OBG talks to Njuguna Ndung’u, Governor, Central Bank of Kenya

Interview: Njuguna Ndung’u

What can be done to ease inflation and ensure a more manageable rate of growth in domestic prices?

NJUGUNA NDUNG’U: It is important to realise that in a country like Kenya, in the Horn of Africa, inflation is affected most by supply side shocks. Drought, the main factor that increases the volatility of prices, impacts both food supply and energy prices. First of all, since Kenya is dependent on hydroelectricity, water is essential to drive electricity production. Second, the impact of a drought on agriculture significantly alters the food supply, forcing the country to import more and decreasing export capacity. In turn, this can create massive costs to society and severe fluctuations in inflation.

For this reason, we use our tools to control inflation when threats start to build into the demand side. If those shocks don’t hit us, we believe we will be on target at 5% in the medium term – where we have been on average since mid-2012. Inflation dropped as low as 3.2% and is now around 8.4%. The question then becomes how can we protect ourselves against these shocks, and how do we ensure we have adequate buffers? In Kenya this is problematic, because there are no supply-side tools. One method is to tighten liquidity, preventing continued high prices and reducing the money supply, but this increases the cost of credit. One of the critical long-term buffers for food supply is to create a commodity exchange similar to what Ethiopia has done.

To what extent are tools available to address the fluctuations in the value of the shilling?

NDUNG’U: The supply shocks and even demand shocks will always drive the nominal exchange rate. Because we do not have a target for the nominal exchange rate, monetary policy is essentially the answer. The wider solution is having buffers; you must be able to intervene in the market to dampen volatility.

A country like Kenya is only able to build those buffers by buying foreign exchange in the market. The fact is that we are not donor dependent. In some countries, donors form the backbone of reserves, while in others it is natural resources. In order for Kenya to accumulate reserves, we have to buy from the market, injecting Kenyan shillings back into the market. In the end, it comes down to policies that support such moves.

How will the country’s eurobond issued in June 2014 affect Kenya’s economic outlook?

NDUNG’U: There is a limit to borrowing domestically to finance investments, and that is where the eurobond comes in. Any country must look at its capacity for absorption and what its needs are. The Kenyan case refers to the National Vision development plan, which includes Vision 2030 and its flagship projects.

The eurobond is not about getting a sovereign bond to search for oil – that is the role of the private sector. Instead, it is to finance targeted projects to support the country’s development agenda. Expanding and decongesting cities drives economic growth and opens production potential, but to do so requires a large infusion of public investment. The Thika Superhighway is a great example, and the funds raised through the eurobonds will enable more large-scale projects like this.

In what way is the central bank working to increase financial inclusion among Kenyans?

NDUNG’U: Financial inclusion is a very important public policy: it allows us to fight poverty sustainably, while giving people the chance to save. MPESA was a mobile bank product that has now grown into a nationwide financial services platform. We created microfinance to reach out to people in rural areas and introduced mobile phone financial services and worked to reduce the cost of financial infrastructure. The latest financial access survey shows 25% of the population is totally excluded from services, but those served by formal sectors have risen 67%. We have changed the profile of the market, but the question remains whether there is a market for long-term finance to support private investors. Since 2011 we have seen that financial sector growth is pulling wider economic growth with it.