1. BACKGROUND TO THE MPC DECISIONS ON 5TH JULY, 2012
Presentation to Chief Executive Officers of
Commercial Banks
Prof. Njuguna Ndung’u, CBS
Governor, Central Bank of Kenya
July 10, 2012

2. Outline MPC decision: The information Available The Evidence:
Inflation
Growth
Exchange Rates
Interest Rates

3. 1. MPC Decision: The information available
At its Meeting on 5th July, 2012, the MPC reduced the CBR from 18.0 percent to percent following both a sustained decline in inflation towards the Government short-term target of 9 percent, and exchange rate stability. The Committee considered the range of monetary policy instruments in use to be robust and they should continue to bring inflation towards the medium-term target and sustain general price stability.
Overall month-on-month inflation continued to decline – it dropped from percent in May 2012 to percent in June 2012 mainly due to a reduction in food and fuel prices. In addition, the declines in the overall 3-month annualised from percent to percent, and the non-food-non-fuel inflation from percent in May 2012 to percent in June 2012 endorsed a positive outlook of a continued decline in inflation.
The average exchange rate fluctuated within a narrower range in June 2012 compared with that in May 2012, indicating stability . The foreign exchange reserves position of the CBK improved further in June 2012 following the receipt by the Government of the second tranche of the USD 600 million syndicated loan.
The Term Auction Deposits with longer tenor which were introduced by the Committee in June 2012 as an additional instrument for liquidity management have enhanced the CBK’s open market operations and stabilised the interbank rate around the CBR.

4. 1. MPC Decision: The information available…
The fiscal measures announced by the Government in the Budget Statement for the fiscal year 2012/13 are consistent with monetary policy objectives.
The country’s policy environment remains strong. The latest Country Policies and Institutional Assessment (CPIA) rating of 3.8 by the World Bank places Kenya fourth overall in Sub-Saharan Africa in terms of policy reform and institutional quality.
Confidence in the economy remains strong as indicated by the continued recovery of the Nairobi Securities Exchange index. In addition, the MPC Market Perceptions Survey conducted in June 2012 showed that the private sector expects inflation to continue declining; the exchange rate to remain stable; and the economy to be resilient in 2012.
However, the Committee noted that the persistently high current account deficit (estimated at 11.3 percent of GDP in May 2012) and risks around the eurozone crisis continue to pose a risk to exchange rate stability and demand for Kenya’s exports as well as foreign earnings from tourism.

5. 2. The Evidence: 2a. Inflation: Inflation is responding to monetary policy measures
Short-term inflation target of 9%
Medium-term inflation target of 5%
All the main categories and measures of inflation continued to decline in June 2012 indicating effectiveness of policy interventions in easing inflationary pressure and restoring price stability.

6. Inflation – Non-bank firms Remain at the same level
2a. Inflation Considerations: Private sector firms expect inflation to continue declining…
Inflation – Banks
Inflation – Non-bank firms
Increase
Remain at the same level
Decline
Nov 42 46 12 35 36 29
Jan-2011 89 4 7 56 20 24
Mar -2011
100 74 2
May -2011 91 6 3 14
July -2011 75 11 66 21 13
Oct -2011 82 16 10
Dec-2011 28 9 63 50
Feb-2012 8 80 26 61
Apr-2012 90 32
Jun-2012 52
The June 2012 survey shows that inflation is expected to continue declining in the remainder of 2012.
Inflation expected to decline on account of: improved food supply and lower energy costs; declining crude oil prices; the tight monetary policy expected to continue dampening the demand for credit; and stability in the exchange rate.
Uncertainty in the resolution of the eurozone debt crisis and volatile crude oil prices are the main risks to the inflation outlook.

7. 2b. Growth Considerations: Private sector firms expect growth to remain resilient in 2012
Non-banks
Economic growth (%)
Banks
Economic Growth %
3-4.4 5
5-5.3
5.4-6
Above 6
Above 6
Jan-2011 16 28 40
28.6
60.7
10.7
Mar -2011 29 59 12 4 36 56
May -2011 46 14
32.4
41.2
23.5
2.9
July -2011 49 37
39.3
Oct -2011 9 52 34 10 65 21
Dec-2011 47 27 50
24.8
12.3
9.7
3.2
Feb-2012 42 8 60
Apr-2012 48 35
43.3
6.7
Jun-2012 32 41 23
40.6
50.1
6.2
3.1
Growth expected to pick-up and average 5 – 5.3 percent in 2012 due to improved economic environment with lower inflation and exchange rate stability, large investment in infrastructure, expected pick-up in credit growth, and regional trade within EAC countries projected to expand faster in 2012.

8. 2c. Exchange Rate Considerations: Exchange rate has stabilised following turbulence in the eurozone
The Kenya Shilling has oscillated in a narrow band from to in June 2012.
Stability is roughly at the levels experienced in 2010.

