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KENYA: MONETARY POLICY, THE OUTLOOK FOR THE ECONOMY AND INVESTMENT OPPORTUNITIES Presentation at the KENYA: MONETARY POLICY, THE OUTLOOK FOR THE ECONOMY AND INVESTMENT OPPORTUNITIES Presentation at the summer gathering of the Adam Smith Seminars – Schloss Spiez, Switzerland by Prof. Njuguna Ndung’u, CBS Governor, Central Bank of Kenya 1 st July, 2014

Outline 1. Background 2. Monetary Policy Conditions 3. Financial Sector Developments 4. Growth Performance Outline 1. Background 2. Monetary Policy Conditions 3. Financial Sector Developments 4. Growth Performance and Outlook 5. Strategic Choices and Investment Opportunities in Kenya 2

1. Background 1. ü ü 1. 2. 3. Kenya is strategically located in East 1. Background 1. ü ü 1. 2. 3. Kenya is strategically located in East Africa as an investment destination: Its geographical location gives access to the Indian Ocean coastline and to a rich hinterland. It is a communications and financial hub for the region. Many international firms have already observed these advantages and located their Africa Offices in Kenya – these include banks as well as business enterprises. Kenyan firms have expanded outside the country’s borders – Kenya is a top supplier of foreign direct investment in the region. Kenya serves 5 land-locked and relatively resource-rich countries in the region. The country has a track record of prudent macroeconomic policy and management which has enhanced market confidence in the economy. A vibrant and stable financial sector predicated on innovations and supportive regulatory environment is supporting growth. 3

2. Monetary Policy Conditions The monetary policy framework is based on a monetary aggregate 2. Monetary Policy Conditions The monetary policy framework is based on a monetary aggregate framework. It has evolved from use of Reserve Money as the operating target to the current aggregates of Net Domestic Assets and Net International Reserves of the CBK due to the changing economic and financial conditions – an intermediate step towards Inflation Targeting. 2. Financial innovations and vulnerability to supply-side shocks continue to require a dynamic approach to the monetary policy framework. 3. The Central Bank Rate (CBR) signals the monetary policy stance and forms the base for all monetary policy operations. Monetary policy has worked in Kenya as demonstrated by: ü A decisive hike in the CBR in 2011 contained inflationary pressure, stabilised the market and the exchange rate. Inflationary credit growth was also curtailed. ü The revised monetary policy framework in 2011 led to interest rates convergence. The Open Market Operations moderated interbank rate fluctuations. 4. Kenya has a floating exchange rate regime – monetary policy formulation incorporates the implications of the open accounts in the balance of payments and their likely impact on money supply. 5. Measures required to ease the vulnerability of inflation to food and fuel supply shocks. 6. The monetary policy measures have delivered the desired price stability. The CBR anchored inflationary expectations – overall inflation is within the target range. 1. 4

2. Monetary Policy Conditions… The Macroeconomic Environment has remained Stable • • • Source: 2. Monetary Policy Conditions… The Macroeconomic Environment has remained Stable • • • Source: Kenya National Bureau of Statistics and CBK A spike in food and fuel prices caused significant inflation pressure in 2011. But the monetary policy measures adopted supported by stable food and international oil prices have seen a decline and subsequent stability in inflation. The stability in the non -food-non-fuel inflation reflects the success of the monetary policy measures adopted. 5

2. Monetary Policy Conditions… The Exchange Rate has Stabilised and the Current Account Deficit 2. Monetary Policy Conditions… The Exchange Rate has Stabilised and the Current Account Deficit of the Balance of Payments is Easing • • • Source: Central Bank of Kenya Exchange rate stability is supported by resilient Diaspora remittances inflows, increased purchases of equity by foreign investors, inflows from foreign direct investment in infrastructure and energy sectors. The CBK level of usable foreign exchange reserves increased to USD 6, 334 million (equivalent to 4. 37 months of import cover) at the end of April 2014 – these will be boosted further after issuance of the Sovereign Bond in June 2014. Exchange rate stability is also supported by an easing current account deficit after the rollout of large infrastructure projects between 2009 and 2012 when imports of heavy machinery for infrastructural development were made. 6

