The Central Bank Should Aim for Zero Inflation

Question 1: Briefly explain role of the following Financial Institutions in the economic development of Kenya: a) Kenya Industrial Estates: Kenya Industrial Estates (KIE) Limited was established in 1967 as a subsidiary of Industrial and Commercial Development Corporation (ICDC) with a major role of promoting indigenous entrepreneurship by financing and developing small scale and micro enterprises.

KIE Limited was established to facilitate development and incubation of micro, small and medium enterprises (MSMEs) countrywide by establishing industrial parks, providing credit and business development services (BDS) in a sustainable manner. The services offered by KIE include; * Development of Industrial Estates and Provision of MSMI Incubation Services Kenya Industrial Estates LTD provides serviced workspace through construction of industrial estates/incubators in fast growing business centres.

These facilities provide entrepreneurs with specific services to nurture and encourage growth of their enterprises to sustainable levels. Apart from flexible and affordable workspace, the enterprises within the incubators are able to access financial support for machinery, equipment and working capital, shared utility services, management and technical assistance including skills upgrading, marketing, accounting, legal, secretarial services and internet and networking.

New industrial estates are being developed in fast growing urban centres and Special Economic Zones as identified in the Vision 2030 * Financial Support Services Credit Facilities: KIE provides affordable medium to long-term finance to MSMIs for the purchase of machinery, equipment and working capital, either for start-ups, expansion, modernization or rehabilitation focusing on priority sectors identified in Vision 2030. Special Credit Facilities for Marginalized Areas: This product is availed in marginalized areas with favourable terms and conditions.

Top up Loan Facilities: This is a product targeting the existing KIE clients (loanees, mortgages and tenants) who have/had good credit record and have potential for growth and wish to acquire additional capital or financial assistance Bid Bond Facility: A bid bond is issues as part of a bidding process by the surety to the project owner, to guarantee that the winning bidder will undertake the contract under the terms at which they bid.

KIE charges for this service at a negotiable rate. Performance Bond Facility: For this product, KIE has set aside funds in a commercial bank to facilitate performance bid bond facility to its ‘A’ Rated Clients Industrial Shed Rehabilitation: This facility is for mortaged industrial workspace where the mortgagee can access credit facilities to rehabilitate or expand and modernize their workspace * Business Advisory Services.

To ensure success and growth of its incubatees, KIE LTD has set up business solution centre’s which provide entrepreneur capacity building training, mentoring and consultancy services, preparation of feasibility studies, business plans, business counseling, needs assessment, project implementation/supervision/monitoring, technology selection services, marketing support, rehabilitation, expansion and repositioning/modernization. Facilitating Inter-Firm linkages This programme involves facilitation of linkages between the small, medium and large-scale enterprises mainly to enable technology transfer.

KIE facilitates improvement of technology and standards of the MSMIs through equipment upgrading, apprenticeship training and provision of working capital. District Business Solutions Center The KIE LTD District Business Solution Centre’s (DBSC) support the government strategy to revitalize the SME sector and thus the economy as articulated in the new sessional paper No. 2 of 2005 on Development of Micro and Small Enterprises of Wealth and Employment Creation for Poverty reduction The Private Sector Development Strategy Paper (PSDS).

The districts in focus are considered the milennium districts and include, Murang’a, Meru South, Bondo, Siaya, Bungoma, Suba, Kilifi, Turukana and Garissa. Business SME solution centre’s are facilities that are set up to offer platforms from which entrepreneurs can develop business ideas into profitable business ventures run and owned by individuals. It also provides breeding grounds for existing business for growth and take-off. b) Industrial & Commercial Development Corporation (ICDC):ICDC is the pioneer Development Finance Institution (DFI) established in 1954, to facilitate economic development of Kenya through provision of medium and long-term financial solutions.

* It provides equity solutions to entrepreneurs through Joint ventures and Strategic partnerships to promote and encourage private sector investment and entrepreneurship for job and wealth creation. * ICDC also seeks to grow existing businesses and promote establishment of new ones through provision of corporate and wholesale loans at competitive rates and also through asset financing. * ICDC also provides Management and Advisory Services to corporate institutions.

The Services offered include: * Corporate Secretarial * Share Registration * Internal audit c) The Agricultural Finance Corporation (AFC): AFC is a wholly owned Government Development Finance Institution (DFI), established in 1963 initially as a subsidiary of the Land and Agricultural Bank. In 1969, it was incorporated as a full – fledged financial institution under the Agricultural Finance Corporation Act, Cap 323 of the laws of Kenya. It was then tasked in assisting in the effective and peaceful transfer of land to indigenous farmers, as well as injecting new capital to farm owners to spur development.

After successful implementation of this task, AFC was further reconstituted in 1969 to assume a wider mandate by taking over the functions of the Land and Agricultural Bank of Kenya. Today AFC remains the leading Government Credit institution mandated to provide credit for the sole purpose of developing agriculture. This role is crucial given that Agriculture is the mainstay of the Kenyan economy where 80% of the Kenyan population which is rural based relies on agriculture as their main support system.

