A weaker Kenya shilling is key to exports growth

Following last year’s high inflation and rapid depreciation of the Kenya shilling, the International Monetary Fund (IMF) was reported to have recently advised the government to adopt “inflation targeting” to restore Kenya’s macroeconomic stability.

This implies that the Central Bank of Kenya is being persuaded to set a specific inflation target and adopt measure that will ensure this goal is achieved.

Persuasion is one thing, but given that the government has a stand-by facility with IMF, the CBK may be more under pressure to adopt the IMF thinking than freely decide whether or not to take the advise as it deems fit.

The Kenyan economy is currently in a fragile state and lacks the economic and institutional fundamentals that would make “inflation targeting” work.

The greatest distress comes from the external sector, especially from oil and manufactured goods.

High oil prices continue to stress the country’s forex reserves, leading to a domestic price spiral and high interest rates.

The export sector remains weak due to low incentives, high cost of doing business and poor terms of trade for export commodities.

These are the real causes of high inflation and rapid depreciation of the shilling.

The exchange rate is the economy’s link to the global economy and the best way for the government to stimulate forex inflows is to have a realistic exchange rate that reflects the present economic reality and future expectations.
In this respect, the monetary authorities should focus attention on the export sector and other activities that will increase foreign inflows, such as tourism and diaspora remittances.

The simple prescription for this is a weaker shilling, which is necessary to stimulate exports by encouraging manufacturers to export more to earn hard currency that will translate into more shillings to cover their domestic costs.

Moreover, a weaker shilling will discourage non essential imports, especially conspicuous consumption, which will be more expensive to finance.

It will also encourage more Kenyans in the diaspora to remit funds home for investment in real estate, as well as in money and securities markets instruments.. Last year remittances totalled $891m and with the right incentives, a target of $1bn can easily be achieved in the future. Remittances would become be the largest source of foreign direct investment.

Tourists will also find Kenya attractive and spend more days and money in the country. Such a policy has multiple benefits.

It will improve the current account deficit by increasing exports and reducing imports, increase financial transactions in the money and capital markets, and stabilise interest rates as banks will have a lot more funds flowing from the external sector.

This is necessary to sustain Nairobi’s position as an industrial, financial and services hub.