Limited options for the troubled shilling

Going by the current foreign exchange (forex) supply and demand imbalance, Kenya has limited options to the headache.

Our economy may not be earning, leave alone saving, enough dollars to meet emergency forex requirements as recently prompted by high oil prices and unscheduled food imports.

Without a healthy positive balance of trade (and payments) it may prove difficult to intervene to support the weakening shilling.

Time may be ripe for economic planners to start formulating medium and long term policies on how to sustainably increase forex inflows to enable the country meet its critical import requirements, including foreign debt obligations.

If oil prices remain above $100 per barrel, which is the most likely case, it will no longer be business as usual as we have to make or save many more dollars to meet our energy requirements.

Recent happenings suggest that we are confronted by a forex reserves problem. First, we heard of Treasury’s unwillingness to provide sovereign guarantees to power projects investors for fear of weakening the forex reserves account.

Secondly, the International Monetary Fund sought to see sufficient forex cover as a condition for budgetary support. Thirdly, forex injection into the market to prop up the shilling has been avoided due, probably, to forex shortage.

Healthy balance

At independence, the Kenya pound (Sh20) was at par with the Sterling pound except in 1966 when the Sterling pound devalued to Sh17, making it weaker than the Kenya currency. The dollar was buying at Sh7 for most of the 1960s and 1970s.

The current exchange rates of Sh153 to the UK pound and Sh93 to the dollar is an indication of how far the shilling has drifted from the two western currencies since independence.

Lessons learned from Kenya’s exchange rate history indicate that strong forex reserves keep the shilling strong. The exchange rates mentioned above remained virtually at the same levels throughout the 60s and 70s because the country had a healthy balance of payments, backed mainly by strong agricultural exports (coffee, tea, pyrethrum, cotton, sisal etc). Tourism was strong and donor fund inflows kept coming. Kenya did not need to import any supplementary foods as food security was not a major concern.

When crude oil prices suddenly rose from about $3 per barrel to $11 in 1973/74, the coffee exports “boom” of the mid 1970s was able to counter-balance impacts of increased oil prices on the exchange rate.

The foreign exchange control regime at the time also monitored and prioritised use of forex to ensure a healthy balance.

Local manufacturing in the 1960s and 1970s was relentlessly promoted to support imports substitution through specific institutions such as the Industrial and Commercial Development Corporation (ICDC), the Industrial Development Bank (IDB), and the Kenya Industrial Estates (KIE). Policy interventions also ensured that only items not produced in Kenya could be imported, and insisted on some element of “local content” for foreign industries like vehicle assemblies.

In the 1980s and 1990s, the forex discipline went down the drain and capacity to defend the shilling went down with it. Agricultural exports irretrievably collapsed; Foreign Direct Investment inflows reduced due to diminished level of governance; stewardship of local manufacturing collapsed; while a number of key multinational manufacturers relocated to Zimbabwe and later to South Africa.