Workers pluck tea leaves in Nandi Hills. World Bank says that the shilling has been supported more by foreign capital inflows, rather than exports. FILE
What you need to know:
An analysis by the World Bank shows that the Kenyan shilling has gained by more than 34 per cent in real terms over the past decade.
The implication of the “artificially strong” shilling is that it makes Kenyan goods more expensive and as a result less competitive in the international markets.
The shilling is currently exchanging at about 85 units to the dollar, having appreciated from a historical low of 107 units reached in late 2011.
A steady inflow of investors’ dollars in the past 10 years has strengthened the shilling but it has also exposed the economy to external shocks while making exports more expensive, the World Bank has said.
An analysis by the Bank shows that the Kenyan shilling has gained by more than 34 per cent in real terms over the past decade.
Foreign investor interest in Kenya has mainly been through the Nairobi Securities Exchange, mineral exploration, opening of companies and regional offices and also what are classified as “un-explained” inflows.
“The real exchange rate is 34 per cent stronger than a decade ago, constraining economic competitiveness,” said the World Bank in an economic update on Kenya.
The implication of the “artificially strong” shilling is that it makes Kenyan goods more expensive and as a result less competitive in the international markets, thereby blunting growth of the export sector which is viewed as the long-term support for the currency.
The shilling is currently exchanging at about 85 units to the dollar, having appreciated from a historical low of 107 units reached in late 2011.
Real exchange rate is calculated by removing the impact of accumulated inflation on the nominal exchange rate.
The World Bank’s conclusion is that the shilling has been supported more by foreign capital inflows, rather than exports.
“Short-term capital inflows have helped stabilise the exchange rate, but heightened vulnerability to external shocks,” the bank said, adding: “The economy remains vulnerable as the current account deficit is above 10 per cent of gross domestic product (GDP), despite global fuel prices moderating in recent months,” said the World Bank.
Economic analysts recommend a gradual process of devaluation to the shilling to put it in line with economic fundamentals and restore competitiveness of the export sector.
Some countries, such as Japan and China, have devalued their currencies to sharpen the competitiveness of their goods in international markets. Japan has recently said it would inject $1.4 trillion in the next two years to increase competitiveness of its exports.
The US has been on a devaluation drive through quantitative easing for several years, while China has repeatedly denied accusations that it keeps its currency weak to increase exports.
“We need to let the Kenya shilling depreciate gradually, not suddenly as happened in 2011. The fundamentals do not support a strong shilling. When you look at the current account, you find that at 10 per cent, it is very high,” said Peter Wachira, senior investment manager at PineBridge Investments East Africa.
Mr Wachira said the support for the local unit by foreign currency inflows was inherently unstable.
“If we had an external shock, God forbid, we would see a sudden fall in the shilling as was the case in 2011. So we should not rely on the inflows, but should increase our exports and reduce imports where possible,” said Mr Wachira.
Kenya is a net importer of raw materials and finished goods, which has steadily widened the current account deficit.
In its April report, the International Monetary Fund (IMF) asked the Central Bank of Kenya not to resist depreciation of the shilling that may result from low interest rates.
The Monetary Policy Committee of the CBK has been lowering the indicative rate in the past 11 months, leading to a fall in the rate on government securities and, to a smaller extent, lending and deposit rates.
“More generally, the CBK should refrain from resisting the likely depreciation that may result from lower interest rates, because it could help to restore competitiveness in a low-inflation context,” said the IMF.
Inflation has been at single digits since late last year, averaging 4.56 per cent between last July and May this year.
The IMF further advised the monetary authority to use mop-ups in the event that exchange rates pressures emerge. This is what the CBK has been doing, mopping a net of Sh35.9 billion in the six days to May 31.
“If exchange rate pressures emerge …, the CBK should preferably respond by mopping up liquidity and resorting to foreign exchange sales only in the event of extreme volatility,” said the IMF.
The World Bank’s update of May this year noted that the Kenyan economy is likely to grow by at least five per cent, up from 4.6 per cent recorded in 2012.
However, it said the Kenya’s economy was underperforming relative to the region. It is still below its Africa and East African peers, which average 5.3 and six per cent, respectively.
“Kenya should also maintain prudent macroeconomic performance and improve its growth rate closer to the average of its peers in Africa and East African Community (EAC), whose growth averages of 5.3 per cent and six per cent respectively,” said the World Bank.
The Bank said the economy remains out of balance, with sharp differences in sectoral performance such that “macroeconomic management, the financial sector and the Information and Communications Technology (ICT) sectors remain very strong, but the port of Mombasa and agriculture are weak.”
