Falling interest rates expose shilling to swings

The falling interest returns on Treasury securities and a growing import basket could pose an instability risk for the shilling, Citigroup analysts have warned.

The three-month and 182-day Treasury bill rates fell to 12.8 per cent from 13.0 per cent and to 13.0 per cent from 13.3 per cent respectively in last week’s auctions, marking the first time that the two rates have eased after a steady increase over the past two months.

The declining yields have removed the shield that the Central Bank of Kenya (CBK) used to cushion the shilling late last year, when it declined sharply to an all-time-low of 107 units to the dollar.

CBK raised the rate to 18 per cent at the time, lifting returns on Treasury bills to highs of more than 20 per cent which attracted inflows of foreign currency and helped to stabilise the shilling at current levels of about 84 units to the dollar.

“Inflation has eased substantially in 2012, allowing the CBK to start to ease monetary policy.

But this will also add pressure for shilling depreciation in the second half of 2012 given the large current account deficit, slowness in bringing the fiscal deficit under control against the background of rising political tensions,” Citigroup said in their latest analysis.

The persistently big import-export gap, currently at more than 11 per cent of total national income, also poses risk to the shilling.

Citigroup Global Markets research said lower inflation had provided the monetary authorities with good reason to cut interest rates, but this was likely to upset the shilling’s stability.

Finance minister Njeru Githae said just over a month ago that a team had been set up at the Treasury to work on modalities of reducing imports as part of dealing with the weakness of the local current.

Data from CBK shows that the currency traded at an average of 84.20 per US dollar at the opening of markets yesterday, which indicates an appreciation since it opened the year at 85.10 units.

Last December, the shilling traded at an average of 89 units to the dollar.

Recently, the Monetary Policy Committee of the CBK lowered the benchmark interest rate to 16.5 from 18 per cent, signalling that the price of money should come down.

The current account deficit, which indicates the gap between the value of exports against imports, is set to close the year at 10.5 per cent, which is an improvement from 12 per cent in 2011, but still high relative to the situation in the past two decades.

According to the Citi analysts, the current account deficit problems will hardly have disappeared even next year as it will stand at 9.5 per cent.

The major issue is the large import bill relative to the exports.