AFC provides subsidized loans e.g seasonal crop credit, water development loan, cash crop loan, horticulture and floriculture development loan, machinery loan, agribusiness loan, livestock and fisheries development loan, the vuna account loan, stawisha group loan and the school based to assist individuals, groups and corporation wishing to engage in agriculture as a business with finances to enable them start, grow and profit from this ventures and to grow the Kenyan economy while creating employment opportunities to the youth and the rural folk. Question 2: a) List the main functions of the Central Bank of Kenya:

They include; 1. It acts as a banker’s bank. 2. It serves as a lender of last resort to commercial banks and also to the government. 3. It encourages the adoption of the financial system according to the changing needs of the markets. 4. It administers external reserves, exchange controls and handles external financial relations. 5. It manages the national reputation. It takes into account accumulated borrowings undertaken by the government to finance its expenditure. 6. It has the sole responsibility of issuing currency. It regulates the issue of notes and coins.

7. The bank is a government banker. It does not maintain the accounts of businesses and individuals in the private sector. It only maintains the accounts of governmental departments. This usually starts in a bank returns as public deposit. 8. Important of all is that it acts as an agent to the government. This is seen when it implements the monetary policy in the pursuit of the government’s national economic development. As part of this process, the bank acts as a medium for a two-way transmission between the government and the financial markets.

Among other things, it collects extensive statistical information on all financial institutions. The information is usually about the following: • The volume of business. • The sectors of the economy that may need financial assistance inform of lending. • Who is providing deposits to financial institutions? 9. The Central Bank of Kenya has a duty to supervise the banking industry in general. The bank can issue directives to commercial banks and other financial institutions indicating how much they should be lending (quantitative directives).

This has been done through what is known as moral persuasion (friendly persuasion). The bank is mandated to inspect and supervise the directives given to non-bank financial institutions and commercial bank. b) Name and explain the measures that the Central Bank of Kenya could take to maintain the value o the Kenyan Shilling: The Central Bank’s principal object is formulation and implementation of monetary policy directed to achieving and maintaining stability in the general level of prices.

The aim is to achieve stable prices – that is low inflation – and to sustain the value of the Kenya shilling. Following amendments to the law, Section 4 paragraph (4) provides that the Minister for Finance may by notice in writing to the Bank set the price stability targets of the Government. As is the case the world over, a central bank exists in a country to safeguard the value of its currency in terms of what it can purchase. When prices of goods and services in an economy keep on rising, the value of these goods and services that the currency can purchase –exchange for- diminishes.

This leads to loss in value of the currency. Monetary policy is the main tool used in the preservation of the value of the currency in an economy. It involves the control of liquidity circulating an economy to levels consistent with growth and price objectives set by the Government. The volume of liquidity in circulation influences the levels of interest rates, and thus the relative value of the local currency against other currencies. It is the responsibility of the Monetary Policy Committee to formulate the monetary policy of the Central Bank of Kenya.

Maintaining price stability is crucial for a proper functioning of a market-based economy. It encourages long-term investments and stability in the economy. Low and stable inflation refers to a price level that does not adversely affect the decisions of consumers and producers. Price stability is a precondition for achieving a wider economic goal of sustainable growth and employment. High rates of inflation lead to inefficiency in a market economy and, in the medium to longer term, to a lower rate of economic growth.

Movements in the general price level are influenced by the amount of money in circulation, and productivity of the various economic sectors, the Central Bank of Kenya regulates the growth of the total money stock to a level that is consistent with a predetermined economic growth target as specified by the Government and outline dinits monetary policy statements. There are three major tools the Bank uses to implement monetary policy: 1. Open Market Operations: Through open market operations, the Bank buys or sells securities in the secondary market in order to achieve a desired level of Bank reserves.

Alternatively, the Bank injects money into the economy through buying securities in exchange for money stock. As the law of supply and demand takes effect to determine the cost of credit (interest rates) in the money market, money stock adjusts itself to the desired level. This process influences availability of money in the economy. 2. Discount window operations: The Bank, as lender of last resort, may provide secured short-term loans to commercial banks on overnight basis at punitive rates, thus restricting banks to seek funding in the market resorting to Central Bank funds only as a last solution.

The discount rate is set by the Central Bank to reflect the monetary policy objectives. 3. Reserve Requirements: The Central Bank is empowered by the law to retain a certain proportion of commercial banks’ deposits to be held as non-interest bearing reserves at the Central Bank. An increase in reserve requirements restricts commercial banks ability to expand bank credit and the reverse is regarded as credit easing. 4. Moral Suasion: (cajoling certain market players to achieve specified outcomes) 5. “Open Mouth Operations”: (talking monetary policy with the market).