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Kenya Central Bank Cuts Main Lending Rate to Boost Private Sector Credit

Kenya’s Central Bank of Kenya (CBK) made a significant move to stimulate economic activity by lowering its benchmark lending rate to 12.00% from 12.75%. This decision, taken by the Monetary Policy Committee (MPC), marks the second consecutive rate cut this year, following a similar 25-basis-point reduction in August. The central bank aims to boost private sector credit growth, address the challenges of slowing economic growth, and adapt to favorable inflationary conditions.

The Context of the Rate Cut

This decision comes at a critical time for Kenya’s economy. The MPC noted a “sharp deceleration” in private sector credit growth and a slowdown in economic activity during the second quarter of 2024, which prompted the need for further monetary easing. The cutting of the lending rate signals a shift towards a more accommodative monetary stance designed to support economic recovery and enhance liquidity for businesses and consumers alike.

This rate reduction is expected to ease borrowing costs for businesses, especially small and medium-sized enterprises (SMEs), and encourage investment in the private sector, which has experienced sluggish growth due to high interest rates and tighter liquidity conditions. According to data from the Kenya Bankers Association (KBA), the growth of private sector credit slowed significantly in the second quarter, with demand for loans contracting, especially in the retail, manufacturing, and real estate sectors.

The CBK also revised its economic growth forecast for 2024, lowering it from 5.4% to 5.1%, citing weaker-than-expected performance in key economic sectors. The country’s second-quarter GDP growth came in at 4.6%, compared to 5.6% in the same period in 2023. This reduction in economic performance reflects the impact of global macroeconomic uncertainties, high borrowing costs, and supply chain disruptions.

Inflationary Pressures and Monetary Policy Easing

Kenya’s inflation rate has been trending downward over recent months, creating room for the central bank to adopt more accommodative policies. In September, inflation fell to 3.6%, down from 4.4% in August, comfortably within the government’s preferred target range of 2.5% to 7.5%. This decline in inflation was largely driven by reduced food and fuel prices, and improved agricultural production following favorable weather conditions.

The government and financial experts had been calling for the CBK to take decisive action to lower rates, especially in light of the recent inflationary trends. John Mbadi, Kenya’s Finance Minister, stated last week that the central bank should consider lowering lending rates due to the favorable inflation environment, a sentiment echoed by the Kenya Bankers Association in their October 3 research note.

Lower inflation reduces the pressure on businesses and consumers and provides more flexibility for the central bank to stimulate economic activity through reduced borrowing costs. Inflation is expected to remain stable over the coming months, but potential risks include rising oil prices and the possibility of adverse weather conditions affecting agricultural production.

Economic Growth Outlook and Key Drivers

The central bank’s decision to cut interest rates follows a challenging year for Kenya’s economy. The growth forecast for 2024 was revised downwards to 5.1%, reflecting a more cautious outlook. However, the bank remains optimistic about 2025, predicting that growth will recover to 5.5%. This recovery is expected to be driven by several factors, including a resilient services sector, robust agricultural performance, and improved export performance.

The Kenyan economy has benefited from the recovery of the tourism sector, which has seen increased visitor numbers following the easing of pandemic-related travel restrictions. Additionally, the agriculture sector continues to play a critical role, contributing to both domestic consumption and export growth. Key agricultural exports such as tea, coffee, and horticultural products have performed well, with rising demand from international markets.

Export growth has also been buoyed by diversified trade with partners in Europe, the Middle East, and Asia, particularly following the signing of several bilateral trade agreements aimed at improving access to international markets. Kenya’s membership in the African Continental Free Trade Area (AfCFTA) is also expected to provide further opportunities for increased trade and investment.

Private Sector Credit and the Impact on Businesses

One of the primary objectives of the CBK’s interest rate cut is to stimulate private sector credit growth. In recent months, businesses have struggled to access affordable credit due to high lending rates, which have stifled investment and reduced liquidity in key sectors. According to the Kenya National Bureau of Statistics (KNBS), private sector credit growth was 2.8% in August, down from 3.1% in July, signaling a concerning trend of weak credit demand amid high borrowing costs.

By lowering the benchmark lending rate, the CBK aims to make credit more accessible, particularly for SMEs, which are considered the backbone of the Kenyan economy. Lower interest rates are expected to reduce borrowing costs for businesses, enabling them to invest in expansion, create jobs, and drive economic growth.

However, the impact of the rate cut on the broader economy will depend on several factors. First, commercial banks will need to adjust their lending practices and pass on the benefits of lower rates to borrowers. There is also a risk that some businesses may remain hesitant to take on new loans due to lingering uncertainties about the economic outlook, particularly in sectors like manufacturing, construction, and real estate, which have been hit hard by the downturn.

Currency and Foreign Exchange Reserves

The Kenyan shilling has performed well this year, appreciating by more than 21% against the U.S. dollar in 2024. This appreciation was largely driven by strong foreign exchange inflows following the government’s successful issuance of a $1.5 billion Eurobond in February, which was used to buy back a maturing $2 billion bond that had sparked concerns among investors earlier in the year.

Despite the strength of the shilling, the CBK’s foreign exchange reserves stood at $8.25 billion as of October 2024, providing a significant buffer against any short-term shocks in the foreign exchange market. These reserves are crucial for maintaining exchange rate stability and supporting imports, especially for essential goods such as fuel and food.

Challenges Ahead

While the CBK’s rate cut is a positive development for businesses and consumers, challenges remain. Kenya faces elevated public debt levels, with total debt estimated to be over 70% of GDP in 2024. Servicing this debt has placed significant pressure on government finances, limiting the scope for fiscal policy interventions.

Additionally, climate-related risks remain a major concern for Kenya’s economy. Erratic weather patterns, such as droughts and floods, have historically disrupted agricultural production, leading to food shortages and higher prices. As agriculture accounts for a significant share of Kenya’s GDP, any adverse weather events could negatively affect economic performance and inflation.

Conclusion

The CBK’s decision to lower the benchmark lending rate to 12.00% is a strategic move to revive private sector credit growth and stimulate economic activity amid slowing growth and lower inflation. The Kenyan economy faces both opportunities and challenges, but with robust exports, a resilient services sector, and improved access to credit, there are reasons to be optimistic about the future.

However, the success of this policy will depend on how quickly commercial banks respond to the rate cut and pass on the benefits to businesses and consumers. The government’s fiscal management, including addressing the country’s debt levels and implementing structural reforms, will also be critical to ensuring sustained growth in the medium term.

Kenya is at a pivotal moment, and while monetary easing provides an immediate boost, long-term stability will depend on the country’s ability to address structural challenges, manage climate risks, and enhance private sector competitiveness.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

9th October, 2024

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