2. Monetary Policy Conditions… Following an Inflation Shock in 2011, Monetary Policy has taken 2. Monetary Policy Conditions… Following an Inflation Shock in 2011, Monetary Policy has taken the Driving Seat Decisive Policy rate hike Interest rate convergence New monetary framework Source: Central Bank of Kenya 7

2. Monetary Policy Conditions… Monetary Policy Curbed Excessive Credit Growth in 2011 Source: Central 2. Monetary Policy Conditions… Monetary Policy Curbed Excessive Credit Growth in 2011 Source: Central Bank of Kenya 8

2. Monetary Policy Conditions… Monetary Operations Work as in Emerging Markets Reverse Repo Rates 2. Monetary Policy Conditions… Monetary Operations Work as in Emerging Markets Reverse Repo Rates Overnight Window = CBR + K CBR + X Tightening bias CBR Accommodating bias Repo Rates ü ü Interbank rate CBR - X Central bank influences liquidity conditions via the operating bands on the CBR (Currently X is at 2. 5 percent) Interbank rate consistent with central bank policy rate Interest rates consistent with the inflation objective The overnight window is CBR + K and K = 6% - punitive enough to allow interbank market redistribute credit 9

3. Financial Sector Developments 1. 2. 3. 4. 5. The banking sector is playing 3. Financial Sector Developments 1. 2. 3. 4. 5. The banking sector is playing a key role in mobilisation of funds to finance projects envisaged in the country’s Vision 2030 development plan. The outreach of financial services targeting the Small and Medium Enterprises – key drivers of the country’s growth. The 2013 Financial Access Survey shows that access to financial services in Kenya has increased – formal access, at 67 percent of the total population, now stands amongst the highest in Africa. Expansion of Kenyan banks in the region continues to provide new business opportunities and diversification of the markets. Kenya has become a regional hub for financial services – Kenyan Banks have subsidiaries in the East African Community region and other countries in Sub-Saharan Africa with branch network outside of Kenya currently standing at 288 branches for 11 Kenyan banks. 10

3. Financial Sector Developments… Mobile phone money transfer services that were introduced in 2007 3. Financial Sector Developments… Mobile phone money transfer services that were introduced in 2007 continue to record tremendous growth – mobile phone money transactions were valued at an average of Ksh. 6. 2 billion per day (4. 4 percent of annual GDP) in February 2014. The growth has been phenomenal. It has become an important platform for financial services. Various measures have been introduced to lower the cost of doing business in the banking sector: 6. 7. ü ü ü Introduction of value capping and cheque truncation to enhance efficiency in payments and clearing systems – currently one day after delivery of the cheque to the bank. Roll-out of East African Payment Systems has facilitated faster cross-border transfers in the region and enhanced trade. Agency banking has propelled the levels of formal financial inclusion at minimal costs. Credit information sharing has expanded access to credit by tackling information asymmetry and lack of physical collateral which had previously given rise to default risks. Establishment of Currency Centres has reduced cash-in-transit costs and related risks. 11

3. Financial Shows Enhanced Financial Access in Kenya Sector Developments… A Regional Comparison South 3. Financial Shows Enhanced Financial Access in Kenya Sector Developments… A Regional Comparison South Africa '13 79 Kenya '13 11 67 Tanzania '13 8 58 Rwanda '12 Uganda '09 28 42 Namibia '11 30 65 Botswana '09 4 59 Nigeria '12 0 55 14 13 13 40 19 23 Mozambique '09 63 14 73 9 10 33 17 26 Burundi '12 31 8 43 Zambia '09 26 30 28 Malawi '08 25 16 42 10 78 20 30 Formal (banked) 40 % 50 Informal 60 70 80 90 100 Excluded Source: Financial Access Surveys in respective countries There has been an increase in the formal banking system in Kenya since 2006 while massively moving out of informal banking modalities. ü In Sub-Saharan Africa, Kenya now boasts of being second in the region in financial inclusion in terms of the low proportion of the unbanked population. ü 12

