The Conduct of Monetary Policy
in East Africa In A Changing
Policy Environment
A Memorial Lecture In Honour of Prof Francis Mwega
By
Prof. Benno J. Ndulu

Outline
• Conduct of Monetary Policy in East Africa
• largely Successful
• Remarkably similar across countries – regional coherence
• Recent Striking Changes in the Behaviour of Monetary Aggregates and
prices in East Africa
• Sharp slow down of Monetary Growth
• Sharp Slow Down Of Private Sector Credit Growth;
• Sharp fall in money market rates - reflected in treasuries
• What Explains theses Changes?
• How Have East African Central Banks responded to these changes?
• What are the key risks to macro stability in the Near and Medium Term?

I. Conduct of Monetary Policy in the EAC
Largely Successful
Two key sets of indicators for measuring such success
• The first relates to achievement of the core mandates of the central
banks - price stability
• Inflation for domestic prices
• Exchange rates for price of tradables
• Secondly, Success is also deduced from ability to ride through major
shocks to enable the economies continue on a path of sustained growth
after brief disruption

Inflation trends in selected EAC countries
Since 2013 Inflation
HeadlineiInflation
rates have
Tanzania Kenya Uganda Rwanda
remained subdued
Burundi Lower limit Upper limit
and within EAC

convergence band
save for Burundi 25
recently, mainly due

to successful
t
conduct of n
e 15
c
r
monetary policy e
P
helped along by 10
stability of oil

prices, and
improved food

supply 0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
c r n p c r n p c r n p c r n p c r n p c r n p c r n p c
e a u e e a u e e a u e e a u e e a u e e a u e e a u e e
D M J S D M J S D M J S D M J S D M J S D M J S D M J S D

Nominal exchange rate index – Reasonably Stable save for
Corrections For Shocks
- Reasonably stable
Nominal exchange rate index (2010=100)
path with correction Tanzania Kenya Uganda Rwanda

for shocks

- Real effective

Exchange rates

Stable
x
e 130
d
- Larger correction n I

in countries purs-

uing more

flexible exch rate

regime 0 1 1 1 1 1 1 1 1 1 2 1 2 1 2 1 2 1 3 1 3 1 3 1 3 1 4 1 4 1 4 1 4 1 5 1 5 1 5 1 5 1 6 1 6 1 6 1 6 1 7 1 7 1 7 1 7 1
- c - r -n - p - c - r -n - p - c - r -n - p - c - r - n - p - c - r - n - p - c - r -n - p - c - r -n - p - c
e D a M u J e S e D a M u J e S e D a M u J e S e D a M u J e S e D a M u J e S e D a M u J e S e D a M u J e S e D

Real GDP performance in selected EAC countries
Real GDP Growth in EAC Countries
Percent
2008 2009 2010 2011 2012 2013 2014 2015 2016
• Growth in the region was strong and
Burundi 4.9 3.8 5.1 4.0 4.4 4.9 4.5 -3.9 0.9
robust supported by public investment in
Kenya 0.2 3.3 8.4 6.1 4.6 5.7 5.3 5.6 6.0
infrastructure, favourable commodity
Rwanda 11.1 6.3 7.3 7.8 8.8 4.7 7.0 6.9 6.0
prices, subdued global oil prices and
Tanzania 5.6 5.4 6.4 7.9 5.1 7.3 7.0 7.0 7.0
favourable weather condition.
Uganda 10.4 6.9 8.2 5.9 3.2 4.7 4.9 5.5 4.8
Sources: African Economic Outlook, 2017 and National Bureau of Statistics • Growth in the region has remained
resilient to shocks, quickly recovering after
EAC QUARTERLY GDP GROWTH each shock – with robust macrostability
Percent
Country 2013 2014 2015 2016 2017
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Uganda 3.4 4.6 3.9 4.1 5.8 7.0 1.4 8.4 5.7 5.6 6.2 5.3 4.1 2.9 1.2 2.0 3.9 6.5 7.5
Rwanda 4.5 7.7 2.7 4.1 7.4 5.9 10.5 6.7 8.0 9.3 8.1 10.0 8.9 7.5 5.4 2.4 1.7 4.0 8.0
Kenya 6.1 7.5 6.4 3.5 5.2 6.0 4.6 5.6 5.8 5.6 6.1 5.5 5.3 6.2 5.7 6.1 4.7 5.0 4.4
Tanzania 6.2 5.9 7.3 9.7 7.8 9.8 5.7 4.4 6.5 6.5 6.8 8.2 6.9 8.5 6.6 5.5 5.7 7.8 6.8
EAC Average 5.1 6.4 5.1 5.3 6.6 7.2 5.5 6.3 6.5 6.8 6.8 7.3 6.3 6.3 4.7 4.0 4.0 5.8 6.7
Sources: National Bureau of Statistics 6

