Bloomberg News

Kenya May Tighten Policy to Stabilize Shilling, Inflation

June 23, 2011

(Updates with comment by analyst in 10th paragraph.)

June 23 (Bloomberg) -- Kenya’s central bank said it may tighten monetary policy further to stabilize the shilling and said it had taken “appropriate action” against unidentified lenders to stem speculative trading in the currency.

The bank will “consider further tightening of monetary policy to tame future inflation and stabilize the exchange rate,” Governor Njuguna Ndung’u told reporters today in Nairobi. “Once we analyse the inflation crisis and see that it is not subsiding, we have room to take monetary policy further.”

Kenya’s shilling has depreciated 10 percent against the dollar this year, ranking it the world’s third-worst performing currency after Suriname’s dollar and Maldives’ rufiyaa. The East African nation is grappling with 13 percent inflation, up from 3.2 percent in October, as the price of corn, the nation’s staple food, soared 33 percent in the period.

The Monetary Policy Committee cut interest rates to a record low in January, before raising them by a total of a half a percentage point at the following two monetary policy meetings in March and May.

The central bank took action to stem speculative trading in the currency market. In the week to June 16, five banks exported $260 million, while at the same time the volume of borrowing from the central bank by “strong” lenders increased, suggesting arbitrage opportunities, Ndung’u said. Four banks were found to be holding “very large overseas positions” that didn’t reflect trading fundamentals, he said, without identifying the banks.

Arbitrage Restrictions

“Their positions are largely associated with their group companies overseas,” he said. “We will restrict them from any arbitrage using the domestic currency.” He didn’t provide further details.

Arbitrage involves the simultaneous purchase and sale of related securities to profit from their difference in price.

The bank will also in future allow all institutions licensed to trade in foreign exchange to make bids when it buys or sells currency. “This will remove the dominance in the market and make forex trading competitive,” Ndung’u said.

The shilling traded at a 17-year-low of 92.05 against the dollar yesterday. It was trading 0.9 percent stronger at 90.05 at 5:04 p.m. in Nairobi. The currency may strengthen after Ndung’u’s comments, said Razia Khan, head of Africa research at Standard Chartered Bank Plc in London.

‘Benign Neglect’

“It is now clear that the authorities are no longer applying a policy of benign neglect toward the foreign-exchange rate, and market participants are likely to react to this signal,” Khan said in an e-mailed note today.

Among other monetary policy tools at the central bank’s disposal are the liquidity ratio, Ndung’u said. The bank may consider changing what qualifies as liquidity at commercial banks, reducing their ability to speculate in the currency market, he said.

“They will have less power to play in the market,” he said. “That can be more effective, maybe before we go to the next MPC meeting.” He didn’t provide further details.

The central bank’s Monetary Policy Committee is scheduled to meet again next month. At its last meeting in May, the central bank also raised its cash reserve ratio by a quarter of a percentage point to 4.75 percent.

--Editors: Paul Richardson, Philip Sanders.

To contact the reporter on this story: Johnstone Ole Turana in Nairobi at jturana@bloomberg.net.

To contact the editor responsible for this story: Paul Richardson in Nairobi at pmrichardson@bloomberg.net.


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