Kenya’s Strengthening Shilling

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By Derek Mutiso

Financial Peculiarities or Reason for Celebration?

The Central Bank of Kenya (CBK) chose to maintain its interest rate at 13% in April 2024, signalling a potential future decrease in lending rates. A backdrop of easing inflation and a strengthening Kenyan shilling against major global currencies guided this decision. 

With inflation trends declining to 5.7%, the lowest in two years, mainly due to reduced costs of essential food items, the CBK’s Monetary Policy Committee (MPC) maintains cautious optimism despite these positive shifts.

The appreciation of the Kenyan Shilling by 18% has played a crucial role in alleviating inflationary pressures stemming from imports. This increase in the Shilling’s value, particularly against the dollar, notably observed between February and March, reflects positively on the economy’s currency strength.

Looking at broader economic performance, leading indicators point towards a robust performance in the first quarter of 2024, propelled by agriculture, services, and ICT sectors. 

The CBK anticipates this momentum to persist, with forecasts suggesting a decrease in food prices over the next three months. This optimistic outlook is attributed to favourable weather conditions, a stronger shilling, and declining fuel prices.

However, concerns have been raised regarding the source of dollars circulating in the market, highlighting that these funds have been borrowed rather than earned through increased exports, productivity, or GDP growth. 

This highlights the significance of adopting sustainable economic growth strategies to reduce reliance on borrowed funds, and underlines the importance of a balanced approach to economic development.”

The question in many people’s minds is, how did this shilling bounce-back happen, and how sustainable it is in the long term.


Kenya’s Exchange Rate System

A good starting point is Kenya’s exchange rate system. An exchange rate system is used to determine the value of various currencies in relation to each other. It is essential in deciding trade and capital flow dynamics.

Kenya uses a floating exchange rate system. This means the value of our currency is determined by the global foreign exchange market and influenced by the interplay of supply and demand for various other currencies. A floating exchange rate operates without trade restrictions or direct government intervention.

Floating exchange rates are susceptible to rapid changes. From time to time, they exhibit significant volatility. The value of a currency can decline within a single day of trading. Factors like exports, foreign investment, and remittances from the diaspora bring about financial inflows to Kenya. For example, suppose the price of tea in the international market goes up. In that case, the demand for Kenya Shillings will also increase, driven by tea exporters who convert their foreign earnings into local currency. A rise in demand for a currency usually leads to an increase in its value.

On the supply end, some key components contribute to the supply of the Kenya shilling:

  1. Value of Imports: When Kenya imports goods and services from abroad, it must pay in foreign currency. Therefore, the more we import, the more we need to exchange our currency for foreign currency. This increases the supply of the Shilling in the foreign exchange market.
  • Outbound Transfers include various outbound financial transactions, such as pension payments to retired expatriates living abroad. These transactions require converting the local currency into foreign currency, increasing the supply of the local currency in the foreign exchange market, and reducing its value.

  3. Value of Investments Abroad: When Kenyan residents invest in assets abroad, such as buying shares in foreign companies, they exchange the Shilling for foreign currency to make these investments. This increases the supply of the local currency in the foreign exchange market and reduces its value.

These factors, among others, collectively influence the supply of a currency in the foreign exchange market and contribute to the dynamics of exchange rate movements.

Interest rates, inflation, and GDP also influence international money flows. If interest rates decline in Kenya, it becomes cheaper for businesses to borrow money for investment purposes. This increased investment can lead to higher economic production in Kenya. As a result, more goods are produced and sold, both domestically and internationally. Increased exports boost the demand for the local currency (the Shilling), causing it to appreciate against other currencies.

However, considering the Kenyan government borrowing abroad, the situation becomes more complex. Initially, increased borrowing can lead to an appreciation of the local currency, as it boosts foreign currency reserves. However, this also raises concerns about the country’s ability to repay its debts, potentially leading to expectations of higher future debt payments. This anticipation may lead to a reversal in the currency appreciation as investors become more cautious.

Why Has the Kenya Shilling Strengthened Against the Dollar?

Some experts believe the Kenya shilling’s recent rise boils down to speculation. Leading Kenyan economist and business consultant Dr Alex Kamau is one of them. In a recent interview aired by Spice FM, Kamau explained that a section of investors in the Kenyan market had been holding on to dollars, expecting them to increase in value.

These investors expected that the Kenyan government would seek dollars locally to meet Eurobond commitments coming up in June this year. That, however, did not happen. The government chose to instead source the dollars externally as a loan. This move caused a sudden influx of foreign currency in the local economy, strengthening the Shilling.

Kamau believes that the current position of the Shilling against the dollar may be temporary. Kenya, after all, is a net importer of goods — and as time goes by, we will deplete our surplus reserves of the dollar, and the Shilling may fall once again. 

Kamau is not alone in his scepticism; he is but one in a group of analysts who believe that by June 2024, when the 2 billion USD Eurobond commitment falls due, the excess dollars in the economy will vanish. 

From an economic point of view, these claims make sense because the dollars recently injected into the economy weren’t due to increased production in Kenya; they have yet to be earned through increased exports to other countries. 

The appreciation of the Kenyan Shilling against the Ugandan shilling is linked to its gain against the dollar. Instead of acquiring dollars directly, Ugandans purchase Kenya shillings and then exchange them for dollars.

What To Hope For In Coming Months 

The recent floods were unexpected and have led to massive economic losses across the board. The true extent of these losses is yet to be documented, as the rains are still ongoing.

During the last major floods in 2018, the government had to allocate US$120 million to repair and maintain road infrastructure. iAfrica researchers revealed that about 40,000 acres of farmland have been affected compared to 21,000 acres in 2018. The government must now plan for further policies and funds to stimulate the agricultural sector and economic growth.

Government spending on development has contracted due to the current regime’s focus on debt repayment. There has been a notable decrease in the prices of consumer goods locally. However, this may also indicate a drop in demand due to reduced incomes brought about by external forces and domestic ones like increased taxes like PAYE and deductions such as NSSF. 

So far, the government is headed in the right direction in some respects. The 2014 Eurobond’s structure, featuring a single bullet payment in 2024, could have been more optimal. Kenya also has gotten a raw deal during negotiations, considering countries like Ivory Coast and Benin managed to get more favourable rates for  their bonds, despite them being in a weaker position than Kenya economically. 

Subsequent Eurobonds, such as the recent 1.5 billion USD negotiated by the current regime, have spread repayments across three instalments in an effort to mitigate sudden economic shocks. Regarding an early Eurobond repayment this year, there’s little benefit as the excess dollars in the market can still be profitably invested before repayment is due in June.

It is a difficult time to sit at the steering wheel of our great nation. Still, with robust policies and good governance, we will wade ourselves out of the murky waters of indebtedness and economic uncertainty. As an investor, it’s prudent to closely monitor the markets and stay prepared for any eventualities.

The author is a business writer and project coordinator, Omeriye Foundation[email protected]


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