Overview
Monetary policy consists of decisions and actions taken by the Central Bank to ensure that the supply of money in the economy is consistent with growth and price objectives set by the government.
The objective of monetary policy is to maintain price stability in the economy. Price stability refers to maintenance of a low and stable inflation.
The Central Bank of Kenya’s principal objective is formulation and implementation of monetary policy directed to achieving and maintaining stability in the general level of prices. The aim is to achieve stable prices, measured by a low and stable inflation, and to sustain the value of the Kenya shilling. The Central Bank of Kenya Act Sections 4 and 5 provides that the Cabinet Secretary for the National Treasury shall, by notice in writing to the Bank, provide the price stability target of the Government at least in every period of 12 months. The target is provided at the beginning of the financial year.
Price Stability and
Economic Growth
The Central Bank’s monetary policy decisions are made to maintain a low and stable inflation rate over time, which is an indication of price stability.
Inflation is a general increase in price levels over time. It is based on the prices of various consumer goods and services, which are evaluated and statistically represented in the Consumer Price Index (CPI). The month-on-month (or year-on-year) inflation rate is determined by comparing the CPI for a particular month to the CPI of that same month in the previous year.
Inflation is caused by numerous factors, both locally and internationally. For example, during periods of drought or excessive rain, the prices of food could increase, leading to an increase in the inflation rate. International factors like increases or decreases in oil prices can also lead to changes in inflation reflecting movements in energy and transport costs. Depreciation in the exchange rate against the major currencies can also cause inflation since Kenya is a net importer of goods. Inflation can also be caused by factors that influence the demand for goods and services, like the amount of money ordinary people have available to spend.
High levels of inflation inhibit economic growth and cause the Kenya Shilling to lose value compared to international currencies, thereby discouraging the purchase of Kenyan goods and services. It also makes it difficult for people to make long-term financial decisions, as they cannot be sure about the future value of their investments and savings. If there is a general decrease of prices over time due to a collapse in demand or increased supply of goods and services, then there is deflation. Deflation inhibits economic growth by reducing profit and lowering investor incentives.
Inflation
As is the case the world over, a central bank exists in a country to safeguard the value of its currency in terms of what it can purchase. When prices of goods and services in an economy keep on rising, the value of these goods and services that the currency can purchase – or exchange for – diminishes.
This leads to loss in value of the currency. Monetary policy is the main tool used in safeguarding the value of the currency in an economy. It involves the control of liquidity circulating in an economy to levels consistent with growth and price objectives set by the government. The volume of liquidity in circulation influences the levels of interest rates, and thus the relative value of the local currency against other currencies.
It is the responsibility of the Monetary Policy Committee to formulate the monetary policy of the Central Bank of Kenya. Maintaining price stability is crucial for a proper functioning of a market-based economy. It encourages long-term investments and stability in the economy. Low and stable inflation refers to a price level that does not adversely affect the decisions of consumers and producers. Price stability is a precondition for achieving a wider economic goal of a strong and sustainable growth and employment. High rates of inflation lead to inefficiency in a market economy and, in the medium to longer term, to a lower rate of economic growth. Movements in the general price level are influenced by the amount of money in circulation and productivity of the various economic sectors. The Central Bank of Kenya regulates the growth of money stock that is consistent with a predetermined economic growth target as specified by the Government and outlined in its Monetary Policy Statements.
Monetary Policy Decisions
and Instruments
Monetary policy is guided by a monetary programme, which is premised on the economic growth and inflation targets provided by the National Treasury. Monetary policy decisions are made by the Monetary Policy Committee (MPC). The MPC meets at least once every two months and reviews data and analysis from various sources including the Central Bank Departments enabling it to decide on any action to maintain or vary its stance.
The Monetary Policy Committee is the organ of the Central Bank of Kenya responsible for formulating monetary policy. The Committee was formed vide Gazette Notice 3771 on April 30, 2008, replacing the hitherto Monetary Policy Advisory Committee (MPAC)
The Monetary Policy Committee is the organ of the Central Bank of Kenya responsible for formulating monetary policy. The Committee was formed vide Gazette Notice 3771 on April 30, 2008, replacing the hitherto Monetary Policy Advisory Committee (MPAC)
The Monetary Policy Committee is the organ of the Central Bank of Kenya responsible for formulating monetary policy. The Committee was formed vide Gazette Notice 3771 on April 30, 2008, replacing the hitherto Monetary Policy Advisory Committee (MPAC)
The Monetary Policy Committee is the organ of the Central Bank of Kenya responsible for formulating monetary policy. The Committee was formed vide Gazette Notice 3771 on April 30, 2008, replacing the hitherto Monetary Policy Advisory Committee (MPAC)
Currency Operations
Commercial banks regularly make deposits of bank notes and coins to their accounts in the Central Bank, where they are processed and sorted. The Central Bank maintains specialised machines that are used to process banknotes and coins, and those that are fit for circulation are set aside for re-distribution.
