Kenya interest-rate market profile 2008-09

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Central Bank attacks rates as inflation rises

Most central banks looking to intervene to stimulate their economies tend to restrict themselves to lowering official interest rates. The Central Bank of Kenya (CBK) had to be a bit more creative than that in 2008.

Faced with steadily rising inflation despite a series of official interest-rate cuts, CBK Governor Njuguna Ndung'u reached into his bag of monetary tricks toward the end of 2008. As prices on the Nairobi Stock Exchange began to decline (see Kenya equities market profile 2008-09) and the wider Kenyan economy followed, CBK looked to cut borrowing costs by reducing capital requirements and broadening demand for short-term Treasury bills.

Not even those measures could slow Kenya's 2008 inflation, which climbed to 27.7% in December (26.6% on an average annual basis) after spending most of the year above 20% compared to 12% in December 2007, peaking in May 2008 at over 30%. That also increased upward pressure on the wages of unionized workers, which according to local reports have lagged behind inflation over the past few years.

But with the economy weakening and the NSE 20 Share Index heading south, the CBK found itself under pressure from investors and bankers to bring the official Central Bank Rate down to around 7-8%, although the CBK generally held the line at around 9% for most of the year. That was despite pressure from the International Moneary Fund (IMF) to raise interest rates to at least the rate of inflation, citing higher rates in neighboring countries.

By September the Kenyan shilling's slide in value against the U.S. dollar forced the CBK in September to intervene in forex markets, injecting some US$20 million to prop up the shilling's value. The currency had been sliding in the months prior to the September sale, which followed a CBK sale of $10 million earlier in the year also aimed at supporting a sagging currency. September's intervention boosted the shilling 2.4% in a single day and it has continued firm since.

CBK

Apparently taking aim at inflation instead, Ndung'u (left) at the same time called on Kenya's investors and executives to help cool things off by lowering their profit margins so the country's economy could "readjust".

But trying to stimulate a sagging economy with opposing pressures on interest rates forced the CBK to get even more creative towards the end of 2008. In early December the central bank again lowered the Central Bank Rate from 9% to 8.5% but also tried to stimulate Kenya's commercial banks into lending money by reducing the so-called cash ratio - the amount of interest-free cash banks are required to deposit with the CBK - from 6% to 5%. Local banking analysts expected the move to reduce borrowing costs but also warned it could exacerbate inflationary pressures.

Later that month the CBK slashed the minimum threshold for investing in Kenyan government Treasury bills (T-Bills) from one million Kenyan shillings (KSh) to 100,000 KSh in an effort to lure more retail investors into the market. The move is aimed at raising retail demand for T-Bills and so lower their benchmark interest rates and the lending rates that commercial bankers set against T-Bill rates.

The immediate impact of the this decision was to pressure banks to increase their relatively low deposit rates to compete with the T-Bill rates for the retail investor's shilling. Average deposit rates amongst Kenya's banks was 4.48% compared to 8.56% for 91-day T-Bills, the CBK reported in January 2009.

Retail investors are expected to flock to T-Bills following the CBK's decision in December to lower the investment thresholds, helping the government diversify its T-Bill market away from the country's commercial banks. Analysts say this could help lower interest rates but may also divert retail investors away from the slumping stock market.

But with low forex reserves, rising levels of external debt and a worsening current account deficit, the CBK might need to pull a few more monetary tricks out of that bag.

Kenya's banks cashed up for regional push

After several years of prudent growth, Kenya's largest banks have built up a nice pile of cash and quite a bit of market goodwill going into 2009. Some are hoping to parlay both into successful banking forays to east African neighbors over the next couple of years.

Some helpful intervention in the Kenyan economy by the Central Bank of Kenya (see story above) appears to have given Kenya's banking sector a boost, with lower interest rates and decreased capital requirements both favoring bank lending in the near-term future. Consequently, Kenyan analysts generally give the banking sector a thumbs-up for expected 2009 performance, Reuters reported in January 2009.

That's despite the fact that the CBK itself began competing with commercial banks late in 2008 in the crucial retail market for Treasury bills by lowering the minimum investment for the securities from 1 million Kenyan shillings to KSh 100,000. That forced the banks to compete with the CBK for retail customers by pushing up interest rates on regular deposits. Fund managers and insurance companies have also joined the retail market for the Kenyan banking shilling.

Kenyan banks hold almost half of all government Treasury bills and Treasury bonds and in 2008 won a battle with stock brokers when the CBK allowed them to trade government debt outside the Nairobi Stock Exchange. The move was interpreted as a shift away from on-exchange debt trading towards developing an OTC market for government bonds, which the banks prefer.

And despite the recent global financial woes, Kenya's largest banks have recently managed to raise capital and are now looking for expansion opportunities in the east African region. Following its IPO of new shares in late 2008, Co-op Bank retained KSh 2 billion of its expected 2008 pre-tax profit of KSh 3.4 billion, depressing its dividend payment, lifting its capital to KSh 14.2 billion.

The decision followed Equity Bank's 2007 sale of one quarter of its shares for KSh 11 billion to British private equity firm Helios EB Investors and Southern Credit's recent efforts to raise KSh 600 from private investors. KCB concluded a KSh 5.5 billion rights issue at the end of 2008 while the local Barclays Bank raised KSh 5.5 billion on the Nairobi Stock Exchange through a corporate bond issue.

Meanwhile Diamond Trust Bank (DTB), one of Kenya's largest and fastest growers, increased its profit in the first three quarters of 2008 by a whopping 32% as net income rose to KSh 724.9 million from KSh 549.5 million in 2007. DTB raised KSh 1.6 billion in new capital from shareholders in November 2007 to fund expansion plans in the region.

But Kenya's banks are running into problems with their strategy of growth through regional expansion. DTB's chairman said in December 2008 that the bank would organically grow new banking operations in neighboring countries like Burundi rather then seek partners for acquisition following negotiation difficulties. Competitor KCB has made a similar decision following problems with potential Ugandan partners.

DTB is one of Kenyan banking's most aggressive expanders, with plans to add new operations in further-flung east African nations like Rwanda, Mozambique and even the island Madagascar to its forthcomeing Burundi move. DTB also operates banks in Uganda and Tanzania as well as its native Kenya.

But despite all the successful capital-raising and ambitious regional expansion plans, Kenya's banks are also bracing for the higher loan-default rates bedevilling their counterparts in the west. Equity Bank CEO James Mwangi warned in late 2008 that rising inflation and interest rates combined with an economic slowdown could put serious pressure on Kenya's banking sector in the forthcoming year.