Last week, a report titled Kenya’s Economic Puzzle: Putting The Pieces Together released by Amana Capital elicited debate when it stated that the Kenya shilling is overvalued by 30 percent. Credit to Amana Capital for sticking their neck out with that pronouncement, the vigour of policy debates is to be bold with your case by putting it out for scrutiny.
I am among those who disagree with that conclusion on the principle of their methodology. It looks like a confirmation bias problem.
To start with, there are many moving parts in what exactly drives a country’s exchange rate but they seem to have as a strait-laced analysis. They simply took the shilling in January 2009 which stood at 72 and compared it with January’s 2019 which was 99 then arrived at the conclusion that there has been a 20 percent devaluation which translates to an overvaluation of 30 percent. This is flawed economic accounting because it simply fails to take into account the volatilities of the shilling in between that ten-year period and the various fundamentals that led to those volatilities.
Second issue is that they seem to have used the consumer price index to arrive at that overvaluation conclusion.
There is nothing wrong with using the exchange rate to reflect on purchasing powe, but to use it to explain overvaluation of a currency is misuse of facts because there are many drivers that influence the CPI including fiscal policies.
The context at which economists talk about a currency being overvalued is in international trade, basically a country’s exports priced higher compared with goods from other countries at the international market.
So, using the exchange rate to analyse purchasing power then arrive at the conclusion that the currency is overvalued is erroneous.
Lastly, the report proposes the need for government to adopt controlled currency devaluation to reflect its true value.
Here, the first question that arises is what exactly is the meaning of “true value” of a currency?
Second, devaluing a currency in a floating exchange system like Kenya’s simply means intervention by the Central Bank of Kenya (CBK) and Treasury bureaucrats to pre-determine an outcome which is weakening the currency. So, it’s ironic for Amana Capital to call for devaluation and in the same report also hit at CBK for managing the currency and not letting it float freely.
Third, what seems to be advocated here by devaluation is government printing money, which has always been a neat way for many struggling governments to pay their bills only for economic laws to catch up with them.
For Kenya, the government needs to tread carefully with this proposal because of the fundamental distortions of the economy.
Looking at the economy’s liquidity data provided by CBK, the numbers show stability in the last two years when it should have a decline since the economy continues to experience a liquidity problem, something even the CBK Governor admitted sometime back.
So, in the event that the government decides to push for liquidity by printing more money, this can only be done within limited scale. Any reckless increase in money supply will lead to demand for the dollar and also any attempt to use the printed money to pay for foreign debt is simpy raiding the CBK dollar reserves, increasing CBK demand for dollars.
Now, any sustained increase in the demand for dollars exposes the shilling and easily blows it under water.
The reality is that Kenya’s exports continue to weaken thus not raking in much needed dollars, the International Monetary Fund(IMF) standby facility that provides CBK quick access to dollars is yet to be restored.
At the same time, we face a double whammy where one-shilling loss of the local currency against the dollar spikes both the price of foreign debt and also the interest rates on them.