Wide fluctuations being experienced in the foreign exchange rates have definitely introduced a new element of risk into international transactions. Just last month alone, the shilling lost one percent of its value to the US dollar bringing its year-to-date losses to 6.2 percent - the Kenyan currency touched a new low of 120.
High demand for the dollar from oil and merchandise importers coupled with foreign investors repatriating dividends also liquidating low-yielding government debt and stock market investments have been cited as reasons partly behind the shilling’s woes.
Possibly, large losses have forced a number of importers/exporters to turn to the forward market to limit the adverse effects of exchange rate movements.
Traditionally, in such events, commercial banks provide forward cover to their merchant clients as a means of hedging foreign exchange exposures. That said, isn't it time the market added an alternative? Let's talk about currency futures.
Why futures? One, we already have a financial futures market established where these contracts can trade at the Nairobi Securities Exchange (NSE) derivatives market NEXT, which can serve as a secondary market - the forward market is an over-the-counter market.
Two, standardisation of exchange-traded contracts has its own special appeal. Introduction of the standardised contracts can only fulfil a market need that is not fully met by current major foreign exchange trading banks.
Three; a futures market will cater to individuals, speculators, small businesses, and other financial concerns that find the interbank market impractical or unsuitable for their needs.
Four; currency futures provide a lower-cost hedging alternative compared to the forward market. This can increase competition. Five; I believe the introduction of currency futures will prove to be a milestone in the evolution of the finance markets in the country. Why now?
Kenyans are presently facing steep rises in the cost of living. Inflation in August rose to 8.5 percent, up from 8.3 percent recorded in the previous month due to fuel inflation specifically increasing to 9.2 percent in the second quarter from 6.82 percent in the previous quarter as a result of elevated international oil prices.
Additionally, the current account deficit is expected to balloon - it’s estimated to have widened to Sh 189.6 billion in the second quarter of 2022 from Sh175.2 billion in the second quarter of 2021 - as the local demand for dollars has been on the rise.
It’s been reported that importers are hedging their positions by increasing their dollar reserves to avoid losses associated with a weak shilling when importing raw materials. Also, think about the massive savings the government will make not having to subsidise the cost of basic necessities.
Currency futures are a clear and able alternative. Besides, the set-up already exists - a clearing house, clearing members, trading members and a ready market.
All in all, the risks associated with movements in exchange rates are too large to be left to only major banks to deal with. This overview of foreign exchange market trading in general and of currency futures, in particular, illustrates how these contracts can help reduce such risks.