Recent Monetary Policy and Financial Sector Outlook in Kenya

1. RECENT MONETARY POLICY AND FINANCIAL SECTOR OUTCOMES, AND OUTLOOK February 24, 2015 Presentation at the 17th Kenya Economic Roundtable, Norfolk Hotel, Nairobi by Prof. Njuguna Ndung’u, CBS Governor, Central Bank of Kenya

2. Monetary Policy Outcomes and Outlook • In the recent months inflation has been on a stable declining trend – energy and food prices did not react to the seasonal January – March dry effect. • The MPC has retained the CBR at 8.50 percent since May 2013 to anchor inflation expectations. The month-on-month overall inflation has continued to decline while remaining within the Government target range in January 2015, but above the 5 percent target – it declined from 7.39 percent in June 2014 to 5.53 percent in January 2015. • Similarly, month-on-month non-food-non-fuel (NFNF) inflation declined from 4.47 percent to 3.51 percent in the period – at levels below the 5 percent medium-term target. NFNF inflation indicates no significant demand driven inflationary pressure or threat to the economy. • The exchange rate remains on a stable trend against the US Dollar despite pressures on most international currencies reflecting the global strengthening of the US Dollar – but the Shilling has retained its value relative to most international currencies. Expectations of lower yields in the Eurozone with anticipation of introduction of quantitative easing to stimulate growth have also contributed to the weakening of the Euro against the US Dollar. • The CBK’s level of usable foreign exchange reserves rose from USD6,084.6 million (equivalent to 4.07 months of import cover) at the end of June 2014 to USD7,196.05 million (equivalent to 4.63 months of import cover) as at 24th February 2015 – the level of reserves was boosted by Government’s sale to CBK of the proceeds of the Sovereign Bond. • The precautionary facility blending the Stand-By Arrangement and the Stand-By Credit Facility will allow the Government to access resources from the IMF to alleviate any balance of payments shocks to the economy.

3. Evidence 1.1:Overall Inflation has continued to decline within the Government Target Range, but was above the 5 percent Medium-Term Target

4. Evidence 1.2: The average international prices of crude and refined petroleum products are projected to decline in 2015 and stabilise from 2016. In addition, the declining international food prices buoyed by abundant export supplies have continued to dampen any upside risks to domestic food prices in the case of food imports. These developments indicate a stable outlook for inflation in the medium-term. Source: FAO Source: IMF Commodity Forecasts, January 2015. Petroleum price is average for UK, Brent, Dubai and West Texas intermediate

5. Evidence 1.3: Following the global strengthening of the US Dollar, the major international and regional currencies have depreciated faster and depicted more volatility compared with the Kenya Shilling. The significant depreciation of the Euro and other major currencies largely reflects the recovery of the USA economy, and anticipation for lower interest rates in the Eurozone given the introduction of quantitative easing by the European Central Bank to stimulate growth and move inflation towards the target.

6. Evidence 1.4: Provisional data shows that the overall balance of payments improved in 2014 relative to 2013 on account of a higher capital and financial account surplus. Although imports of machinery and equipment for infrastructure development, and transport equipment continue to weigh down on the current account balance, they have enhanced the future capacity for growth. The decline in international prices of oil will ease pressure on the oil import bill and the current account deficit. (%)

7. 2. Financial Sector Outcomes and Outlook: • The banking sector has witnessed tremendous growth supported by a sound regulatory and supervisory framework, financial innovations, diversification of products, prudent risk management and a stable macroeconomic environment. • The growth in credit to the private sector remains strong across the key sectors of the economy – the 12-month growth in private sector credit stood at 21.8 percent in January 2015. The manufacturing sector accounted for 13 percent of the total lending as at January 2015. • The CBK has introduced a capital conservation buffer of 2.5 percent above the minimum regulatory core and total capital ratios of 8 percent and 12 percent, respectively, effective from 1st January 2015: • The buffers have enabled banks to absorb additional loan loss provisions required for the slight increase in non-performing loans (NPLs) registered in 2014. For those with no increases in NPLs, the buffers have enhanced their resilience. • The minimum core and total capital ratios are now 10.5 percent and 14.5 percent, respectively, which every bank must maintain at all times. Kenyan banks have been building these buffers over the last 24 months. • At the end of January 2015, the actual core and total capital ratios were 16.7 percent and 20 percent, respectively. • The capital buffers have provided the banking sector with a strong rating and a strong capacity for the future.

8. Evidence 2.1: The Financial Sector has been driving the overall real GDP growth (left panel). The 12-month manufacturing sector growth has been sustained above 5 percent since 2013 Q3 reflecting the strong credit growth to the sector (right panel)…

9. Evidence 2.2: Kenya among the best in Africa for reducing financial exclusion. The proportion of the adult population using formal financial services stands at 66.7 percent up from 25 percent in 2006.

10. Evidence 2.3: Financial access touch points have been expanding. Kenya is ahead of its peers in financial inclusion Source: Country Geospatial Surveys, 2013

11. Evidence 2.4: The Banking Sector remains resilient and has built adequate capital buffers to mitigate the impact of adverse business cycles

12. 3. Conclusions • Monetary policy measures have delivered the desired results. • The exchange rate has remained on a stable trend. Its long-term adjustment is consistent with fundamentals. • The banking sector remains strong supported by a sound regulatory and supervisory framework – capital buffers have enhanced the resilience of the sector – there 0ver 300 branches of Kenyan banks in the region – they cannot be weak! • The efficiency and effectiveness of the National Payments System has been enhanced: • Various innovative products leveraging on advanced technology and the mobile phone financial services platform have been rolled out. • The introduction of cheque truncation has reduced clearing time of cheques to T+1. • The East African Payments System has enhanced trade in the region through facilitation of faster cross-border transfers. • The EAC regional banks are moving to convertibility of currencies to enhance EAPS and facilitate trade.