Kenya’s Central Bank of Kenya (CBK) has lowered its benchmark interest rate by 50 basis points, reducing it to 10.75% from 11.25%, in a bid to stimulate economic growth amid slowing expansion. The decision, announced by CBK Governor Kamau Thugge in an official statement on Wednesday, marks the lowest interest rate in nearly two years.

The rate cut was in line with economists’ expectations, as benign inflation and currency stability provided room for monetary easing. The move is aimed at boosting credit availability, lowering borrowing costs, and encouraging economic activity, particularly in the private sector.

“Inflation is expected to remain below the 5% midpoint of the central bank’s target range in the near term, supported by a low and stable core inflation, low energy prices inflation, and exchange rate stability,” Thugge stated.

However, while the interest rate reduction is expected to stimulate economic expansion, Kenya faces significant external debt obligations, reduced private-sector lending, and economic headwinds from global markets.

Key Drivers Behind the Rate Cut

1. Inflation Remains Under Control

One of the biggest factors influencing the Monetary Policy Committee’s (MPC) decision was inflation stability.

• Kenya’s headline inflation has remained below 5% for eight consecutive months, rising only slightly from 3.0% in December to 3.3% in January.
• Core inflation, which excludes volatile food and energy prices, declined to 2.0% from 2.2% in December, indicating muted demand pressures in the economy.
• Stable fuel and food prices, coupled with a relatively strong currency, have prevented imported inflation shocks.

“The wide gap between headline inflation and the benchmark rate gave the committee room to ease, even as central banks globally remain cautious,” Thugge explained.

This suggests that Kenya is in a rare position where it can lower rates without fueling inflationary pressures, unlike many other emerging markets.

2. Currency Stability and Foreign Exchange Reserves

Another critical factor in the MPC’s decision was the stability of the Kenyan shilling (KES).

• The shilling has been stable at around 129 per US dollar for the past six months, making it one of the world’s best-performing currencies in 2024.
• Unlike many other African currencies that suffered significant depreciation, Kenya’s shilling benefitted from strong remittance inflows, higher foreign direct investment (FDI), and a series of successful bond sales.
• The issuance of tax-free infrastructure bonds, popular among foreign investors, has also helped boost dollar inflows into Kenya, reducing pressure on the local currency.

3. Weak Economic Growth in 2024

Kenya’s economic growth slowed to 4.6% in 2024, down from 5.6% in 2023. While a recovery to 5.4% GDP growth is expected in 2025, the government is looking for ways to accelerate expansion.

Key contributors to the slowdown included:

• Lower consumer spending due to high interest rates.
• Weak private-sector credit growth, which declined by 1.4% in December 2024.
• A challenging global economic environment, including the impact of U.S. President Donald Trump’s economic policies on emerging markets.

4. External Debt and Fiscal Pressures

Despite the rate cut’s benefits, Kenya still faces significant fiscal challenges. The country has a $4.56 billion external debt repayment obligation in the current fiscal year, requiring the government to borrow an additional $2.7 billion from offshore sources to plug the 4.3% budget deficit.

• Kenya’s total public debt stands at approximately $78 billion, with 40% of it owed to foreign creditors.
• The government has sought financial assistance from the World Bank and International Monetary Fund (IMF) to help stabilize its debt burden.
• A $1.5 billion loan from Abu Dhabi is also expected to be partially drawn down to boost forex reserves and meet debt repayment deadlines.

“Kenya has a steep external debt wall to scale,” the Treasury stated.

While the rate cut is designed to support domestic growth, it may increase the government’s debt burden, as lower interest rates can lead to higher borrowing levels.

Impact on Banks and Private-Sector Lending

1. Reduction in Cash Reserve Ratio

In addition to the interest rate cut, the CBK slashed the Cash Reserve Ratio (CRR) by 100 basis points, bringing it down to 3.25%.

• This move is designed to free up liquidity in the banking sector, encouraging banks to lower lending rates and extend more credit to businesses and households.
• The CRR reduction is expected to unlock billions of shillings that banks would otherwise have held in reserves, allowing them to increase lending to the private sector.

2. Warning to Banks on Lending Rates

CBK Governor Kamau Thugge issued a strong warning to commercial banks, urging them to pass on the benefits of lower borrowing costs to consumers.

• Some banks have been reluctant to lower interest rates, citing higher credit risks due to rising loan defaults.
• Private-sector lending contracted by 1.4% in December, raising concerns about economic stagnation.
• CBK has threatened penalties for banks that fail to reduce lending rates, emphasizing that stimulating credit growth is critical to Kenya’s economic recovery.

“With these measures, banks are expected to take the necessary steps to lower their lending rates further, stimulate growth in credit to the private sector, and support economic activity,” Thugge stated.

If banks comply, lower interest rates could drive increased borrowing, leading to higher business investment and job creation.

Challenges and Risks Ahead

While the rate cut is expected to support economic expansion, Kenya still faces several downside risks:

1. Debt Sustainability Concerns
   • With high public debt levels, further borrowing at lower rates could worsen Kenya’s fiscal position.
   • If economic growth does not accelerate significantly, the country may struggle to meet its debt obligations in the coming years.
2. Global Economic Uncertainty
   • The U.S. Federal Reserve’s interest rate policy could impact global capital flows, affecting Kenya’s ability to attract foreign investment.
   • Trump’s economic policies and potential trade barriers may pose additional risks for emerging markets.
3. External Market Pressures
   • If global commodity prices rise, Kenya could face higher import costs, leading to inflationary pressures.
   • Supply chain disruptions from international conflicts or economic slowdowns could also impact Kenya’s export earnings.

Conclusion

Kenya’s decision to cut interest rates to 10.75% signals a bold move to stimulate economic activity, particularly in the private sector. While inflation remains under control, currency stability and monetary easing provide an opportunity to accelerate growth.

However, high public debt, external financing risks, and global economic uncertainty continue to pose significant challenges. If private-sector credit growth improves and banks lower lending rates, the economy could regain momentum in 2025, but long-term fiscal discipline and structural reforms will be crucial for sustainable development.

For now, Kenya’s policymakers must strike a delicate balance between stimulating growth and managing debt sustainability—a challenge that will shape the country’s economic trajectory in the years ahead.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

6th January, 2025