Shilling’s decline could scale down ballooning imports

The recent weakening of the shilling against the dollar could help address Kenya’s uncompetitive production of goods and reduce imports, economists at CfC Stanbic say.

The regional head of macroeconomic research, Phumelele Mbayo, on Wednesday said despite its depreciation in nominal terms, the shilling is still relatively strong in real exchange rate compared to the currencies of Kenya’s trading partners. This makes it cheaper for Kenyans to import goods that could be produced locally.
The real exchange rate of a currency is determined by comparing the cost of equivalent goods across countries and adjusting for inflation.

“The shilling has depreciated to the dollar at an annualised rate of between four and five per cent over five years— which is slower than other regional currencies— at a time when the common theme around the world is the dollar strengthening at about 14 per cent on trade weighted basis,” said Mr Mbayo.

Kenya’s main trading partners, including East African countries, the EU, India and China have seen their currencies fare worse against the dollar over the past one year.

“Considering that the underlying macroeconomic factors are stable, there is no need for concern over the nominal (one-on-one) exchange rate. The strong shilling in real terms on the other hand will eventually affect the growth ambitions of Kenya,” said Mr Mbayo.

A strong currency in real terms hinders the growth of the economy by discouraging the local production of goods.

The shilling has been in focus in recent months following sustained depreciation in nominal terms to the current 97 units to the dollar from 90.40 in January, with a new three-and-a-half year low of 99 seen only last week.

The contention has been that it is likely to lead to cost-push inflation, given the import dependency of the Kenyan economy.

“We still see inflation (6.87 per cent in May) rising and on course to breach nine per cent before the end of the year.  This will be reinforced by recent shilling weakness, as well as the anticipated rise in oil prices in the second half of the year,” said Standard Chartered head of research for Africa Razia Khan in a note last week.

The CfC Stanbic economists however see the inflationary pressure as driven mainly by food component, meaning increases outside the preferred band of between 2.5 and 7.5 per cent have been rare and short-lived.

On the impact of imports on the trade deficit, Mr Mbayo said the growth of imports minus those of machinery and equipment for capital projects has not grown substantially since the regulator started easing monetary policy in 2012 to encourage economic growth.

CBK’s monetary policy committee is set to meet next week and could raise the base rate by about 100 basis points with an eye on the shilling fall and attendant inflationary pressure.

“That the economy seems broadly balanced suggests to us that the current upside spiral in the exchange rate is neither likely to be durable, nor will it foster a lasting increase in inflation pressures,” said Mr Mbayo.

“Given that the currency has no underlying problems, the higher yields that come as a result of the rate hike should eventually attract higher foreign inflows into the Kenyan fixed income market, and help the shilling strengthen once again.”