How a strong Yuan may affect Kenyan consumers

Kenyan consumers may be headed for a period of pricing turbulence as the economy adjusts to a much stronger Chinese currency whose peg to the dollar has been a key anchor against global inflation.

The Bank of China on Saturday announced that it was ditching the policy of pegging the Yuan against the dollar, ending nearly four years of a trade spat with the US and Europe and buoying stock markets around the globe.

Economists said appreciation of the Yuan could have far reaching effects on Kenya, raising the cost of Chinese imports and increasing the public debt burden.

“This new policy means that China will allow market forces to determine the direction of the exchange rate,” said John Akoten, an economist.

Depending on how fast Beijing moves with the new exchange rate policy, Kenyan manufacturers, who have had to shield every inch of their domestic market against swamping by cheap goods from China, could get a new lease of life as Chinese goods begin to cost more.

“A better priced Yuan should raise the cost of Chinese goods, erode their competitiveness in foreign markets and allow our manufacturing sector to compete,” said Mr Polycarp Igathe, the managing director of Haco Industries.

Economists however warned that the pricing relief for local manufacturers could be short lived.

“A flexible Yuan could disrupt the flow of trade between Kenya and China as the cost of capital goods imports that are mostly dollar-denominated rises, pushing up the cost of production in Kenya and eroding all the possible gains in consumer market,” said Dr Samuel Nyandemo, a senior lecturer of Economics at School of Economics University of Nairobi.

Dr Akoten reckons that any substantial loss in business could see Beijing take deliberate steps to reduce the price margins for Chinese goods to retain the market share.

Other possible lines of action for China include offering subsidy to manufacturers to increase their competitiveness in the global market.

The biggest loser in Beijing’s currency policy change could however be government, which will bear a heavier debt burden should the Yuan appreciate significantly.

A strong Yuan means Treasury will need more dollars to service the Chinese debt – especially because most of the debt is dollar -denominated and it will take more dollars to buy the Yuan.

The Yuan has been pegged to the dollar at the rate of 6.83 since 2008 a move that has soured relations between China and its biggest trading partners – the US and European Union.

Little change in the balance of trade is expected because the volume of Kenya’s imports from China is set to continue growing in the medium term bending the tilt in favour of the Asian nation.

“The balance of trade will continue to be in favour of China as we import more from them than we export,” said Judd Murungi, the head of research at CFC Stanbic Financial Services.

“We can only expect a change if the appreciation continues to a level that substantially impacts on the cost of the capital goods forcing importers to shift to other source markets.”

The shilling has been trading at the rate of Sh11.83 to the Yuan and moved marginally to a rate of Sh11.9 following the decision to ditch the dollar pegging policy.

Joshua Anene, a currency dealer with CBA Bank, said the immediate result of Beijing’s currency policy shift may be flight by traders from riskier basket of currencies such as the shilling making the Yuan even more expensive.

Economists welcomed China’s currency policy change as positive, saying it could only improve trading relations between major powers.

“Anything that helps promote a healthy relationship between China and the US is important for the global economy,” said Sandy Mehta, the principal and chief investment officer at New York-based Value Investment Principals.

Major European and Asian stock market indices closed higher on June 21 while in the US, major market benchmarks were narrowly lower.

Although commodity markets were mixed on Monday, a Yuan revaluation is expected to eventually push prices of oil, metal, and other materials higher.

“With a stronger currency, the Chinese can buy more commodities,” said Mr Mehta.

Chinese companies can buy other things, too — including foreign companies, real estate, stocks and other investments.

“You’ll see acquisitions being made all across the spectrum,” says Randy Bateman, president of Huntington Asset Advisors.

Key targets for Chinese mergers and acquisitions, he says, could be companies specialising in energy, materials, or technology.

A stronger currency could also help develop China’s consumer market as the Yuan enables the Chinese to buy more products from the US and elsewhere, Lincoln says.

In particular, he says, there could be demand for consumer and health-care products.

The change of policy is also expected to bring to a close China’s role as an anchor of consumer goods pricing across the globe.

Between 2005 and September 2008 as economic activity rose to a peak across the globe causing fears of price surges, China, with its large exports of cheap goods was credited with keeping consumer goods within the reach of most households saving governments and policy makers the pain of inflation-driven unrest.

But economists now say this could be a turning point in which China gets its own inflation under control while raising prices—both of commodities and its exported manufacturing goods—for the rest of the world.

“This is the beginning of a long process where China stops exporting deflation and starts exporting inflation,” he said.

Trade between Kenya and China has been growing steadily helped by Kenya’s importation of capital goods from the Asian nation.

The value of Kenyan imports from China rose to Sh74.5 billion last year, a threefold rise from Sh23 billion in 2005 compared to exports worth Sh2.49 billion in 2009 from Sh1.29 billion in 2005.

Kenya’s imports from China include telecommunications equipment, office machinery, industrial machinery, motor cycles, rubber tyres and flat rolled products of iron and steels. Kenya export to China is largely tea which is used for blending.

China has become the second most important source of non-oil imports to Kenya after India — replacing traditional markets such as the UK, Japan and US.

Globally, a more flexible Yuan is however expected to increase the cost of Chinese imports sparking a trade realignment process with India, Malaysia, Taiwan and Japan as the major beneficiaries.

Although Beijing made the exchange rate policy shift announcement on Saturday, it gave few details on how rapidly it would be implemented.

Few observers expect quick moves, pointing to the fact that communist China rarely changes economic policies in a dramatic fashion.

“Rather, Chinese officials prefer to move in a very deliberate fashion to minimize the probability of negative shocks to the economy,” Wells Fargo global economist Jay Bryson said in a June 21 note.

This means that the actual effect of this policy shift may take longer (an average of three years) to filter into the Kenyan economy.

China’s position as a development financier in Kenya has continued to grow since President Kibaki came to power in 2003.

Beijing is, for instance, the main financier of major infrastructure projects such as the ongoing construction of the Nairobi-Thika Highway, the Nairobi-Namanga road, Nairobi-Oloitokitok road and the Nakuru-Eldoret highway.

The Chinese government is a partner in the ongoing expansion and modernisation of Nairobi’s Jomo Kenyatta International Airport.

And in a recent visit to China, President Kibaki signed a new funding agreement for the construction of the Lamu Port which is expected to improve Kenya’s maritime business.

In the next financial year of 2010-2011 Kenya is expecting Sh16.79 billion financing from the Chinese government, making it the single largest bilateral donor to the country.

The funds will be used for the Nairobi-Thika Highway improvement project, Nairobi Eastern and Northern Bypass project and drilling of Olkaria IV Geothermal wells.