Only bold measures will halt decline of the Kenya shilling

The sharp depreciation of the shilling in the last few weeks has set off a flurry of comments, discussion and debate on the currency. Some of it is confused and confusing, but there are two key issues one needs to understand.

The most important is that the shilling’s depreciation is not the problem but merely a symptom of underlying problems.

Think of it as a car dashboard alert that lights up to warn you to correctly identify and address an underlying problem with your engine.

The second issue is that there are underlying structural problems with the economy and there are immediate causes that triggered the depreciation.

These include foreign direct portfolio outflows from the stock market (market is down 40 per cent since January), the appreciation of the US dollar, and less dollars in the market as a result of the recent closures of hawalas.

On the other hand, there are several structural underlying reasons for the shilling’s weakness – the genesis of which lies in the widening trade and current account deficits.

As long as we are importing too much and exporting too little – and the economy remains imbalanced – the shilling will always remain vulnerable to shocks. We are also running a big fiscal deficit and government borrowing is a big negative for the currency’s value.

The immediate actions required to deal with these problems can provide only temporary relief and give us more time and/or space to solve the underlying problems.

But unless we resolve the structural issues, this problem will always recur. To deal with these structural causes, both the government and the citizens have to undergo a permanent change in attitude and behaviour.

How do we expect to have a strong and stable shilling when we import Tilapia from China and KFC says it prefers Egyptian potatoes to our Kinangop ones because they have better shapes and sizes?

How do we prevent our shilling from being vulnerable to external shocks when we have a big fiscal deficit because we have to borrow to pay billions to unproductive and graft-laden commissions, fund useless MCA trips to Italy so they can go study how spaghetti is grown (it is actually made) or as the Kiambu ones said “to study the railway” (whatever that means)?

Our shilling cannot stop being volatile when we always experience food inflation, a packet of ugali flour costs Sh120 and milk is expensive not because we have genuine shortages but because of cartels that have hijacked the supply side of the economy.

Maize and milk farmers are unable to sell their produce unless at throwaway prices and yet these products are being sold at exorbitant prices in our supermarkets. It’s a dog’s breakfast.

How do you expect to have a strong and stable shilling when, because of insecurity, fewer tourists are coming into the country and bringing in dollars and it is cheaper and safer for a Kenyan family to board a plane and have a nice holiday in Dubai than to take a bus or drive to the South Coast for their vacations?

How do you want a stable shilling when as soon as you get your first million shillings, you want to speculate on some idle land instead of investing in stocks, meaning we have more foreign than domestic investors at the Nairobi Securities Exchange who can walk away any day and increase demand for dollars?

Even if the government is trying to address these underlying issues, it can only do so much as measures to boost export competitiveness cannot be implemented overnight.

That requires a sustained focus on manufacturing high-end, sophisticated products. So we have three options for now, none very palatable, to stabilise the Kenya shilling in the short-run.

The first option is to let the currency fall further and find its bottom, wherever that may be. In most countries a cheaper currency would boost exports and help close the Current Account Deficit (CAD).

But our manufacturing industry is too small to ramp up quickly. So a turnaround in the balance of payments may take time during which investors could panic.

Meanwhile the weaker currency may destabilise the domestic economy by adding to inflation and Wanjiru will definitely suffer.

We also now have a bigger foreign debt component than we had during the Kibaki era and interest payments on foreign debt will become a bigger burden and reduce the amount of funds available for development.

The second option is to increase interest rates to attract more foreign money. The Central Bank of Kenya has already called for an early Monetary Policy Committee (MPC) meeting for next week instead of the scheduled July meeting.

It would be irresponsible if they don’t raise interest rates during this special sitting. But this would further hammer domestic businesses, which are already in poor shape, and probably increase bank bad debts too.

Bad debts are already a worry for the economy, having increased by Sh10.2 billion in the first 3 months of 2015 alone.

We can also already see equity investors starting to worry about corporate earnings and any further pull out of their billions of investments in listed shares will lead to the economy slowing further with rate increases. Add a credit crunch to that and this will make things even worse.

The last option is to lower government borrowing which is expected to be over five per cent of GDP in 2015 and which has stoked excess demand in the last few years, widening the CAD.

The populist political mood and with the Jubilee administration wanting to put runs on the board (sorry those who don’t follow cricket) and engage in massive projects will make big spending cuts difficult.

There is simply no way the administration can cut its way to a smaller deficit. Which means we need more tax revenues. But with a narrow tax base (only a tiny percentage of Kenyans pay income tax) this might mean concentrating tax rises on the formal economy, which is already reeling.

The only lasting solution for the shilling’s problems is to reduce the CAD to a sustainable level, which requires structural solutions. The CBK has very little policy space or instruments to deliver the needed structural solutions.

They fall within the ambit of the government. All CBK can do in the interim is to stabilise the market volatility and that will come at a cost. A big cost!

Mr Wehliye is senior vice president, Financial Risk Management, Riyad Bank, Saudi Arabia.