Kenya's Parliament has repealed its cap on the lending rate for banks, a move that is anticipated to boost business activity and economic growth in the East African nation.
Parliament last week failed to secure the two-thirds majority required to force through the Finance Bill 2019 with the limit intact, after President Uhuru Kenyatta refused its assent.
Kenyatta's government in September 2016 capped interest rates chargeable by banks at no more than 4% of the base rate set by the Central Bank of Kenya (CBK).
The cap was intended to address poor affordability and availability of credit to working people, and was popular politically in a society where consumer debt levels are increasing.
But in a memo last month, the president bemoaned its unintended consequences of reducing credit to the private sector, damaging economic growth and weakening the effectiveness of monetary policy, and refused to assent its renewal.
The International Monetary Fund (IMF) had also identified the repeal of the commercial lending cap as a condition for Kenya to be granted an extension to its standby credit facility.
Discussions were held in Nairobi in December 2018 to explore the possibility of a new arrangement.
"Agreement was not reached at that time, but the IMF has remained engaged in discussions with the authorities on a policy mix that will allow Kenya to maintain macroeconomic and debt stability while protecting developmental spending in support of inclusive growth," an IMF spokesperson told CNBC on Tuesday.
"The recent repeal of the interest rate cap is welcome, as it should help spur bank lending, especially in the SME sector. It is, however, just a part of the policy mix. The focus is now on raising revenue to reduce the fiscal deficit while protecting investment and other priority spending."
"As the IMF and CBK had warned, the cap made banks much less willing to lend, and the weight of this fell disproportionately on poorer or riskier borrowers, who banks weren't willing to lend to at artificially low lending rates," John Ashbourne, senior emerging markets economist at Capital Economics, told CNBC.
"This caused the growth of private sector lending to slow, limiting credit to the economy and preventing businesses from borrowing to invest."
The cap removal is expected to free up capital for higher-risk entrepreneurial activity and core business activity, according to Marshall Stocker, vice president and director of country research at investment firm Eaton Vance.
"The rate cap was remarkably restrictive and the unintended consequence was that banks diverted their investments into Kenyan government liabilities and away from all but the most creditworthy private sector activities," Stocker told CNBC.
CBK Governor Patrick Njoroge told Reuters on Tuesday that the repeal has provided "clarity" to the Monetary Policy Committee (MPC), which had been prevented from cutting rates due to concerns about a "perverse" monetary reaction due to the lending cap.
"We were of the view that when Kenyan monetary policy rates were lowered, the result was actually a contractionary impact to the economy since the maximum lending rate would also drop when rates were cut, making investments in risk-based assets, those which are in the real economy, even less attractive," Stocker explained.
But despite pressure from the CBK, the IMF and domestic lenders causing the government to change course on the cap, its repeal had continued to face significant opposition in Parliament.
"While the cap was causing serious harm to the economy, it also created winners among people who were able to access credit — a special interest group that was able to organize itself in support of the law," Ashbourne explained.
Stocker suggested that the delay in removing caps stemmed from legislative bodies being "blind" to the unintended consequences of their well-intentioned policymaking.
"To paraphrase a colorful saying: the road to economic mismanagement is paved with good intention," Stocker said.
"This is not the first time rate caps have failed. They've actually failed in every example I can think of. I'd recommend parliaments around the world take pause to consider the grand history of economic policy mistakes so as to avoid repeating the mistakes of others."
On the day Kenyatta's refusal to assent the Finance Bill was published, eight of the 10 bank stocks listed on the Nairobi Securities Exchange surged.
According to Kenya-based newspaper Business Daily, NCBA Group, the recently listed merger between domestic banks NIC and CBA in which the Kenyatta family reportedly has a 13.2% stake, gained 8.5% while shares of I&M Bank jumped 8.8%.