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Cablegate: Kenya's Central Bank Governor Too Optimistic

VZCZCXYZ0002
PP RUEHWEB

DE RUEHNR #0447/01 0421328
ZNR UUUUU ZZH
P 111328Z FEB 08
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC PRIORITY 4656
INFO RUEHXR/RWANDA COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC

UNCLAS NAIROBI 000447

SIPDIS

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DEPT ALSO PASS TO USTR FOR BILL JACKSON
DEPT ALSO PASS TO DEPT OF LABOR FOR MICHAL MURPHY, SUDHA HALEY,
PATRICK WHITE AND MAUREEN PETTIS
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TREASURY FOR VIRGINIA BRANDON
COMMERCE FOR BECKY ERKUL

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ELAB ETRD EINV KE
SUBJECT: KENYA'S CENTRAL BANK GOVERNOR TOO OPTIMISTIC

REFS: (A) NAIROBI 383, (B) NAIROBI 380, (C) NAIROBI 353,

(D) NAIROBI 192

SENSITIVE-BUT-UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY. FOR
INTERNAL USG DISTRIBUTION ONLY.

1. (SBU) Summary: Kenyan newspapers disregarded the sugar-coating in
Central Bank of Kenya (CBK) Governor Njuguna Ndung'u's claims that
the impact of post-election violence would most likely be confined
to the first quarter. They highlighted his admissions that there
could be a major slowdown, that investors could postpone
investments, and that the damage could be long-term, especially in
the labor sector. Despite some internal contradictions, Ndung'u's
statement made clear the CBK's primary goal is to keep underlying
inflation within the 5% target to encourage long-term economic
growth, and that the CBK will oppose an easing of monetary policy or
encouraging higher interest rates because money supply growth is
already well above target. He did not propose a strategy for
addressing the crisis, saying the CBK and the government need more
specific information from the banking sector before formulating
policy. End summary.

Sugar-Coated CBK Governor's Press Release
----------------------------------------
2. (U) CBK Governor Njuguna Ndung'u responded to the dire warnings
from private sector leaders that the current political crisis
threatens to cut Kenya's 2008 growth down to 4%, or even zero, with
an optimistic, four-page February 6 press release entitled, "Kenya
Has Slipped, It Can Rise Again." Despite including a few caveats,
he stressed the economic impact of the crisis would most likely be
short-term. Ndung'u admitted the turmoil had destroyed factors of
production, disrupted access to raw materials, disrupted
distribution and supply channels, raised insecurity, displaced
labor, caused fuel shortages, dented business and consumer
confidence, and would cause delays in investment decisions. He
admitted that GDP growth for 2008 may not reach the pre-crisis 8%
projections because of the damage to tourism, manufacturing,
agriculture, transport and communication. However, he predicted the
political crisis would be short-lived, with damage limited to the
first quarter, and that strong fundamentals would achieve growth,
albeit slow, in 2008, rather than no growth at all.

Need More Info Before Precipitate Policy Making
--------------------------------------------- --
3. (U) Ndung'u said the CBK is still trying to quantify the economic
costs of the political crisis, and is waiting for the banking sector
to report the full extent of losses and possible write downs. When
this information becomes available, he said the fiscal and monetary
authorities would formulate a plan to handle this political-economic
shock. He indicated the CBK would concentrate on keeping underlying
inflation within the 5% target to encourage investment and promote
long-term real economic growth, and not undertake precipitate
policies to support the shilling, increase liquidity, or raise
interest rates.

Media Ignorance is Not Reason To Intervene
-------------------------------------------
4. (SBU) Ndung'u took advantage of the media's misplaced blame on
"speculative attacks" as the cause of the shilling's depreciation to
deride the media's analytical capacity and warn the public to be
skeptical of calls for the CBK to intervene in the foreign exchange
(forex) market. While he correctly blamed the depreciation on
market expectations that future foreign exchange earnings will be
constrained, he incorrectly claimed this was caused more by donors
cutting off aid than by an expected decline in economic performance.
Ndung'u tried to reassure markets by stating the CBK and commercial
banks have plenty of foreign currency on hand. Official foreign
exchange reserves at the end of December 2007 were $3.36 billion
(equivalent to 4.8 months of imports), while commercial banks' held
another $1.2 billion. He said the CBK is committed to stabilizing
exchange rate movements only when they are driven by non-fundamental
factors, rather than day-to-day volatility (in his words, "noisy
trading").

Q1 High Inflation Reflects Only Temporary Supply Constraints
--------------------------------------------- ----
5. Ndung'u stressed that increases in overall inflation such as the
18.2% rate in January were caused by temporary shortages caused by
failed rains and ethnic unrest and violence in food surplus areas.
He contended these short-run shocks do not represent fundamental
changes, but acknowledged that sizable increases in food and energy
prices might continue beyond the first quarter, erode real incomes,
and be inconsistent with the objective of price stability. (Note:
The CBK excludes food and energy prices from the underlying
inflation rate it uses as its inflation target. End note.)

No Easing of Monetary Policy
----------------------------
6. (SBU) Although Ndung'u's statements on banking sector liquidity
were internally inconsistent, he admitted the risk that commercial
banks would have to repair balance sheets and restore capital, which
could force them to restrict new lending, significantly affecting
the level of economic activity. He maintained, however, that easing
of monetary policy is not necessary and may not be appropriate
because broad money growth increased massively in December in
connection with election and holiday related spending, and increased
further in January, as Kenyans increased their precautionary
balances in times of uncertainty. Reserve money has been
significantly above target, and must be contained to cut inflation.
He argued that a reduction in the benchmark Central Bank Rate (CBR)
might mislead the market to think "the CBK is focusing more on
stabilizing demand than meeting the inflation target." He said the
Monetary Policy Committee (MPC) would assess the medium-term outlook
for inflation and the risks to demand and activity, in the short
term.

Tribal Tension Threatens Kenyan Labor Market
--------------------------------------------
7. (U) The one factor Ndung'u admitted would cause a long-term
reduction in production was the disruption of workforces caused by
tribal tensions. He warned that "ethnic cleansing" in various parts
of the country had a direct negative effect on the economy. Ndung'u
called for strong policy intervention to prevent the hiring of
personnel based on location and ethnic group, rather than merit,
from taking root in the labor market.

Comment
-------
8. (SBU) It is understandable that Ndung'u feels obliged to minimize
the economic crisis (ref D), but the press was not deceived, and its
coverage emphasized the more dismal caveats in his press release.
Ndung'u would do well to speak more clearly, concisely, and
realistically, acknowledging the private sector's warnings as valid
if a political settlement is not reached quickly (ref C). We hope
he is being more upfront with political leaders. Ndung'u is a good
economist and a good Embassy contact, and the CBK governor plays an
important role in Kenya's macro-economic management. However, the
tightrope between acknowledging reality and maintaining morale that
any government economic official has to walk in such a crisis is
difficult. Ndungu's cheerleading threatens to weaken the
credibility he will need over the coming months as the GOK tries to
manage the economic fallout of the crisis.

RANNEBERGER

© Scoop Media

 
 
 
 
 
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