Inflation: Why I accuse the Central Bank of Kenya

J’Accuse or I accuse, is the title of the now famous open letter to the president of France by Emile Zola. Published on January 13, 1898 in the newspaper L’Aurore, it caused a stir.

The French military had, on trumped up charges and in a sham trail, convicted Alfred Dreyfus, a Jewish military officer, of spying for Germany. Because of widespread anti-Semitism in the French establishment, senior officers who should have, did not defend the wrongly accused officer. The evidence showed Dreyfus had been set up, so Zola decided to stand up for him.

For writing the letter, Zola was himself convicted of libel. He had anticipated he would. His trial, as was his plan, provided a platform to expose the lies and deceit that had been used to unjustly convict Dreyfus. Ultimately, the Dreyfus conviction was quashed, and his military honour somewhat restored. The whole affair has been the subject of many articles, books and movies.

J’accuse has come to mean the accusation of authorities who are doing something wrong, or who are complicit in a wrong-doing.

Here at home, Philip Ochieng, the journalist, editor and author, wrote a book about journalism and politics in Africa with the title I Accuse the Press. Published in the early nineties, the late editor of the Kenya Times used the book to accuse the press of sometimes being a mouthpiece for politicians. He particularly singled out, and some say unfairly so, his professional rival Ben Githii, then of the Standard, accusing him of doing Charles Njonjo’s bidding.

What has all this got to do with the economy, you may ask? Well, because J’accuse the Central Bank of Kenya, of hanging the private sector out to dry, and making domestic borrowing unsustainable for both government and the private sector. Here is why.

Key drivers of inflation

The protests of many economists notwithstanding, the Central Bank’s main policy tool for controlling inflation is adjustments to interest rates. Although it may sound counter intuitive, when the cost of living is high, the Central Bank will raise interest rates, making money more expensive, slowing down consumption, thereby reducing inflation!

Economists, myself included, point out that the tool is not very effective as it has little effect on the key drivers of inflation. Primarily imported, the largest components of inflation are food, fuel and energy. Whenever we have a dry spell, cost of food escalates. When international crude oil prices are high, it translates directly to high prices at the petrol stations, and electricity bills.

Sustained, widespread heavy rains over the last eight months, have greatly improved food supply particularly of vegetables, bringing the July 2024 inflation down to 4.3 per cent. This is the lowest inflation has been in four years. But it has come at a very heavy price. Interest payments on domestic loans are through the roof for both government and the private sector. Both are at high risk of debt distress.

But when the Monetary Policy Committee (MPC) of the Central Bank met early August, they reduced the central bank policy rate only nominally to 12.75 per cent from the previous 13 per cent. They left the gap between inflation and policy rate at it widest over the last four years.

No doubt the MPC must have considered other data at its disposal. The latest quarterly commercial banks’ credit officer survey shows that gross loans decreased by 1.0 per cent to Sh4,041.3 billion between March and June. The decrease in gross loans was largely witnessed in key production sectors including agriculture, manufacturing, mining and quarrying, financial services, and tourism, restaurant and hotels sectors.

Government expenditure

The shrinking loan book should worry the CBK, Treasury Mandarins and the commercial banks themselves. We have reached an inflection point, the economy going into recession. There will be no private sector expansion at the current high interest rates. A stagnant private sector will result in poor economic growth. Lower growth will mean even less tax collection. Both will be troublesome for the new leadership at the Treasury, coming at a time when increases in taxation has been rejected by the citizens and the courts for two years in a row.

The credit manager’s survey shows that the asset quality of the commercial banks loan book, measured by the ratio of gross non-performing loans (NPLs) to gross loans, deteriorated from 15.7 per cent in March, to 16.3 per cent in June 2024. This was due to increase in gross NPLs of 2.5 per cent.

Both the shrinking and deterioration of the quality of the loan book are caused by the sustained high interest rate regime. The private sector is tanking, choking on high interest rates. With inflation below the price stability target of 5 per cent, one would have expected the Central Bank to ease up, but they did not.

Government is itself paying 18.3 per cent interest rate for the Sh74.2 billion it borrowed this week in the re-opened six and half year bond. The market was less enthusiastic for the seventeen-year bond, which raised only Sh14.53 billion despite a high interest rate of 17.73 percent. The preference for short-term securities is firmly established, worsened by the recent downgraded sovereign credit rating.

Credit rating agencies are correctly interpreting that the rejection of the finance bills for two years in a row, and widespread anti-tax protests, will mean very strained government finances. Unless government expenditure is significantly reduced, the pressure to borrow will remain very high. Market sentiment reflects this reality. At the weekly auction, interest rates on the three, six months and one-year treasury bills maintained their upward pressure, the lowest being at 15.8 per cent.

Debt distress for both private and public sectors will not ease until interest rates are back to single digits again. That is why the Central Bank should use this window of low inflation to make the necessary adjustments.

@NdirituMuriithi is an economist and partner at Ecocapp Capital