3. Financial Sector Developments… Financial Inclusion Developments since 2006 Source: Financial Access Surveys since 3. Financial Sector Developments… Financial Inclusion Developments since 2006 Source: Financial Access Surveys since 2006 ü ü ü 67 percent of Kenyans can access financial services Only about 7. 8 percent are served by informal financial services 25 percent of the population are still excluded 13

4. Growth Performance and Outlook 1. 2. 3. 1. 2. 3. 4. Kenya’s economy 4. Growth Performance and Outlook 1. 2. 3. 1. 2. 3. 4. Kenya’s economy grew by 4. 7 percent in 2013 from 4. 6 percent growth in 2012 mainly reflecting a strong performance of the financial intermediation sector and a stable macroeconomic environment. The financial intermediation sector grew by 7. 2 percent in 2013 from 6. 5 percent in 2012. The growth outlook for 2014 remains positive with the economy projected to grow by 5. 8 percent in 2014 and 6. 4 percent in 2015 on account of the strengthening global economy which is expected to boost exports; the stable macroeconomic environment; increased public investment in infrastructure; structural reforms; expenditure rationalisation programmes; and increased foreign direct investment in infrastructure and energy sectors. Confidence in the economy remains high: The latest sovereign rating by Fitch Rating agency conducted in February 2014 placed Kenya at “B+ with a stable outlook” while that by Moody's undertaken in May 2014 placed Kenya at “B 1 with stable outlook”. The latest World Bank Country Policy and Institutional Assessment rating of 3. 9 places Kenya as one of the top two countries in SSA. Prudent fiscal management has safeguarded Kenya’s debt position – the total public debt in NPV terms is estimated at 40 percent of GDP which is within a sustainable range. Entry into the international capital markets has boosted Kenya’s rating and raised hope of a strong roll-out of public investments – the debut sovereign bond subscriptions were USD 8. 8 billion for an offered amount of USD 2. 0 billion at yields of 5. 875% for the 5 years and 6. 875% for the 10 -years. This is perhaps the best pricing so far in Africa for the bonds. 14

5. Strategic Choices and Investment Options 1. 2. ü ü The addition of Ethiopia 5. Strategic Choices and Investment Options 1. 2. ü ü The addition of Ethiopia brings to 5 the number of land-locked, relatively resource rich countries that will be served by Kenya through the Lamu Port Southern Sudan. Ethiopia Transport (LAPSSET) Corridor Project – these countries will require efficient ports, transit airports, road networks and efficient rail networks. This adds to the widening EAC market for Kenyan firms. But this calls for speed and prioritization in: Finalization of infrastructure investment roll-out – including strategic regional financing of these infrastructure projects. Improving the efficiency of the existing infrastructure facilities; Mombasa Port and transit airports. Investing heavily in a transit international airport – Nairobi, like Dubai is becoming a world centre. Kenya should be the natural transit country by air, sea and serving the neighbouring land-locked countries; rail and road network. These projects, ports and transit airports can be repackaged for private sector equity contribution or public-private-partnerships (PPP) through FDI – this should therefore not lead to an over accumulation of public debt. 15

5. Strategic Choices and Investment Options… 3. ü ü 4. 5. ü ü ü 5. Strategic Choices and Investment Options… 3. ü ü 4. 5. ü ü ü Nairobi is developing as a financial hub for the region – this should be accelerated by formation of; Nairobi International Financial Centre (NIFC) Multicurrency Clearing House for the Eastern African region Economic Zones and Cities – like Konza IT City; Isiolo Transit, Mombasa and Kisumu Economic Zones. Need to move mobile phone banking to a mass market beyond transfers, payments and Micro-saving – like mobile market. Strategic engagement with the BRICs economies and PPP will be necessary to provide funding for these mega projects – rather than accumulate public debt. In the long-term: Regional initiatives will promote trade and employment in the EAC region: Exploitation of the recently discovered oil fields with concomitant infrastructural development will enhance growth. A large market for Eastern Africa region will support growth. 16

THANK YOU 17 THANK YOU 17