The Central Bank of Kenya and the University of Nairobi hosted a public lecture in honour of the late Prof. Francis Mwega on February 27, 2018. The keynote address was by Prof. Benno Ndulu, the former Governor of the Bank of Tanzania, on the subject ‘Conduct of Monetary Policy in a Changing Policy Environment’.

The public lecture drew a large audience comprising of CEOs and other representatives of private sector institutions, policy makers and other senior Government officials, the Deputy Governor of Bank of South Sudan, Mr. Odera Innocent Ochan, Vice Chancellors and other senior university staff, as well as development partners including the World Bank and IMF, research institutions including the African Economic Research Consortium (AERC) and KIPPRA, the CBK Board of Directors, and current and former CBK Governors and MPC/MPAC members.

The Keynote Speaker, Prof. Benno Ndulu, served as the Governor of the Bank of Tanzania from January 2008 to January 2018. He started his career at the University of Dar es Salaam in the early 1980s before joining the World Bank as a Lead Economist. He is best known for his involvement in setting up and developing one of the most effective research and training networks in Africa, the AERC.

More recently, Prof. Ndulu has coauthored a book titled Tanzania: The Path to Prosperity, published by Oxford University Press. The book highlights the challenges of securing economic prosperity in Tanzania in the coming decades.

“We in the Central Banking fraternity, also recognize Prof. Ndulu for his key role in driving the regional integration initiatives, especially harmonization of monetary, exchange rate and financial sector policies, within the auspices of the East African Community,” stated Dr. Patrick Njoroge, Governor of the Central Bank of Kenya, in his introductory remarks.

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The Conduct of Monetary Policy in East Africa in a Changing Policy Environment

A Memorial Lecture in Honour of Prof Francis Mwega by Prof. Benno J. Ndulu

Conduct of monetary policy in the EAC has been largely successful. Two key sets of indicators for measuring such success: The first relates to achievement of the core mandates of the central banks – price stability, inflation for domestic prices, and exchange rates for price of tradables. Secondly, success is also deduced from ability to ride through major shocks to enable the economies continue on a path of sustained growth after brief disruption

Since 2013 inflation rates have remained subdued and within the EAC convergence band, save for Burundi recently, mainly due to successful conduct of monetary policy helped along by stability of oil prices, and improved food supply

Nominal exchange rate index has been reasonably stable with correction for shocks; real effective exchange rates stable; and larger correction in countries pursuing more flexible exchange rate regimes.

Growth in the region was strong and robust supported by public investment in infrastructure, favourable commodity prices, subdued global oil prices and favourable weather conditions. Growth has remained resilient to shocks, quickly recovering after each shock – with robust macrostability.

Managing Shocks for Sustained Macrostability

Since 2008 the region managed to ride through three major shocks with consequence on macrostablity:

• Global Financial Crisis (2009) – the biggest shock with impacts transmitted through a spike in exchange rates (heightened by speculative attacks) and through a global economic recession

• The Euro Crisis (2011/12) – again transmitted mainly through a spike in exchange rates and its impact on lengthening the period of recovery from GFC recession

• Commodity Price Collapse (2014/15), with its effect transmitted mainly via pressure on exchange rates

Judging from the short duration of stress from each shock – short lived inflationary and exchange rate spikes and quick recovery of growth – management of shocks was quite successful.

Major Changes Impacting the Conduct of Monetary Policy

More frequent supply side shocks with exogeneous impact on inflation; sharp rise in transaction velocity of circulation with the advent of mobile money; dilution of fiscal dominance; and changes in the approach to conducting monetary policy – from targeting quantities to targeting prices

The impact of slow growth in monetary aggregates was partly reduced by rising transaction velocity of money associated with ongoing financial innovations and technological dividend.

The main imperatives of monetary policy implementation have changed significantly. In 2008 when I became Governor of the Bank of Tanzania – our main preoccupation was mopping up liquidity from the system to reduce inflationary pressure. Fiscal dominance meant Government was busy injecting via spending foreign savings and the Central Bank mopping up excess liquidity arising from this.

Currently fiscal dominance is significantly diluted. Greater government reliance on domestic revenue means enhanced neutrality in monetary effects of govt operations – withdraw liquidity when collecting revenue and injecting liquidity when spending it. Significant proportion of foreign savings – via grants or loans –  spent on big projects meant leakages via imports of goods and services and fees. Loans given in kind – i.e. with no cash transfer for big projects also meant less liquidity injections.

Central Banks have been pushed to rely more on their own instruments to provide liquidity, for example, via repos, purchase of forex from the market, etc. – depth and efficacy of financial markets are key challenges for effectiveness of transmission mechanisms

Sharp decline in liquidity injecting financing as donor budget support sharply decreased, and non-concessional borrowing also slowed down with increase in the cost of borrowing. Loans given in kind are not-liquidity injecting – many Chinese-funded infrastructure loans are in that form (Rail in Kenya; Gas pipeline in Tanzania). Dominance of large infrastructure projects in the development budget – where foreign firms dominate in securing contracts –means large leakages in the multiplier effects. As the share of development budget rises, these leakages become more pronounced.

Major Macrostability Risks Going Forward

Independence of Central Banks to pursue price stability and protect the value of the local currency; tendency to fix interest rates, a key price of monetary policy, blunts efficacy of monetary policy transmission; debt sustainability / debt distress – unsustainable levels of borrowing, risks from currency mismatch in major borrowing for infrastructure, big push (borrowing for non-tradable services), and risks from maturity mismatch for major infrastructure investment; and the end of quantitative easing in US to be followed by Europe.

Debt Sustainability Challenges – Are we borrowing too much?

Based on DSA carried out for each of the East African member countries, external debt and total public debt are broadly within the acceptable international thresholds and EAC limit of PV of debt at 50%. None is currently already at risk of distress.

Nevertheless, recent build up has been rapid with higher cost and shorter maturities as non-concessional borrowing increased faster than debt stock. PV of Kenya’s total public debt ratio to GDP has approached the 50% mark (although there are disputes for discount rate for domestic debt) and could breach the threshold for sustainable debt.

The Risks from Currency Mismatch

The greater risk is that from currency mismatch (liquidity risk). Loans for large infrastructure projects (transport, power, water communications) are contracted in foreign currency and have to be repaid in the same, but revenue streams from these investments are in local currency and servicing to a large extent depends on growth of export sector.

Unless these investments accelerate growth of exports, a country may face challenges in externalizing debt service even if there is enough revenue from these investments. Hope lies in getting oil and gas exports to start flowing early to boost foreign exchange earnings

Concluding Remarks

The conduct of monetary policy in the region has been overall successful. Part of this success can be attributed to letting Central Banks pursue its mandates unencumbered. Sustaining this success will partly depend on: Protecting the independence of central banks to implement its mandate; improved accountability of central banks for its actions – including more effective communication of its activity; and stronger capacity and flexibility to manage response to shocks.

Let us sustain regional coordination and coherence of policy and action in response to shocks and in this era of cross-border banking.