Shilling hits new low amid fresh political wrangles

The gradual recovery of the key sectors that are the source of dollar inflows is expected to hold the Kenya shilling steady despite recent political developments that have rattled the local currency.

The shilling on Tuesday touched an eight-month low against the US dollar but later recouped some losses, sparking concerns that unfolding events in the political arena could lead to a repeat of the wild currency swings last seen in early 2008.

In early morning trades commercial banks quoted the shilling at Sh77.50-70 to the dollar, compared with Monday’s close of Sh77.40-50 and Sh77.75-95, its weakest since June last year.

Currency dealers say that strong fundamentals that were virtually absent in the heady days following the post-election turmoil are evident as the Kenyan economy recovers.

The steady revival of Kenya’s tourism industry, resurgent global prices for tea and coffee and the resumption of demand for Kenya’s horticultural products in the EU stand to form a soft landing cushion for the Shilling.

“If we’re going by Kenyan politics, then there will always be some sort of noise. This never changes,” says Dickson Magecha, a member of the governing committee of the Financial Markets Association.

Still, political uncertainty remains a chink in the Kenyan economy’s armour with foreign investors quick to unwind their investment positions in East Africa’s largest economy leading to wild swings in the currency.

The Kenyan shilling is the second most liquid currency in Africa after the South African rand. Kenya also boasts of the having among the most developed stock and capital markets in the region.

The shilling’s fall however shows just how fragile business sentiment in the country is and highlights the heavy bearing political risk has on the country’s economic trajectory.

Vulnerable to shocks

The recent spat between President Mwai Kibaki and Prime Minister Raila Odinga over the suspension of two Cabinet ministers is the latest in a series of cracks witnessed within the grand coalition government.

“After the movements in 2007 and onto 2008, currency traders have been more averse,” says Mr Magecha.

The Kenya Shilling’s liquidity makes the currency more vulnerable to the shocks in the global financial markets.

According to Chris Muiga a senior dealer at KCB Bank, a 30 per cent depreciation in the value of the Kenya shilling back in 2008 could be attributed to a combination of offshore players exiting short US dollar positions after the Safaricom initial public offering coupled with a flight to safety by the same offshore players due to the global economic crisis.

While Kenya remains a net importer of oil, industrial machinery and vehicles – which would favour a strong Shilling, a weak currency means a higher value of earnings for exporters.

A higher currency value will make foreign goods and services relatively cheaper, stimulating imports, while domestic goods will seem relatively more expensive to foreigners, thus reducing exports.

If that trade deficit is viewed as a problem for the economy, the central bank may be pressured to intervene to reduce the value of the currency in the foreign exchange market and thereby reverse the rising trade deficit.   

International trade and investment decisions are much more difficult to make if the exchange rate value is changing rapidly.

If the exchange rate changes rapidly, up or down, traders and investors will become more uncertain about the profitability of trades and investments will likely reduce their international activities.

As a consequence, international traders and investors tend to prefer more stable exchange rates and will often pressure governments and central banks to intervene in the foreign exchange market whenever the exchange rate changes too rapidly.

Currency dealers say the ability of a central bank to raise the value of its currency through direct foreign exchange interventions remains limited.

In order for the CBK to buy dollars, it must have a stockpile of foreign exchange reserves.

Foreign exchange reserves are typically accumulated over time and held in case an intervention is desired.

Usable official foreign exchange reserves held by the Central Bank stood at $3.26 billion on Friday last week, compared with $3.28 billion in the first week of February.

While the CBK’s participation in the currency markets was frequent last year as the bank created demand for US dollars in the face of a strengthening Shilling, the Central Bank’s policy remains one of letting the free market economics of demand and supply dictate the direction of the local currency.