The Treasury on Tuesday made a stark admission of the shilling being undervalued against the dollar, placing Kenya on a collision course with the International Monetary Fund (IMF) that advocates a freely traded exchange rate.
Treasury Cabinet Secretary John Mbadi said at a press briefing on Tuesday that the shilling could strengthen to Sh118 to the dollar if allowed to fall freely in a setting of increased inflows of the US currency.
This suggests that Kenya has been influencing the trade of the shilling against the dollar, adding the exchange rate to the monetary policy tools for managing inflation.
It termed the shilling too stable, having traded on a narrow range between Sh129.22 and Sh129.24 since the start of the year despite weakening against other major world currencies, including the euro and British Pound at 12 percent and 6.1 percent, respectively.
“By the way, the stability of the shilling has a basis. I was even saying, if it [the shilling] is just allowed free fall, the shilling would even trade at 118 to the dollar,” said Mr Mbadi, suggesting a State bias for a weaker shilling.
“Because our current account balance has been improving. Our exports are doing better.”
Mr Mbadi says the local currency’s stability is backed by improving macroeconomic fundamentals, including improved diaspora remittances, tourist receipts and strong export earnings.
A stronger shilling leads to cheaper imports and makes domestically focused companies that rely on inputs from overseas in foreign currency face lower input costs, easing inflation.
It also weakens the Kenyan firms’ foreign earnings, while also making local goods expensive abroad.
Analysts who spoke to the Business Daily anonymously said that the government was likely intervening to keep the shilling weak through purchase of dollars by the Central Bank of Kenya (CBK).
The CBK’s position is that Kenya has a flexible rate policy and only intervenes to smooth volatility.
Mr Mbadi said that the stability of the shilling was supported by a steady inflow of earnings from exports and tourism as well as diaspora remittances.
Export earnings fell 3.06 percent to Sh554 billion in the six months to June, while tourism receipts are expected at between Sh560 billion and Sh650 billion this year from Sh452.2 billion in 2024.
Remittances rose 5.88 percent to $2.519 billion in the six months to June, with the foreign exchange reserves of about $12.1 billion (Sh1.56 trillion) providing ample cover.
The stable shilling got a boost from the 2023 deal to purchase fuel on credit from three state-owned Gulf companies, allowing the country to build up dollars for the purchase over time, rather than requiring about $500 million every month to pay for imports.
Dr David Ndii, the chairperson of the Presidential Council of Economic Advisers, argued that the CBK had been switching between setting interest rates and creating a dollar peg as a measure to check imported inflation.
Most critical goods, including food and petroleum products, are imported and paid for in dollars.
“We say our [monetary] instrument is interest rates, but when you try to uncover it, it flips between the two [interest rate and exchange rate]. Sometimes we use interest rates and sometimes we use the exchange rate and that’s what I call common sense,” said Dr Ndii at the NCBA Economic Forum last week.
Dr Ndii further said that Kenya, unlike developed markets, could not rely on interest rates alone as the key monetary policy tool, as the economy is too small and open to shocks, which limits the transmission of interest rate decisions.
Under the IMF’s policy orthodoxy, the exchange rate is expected to serve as a shock absorber — adjusting naturally to external pressures rather than being fixed or heavily managed to help the economy adjust automatically to global shocks.
For instance, if exports slow, a weaker shilling makes Kenyan goods cheaper abroad, helping exporters recover, hence “absorbing” part of the shock.
However, for most frontier economies such as Kenya, which carry large external debt obligations, allowing the exchange rate to adjust freely not only leads to a higher import bill but also increases debt servicing costs, since much of their borrowing is denominated in foreign currency.
Even countries under severe fiscal strain have been known to support their currencies artificially, despite being led by avowed free market advocates.
A case in point is Argentina’s libertarian President Javier Milei, who has intervened in the market to stabilise the peso despite his ideological commitment to minimal state interference.
Mr Milei, who inherited an economy battered by hyperinflation and chronic debt, has propped up the peso through market intervention, a strategy that has eroded foreign reserves but is intended to contain inflationary pressures.
Mr Mbadi said the government’s failure to proactively manage its liabilities ahead of the bullet repayment of a $2 billion Eurobond signalled to international markets that Kenya was at risk of default — a development that, he added, contributed to the shilling’s sharp weakening.
“After managing the Eurobond of 2024, this year, we thought quickly and managed the 2027 Eurobond when the markets were open,” he said.
