Why IMF wants CBK to let the shilling depreciate

Operating the chama assets in the names of the founders is very risky in as much as you trust them. FILE PHOTO | POOL

The International Monetary Fund (IMF) wants Kenyan and other central banks in sub-Saharan Africa with a floating exchange rate to let their currency depreciate to encourage local production and export-oriented investments.

This comes at a time when the Kenya shilling has already hit a record low exchanging at an average of 134.56 against the dollar, inflating the size of the country’s external debt and the cost of importing critical inputs such as fuel and fertiliser.

However, the IMF, in a new note on the exchange rate, has sought to allay fears of a weaker shilling that might tempt the Central Bank of Kenya (CBK) to prop up the local currency.

Instead, the central banks in the so-called “non-pegged regimes” like Kenya, have been urged to just tame inflation by tightening the monetary policy to encourage capital inflows and implement austerity measures to tame the growth of debt.

The IMF has long been asking the CBK to let the exchange rate act as a shock absorber even as the local currency is battered by a myriad of shocks that have triggered an outflow of capital and a disruption in the global supply chain that has pushed up the costs of imports.

“As for non-pegged regimes, in most countries, letting the exchange rate depreciate is necessary to facilitate adjustment to external shocks that are durable, such as changes in terms of trade and higher interest rates in advanced economies,” said the IMF in a new note.

Non-pegged countries are those where the exchange rate is not fixed to another currency on a legal basis.

According to the IMF, exchange rate adjustments for a floating exchange rate provide price signals that help all agents in the economy, including the government, to adapt to new external realities.

“For example, exchange rate depreciations can persuade consumers to switch consumption toward more domestically produced goods and urge governments to prioritise their foreign-exchange-related spending and investors to invest more in export-oriented businesses,” added the IMF.

Last December, the IMF, which had in an earlier report accused CBK of managing the country’s currency, noted that Kenya’s exchange rate should function as a shock absorber.

This, the IMF added, should be supported “by a well-functioning interbank FX market, with forex interventions (sales) limited to addressing excessive volatility.”

The IMF has a three-year programme with Kenya aimed at helping the country reduce its debt vulnerabilities and economy recover from the blows of the Covid-19 pandemic.

A widely held view by economists is that flexible exchange rates insulate economies from external shocks such as the raise in interest rates in advanced economies.

When a currency is devalued its demand also goes down, with the country’s exports fetching more in the global market.

Imports such as palm oil, however, become expensive, forcing consumers to go for substitutes produced locally.

Unfortunately, it seems like CBK’s pace of allowing the local currency to weaken and act as a shock absorber has been falling behind market expectations, according to EFG Hermes, an Egyptian-based investment bank.

Moreover, things can get worse in what EFG described as a “thin FX (forex) market” like Kenya’s resulting in cautious market behaviour from market players.

National Treasury officials in former President Uhuru Kenyatta’s administration described the dollar shortage in the country as “artificial” noting with some manufacturers, fearing that this critical foreign currency is scarce went on to accumulate it.

“They create an artificial shortage which is not reflecting the reality on the ground,” said former Treasury PS Julius Muia.

Dr Patrick Njoroge, the CBK governor, has insisted the country has enough dollars.

The CBK under Dr Njoroge has been accused of fomenting the dollar crisis, with financial analysts saying the that the regulator introduced tough rules on the foreign exchange interbank market, crippling market operations.

Through the interbank forex market, banks can trade hard currency with one another at rates that determine the official or spot rate.

The IMF is appreciating that letting the local currency depreciate will come with adjustment costs in terms of higher inflation and public debt.

“In countries where reserve buffers are low, currency depreciation and its associated costs are unavoidable. Policymakers can take several steps to mitigate the adverse impact and contain exchange rate pressures,” said the IMF.

Some of the measures that countries can take even as they let the currency depreciate are through tighter monetary policy that can keep inflation expectations in check and reduce exchange rate pressure by attracting capital from abroad and stem outflows.

Fiscal consolidation — or policies aimed at increasing revenues and cutting spending — will keep public debt sustainable and rein in external imbalances, particularly in countries where fiscal imbalances are key drivers of exchange rate pressures, explained the IMF.

“Cutting government expenditures that directly or indirectly affect imports can be particularly helpful to lower the demand for foreign exchange — for instance, eliminating fuel subsidies can reduce fuel imports,” said the IMF.

Kenya’s external debt ballooned by a staggering Sh344.4 billion, giving dimension to the impact of a weakening shilling whose exchange rate against the greenback has tanked to a historic low.

The CBK data shows that total external debt as of January stood at $37.63 billion (Sh4.7 trillion), where the mean exchange rate was 124.4 against the dollar.

The IMF also reckons that strengthening the social safety net through well-targeted measures will support the poor, who are more adversely affected by the rise in prices.

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