Managing Shocks for Sustained Macrostability
• Since 2008 the region managed to ride through three major shocks with
consequence on macrostablity
• Global Financial Crisis (2009) – the biggest shock with impacts transmitted through
a spike in exchange rates (heightened by speculative attacks) and through a global
economic recession
• The Euro Crisis (2011/12) again transmitted mainly through spike in exchange rates
and its impact on lengthening the period of recovery from GFC recession
• Commodity Price Collapse (2014/15) with its effect transmitted mainly via pressure
on exchange rates
• Judging from the short duration of stress from each shock – short lived
inflationary and exchange rate spikes and quick recovery of growth –
Management of shocks was quite successful.

Remarkable Similarity Across Countries in the Path of
Monetary Aggregates and Price Indicators Across the
Region
It is not by accident – the region is on a path to Monetary Union and
the Central banks via MAC have actively coordinated approaches and
action
• Harmonization in the approaches to the conduct of monetary policy has
strengthened over time.
• Coordination of responses to common shocks e.g. Global Financial Crisis

• Cross border operations of regional and international banks has
necessitated coordination in regulation and handling of common challenges.
• Exchange of information and data has facilitated this coordination

II. Recent Significant Developments in the Path
of Monetary Aggregates and Prices
• Sharp slow down of Growth Rates of all Monetary Aggregates
• A Virtual Collapse of growth of Credit to the Private Sector – mainly
driven by a spike in the risk premium as indicated by spikes in Nonperforming loans across the region
• Sharp decline in yields in the market for treasuries a key benchmark
for other financial prices
• But lending Rates stayed strikingly stable or rose widening the gap
between treasuries and lending rates in most countries

EAC money supply Growth Trends
• Growth of
Annual growth of M3
money
Tanzania Kenya Uganda Rwanda
supply

tracks
Inflation

reasonably

well

• It has now
begun to t 25
n
e
c
pick up in r
e 20
P
some of the

EAC
countries 10
after sharp

deceleration

over the last
0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
two years - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
c r n p c r n p c r n p c r n p c r n p c r n p c r n p c
e a u e e a u e e a u e e a u e e a u e e a u e e a u e e
D M J S D M J S D M J S D M J S D M J S D M J S D M J S D

Growth of Credit to the Private sector has
slowed down sharply
Annual growth of credit to the private sector
Tanzania Kenya Uganda Rwanda

t
n
e 20
c
r
e
P

-10
0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
c r n p c r n p c r n p c r n p c r n p c r n p c r n p c
e a u e e a u e e a u e e a u e e a u e e a u e e a u e e
D M J S D M J S D M J S D M J S D M J S D M J S D M J S D

Sharp Rise in NPLS Has Raised Risk Premium
Tanzania NPLs/gross Loans Kenya NPLs/gross Loans Uganda NPLs/gross Loans Rwanda NPLs/gross Loans

t
n
e
c
r
e
P

1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
- - - - - - - - - - - - - - - - - - - - - - - - - -
p c r n p c r n p c r n p c r n p c r n p c r n p c
e e a u e e a u e e a u e e a u e e a u e e a u e e
S D M J S D M J S D M J S D M J S D M J S D M J S D

