Repeal of interest cap law to spur economic growth

In November, we saw a sizable strengthening of the Kenya shilling against the US dollar, especially between November 1 and November 24.

This stands as remarkable because during the same period the US dollar itself also strengthened against other major currencies including the euro, Canadian dollar, Japanese yen, Australian dollar, Tanzania shilling, and Swiss franc.

Inasmuch, Kenya’s currency strengthening overtook even America’s currency gains. Our currency appreciation went even higher against the euro, among others. Why did our currency do so well?

Usually, three main factors influence domestic currency rate fluctuations: gross domestic product growth or contraction, securities exchange price rises and declines, dependent commodity price dips or climbs and interest rate changes.

Even though the International Monetary Fund lowered its economic growth forecast for Kenya, which would usually depress the value of our currency, we still appreciated.

Our equity prices peaked on November 6 then caved down to July values, yet our currency still appreciated.

Our economy is not hostage to any one commodity like Zambia is to copper or Nigeria is to oil, so commodity changes do not usually impact our shilling. That leaves us with interest rates to explain the Kenya shilling appreciation.

November saw the dramatic parliamentary battle versus State House to repeal the well-intentioned but ill-fated interest rate cap.

Following the removal of the cap, banking stocks shot up through the roof.

However, other businesses will now have to pay more for their debt and thus depress their earnings. When we survive in an economy whereby increasing national debt pushes up the rate of return payable on Treasury interest rates to nearly 10 per cent for 364-day bills on offer, then only earning a negligible 200 to 400 basis point spread differential above the lowest risk category of government debt does not warrant a benefit for commercial and retail lending compared to the risk.

Also, when interest rates increase, investors around the world bring money into an economy to benefit from higher returns on deposits.

So, due to the increased demand for shilling denominated deposits, our currency would usually increase as it has done this November. But simultaneously, interest rate raises also usually slow economic growth because individuals and businesses must pay more for debt and thus the amount of money in circulation in the economy declines. This change typically creates a shrinkage in our gross domestic product. It should prove unsurprising, therefore, that our economy contracted as the supply of money in circulation shrank due to the interest rate cap.

This created an unusual economic condition in Kenya at the present.

Removal of the artificially low-interest-rate cap will oddly increase lending as well as also boost the economy.

The combination of increasing interest rates coupled with the strange improvement in our economy should both work to strengthen the Kenya shilling even more against other regional and global currencies in the coming months.

However, an atypical moderating factor could further hinder economic growth despite the above changes. The corruption crackdown in 2019 decreased the amount of money circulating in our economy. Usually, a reduction in corruption improves an economy. But if corruption occurrences and rates stay the same and may be held constant, then corruption crackdowns make the still pilfering criminals less likely to draw attention to themselves.

They reduce their spending and stop flaunting their ill-gotten gains. Luxury goods producers and importers have reported dramatic reductions in orders this fiscal year.

We might fall into the Nigerian trap whereby corruption thrives but proceeds from graft get funnelled out to overseas havens and do not stick around to boost the domestic economy.

Historically, much of Kenya’s corruption proceeds still got spent in Kenya and boosted the economy, albeit in an unfair distribution of resources. That local spending of corruption trend is diminishing in our republic.

Given the uncharacteristic current state of our economy, the above peculiar forces and their impacts on the Kenyan shilling next month should provide interesting case study material for generations of Kenyan students in the decades to come.