Shilling rally wipes Sh99bn from local dollar holdings

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Wealthy Kenyans, traders, and businesses took a Sh98.9 billion hit as the value of foreign currency deposits plunged from the recent strengthening of the Kenya shilling.

Foreign currency deposits, expressed in local currency terms, saw their largest month-on-month drop in more than five years in February, dipping to Sh1.502 trillion from a peak of Sh1.601 trillion in January, according to data from the Central Bank of Kenya (CBK).

The 6.1 percent drop in the mostly US dollar deposits coincided with a 10.6 percent gain for the shilling, which moved from Sh160.67 against the greenback to Sh143.51 in the same period.

This implies that the drop in foreign currency deposits is largely a factor of a stronger local currency than an absolute drop in the nominal hard currency holdings by the banks.

According to Absa Bank Kenya’s director for consumer banking, Moses Muthui, the sector remains awash with hard currency as holders of foreign exchange maintain their balances despite the recent gains for the shilling.

“The dollars and other foreign currency monies are very much there. We are awash with foreign currency liquidity in terms of the real hard currency,” he said in an interview on Wednesday.

“Most of the holders of foreign currency are traders, business people, and corporates and they need this to manage their business and trade flows, given Kenya’s position as a net importer.”

Last year, speculation on the weakening of the shilling led to a large build-up of hard currency in banks as both corporates and households moved to seek a hedge against the weakening domestic unit.

Foreign currency deposits, expressed in local currency terms, for instance, rose from Sh945.2 billion to Sh1.54 trillion between January and December 2023.

Expressed in US dollar terms, the deposits remained on the ascendance, rising to $10.17 million in the quarter to December from $8.98 million in the quarter to the end of 2022.

The weakening of the local unit by more than 20 percent in 2023 led to not just a higher demand for hard currency but also a rise in dollar deposits in local currency terms.

Risks surrounding the June 2024 Eurobond maturity served to drive investor jitters, taking the performance of the shilling to its worst levels in nearly three decades as some speculated a devaluation of the unit in a default event, helping lift the demand for dollars.

The partial repayment of the Sh262.2 billion ($2 billion) payment in February has, however, turned sentiment in favour of the shilling, wiping out some of the paper gains made by dollar depositors.

Despite losing some of its gains and momentum, the Kenya shilling remains among the top currency gainers against the US dollar with a year-to-date return of 16.4 percent as of Tuesday, when the unit traded at Sh131.14.

At current levels, the Kenya shilling is widely expected to find equilibrium, ending the wild swings seen in the last two years.

“The shilling is still trying to find its level based on demand and supply, but volatility has reduced. For banks, there is very little money to be made from forex because it has returned to being a high-volume, low-margin business,” Equity Group CEO James Mwangi said in a recent interview.

Aside from the interplay between demand and supply, the CBK has previously attributed the rise of foreign currency deposits to commercial banks accumulating the deposits from their regional operations.

Commercial banks have amassed hard currency deposits by borrowing externally from entities such as development finance institutions to support their lending activities.

The demand for dollar-denominated loans by households and businesses has also driven commercial banks to maintain hard currency deposits.

Despite the risks involved in contracting such facilities, dollar loans can attract relatively lower costs when contrasted with domestic interest rates.

“People would want to get foreign currency facilities because the interest rates are in the low single digits. A five percent US dollar loan when there is inflation and currency depreciation ends up being equal or less expensive to a Kenya shilling loan priced at say 17 percent,” added Mr Muthui.

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