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Why is the Kenya shilling losing against US Dollar?

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A weak shilling cost the taxpayer an extra Sh65 billion monthly in the year to June 2023. PHOTO | SHUTTERSTOCK

Since the beginning of 2020, the Kenya shilling has lost approximately 25 percent of its value against the US dollar, falling from Sh99 to Sh124.

This means that Kenyans will need to spend 25 percent more shillings to buy the same amount of dollars.

Importers have had to pay an extra 25 percent and have repriced their items, raising the cost of consumer goods and contributing to higher inflation in Kenya.

Exporters, on the other hand, are receiving more shillings for the same quantity of exports, and their products appear to the rest of the world to be cheaper.

According to the Central Bank of Kenya (CBK), annual inflation in 2022 was 9.06 percent, up from 5.73 percent in 2021.

This means that a product that cost Sh1,000 in January 2020 now fetches Sh1153.09.

There are various reasons why the Kenyan unit has lost value against the greenback. First, the Federal Reserve Bank of the United States (Fed) has been extremely aggressive in monetary tightening, raising interest rates from a limit of 0.25 percent in March 2022 to 4.5 percent now.

As a result, the US dollar has risen in value relative to other currencies, including the Kenyan shilling. In September 2022, we witnessed the Euro trading at a historic low of 0.9535 against the US dollar.

That represented a 15 percent fall from the exchange rate at the start of 2020. The Japanese yen had lost 40 percent against the US dollar by October 2022, having peaked at 151.9 before beginning to recover.

In Nigeria, the Naira lost 26.7 percent against the dollar between January 2020 and today.

Read: Bank dollar rate jumps to Sh130 on high demand

Bonds are the second major contributor to the massive loss in exchange rates. Bonds are widely regarded as low-risk investments with predictable payments.

Bonds typically account for a large portion of the portfolios of investment banks, hedge funds, pension funds, and other investors.

Bonds in first-world economies are regarded as the safest, attracting more investors. Frontier economies, such as Kenya, are generally considered as high risk, therefore their central banks must provide higher bond yields to entice investors.

Because their economies are considered generally stable, emerging economies such as Brazil tend to give lower yields than frontier economies.

So, what occurred when the United States began rapidly hiking interest rates?

The yield on US bonds increased from 1.88 percent in January 2020 to 3.48 percent today. This triggered an exodus on bond markets in frontier and emerging economies.

On the risk side, the majority of debt outlays in the global south are denominated in US dollars. As interest rates rose, their obligations grew larger, increasing the likelihood of default on their debts.

Furthermore, inflation rates were rising during the same period, discouraging foreign investors because inflation was suppressing their current assets.

According to the Business Daily, foreign investors pulled out Sh24 billion from the Nairobi Securities Exchange (NSE) in 2022.

Third, global financial markets are forward-looking. This means that investors make decisions based on projected outlooks.

In Kenya, investors pulled out their investments following fears that the General Elections in 2022 would cause disruptions in economic activity.

Read: Shilling sinks to a new time low against the dollar

After the polls were held peacefully, they began reinvesting rapidly. However, in the wake of the New Year, a sequence of policy changes and economic reports have dampened the investment outlook in Kenya.

The ultra-aggressive taxation policy in Kenya which includes tripling capital gains taxes from five percent to 15 percent has pushed investing away while others began selling their interests to pump elsewhere.

Furthermore, the scarcity of dollars has generated an alternate black market in Kenya, Nigeria, and many other African countries.

The currency rates on the black market are much higher than those provided by central banks.

People and corporations have been stockpiling dollars due to the general perception that they are a relatively stable store of value, while interest rates have been rising month after month.

Lastly, the monetary and fiscal tightening in Kenya has forced businesses to either cut operations here or move entirely. This includes the CBK raising rates from seven percent to 8.75 percent in 2022 among others

The market knows this and is pricing it in by purchasing dollar-denominated assets while dumping Kenya shilling-denominated assets.

Rufas is a lead Markets Analyst at FXPesa. E mail :[email protected]