‘African central banks need well designed policies’

Given the tottering global growth and attendant economic challenges, a suite of monetary policies meant for local challenges have been prescribed for the continent’s central banks.

Besides, it is especially important that Sub-Saharan African central banking explore the challenges faced as it addresses the increasingly complex forces at work in the global economy.

The Deputy Managing Director of International Monetary Fund (IMF), Mitsuhiro Furusawa, made the observations in his lecture titled “Monetary Policy and the Future of Central Banking: Implications for Africa”, in Nairobi, Kenya.

According to him, of particular concern is a global economy marked by subpar growth with downside risks related to the ongoing adjustment in the world economy.

In addressing these challenges, he said monetary policy has a central role to play, but along with fiscal policies, adding that well-designed and well-implemented monetary policies are essential for a country to achieve strong, sustainable and inclusive growth.

Taking a retrospect of the evolution of central banking, he reviewed developments in central banking and monetary policy over the last 50 years, and then placed those them in the African context.

“Traditionally, the primary objectives of monetary policy have been to maintain price and financial stability and to help achieve full employment. At times there may appear to be a conflict between the goals of low inflation and economic growth. But we have learned from hard experience that high inflation distorts the private sector’s savings and investment decisions- leading ultimately to slower growth.

“That is why countries have increasingly placed greater emphasis on price stability, and many of them have made low and stable inflation the primary objective for monetary policy,” he said.

To achieve the price stability objective, he said monetary policy frameworks have evolved over time and noted that in the period after World War II, monetary policy operated in the context of fixed exchange rates under the Bretton Woods system.

“Following the collapse of that system in 1972, central banks generally used monetary targets and soft exchange rate pegs to bring down the high inflation that the world experienced through the early 1980s.

“However, as inflation fell, and financial innovation emerged, the link between money targets and inflation outcomes became increasingly tenuous. In addition, the increase in capital flows and the market volatility that followed, created significant challenges for small, open economies operating soft exchange rate pegs to deal with external shocks, while seeking to achieve price stability.

“This is why central banks have gradually switched to forward-looking monetary policy frameworks to stabilise their economies. Starting with New Zealand in 1989, many central banks responded to these challenges by switching to formal inflation targeting as a framework for monetary policy,” he said.

According to him, this approach essentially combines an explicit inflation target with a commitment to use market-based instruments and a flexible exchange rate to achieve the inflation target over the medium term.

Besides, not all central banks adopted formal inflation targeting frameworks. But in most cases the operational framework has been similar, that is to say, it was centered on adjusting short-term policy rates to maintain low and stable inflation over the medium term.

“These forward-looking monetary policy frameworks have been supported by legislative mandates to give central banks operational independence. This has been coupled with procedures that ensure central bank transparency and public accountability,” he said.

These trends certainly have influenced the way central banking and monetary policy have evolved in Sub-Saharan Africa.

In the immediate post-colonial era, the new central banks lacked independence from their governments: they were directed to finance large fiscal deficits. There were pervasive foreign exchange and interest rate controls.

Starting in the late 1980s and increasingly during the 1990s, he said the region largely adopted monetary policy frameworks based on either monetary targets or exchange rate pegs. These were supported by smaller fiscal deficits and reduced central bank financing of those deficits.

Now, however, the weaker relationship between money and inflation, and the changing financial landscape, are again calling on African central banks to adjust their strategies.

“Ghana, South Africa, and Uganda have adopted formal inflation-targeting regimes. Other countries with flexible exchange rate regimes are de-emphasizing the role of monetary aggregates and incorporating elements of the monetary policy practices of industrial and emerging market countries.

“These practices include greater reliance on interest rates for the transmission of the monetary policy stance, improved liquidity management, and greater focus on policy analysis, forecasting, and communications.

“Kenya does not formally target inflation. But since 2011 it has adopted a more forward-looking monetary policy framework centered around the CBK’s policy rate, which is set by a monetary policy committee.

“As many of you know, this policy is aimed at maintaining inflation within the government’s target range of 2.5 percent on either side of the five percent medium-term target. Using this framework, Kenya has successfully managed to keep inflation within the target range most of the time over the past several years.

“Sub-Saharan Africa’s shift toward more forward-looking monetary frameworks has been supported by reduced fiscal deficits, generally more flexible exchange rate regimes, and a more intensive use of market-based monetary instruments,” he said.

But at the same time, Furusawa said financial systems in the region have experienced significant deepening over the past decade and should translate into potentially stronger monetary transmission over time.

To him, a key element of this deepening has been the region’s emergence as a world leader in innovative financial services based on mobile phone technology, leading to a breakthrough in financial inclusion, especially here in East Africa.

“And as you know, Kenya has led the way: over 75 per cent of your population has now financial access, up from about 40 per cent just five years ago. This reflects the fast spread of M-Pesa, M-Shwari, and M-Kesho, which has helped reduce transaction costs and facilitate personal transactions.

“Kenya also has one of the most diversified and deep financial sectors in Sub-Saharan Africa. Your well-established government bond market is providing key support for effective transmission of monetary policy. Other African countries are making similar progress,” he added.

Nonetheless, many central banks in Sub-Saharan Africa are facing serious obstacles as they design and implement effective monetary policies, not least because of the combination of external and domestic challenges.

The external factors are well known to this audience. Many African countries have been feeling the pain of the collapse in commodity prices. Growth has fallen sharply, and inflation is rising as a result of exchange rate depreciation.

Countries that are less dependent on commodities exports—including Kenya—are doing better. But the room for maneuver that their central banks have enjoyed for the past several years is becoming more confined.

A key reason for this is the region’s integration into global trade and financial networks. You are subject to forces well beyond your control.

For example, the uncertainty surrounding the timing of exit from unconventional monetary policies in advanced countries has increased the volatility of capital flows.

The risk is that a sudden reversal of capital inflows could lead to a large and disorderly depreciation of the local currency, with adverse implications on both inflation and financial stability.

“All of this greatly complicates the conduct of monetary policy. Still, the good news is that many of Sub-Saharan Africa’s central banks have built adequate international reserve cushions. This includes Kenya, giving the CBK greater room for maneuver, and reducing the risk of a sudden reversal of capital flows in the first place.