Shilling’s fall against dollar signals rise in cost of living

The Kenyan shilling continued its slide against the major world currencies, signalling a looming rise in the cost of living in a country that is over-dependent on imported goods.

The shilling closed yesterday’s trading 10 cents weaker at 94.35 to the dollar, staying on a losing path that started last month and moving closer to breaching the psychological mark of 95 units to the dollar as rising demand for the dollar continued to weigh against weak inflows.

Kenya is a net importer of consumer goods such as petroleum, processed foods and clothing as well as raw materials and machinery used by its nascent manufacturing industry, whose costs are expected to rise with a weaker shilling pushing up the rate of inflation.

A weaker shilling, however, has the impact of making Kenyan exports more affordable and should therefore help drive volumes, besides translating to better earnings for every dollar.

Analysts, however, said overreliance on imports means the economy could wipe out any benefits the importers may get from a weaker shilling, leaving consumers in a worse position.

“Taking all the market factors into consideration, a weaker shilling would increase inflationary pressure and ultimately result in a higher cost of living,” said Ecobank Kenya country treasurer Bobby Otieno.

“Reduced inflows from tea and tourism sectors, payment of dividends by multinational companies and a reduction of inflows via forex bureaus with the crackdown on terrorism financing have significantly impacted the forex reserves.”

Inflation stood at 6.31 per cent in March up from 5.61 per cent in February – a figure that is still within the Central Bank of Kenya (CBK) target of between 2.5 and 7.5 per cent.

READ: Inflation up 6.31pc in March as cost of food rises

In addition to the expected rise in the cost of living (inflation), a weaker currency has a wider impact on the economy, especially on interest rates.

“If inflation goes up above the CBK’s target margins, the CBK will be forced to increase the base rate. This will in turn increase the cost of credit to the private sector and ultimately slow down the rate of growth,” said Commercial Bank of Africa senior dealer Joshua Anene.

Kenya imported goods worth Sh1.618 trillion in 2014, up 15 per cent or Sh210 billion more compared to Sh1.408 trillion in 2013, according to the Kenya National Bureau of Statistics (KNBS).

The value of imports rose only marginally by Sh32 billion or 6.5 per cent — from Sh504.3 billion to Sh537.1 billion — meaning that Kenya’s trade deficit widened by Sh177.7 billion to Sh1.08 trillion. The imports were mainly in form of capital goods for infrastructure projects, fuel and manufactured goods.

The KNBS’s producer price index (PPI) for the first quarter of 2015 also shows that the overall cost of production for manufacturers increased by 1.52 per cent compared to a decrease of 1.23 per cent recorded in the fourth quarter of 2014.

“The main contributors to the first quarter increases were manufacture of food products (up 1.79 per cent), manufacture of beverages (up 2.52 per cent) and manufacture of rubber and plastic products (up 2.85 per cent),” the KNBS says in the PPI report.

Costs associated with food and non-alcoholic beverages have the biggest weighting in the monthly inflation index at 36 per cent and account for up to 40 per cent of the producer price index.

READ: Rising maize farmgate prices spark inflation fears

Consumers have been enjoying some respite on inflation helped by low cost of petroleum products arising from a recent dip in global crude oil prices.

Consultancy firm PricewaterhouseCoopers (PwC) put the total savings on oil import bill in the past year at $200 million (Sh18.5 billion).

Oil prices have, however, rebounded since January when a barrel was priced at an average of $46 to an average of $65 a barrel today, meaning pump prices are likely to rise in the Energy Regulatory Commission’s next two review cycles.

The shilling’s quick slide towards the 95 units to the dollar has also gone against the general expectation that this exchange rate would only be realised progressively towards the end of the year — raising the possibility that the shilling may drop further than the projected levels.

“We had not forecast that we would get to 94 so early in the year and we have breached that level quite easily. This means we could see the exchange rate anywhere between 95 and 98 to the dollar by year-end,” said Mr Otieno.

Dealers said the shilling’s weakening is also driven to some extent by domestic factors and not just the dollar’s global strengthening. Last week the dollar lost some ground to other world currencies, a development that was not felt in the Kenyan market.

The CBK has, however, come in to reassure the market that it is closely monitoring developments in the foreign exchange market and that it will continue to use appropriate monetary policy instruments to minimise exchange rate volatility.

“The bank has adequate foreign exchange reserves in excess of 4.5 months of imports to cushion the exchange rate against these short-term shocks and volatility,” the CBK said in a statement issued on Tuesday last week.

The bank intervened in the market yesterday with dollar sales as the shilling dropped to an intra-day level of 94.40/50.

It is the eighth time the CBK has intervened in the market in recent times to minimise volatility through the sale of dollars as the shilling depreciated to cross a key psychological limit. The regulator has, however, not sought to determine the direction of the exchange rate.

READ: Central bank sells dollars as shilling hits 3-year low

The shilling has in the past been seen as overvalued to the dollar and some economists have advised the authorities to allow it to depreciate gradually.

Last July as the shilling hit 88 units to the dollar, Francis Mwega, a CBK monetary policy committee member, said in a research paper that the local currency was overvalued by 4.3 per cent.

The World Bank put the cumulative overvaluation over a decade at 33 per cent.