly, the argument that the new VAT measures will cntribute nly t mild shrt-term inflatin has t cnfrnt the fact that the implementatin has seen drastic price increases in basic cmmdities even beynd the tax measure in instances pprtunistically and clearly inflatin expectatins. While the MPC acknwledges the instability in the Middle East and Nrth Africa as stands t cntribute t an increase in dmestic fuel prices, the full ptential impact needs t be appreciated. Sme frecasts f the internatinal il prices (Figure 3) indicate a stable even mildly declining regime in the range f USD 95 USD 100 per barrel. It is difficult t cuntenance such frecast when yu cnsider the shifting ge-plitical dynamics in the Middle East. The prspect f Western military interventin in Syria is ne reasn why the frecast may be verly ambitius, but nt the nly ne. A cmbinatin f strikes and sabtage has hurt Nigerian, Iraqi and Libyan il prductin. And the amunt f spare capacity in il utput a gauge f future price mvements is at its lwest level since On the lcal frnt, the Energy Regulatry Authrity has

5 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 PAGE 5 increased the pump price and there are all indicatins that the cnsumer will be frced t subsidize the inefficient refinery in Mmbasa. All this will be inflatinary. 115 Figure 3: Prjected Spt Crude Price (USD/bbl) Surce: IMF Learn Frm Recent Histry? Which Histry? With the MPC indicating that it will cntinue t mnitr the key macrecnmic aggregates and any emergent risks that may impact n price stability, we can nly assume that t be an indicatin f its willingness t make a quick respnse in the event f thse risks becming mre prbable. But that can nly be an assumptin that needs t be tested against arguments that we have frnted abve t the effect that the inflatinary mmentum may be building under MPC s watch. What is at stake is plicy credibility. We have been in such a spt in the past. As Figure 1 shws, during the perid February 2011 August 2011 when inflatin sharply rse frm 5.75 percent t 16.7 percent, the CBR was in the 5.75 percent 6.25 percent level. This was arguably a clear plicy misstep whse crrectin necessitated a drastic tightening by way f drastic increase in the CBR and restricted use f the discunt windw. Thse wh share ur view hasten t add that the plicy cmmunicatin was nt clear, a fact that manifested itself in an even large increase in the interbank rate during the time. It remains t be seen whether lessns have been learned. Such learning can nly take place if there is an appreciatin that there is a cst t a delayed plicy respnse if such respnse will entail shcking the system by a drastic adjustment. It may be imprtant t seek t juice up the ecnmy during plitically pprtune mments. But that has its csts. In view f the circumstances, the prspects f ecnmy s real grwth trajectry seen in Figure 4 being maintained and the target f 5.6 percent fr 2013 being hit seem less likely by the day. That is why there has t be a recgnitin that a slightly less accmmdative mnetary plicy stance des nt necessarily amunt t a tightening but stands t send the signal f vigilance t secure stability.

6 PAGE 6 Figure 4: Real GDP Grwth (%) Surce: KNBS Cnclusin In justifying the decisin t hld the CBR at 8.5 percent, the MPC nted that inflatin has remained within the target range. As we argue abve, there are a number f majr risks that the MPC ignred, nt least the fact that even within the target range inflatin is strngly establishing an increasing trend and will sn versht the target. We therefre see the plicy decisin as a missed pprtunity n the part f the MPC t assert its plicy credibility credentials. Markets are usually frward lking, respnding t what the plicy maker is expected t d and nt what the plicy maker des. We surmise that in the prevailing circumstances, a slightly less accmmdative mnetary plicy stance- which des nt necessarily amunt t a tightening will have been justified fr it culd have sent the signal f vigilance n the part f MPC t secure stability. While it is tempting t seek t juice grwth because that may be ne f the ways f fending ff medium term inflatin, the plicy decisins may end up frustrating the very grwth if they make it inevitable t shck the system s as t have stability.

7 PAGE 7 This Research Nte is a publicatin f the Kenya Bankers Assciatin Centre fr Research n Financial Markets and Plicy. The Centre was established by the Kenya Bankers Assciatin in 2012 t ffer an array f research, cmmentary, and initiate dialgue n critical plicy matters that impact the financial sectr. Thrugh these activities, the Centre acts as a platfrm fr intellectual engagement between experts n financial markets, banking industry players and plicy makers. The views expressed in this Research Nte d nt necessarily represent thse f the Members f the Kenya Bankers Assciatin. The cntent f this publicatin is prtected by cpyright law. Reprductin in part r whle requires express written cnsent. Cmments n this Research Nte can be frwarded t the Centre s Directr at research@kba.c.ke r jsr@kba.c.ke Kenya Bankers Assciatin 2013