GLOBAL ECONOMIC CRISIS: FUTURE PREPAREDNESS

1. GLOBAL ECONOMIC CRISIS: FUTURE PREPAREDNESS Njuguna Ndung’u Governor, Central Bank of Kenya July 30, 2009

2. Three Responses to the Main Issue: • Continue the development path: defend and ring-fence development spending to support capacity for future growth • Build stronger and stronger banks – through re-capitalizing, consolidation and mergers to cover the EAC region • Regulators should talk and coordinate with each other: have a coordinating platform, build supervisory capacity in the region and more strongly build the information capital to be used by credit reference bureaus in the region 2

3. Economic Performance and Forecasts for OECD and Emerging Economies 3

4. Africa Not Spared: Growth Outlook Revised Down Significantly 2009/10a IMF, WEO October 2008 estimates 2009/10b IMF WEO April 2009 estimates 2009-10 numbers are forecasts 4

5. Initial Phase of Economic Crisis • Through weakening of local currencies, declining reserves and stock exchanges • Depreciation as a result of • Declining commodity prices and general deterioration of terms of trade • Non-resident outflows from equity and bond markets (“Flight to safety”). In addition the US dollar perceived by investors as a safe haven. (The distorted US dollar relative price) • The market-determined or flexible exchange rate acted as an automatic stabilizer during this crisis in most African economies 5

6. Initial Phase of Economic Crisis… • Weakening of Stock Exchanges as a result of • Outflow of non-residents’ funds • Unfavorable investor sentiments: concerns about global recession and negative impact on domestic economies • Drawdown of foreign exchange reserves • The law defines 4 months of import cover • Kenya went to as low as 2.7 months of import cover • But this is what forex reserves are for, accumulate in good times and cushion against shocks and drawdown in bad times 6

7. Economic Crisis • Commodity exports have been one of the main drivers of growth in many African countries • The economic crisis has dampened the expectations on commodity futures markets thereby inducing falling prices and demand for most commodities • The crisis has taken a heavy toll on countries that are highly dependent on natural resources (e.g. copper, oil, timber and diamonds) • The fall in copper and diamond prices has resulted in a significant drop of export receipts for Zambia and Botswana, respectively 7

8. The Financial Sector Remains Sound and Safe Indicators of Financial Sector Soundness : • Capital adequacy: All the 45 banks meet the criteria for minimum core capital requirements (capital adequacy 18.1% June 09 vs required 12%) • Adequate liquidity to meet the payment needs of the financial system. (Liquidity ratio average 42.4% vs required 20%) • Appropriate balance between loans and deposits ratio (75%: Kshs712B against Kshs953B - June 2009) 8

9. Indicators of Financial Soundness… • The interbank cash market continues to be liquid and stable, the rates are coming down consistent with monetary policy projections • Lending to private sector increased by 19.2% during the year to June 2009 • The ratio of gross non-performing loans to gross loans at 9.4% in June 2009 has declined from a high of 10.60% in December 2007 • Return on capital was on average Kshs25 for Kshs 100 invested • Return on shareholders funds 25.3% 9

10. Monetary Policy Stance • The Central Bank of Kenya is pursuing an accommodative monetary policy stance to help cushion the economy from the negative effects of the Global Financial Crisis • Measures taken so far • Reduction of Cash Reserve Ratio from 6% to 5% in December 08 - thus releasing an equivalent of Kshs8bn for lending to the economy and further to 4.5% in July 2009 • Reduction of CBR from 8.0% to 7.75% to signal to banks to lower lending rates • Allowing a reduction in foreign exchange reserves to less than 3 months to take pressure off the depreciation pressure of the Kenya shilling vis-à-vis the hard currencies [Had the CBK not allowed this, the inflationary effect of the shilling’s depreciation would have been worse - in terms of intermediate imports, oil prices etc] 10

11. Monetary Policy Stance… • Monetary Policy stance adequate for now • Banking system not lending to private sector because of perceived risks associated with global financial crisis. Once banks lending resumes the liquidity of the system will be reviewed by MPC among other instruments. • CRR is used sparingly [like a water valve – once water is out, no control] (it reduces the monetary base and increases the money multiplier, it is not a tool for liquidity management) • Price signals are good shock absorbers for supply shocks. • In an economy buffeted by supply shocks such as food, using CBR rather than CRR was a more appropriate response in the crisis period. • price effect (CBR) is superior and efficient to quantity effect (CRR) • Too much liquidity in a sluggish economy might choke the economy generating inflationary pressure. Providing liquidity only when it is needed is prudent monetary policy and good economics • the barometer for liquidity [Interbank rates at less than 3%]. 11

12. Overall the Global Financial Crisis Presents Three Challenges 1. Financial Sector Contraction – due to confidence–risk averseness • Less resources mobilised yet banks are awash with liquidity • But we can ring-fence domestic confidence and solve the resource constraints 2. Real Sector Economic Decline: Poses Significant Risks • But also Slow Adjustment • Production processes must be supported through public investment - Protect wage goods 3. Public Sector Resource Constraints: • Buffeted by several shocks • Flexibility of adjustment - ODA/BoP support has come via ESF 12

13. Going Forward • To support Government policy as envisaged in Vision 2030 - strong, stable and efficient banks that offer services to a wider public are required. • To realise this objective, the Law was amended requiring banks to gradually increase their minimum core capital to Kshs1bn by 2012. • Consolidation of banks expected – but more importantly, they should be strong in their market niche. 13

14. Going Forward... • National Survey on Financial Access conducted • Access to financial services by majority of Kenyans still limited • Microfinance Act enacted and Regulations gazetted (One Microfinance Institution licensed) • Regulations on Credit Reference Bureaus Gazetted • Expansion of branch network • Proposal to allow banks to use agents incorporated in 2009 Finance Bill – Principal/Agent model of financial service delivery 14

15. Going Forward... Six Incremental Solutions – The Bank Advises: 1. Partnership: make resources available to ride over shocks – BoP support and quick disbursements from AfDB, IMF, and WB 2. Domestic resource mobilization strategies • Target to support production and open up production potential • Avenue for investment & savings – (see the Kenya Infrastructure Bond Model, see also Diaspora Bonds) • Protect the wage good – consumption (KaziKwaVijana) 3. Strengthen institutions and capacity in those institutions to focus on: • Provision of a coordinating framework across regulators (formation of Financial Sector Committee) • Innovative policy strategies 15

16. Going Forward... 4. Stay the path of reforms – do not sacrifice long-run growth • Development budgets should not be cut – should be increased • Remain within attainable targets • In the 1980s and 1990s – short-run shocks were used as an excuse to cut Development Budgets – sacrificed long-term growth 5. Aid Delivery Modalities in Times of Crisis: Quick disbursements to allow countries ride over shock quickly to protect economic erosion • But also DSA frameworks should signal changes in the policy paradigm 6. Look at the global financial architecture - see G20 Proposals from London coming from diverse groups and C10 16