Why CBK Should Reduce Interest Rates Significantly in the Wake of Coronavirus Outbreak

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Many of you have heard that most people in Nairobi, or in Kenya at large, live from hand to mouth. That is probably right, but there is no party that lives from hand to mouth than businesses; and this is where the Central Bank comes in most of the time to provide reprieve.

Before explaining how that happens, I’d like to note that intervening to save businesses from running broke always have a net positive effect on the general economy. You have heard, possibly in multiple occasions that CBK increases or decreases interest rates as a monetary policy. Kenya’s Monetary Policy Committee met last on January 27, and are due to meet this month. It usually meets to review interest rates.

When the economy is on a slowdown, like the current case, CBK is supposed to lower interest rates. A slow down happens when there is a large scale decline in business activities. This mostly happens when there is a sharp decline in demand, occasioned by issue like the current Covid-19 or post-election violence.

Presently, airlines have experienced sharp revenue decline, hotels, tour agents, and almost everyone in the chain. This is where the concept of hand to mount in businesses come in. On average, a business maintains sufficient working capital to pay for essential services. Most of this capital maintained, usually called day to day capital, is largely dependent on sales.

When there is a sharp decline in demand, businesses fall short of collecting enough money to honour short term obligations. If the businesses incurs some fixed costs, like a 280-passneger airline that will use same resources to fly 50 passengers, it will exhaust its liquid resources within days. Almost all other businesses experience the same problem. That means without measures to get these businesses money urgently to continue running normal operations, they would easily collapse.

One would think that businesses should plan on this kind of risk. Businesses operate on the principal of optimization. While they try to address liquidity related risks, it is not logical to trap huge resources in businesses that can do other things. To optimize on resources, the rest of the money are put on other productive use.

It thus becomes essential for the CBK, in periods like this to lower the interest rate not just to save these businesses, but also to stimulate the economy. This money will eventually trickle down to employees and the rest of the economy, restoring businesses almost at the same level it was. In very extreme measures, governments can intervene to provide businesses with financial relief. This is why the U.S. is lining up hundreds of billions to pump into the economy to save businesses. Businesses are the source of employee incomes, and thus if they are running, then employees are also earning money. This creates an economic cycle to ensure rapid economic activities.

The CBK’s last review reduce interest rates from 9.0% to 8.5%, and it claimed the private sector was able to take more loans as a result of that reduction. Considering the mass panic and the almost obvious grounding of the economy, it is now essential that next meeting should reduce the interest rate significantly to allow businesses access more credit and resume normal operations. It would be an honour to see the rates reduce by over 400 basis point, settling at 4.5% or less. Additional measures like reducing the reserve ratio (the minimum deposit banks are required to keep with CBK) will also provide the necessary relief in pumping more money into the economy.

While undertaking those measures, it is important to be aware that the crisis still ongoing. If it does not come to an end within the next few weeks to allow full resumption of the economy, the additional measures will be required. It is a tricky situation but we can only hope that authorities, including CBK take appropriate measures to ensure the economy resumes as soon as it is possible.

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