The Central Bank of Kenya (CBK) recently increased its benchmark lending rate to an 11-year high of 14.5 percent, in a bid to curb inflation and stabilize the shilling. This move has had a ripple effect on the cost of borrowing for consumers and businesses, who are now feeling the pain of higher interest rates.
Consumers face higher loan repayments and reduced spending power
One of the immediate impacts of the CBK’s rate hike is that banks have started increasing their base lending rates, which determine the cost of loans for customers. For instance, NCBA Bank has increased its base lending rate to 16 percent, up from 13 percent. This means that customers who have taken out loans from the bank will have to pay more in interest and principal repayments.
Higher loan repayments will reduce the disposable income and spending power of consumers, who are already struggling with the high cost of living. According to the Kenya National Bureau of Statistics, the inflation rate rose to 8.6 percent in November, the highest level since January 2018. The main drivers of inflation were food, fuel, and electricity prices, which have soared due to supply disruptions, drought, and global oil price shocks.
Consumers who are unable to service their loans may also face the risk of defaulting or having their assets repossessed by banks. This could worsen the already high level of non-performing loans (NPLs) in the banking sector, which stood at 14.9 percent as of September, well above the 5 percent threshold.
Businesses face higher borrowing costs and lower profitability
The CBK’s rate hike also affects businesses, especially those that rely on bank loans to finance their operations and expansion. Higher interest rates will increase the cost of capital and reduce the profitability and cash flow of businesses. This could hamper their growth prospects and competitiveness in the market.
Some of the sectors that are most vulnerable to rising interest rates are manufacturing, construction, real estate, and agriculture, which have high levels of debt and low levels of liquidity. These sectors are also facing other challenges, such as low demand, high taxes, regulatory hurdles, and infrastructure bottlenecks.
Businesses that are unable to cope with the higher borrowing costs may resort to cutting costs, laying off workers, or scaling down their operations. This could have a negative impact on the employment and output levels in the economy, which are already under pressure from the Covid-19 pandemic and its aftermath.
What are the implications for the economy and the policy outlook?
The CBK’s rate hike is aimed at achieving its dual mandate of maintaining price stability and supporting economic growth. The CBK expects that the higher interest rate will help to anchor inflation expectations and attract foreign inflows, which will strengthen the shilling and ease the pressure on the current account deficit.
However, the rate hike also comes with trade-offs and risks, as it could dampen the economic recovery and worsen the debt burden of consumers and businesses. The CBK will have to balance these conflicting objectives and monitor the impact of its policy actions on the economy and the financial sector.
The CBK has indicated that it will remain vigilant and ready to adjust its policy stance as necessary, depending on the evolving economic and financial conditions. The CBK will also have to coordinate with the fiscal authorities, who have a role to play in ensuring fiscal discipline, enhancing revenue collection, and prioritizing pro-growth and pro-poor spending.
