Probe links shilling fall to flight by rich Kenyans

A rush by wealthy Kenyans to convert their cash into dollars when the shilling started weakening last year accelerated depreciation of the currency, a Central Bank of Kenya (CBK) audit has revealed.

A new report by the Monetary Policy Committee, which is CBK’s main policy making organ, says last year’s sharp depreciation of the shilling to an all-time-low of 107 units to the dollar caused panic and a run to more stable currencies.

“The main drivers responsible for the increase in the level of activities were identified as (among others) the preference by Kenyans to hold their wealth in foreign currency,” said the report titled MPC’s eighth bi-annual report.

“In addition, due to the weakening of currencies in other markets, most Kenyan exporters preferred holding their wealth in US dollars,” the report adds. Currency dealers’ use of electronic brokerage systems (EBS) which increased the frequency of trading also exerted pressure on the exchange rate, prompting the regulator to suspend their use on the basis that it exposed the market to speculative external traders.

The dealers were moved to making foreign exchange deals over the phone, as opposed to matching of orders on an electronic screen.

“It was observed that the system exposed the market to a range of external players and allowed for a much higher level of activity and was therefore contributing to the rapid activity in foreign exchange trading and volatility of the exchange rate,” said the regulator.

CBK says it conducted audits of all commercial banks foreign exchange trading activities between May and October. The investigation found that banks increased “reverse carry” deals, shortening the tenor of currency swaps.

“Reverse carry transactions allowed an off-shore financial institution with counter-party agreements with banks in Kenya to borrow shillings and buy and hold US dollars,” says the report.

The audit recaps a rush by sellers of imported goods to quote their prices in dollars as the shilling took a steep depreciation curve late last year.

Motor vehicle dealers, importers of heavy machinery and retailers of computers and other information technology hardware changed their price tags to dollars to cushion their profit margins from exchange rate losses.

Demand for foreign currency loans from international traders also went up as the cost of doing business rose due to rapid depreciation of the shilling.
This saw local commercial banks seek financing from international development institutions such as IFC.

Besides the currency volatility fears, investors also turned to the dollar over fears that their wealth would be eroded by inflation, which peaked at 19.72 per cent in November. “It makes sense to hold wealth in a stable currency,” said a currency trader who sought anonymity for fear of retribution from the regulator.

The dealer said that investors were still invoicing and holding their wealth in foreign currencies as the huge import bill which was the fundamental issue affecting the Kenyan currency was not being addressed.

The country’s huge current account deficit has revived fears of another meltdown of the currency as the shilling touched a five-month low of 87.80 units to the dollar two weeks ago.

The CBK report says “there is need for a long-term policy to support the export sector in order to increase foreign exchange inflows and augment foreign exchange reserves. This will ease pressure on the exchange rate, and domestic prices in general, in the long run”.