Shilling gets a boost from unofficial forex inflows

The amount of foreign cash entering Kenya from non-export sources doubled in the year to August, providing the much needed hard currency to defend a feeble shilling, but also adding impetus to growing concerns over looseness of the financial system and the security exposure that comes with it.

(Also read: CBK cancels licences of four forex bureaus )

Official data shows that the value of “net errors and omissions” – inflows that came in through unofficial channels – doubled to $1.465 billion (Sh137 billion) in the year to August compared to a similar period last year.

Public finance experts say the huge forex inflows partly explain why Kenya has been able to punch above its head to pay $14.3 billion worth of imports in the year to August.

The value of Kenya’s imports rose sharply to stand at two and half times the value of exports – showing the key role that hard currency now plays in the economy.

The bulk of the increase took place in the month of August when the unofficial cash inflows rose by half to $1.465 billion.

Ms Razia Khan, StanChart’s head of research for Africa, said she was “staggered by the size of errors and omissions”, but conceded that the reasons behind the figures remain a “tough call” to make.

“Kenya appears to be a recipient of inflows that do not fall into the traditional categories into which the balance of payments is split,” she said.

The inflows have in the past raised suspicion that Kenya is being used to launder money from criminal sources such as drug trafficking, gun running and piracy.

It has not escaped observers that the unofficial inflows continued to rise despite last year’s coming into force of anti-money laundering law that parliament enacted two years ago.

The Central Bank of Kenya (CBK), however, insists that the unofficial inflows are mainly the result of failure by banks to properly account for all forex receipts from their customers.

“A major source of discrepancy is the inherent inability of commercial banks to accurately classify all the transactions to fit the relevant categories as the customers may not provide adequate information to enable them to do so,” the CBK said in response to our queries on the possible sources of the cash.

“Whatever the banks are not able to fit in any of the classification will end up in the errors and omissions bracket, which is usually the balancing item,” said the CBK.

The steep increase in the volume of inflows as Kenya faced one of the most challenging economic environments —characterised by high inflation and exchange rate turbulence—puts the financial services market under the spotlight, especially over the possible use of it to launder dirty money.

Last year, the unexplained cash inflows sparked a fierce debate over the integrity of Kenya’s financial markets surveillance system and the impact of the flows on the cost of living for ordinary Kenyans.

The CBK, which is the financial markets regulator, put up a big fight against claims that a large chunk of the money originated from neighbouring Somalia where 20 years of lawlessness has provided a fertile ground for criminal gangs such as pirates and traffickers of counterfeit goods.

The unofficial inflows have also been blamed for the steep rise in real estate prices in Nairobi and Mombasa – prompting the Office of the President to order an audit into property ownership in January last year. Nothing has since come out of the investigation.

Treasury published the latest report on the unexplained cash inflows three weeks after Kenya launched a military offensive against Somalia’s Al-Shabaab militia – which it has accused of kidnapping foreigners from its territory.

Errors and omissions are recorded as part of the capital and financial account in the balance of payment – which shows transactions between Kenya and other countries.

In August this year, Kenya’s capital and financial account was worth $4 billion (Sh372 billion) – making the unofficial flows a major part of the equation.

A recent review of the errors and omissions data by US-based economic analysts, Trading Economics, suggested that apart from earnings attributable to its economic sectors, Kenya has also taken advantage of its location as “a regional hub for trade and finance in East Africa” to accumulate foreign exchange that is not from official flows.

The payments are divided into current flows such as exports and imports that sit in the current account, long-term financing in the capital account while financial account contains investment assets and liabilities.

It is the financial account that also reflects foreign exchange transactions that cannot be explained and is therefore labelled as “net errors and omissions.” Ms Khan said Kenya’s problem is not one of inability to measure the flows accurately— as has been the case in Nigeria— but that the category of cash that cannot be explained has continued to grow.

The errors are way out of proportion to Kenya’s total national income compared to neighbouring Uganda and Tanzania.

Comparable data shows that at the end of 2010, Tanzania and Uganda had only $28.8 million (or 0.1 per cent of GDP) and $84.5 million (0.5 per cent of GDP) as net errors and omissions respectively compared to Kenya’s $847 million (2.6 per cent of GDP).

This means that Kenya unexplained flows were eight times the combined flows in Uganda and Tanzania.

Opinion remains divided, but some analysts say Kenya’s near total removal of barriers to movement of money relative to its neighbours explains the differences.

Kenya is the most financially open of the East African Community countries according to a study by the International Monetary Fund (IMF) that was published last year.

The study looked at foreign exchange and interest rates at the interbank market to estimate the level of financial openness in each country.

“Data from Kenya, Tanzania, and Uganda suggest different levels of financial openness. Kenya is most open, followed by Uganda, and Tanzania,” said the IMF.

When the “errors and omissions” issue first raised outcry in 2010, some experts said Kenya was a safe haven for the Indian Ocean piracy.

Others also suggested that the unexplained forex inflows resulted from Kenya’s position as a hub for regional operations of NGOs and multinationals that also receives large amounts of transit money.

Ms Khan suggested that the Kenya shilling has over the years received some support from the unexplained flows. Kenya’s capital and financial account also benefitted from private inflows of hard currency to key sectors of the economy such as energy and private loans.

Some of hard currency inflows also went into financing of infrastructure projects. Programme loans rose from $545 million at the beginning of the year to $611 million in July but slowed down to $569 million in August, according to Treasury data.

Official remittances stayed in the range of $52 and $84 million per month and totaling $643.8 million for the nine months ending September.

[email protected]