Flight of Sh17bn in foreign currency sparked shilling’s rapid fall as banks moved to cash in

Foreign currency worth Sh17 billion ($201 million) flowed out of Kenya before the drastic fall of the shilling last October, data from the Central Bank of Kenya (CBK) shows.

Panicky importers rushed to buy dollars and some banks with a finger on the pulse of the financial markets saw an opportunity to cash in. The banks, whose monthly foreign currency receipts are used to compile the balance of payment data, had practically a one-way bet that ensured they made good income from the trade.

It was the ever-increasing amounts of financial flows that was the main source of support for the local currency and the single largest source of finance for the imports last year, since the receipts from exports are too low to cater for Kenya import needs.

The amounts are shown on the capital and financial account, which includes foreign cash entering the stock and money markets, what is invested in the long-term business concerns as well as foreign currency, which cannot be explained and is labelled as errors and omissions. The account is part of the balance of payments that essentially shows transactions between local and foreign residents.
Predictions by analysts also indicate that this year might also show some outflow from the financial markets.

An analysis by the World Bank in the Global Economic Prospects 2012 found that when the world financial markets came under turmoil last year, the most liquid and open stock and money markets like those of Kenya, Nigeria and South Africa – whose markets are tracked by the widely-followed Morgan Stanley Capital International indices (MSCI) – tended to be most adversely affected with a major impact on their currencies.

The World Bank noted that between last April and October, while the MSCI World Index fell by 23 per cent, indices in the three most liquid stock exchanges in the region fell sharply: South Africa by 24 per cent, Nigeria by 21 per cent, and Kenya by 43 per cent.

“Hence for economies in the region with more liquid financial markets (stock and bond markets), the downturn in Europe could lead to destabilising capital flows with negative consequences on exchange rate volatility,” said the World Bank.

Cumulatively for 12 months to August the capital and financial account stood at Sh336 billion ($3.999 billion) but as soon as this amount decreased by about Sh17 billion ($201 million) last September as revealed in CBK’s Monthly Economic Review for October, the rapid decline of the local unit began before reaching a low of Sh107 to the dollar on October 11 last year.

As the third quarter of the year ended, the situation deteriorated to the extent that the overall balance of payments had moved from a positive in 2010 to negative by September 2011.

“Kenya’s overall balance of payments position reduced from surplus of $365 million in the year to September 2010 to deficit of $220 million in the year to September 2011. The movement follows the widening of the current account deficit, which surpassed improvement in the capital and financial account,” said CBK’s October report.

It shows that pressure was building on the shilling against such currencies as the dollar and the euro as well as the sterling pound throughout last year.

Analysts said that the capital and financial account should ideally not be used to fund imports.

“The best way to fund imports is through exports. If you depend on short-term flows on the capital and financial account, then you are bound to have problems along the way. Asian countries that depended on short-term flows faced a crisis when there was an outflow of capital,” said Kenneth Kaniu, senior investment manager at Stanbic Investments (East Africa).

Mr Kaniu said that services would not be enough to sustain increased imports as had been shown by the problems that faced Dubai when outflows put the emirate in a crisis a few years ago.

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