Central Bank on the spot as shilling falls to new low

The Central Bank of Kenya (CBK) came under the spotlight yet again as the shilling tumbled to new record low of 94.75 against the dollar, weighed down by importers’ demand for the greenback, global selling of riskier assets and the bank’s activity in the market.

The latest plummeting of the Kenyan currency pushed its total loss against the dollar this year to 17.5 per cent or 4.3 per cent since the beginning of August forcing the CBK to use reverse repos for a second day after injecting Sh15 billion ($160.5 million) into the market on Monday.

Central Bank has been on the horns of a dilemma on how to deal with the currency turbulence rooted in both monetary and fiscal segments of the economic policy. The dilemma lies in the fact that tightening liquidity (reducing the amount of money in circulation) when the economy is under the spell of a severe drought and other supply challenges poses the danger of raising interest rates and ultimately causing a general rise in the pricing of goods and services or inflation.

Increasing liquidity or raising the amount of money in circulation as the CBK has done in past few days causes a totally new challenge of fuelling the shilling’s weakness and raising the cost of all imported goods and inflationary pressure.

“We are having sleepless nights over the exchange rate issue because it is a very serious matter,” said CBK governor Njuguna Ndung’u.

“We expected that the cost of energy would put balance of payment under pressure, which is why we requested support from the International Monetary Fund,” said Prof Ndung’u. “We have seen that final consumption has responded to the depreciation of the local currency and demand has gone down.” The bank started injecting funds into the money markets through reverse repos last month to see off a liquidity crunch that threatened to worsen as corporate tax payments fell due.

The shilling had fallen through resistance at 94.00, weighed down by energy and food importers’ demand for dollars, and on the back of a continuing global sell off of emerging and frontier assets perceived as risky.

Activity at the Nairobi Stock Exchange reflected the investor flight with the loss of Sh200 billion since January and a decline of the NSE20 share index to 3520 points from 4495 at the beginning of the year.

The worldwide sell-off came as investors lost confidence that the US and Europe can rein in their debt burdens quickly and avert another recession.

Analysts have expressed doubts that the central bank is taking adequate measures in its monetary policy direction, with some saying it needs to tighten after inflation rose to 15.53 per cent in July. “CBK has lost market confidence and to make matters worse there’s global turmoil. The only way out is for CBK to listen to the market, hike rates and act in a manner to suggest they are fighting inflation,” said a dealer with one commercial bank who did not wish to be named. “CBK also need to tighten liquidity. Doing (reverse) repos of unlimited amounts will not help the shilling’s cause.”

Traders said the shilling could weaken further in the next few days, though a move by the Central Bank to reduce the amount of foreign currency banks are allowed to hold could offer some support, as could dollar inflows from the tourism sector.

Kenya’s balance of trade (exports minus imports) stood at negative $47.6 million by end of April, a further dip from April 2010’s negative $28.7 million. Oil and machinery from abroad make up more than 30 per cent of the total imports. - REUTERS

Additional reporting by Geoffrey Irungu.