EAC money market interest rates Declined Sharply Reflecting
Flight to Safety of Government Paper
91-day T-bill rate 182-day T-bill rate
Tanzania Kenya Uganda Rwanda Tanzania Kenya Uganda Rwanda
25 30

t t
n n
e e 15
c c
r r
e e
P P

0 0
0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7 0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
c r n p c r n p c r n p c r n p c r n p c r n p c r n p c c r n p c r n p c r n p c r n p c r n p c r n p c r n p c
e a u e e a u e e a u e e a u e e a u e e a u e e a u e e e a u e e a u e e a u e e a u e e a u e e a u e e a u e e
D M J S D M J S D M J S D M J S D M J S D M J S D M J S D D M J S D M J S D M J S D M J S D M J S D M J S D M J S D
• Countries in the EAC which are more open to global market, experience
relatively large swings in money market interest rates e.g. Uganda

EAC money market and commercial banks interest rates
TZ 364-day WAY TZ Central Bank rate KE 364-day WAY KE Central Bank rate
TZ Overall Time Deposit Rate TZ Overall Lending Rate KE Overall Time Deposit Rate KE Overall Lending Rate
TZ Interbank rate KE Interbank rate
35 35
30 30
25 25
t n 20 t n 20
e e
c c
r e 15 r e 15
P P
10 10
5 5
0 0
0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 7 7 7 0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
-c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c -c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c -r -g -c
e p u e p u e p u e p u e p u e p u e p u e e p u e p u e p u e p u e p u e p u e p u e
D A A D A A D A A D A A D A A D A A D A A D D A A D A A D A A D A A D A A D A A D A A D
UG 364-day WAY UG Central Bank rate RW 364-day WAY RW Central Bank rate
UG Overall Time Deposit Rate UG Overall Lending Rate RW Overall Time Deposit Rate RW Overall Lending Rate
UG Interbank rate RW Interbank rate
30 20

20 14
t n t n 12
e c r e P 15 e c r e P 1 8 0

5 4

0 0
0 1 -c
e D
1 1 -r
p A
1 1 -g
u A
1 1 -c
e D
2 1 -r
p A
2 1 -g
u A
2 1 -c
e D
3 1 -r
p A
3 1 -g
u A
3 1 -c
e D
4 1 -r
p A
4 1 -g
u A
4 1 -c
e D
5 1 -r
p A
5 1 -g
u A
5 1 -c
e D
6 1 -r
p A
6 1 -g
u A
6 1 -c
e D
7 1 -r
p A
7 1 -g
u A
7 1 -c
e D
0 1 -c
e D
1 1 -r
p A
1 1 -g
u A
1 1 -c
e D
2 1 -r
p A
2 1 -g
u A
2 1 -c
e D
3 1 -r
p A
3 1 -g
u A
3 1 -c
e D
4 1 -r
p A
4 1 -g
u A
4 1 -c
e D
5 1 -r
p A
5 1 -g
u A
5 1 -c
e D
6 1 -r
p A
6 1 -g
u A
6 1 -c
e D 14
7 1 -r
p A
7 1 -g
u A
7 1 -c
e D

But Lending Rates Have stayed Stubbornly
High
• Notwithstanding sharp decline in interbank cash market rate and
Treasuries’ market rates lending rates have stayed stubbornly high.
In Tanzania they even rose slightly. In Kenya they moved down but
not significantly.
• To a large extent this is due sharp rise in NPLS raising risk premiums
• Risk-adjusted rates followed suit or stayed stubbornly above
declining cost of funds or declining market rates

The Gap between Lending Rates and market
Rates Has Widened
• Interbank Cash market rates have fallen sharply in line with with
Central Bank easy monetary policy – Response from banks has been
to use this position to lend to Governments or accumulate liquidity
in the form of excess reserves in the Central Banks
• With high NPLS banks have
• slowed down credit to the private sector
• Lent more to each other driving rates down
• Increased demand for govt paper, way beyond govt needs (heavy
oversubscriptions driving maket rates down.

