BACKGROUND TO THE MPC DECISION IN THE MEETING OF 27TH JULY 2011 Presentation to the Media by Prof. Njuguna Ndung’u, CBS Chairman, Monetary Policy Committee August 1, 2011

Outline Key Messages from the MPC Meeting Economic Growth Developments in Inflation Exchange Rate Direction: Inhibiting Expectations Monetary Policy Successes for the Period Managing Expectations: Role of Stakeholders

1. Key Messages from MPC Meeting The MPC has been implementing a tight monetary policy stance since March 2011 to rein in inflation, dampen inflationary expectations and stabilise the exchange rate. To facilitate commercial bank liquidity management and lessen recourse to the Discount window, they are now required to maintain Cash Reserve Ratio (CRR) based on a weekly average instead of the current daily average. The tight monetary policy stance will not achieve the desired results if the supply side of food, fuel and energy are not signalling relief. They would merely fuel inflationary expectations. Monetary policy has been successful in constraining the growth of broad money supply below its non-inflationary target. Private sector credit is growing, and mainly financing activities in the productive sectors – this therefore rules out demand pull inflation. A wide range of economic indicators analysed as well as the results of the July 2011 Market Perception Survey revealed strong economic growth and sustained confidence in the economy. In its meeting of 27th July, 2011, the MPC retained the CBR at 6.25 percent, but will continue to monitor the situation. Monetary policy was observed to be tight enough .

2. Economic Growth: Sustained Economic Activity Despite Shocks on the Economy Imports by Category (USD Million) 12-month cumulative power and cement consumption Strong economic growth supported by imports of capital and intermediate goods. This is depicted by increased power and cement consumption.

2. Economic Growth: Sustained Economic Activity Despite Shocks on the Economy … Quarter growth in Real GDP and Credit to Private Sector 12-Month GDP growth (%) Strong economic growth has also been supported by credit expansion to the productive sectors of the economy. Sustained strong growth performance is necessary to ease inflationary pressure.

3. Developments in Inflation: Non-Food, Non-Fuel Inflation within Target Food and Fuel inflation that was declining in the first six months of 2010 increased in a similar period in 2011 significantly driving the rise in overall inflation. In addition, there have been minimal inflationary pressures on the food and fuel items.

3. Developments in Inflation: Supply Side Factors Driving Inflation … 12-month Money supply and credit growth, and overall inflation (%) Quarterly sectoral credit expansion (Ksh Billion)   2010 2011 Q1 Q2 Q3 Q4 Agriculture -1.1 2.4 1.9 1.2 2.0 5.6 Manufacturing 4.7 6.2 10.9 2.6 4.9 11.8 Trade -12.2 7.5 9.5 13.7 12.0 Building & construction -9.9 -4.8 0.6 0.9 3.6 3.3 Transport & communication -6.4 0.1 3.7 11.6 Finance and insurance 4.3 -4.4 -2.4 1.5 Real estate 27.9 11.3 5.9 6.1 13.0 Mining & quarrying 5.8 2.3 -0.2 -1.5 7.8 3.1 Private households 24.6 2.8 -0.9 6.5 15.3 Consumer durables 3.2 -4.2 2.1 5.4 6.0 1.7 Business services 4.2 8.8 8.6 2.2 Other activities -5.5 -5.2 8.7 5.2 17.8 Total 21.1 39.9 43.7 45.5 66.0 88.5 Growth in broad money supply (M3) has been slowing down while private sector credit expansion has been more towards financing economic activities in the productive sectors. These effects therefore ruled out demand pull inflation.

4. Exchange Rate Direction: Inhibiting Expectations International events continue to shift the relative strengths and weaknesses of Kenya’s major trading currencies. Swiss Franc, Japanese Yen and Canadian Dollar have been main gainers with international currency portfolio shifts.

5. Monetary Policy Successes for the Period: Quantitative Targets Achieved Broad Money growth still below target - an indication that the current inflationary pressure is emanating from the supply side.

6. Managing Expectations – Role of the Media… The media plays an important role in shaping inflationary expectations. Some media reports have been exacerbating inflationary expectations.

6. Managing Expectations – Role of the Media…

6. Managing Expectations – Role of Other Stakeholders… Upwards adjustments in fuel prices despite zero-rating of taxes and declining world oil prices has also exacerbated inflationary expectations.

Growth in Private Sector Credit Lending Interest rates 6. Managing Expectations : Changes in Perceptions/Expectations (% of Banks)... Growth in Private Sector Credit Lending Interest rates Decrease Remain the same Increase by 1-10% Increase by 10—20% Increase by above 20% Decline by More than 2 % 1-2 % Remain the same Increase by 1-2% Sep -2009 52 44 Nov-2009 33 50 17 Jan-2010 7 93 53 47 Mar-2010 15 45 40 5 May-2010 30 25 4 76 20 July-2010 14 75 Sep-2010 3 56 32 6 59 26 9 Nov-2010 24 46 58 Jan-2011 8 27 34 31 39 29 Mar-2011 28 12 60 May-2011 18 49 July-2011 21 Banks expect to raise interest rates and slowdown lending to the private sector as a consequence of tight liquidity in the market.