In its role of issuing currency, the Central Bank must also ensure that currency is distributed throughout the country. To accomplish this, the Central Bank has Branches in Mombasa, Kisumu and Eldoret and Centres in Nyeri, Nakuru, Meru and Kisii. These Branches and Centres form a key focal point for currency distribution to the local financial institutions.
Commercial banks in Kenya are required by law to keep a specified proportion of their total deposits at the Central Bank. This proportion of deposits is called the Cash Reserve Ratio (CRR), and when the Central Bank needs to significantly adjust the amount of money in the market, it can increase or decrease the ratio.
The CRR deposits are held in the CBK at no interest. The CRR is currently set at 5.25 percent of the total of a bank’s domestic and foreign currency deposit liabilities. To facilitate commercial banks’ liquidity management, commercial banks are currently required to maintain their CRR based on a daily average level from the 15th of the previous month to the 14th of the current month and not to fall below a CRR of 3 percent on any day.
Commercial banks in Kenya are required by law to keep a specified proportion of their total deposits at the Central Bank. This proportion of deposits is called the Cash Reserve Ratio (CRR), and when the Central Bank needs to significantly adjust the amount of money in the market, it can increase or decrease the ratio.
The CRR deposits are held in the CBK at no interest. The CRR is currently set at 5.25 percent of the total of a bank’s domestic and foreign currency deposit liabilities. To facilitate commercial banks’ liquidity management, commercial banks are currently required to maintain their CRR based on a daily average level from the 15th of the previous month to the 14th of the current month and not to fall below a CRR of 3 percent on any day.
Commercial banks in Kenya are required by law to keep a specified proportion of their total deposits at the Central Bank. This proportion of deposits is called the Cash Reserve Ratio (CRR), and when the Central Bank needs to significantly adjust the amount of money in the market, it can increase or decrease the ratio.
The CRR deposits are held in the CBK at no interest. The CRR is currently set at 5.25 percent of the total of a bank’s domestic and foreign currency deposit liabilities. To facilitate commercial banks’ liquidity management, commercial banks are currently required to maintain their CRR based on a daily average level from the 15th of the previous month to the 14th of the current month and not to fall below a CRR of 3 percent on any day.
Other Monetary
Policy Tools
Central Bank Rate (CBR)
The CBR is reviewed and announced by the Monetary Policy Committee (MPC) at least every two months. Movements in the CBR, both in direction and magnitude, signal the monetary policy stance. In order to enhance clarity and certainty in monetary policy implementation, the CBR is the base for all monetary policy operations.
Whenever the Central Bank is injecting liquidity through a Reverse Repo, the CBR is the lowest acceptable rate by law. Likewise, whenever the Bank wishes to withdraw liquidity through a Vertical Repo, the CBR is the highest rate that the CBK will pay on any bid received. However, to ensure flexibility and effectiveness of monetary policy operations in periods of volatility in the market, the CBK can raise the maximum acceptable interest rates on Term Auction Deposit to above the CBR. Movements in the CBR are transmitted to changes in short-term interest rates. A reduction of the CBR signals an easing of monetary policy and a desire for market interest rates to move downwards. Lower interest rates encourage economic activity and thus growth. When interest rates decline, the quantity of credit demanded should increase.
Central Bank Rate (CBR)
The CBK can also inject or withdraw liquidity from the banking system by engaging in foreign exchange transactions. A sale of foreign exchange to banks withdraws liquidity from the system while the purchase of foreign exchange injects liquidity into the system. Participation by the CBK in the foreign exchange market is usually motivated by the need to acquire foreign exchange to service official debt, and to build-up its foreign exchange reserves in line with the statutory requirement.
The CBK uses its best endeavours to maintain foreign reserves equivalent to four months’ imports as recorded and averaged for the last three preceding years. The CBK does not participate in the foreign exchange market to defend a particular value of the Kenya shilling but may intervene in the exchange market to stabilise the market in the event of excess volatility.