III. Major Changes Impacting the Conduct of
Monetary Policy
• More Frequent Supply Side shocks with exogeneous impact on
Inflation
• Sharp Rise in Transaction Velocity of Circulation with the advent of
mobile Money
• Dilution of Fiscal Dominance
• Changes in the approach to conducting monetary policy – From
Targeting Quantities to Targeting Prices

Transaction velocity of money in the EA Region
• The impact of
Transaction Velocity
slow growth in
Tanzania Kenya Uganda Rwanda
monetary

aggregates was
partly reduced

by rising
transaction

velocity of
money

associated with
ongoing financial

innovations and
technological

1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7
dividend 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1
- - - - - - - - - - - - - - - - -
c c c c c c c c c c c c c c c c c
e e e e e e e e e e e e e e e e e
D D D D D D D D D D D D D D D D D

The main Imperatives of Monetary Policy
Implementation have changed significantly
• In 2008 when I became Governor of the Bank of Tazania – our main preoccupation was
mopping up liquidity from the system to reduce Inflationary pressure.
• Fiscal dominance = Govt busy injecting via spending foreign savings and the Central
Bank mopping up excess liquidity arising from this
• Currently fiscal Dominance significantly diluted
• Government greater reliance on domestic revenue means enhanced neutrality in monetary
effects of govt operations – withdraw liquidity when collecting Revenue and injecting liquidity
when spending it
• Significant proportion of foreign savings – via grants or loans spent on big projects meant
leakages via imports of goods and services and fees
• Loans given in kind – i.e. with no cash transfer for big projects also meant less liquidity
injections
• Central Banks have been pushed to rely more on their own instruments to provide liquidity e.g.
via repos, purchase of forex from the market etc – depth and efficacy of financial markets key
challenges for effectiveness of transmission mechanisms

Fiscal Operations Much less Liquidity Injecting
• Sharp decline in liquidity injecting financing as donor budget
support sharply decreased, and non-concessional borrowing also
slowed down with increase in the cost of borrowing
• Loans given in kind are not-liquidity injecting – many Chinesefunded infrastructure loans are in that form (Rail in Kenya; Gas
pipeline in Tanzania)
• Dominance of large infrastructure projects in the development
budget – where foreign firms dominate in securing contracts=
means large leakages in the multiplier effects
• As the share of development budget rises these leakages become
more pronounced

Those countries that have shifted to price-based conduct
of monetary Policy Policy Rate tracks Markets better
• They use policy rates more actively
• They track short term rates more accurately
• But not long term rates

EAC Policy rates and short-term money market interest rates
TZ Central Bank rate TZ Repo rate TZ Interbank rate KE Central Bank rate KE Repo rate KE Interbank rate
35 35
30 30
25 25
tn 20 tn 20
e e
c c
r r
e P 15 e P 15
10 10
5 5
0 0
0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 7 7 7 0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 7 7 7
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
-r
p
-g
u
-c
e
D A A D A A D A A D A A D A A D A A D A A D D A A D A A D A A D A A D A A D A A D A A D
UG Central Bank rate UG Repo rate UG Interbank rate RW Central Bank rate RW Repo rate RW Interbank rate
30 14

tn
e c r e P 15
tn
e c r e P 6

5 2
0 0
0 1 -c
e D
1 1 -r
p A
1 1 -g
u A
1 1 -c
e D
2 1 -r
p A
2 1 -g
u A
2 1 -c
e D
3 1 -r
p A
3 1 -g
u A
3 1 -c
e D
4 1 -r
p A
4 1 -g
u A
4 1 -c
e D
5 1 -r
p A
5 1 -g
u A
5 1 -c
e D
6 1 -r
p A
6 1 -g
u A
6 1 -c
e D
7 1 -r
p A
7 1 -g
u A
7 1 -c
e D
0 1 -c
e D
1 1 -r
p A
1 1 -g
u A
1 1 -c
e D
2 1 -r
p A
2 1 -g
u A
2 1 -c
e D
3 1 -r
p A
3 1 -g
u A
3 1 -c
e D
4 1 -r
p A
4 1 -g
u A
4 1 -c
e D
5 1 -r
p A
5 1 -g
u A
5 1 -c
e D
6 1 -r
p A
6 1 -g
u A
6 1 -c
e D
22 7 1 -r
p A
7 1 -g
u A
7 1 -c
e D

IV. Major Macrostability Risks Going Forward
• Independence of Central Banks to pursue price stability and protect
the value of the local currency
• Tendency to fix interest rates, a key price of monetary policy blunts
efficacy of monetary policy transmission
• Debt Sustainability / Debt distress
• Unsustainable levels of borrowing
• Risks from Currency mismatch in major borrowing for infrastructure big
push (borrowing for non-tradable services
• Risks from Maturity mismatch for major infrastructure investment
• End of Quantitative Easing in US to be followed by Europe

