Strong dollar leaves Shilling in steady slide

The shilling lost ground against the US dollar at the close of trading last week leaving behind a market trend that analysts said could deepen Central Bank of Kenya (CBK) intervention in the currency markets.

Commercial banks quoted the shilling at 81.00-10 to the dollar in Friday’s trading, compared with Thursday’s close of 80.90-81.00 as the local currency tracked the performance of global currencies against the greenback.

CBK mopped up $16 million from currency markets last week, stepping up its recent intervention aimed at reversing further weakening of the local currency.

“Right now there is a lot pressure on the local currency,” says Kennedy Butiko, a senior forex dealer at Bank of Africa.

The Central Bank’s action in easing pressure off the shilling is a temporary respite for importers who have had to sell more Kenya shillings in exchange for a unit of the dollar.

Although the weakening of the shilling has cushioned local exporters by increasing the revenues on the exports, a net importing country such as Kenya stands to lose out from a steady weakening of its currency.

Currency dealers are predicting the shilling to trade in the 80.70-81.50 range in coming days while citing the low interest rates prevailing in the country as a compounding factor towards a weaker shilling.

Yields have been falling this year due to unprecedented high demand across the curve, with abundant liquidity chasing limited investment options.

“The fact that interest rates are still depressed is serious cause of concern,” said Chris Muiga, a senior dealer at KCB Bank.

Shocks temporary

To the Central Bank these shocks are temporary and the exchange rate movements are fulfilling their role.

According to the CBK, once the volatility in the international market is stabilized and uncertainty in the euro zone is resolved, the shilling will rediscover its path consistent with the fundamentals outlined above.

The Bank expects that the private sector and firms have their hedge instruments in place to mitigate the current volatility in the foreign exchange market as they are temporary.

Still, currency traders are reluctant to rule off further weakening of the local currency.

“We can expect the shilling to touch year the year high 82.30 level,” says Mr. Muiga.

When the central bank wishes to raise the value of the shilling, it usually buys dollars or Euros in exchange for local currency.

The increased demand for shillings in the currency market by the central bank will raise the value of the shilling and cause a dollar depreciation. 

Value of currency

The ability of a central bank to raise the value of its currency through direct FOREX interventions is however limited.

In order for the CBK to buy dollars, it must have a stockpile of foreign exchange reserves.

The CBK’s foreign exchange reserves stood at $3.4 billion last week compared to $3.3 billion in December last year.

Foreign exchange reserves are typically accumulated over time and held in case an intervention is desired.

The degree to which the CBK can raise the shilling value with respect to the dollar through direct foreign exchange intervention will depend on the size of its foreign exchange reserves.

With Kenya being a net importer it can be argued that a stronger unit would be better for the economy as the country would be able to source goods and capital goods procurement more cheaply.