9. 2d. Interest Rate Considerations: Interbank rate has stabilised around the CBR
Open Market Operations using repos, late repos, and Term Auction Deposits have successfully dampened volatility in the interbank market and focused it around the CBR.
91-day Treasury bill rates have also stabilised.

10. 2d. Interest Rate Considerations: Interbank rate has largely remained within the bound of CBR ± 2% indicating reduced volatility...

11. 2d. Interest Rate Considerations: Interbank rate revolves around the CBR…
Why is this the case? The basic simple operation rules and guidelines:
Vertical Repos use the CBR as the ceiling in the bidding process.
The TAD also uses the CBR as the ceiling.
The current guidelines for the interbank rate is that it should be within ±2% of the CBR:
If the interbank rate is Below the CBR by more than 2%, this will invite aggressive mop-up of liquidity through both vertical Repos and TAD.
If the interbank rate is Above the CBR by more than 2%, this will invite liquidity injection using various instruments.

12. Banks’ growth in credit supply Non-banks’ growth in credit demand
2d. Interest Rate Considerations: Changes in Credit Growth Perceptions/Expectations(% of firms) ...
Banks’ growth in credit supply
Non-banks’ growth in credit demand
Decrease
Remain the same
Increase by 1-10%
Increase by 10—20%
Increase by above 20%
Nov-2010 9 24 46 15 6 23 8
Jan-2011 27 34 31 5 48
Mar-2011 28 40 12 29 47
May-2011 18 22 41 20 17
July-2011 21 39 7 4 32
Oct-2011 26 37 38 19
Dec-2011 10 65
Feb-2012 50 33 11
Apr-2012 52 3 35
Jun-2012 16 53 25
Banks expect demand and supply of credit to pick-up in the second half of 2012 arising from declining interest rates, lower inflation, and lower cost of funds.
Unlike the April 2012 survey, non-bank firms are expecting to increase their demand for credit

13. Interest rates Spreads
2d. Interest Rate Considerations: Interest Rates and Spreads by Bank Category (%)...
Lending rates
Deposit rates
Interest rates Spreads
All banks
Small banks
Medium banks
Large Banks
Apr-11
13.92
14.34
13.99
15.01
3.47
4.5
3.37
2.1
10.45
9.84
10.63
12.9
May-11
13.88
14.37
14.06
14.97
3.57
4.45
3.76
2.12
10.31
9.92
10.3
12.86
Jun-11
13.91
14.27
14.02
14.93
3.68
4.55
3.84
2.09
10.23
9.72
10.19
12.84
Jul-11
14.14
14.35
14.58
15.08
3.85
4.59
4.20
2.32
10.29
9.76
10.38
12.76
Aug-11
14.32
14.61
14.85
15.07
4.07
4.65
4.36
2.62
10.25
9.96
10.5
12.45
Sep-11
14.79
14.78
15.13
15.51
4.21
4.91
4.69
2.43
10.58
9.88
10.44
13.08
Oct-11
15.21
15.17
15.52
15.95
4.83
5.14
5.29
3.04
10.39
10.03
10.24
12.91
Nov-11
18.48
17.57
19.37
18.82
5.75
6.66
6.41
2.99
12.73
10.9
12.96
15.83
Dec-11
20.04
19.12
20.59
20.95
6.99
7.24
7.54
3.63
13.05
11.88
17.32
Jan-12
19.54
19.60
20.32
19.70
7.66
7.65
8.49
4.15
11.95
11.83
15.55
Feb-12
20.28
19.93
21.20
20.52
8.01
8.26
8.61
5.18
12.27
11.67
12.59
15.35
Mar-12
20.34
19.08
21.04
21.09
8.06
8.93
5.01
12.33
11.01
12.12
16.09
Apr-12
20.22
19.65
21.38
20.97
9.04
8.35
6.61
11.18
11.30
11.19
14.36
May-12
20.12
20.00
20.68
21.00
8.42
8.38
9.50
5.09
11.70
11.62
15.91
Average interest rate spreads rose slightly between April and May 2012 but remained lower compared with the level in March 2012.
However, the spreads across categories of banks increased except for medium. Medium and small banks maintained competitive deposit rates and had lower spreads.

14. 2d. Interest Rate Considerations: Minimum and Maximum Deposit Rates Across Banks (%)
Mar 2012
Apr 2012
May 2012
Jun 2012
Min
Max 1
Overall
0.00
27.50
28.00
24.00
26.00 2
By Market Segment
Corporate
Personal
23.50
22.50 3
By Bank Size
Small
Medium
Large
22.00
20.00 4
By Maturity
Demand
0-3 Months
4-11 Months
0.10
2.00
1 - 2 Years
23.25
2.50
23.00
3 - 5 Years
18.00
Over 5 Years
5.00
3.00
While the maximum deposit rates in small banks rose it fell in large banks indicating differing perception of the cost of retaining deposits.
Only deposits with tenor greater than 3 months and less than 2 years had higher rates.