Rising Challenges to Central Bank
Independence
• Notwithstanding the fact that independence/autonomy of central
bank independence is enshrined in Constitutions and Law there are
frequent operational challenges to this independence
• Interest rate controls and directed credit – most frequent pressure
in the region – more on this in the next slide
• Rising capital inadequacy and dependence on fiscal subventions will
undermine autonomy and separation of fiscal and monetary policy
mandates
• Almost a decade of very low returns/yields to central bank foreign
investment due to quantitative easing have eroded capital adequacy of
central banks and exposed them to risk of dependence on subventions

Deliberate Policy Interventions to Promote
Credit by Lowering Rates Unfruitful
• Tying lending rates to policy rates is at best tenuous. Objectives of policy rates
are related to price stability – while capping interest rates targets affordability
of lending rates
• It is also likely that those who least can afford high interest rates may be
skewed out of credit market by higher risk assessment rather than simply
interest rates – e.g. those who benefited for unsecured credit – e.g. Mkesho,
Mpawa
• Interest Controls are not new, they were tried across the region in the past, and
the ensuing rationing of credit at set rates disproportionately skewed out those
who were targeted most for help driving them to loan sharks
• Interventions that target reduction of risk premium or requirements for
expensive collateral – e.g. credit scoring system based on mobile telephony and
mobile money usage – would be most effective solutions instead.

Debt Sustainability Challenges – Are we
borrowing too much?
• Based on DSA carried out for each of the East African member
countries External debt and Total public debt are broadly within the
acceptable int’l thresholds and EAC limit of PV of debt at 50%
• None is currently already at risk of distress
• Nevertheless recent build up has been rapid with higher cost and
shorter maturities as non-concessional borrowing increased faster
than debt stock
• PV of Kenya’s total public debt ratio to GDP has approached the 50%
mark (although there are disputes for discount rate for domestic
debt) and could breach the threshold for sustainable debt

The Risks from Currency Mismatch
• The Greater risk is that from currency mismatch (liquidity risk)
• Loans for large infrastructure projects (transport, power, water
communications) are contracted in foreign currency and have to be
repaid in the same
• But revenue streams from these investments are in local currency and
servicing to a large extent depends on growth of export sector.
• Unless these investments accelerate growth of exports, a country may
face challenges in externalizing debt service even if there is enough
revenue from these investments
• Hope lies in getting oil and gas exports to start flowing early to boost
foreign exchange earnings

The Risks of Maturity Mismatch
• Some debts start getting repaid even before investment is complete
• This is particularly the case for debt contracted in the capital
markets – usually medium term in maturity
• This mismatch in timing leads to a “solvency” risk – no revenue
available to service the debt
• Large and lengthy gestation period projects = such as standard
gauge railway if funded this way could spell out such risk for the
countries concerned
• This is particularly troublesome if debt has to be rolled over at
higher cost.

End of Quantitative Easing and Rise in interest
Rates
• USA is already moving full steam to reversal while Europe is winding
down QE. Two major impacts are worrisome vis a vis macrostability
• Reversal of capital flows back to USA and Europe to take advantage
of higher returns and reduced risks – likely to engender
• significant pressures on and volatility of exchange rate and
• tightening of liquidity particularly if foreign currency denominated deposits
decline and subdues liquidity injection via inflows of foreign savings
• Initial large negative effect on central bank income via revaluation
losses as price of its foreign assets decline with rise in interest rate -
engendering inadequacy of capital and thraeat central bank
independence.

Concluding Remarks
• The conduct of monetary policy in the region has been overall
successful
• Part of this success can be attributed to letting Central Banks pursue
its mandates unencumbered
• Sustaining this success will partly depend on
• Protecting the independence of central banks to implement its mandate
• Improve accountability of central banks for its actions – including more
effective communication of its activity
• Stronger capacity and flexibility to manage response to shocks
• Let us sustain regional coordination and coherence of policy and
action in response to shocks and in this era of cross-border banking.