Is Kenya shilling set for a big slide amid FX slump?

By Herald Onyango
Posted on Monday, 19 December 2022 10:51

FILE PHOTO: Kenya Central Bank Governor Patrick Njoroge addresses a news conference at the Central Bank of Kenya (CBK) headquarters in Nairobi, Kenya July 25, 2019. REUTERS

Kenya’s maturing debt, tightening monetary policies by big economies, and ballooning import bills will force the East African country to spend more of its forex reserves (FX) to meet financial obligations in the external market, most of which are dollar-denominated transactions.

This combination of factors points out that the limited FX might face a further slump, which will continue crushing down the value of the Kenya shilling against the dollar, indicating tougher times for the importers and commercial banks.

As of 9 December, FX reserves dropped below the statutory requirement of four months of import cover to $7.1bn, representing a 23.9% plunge compared to $8.8bn held in the first week of January 2022.

With the US trying to contain the highest inflation through tighter monetary policy, economists are seeing the dollar shortage worsening as foreign investors move their capital to more stable jurisdictions offering better returns.

“There are few alternatives so many people are going to invest in the dollar and US government bonds. That is obviously sucking dollars away from some countries,” says Kwame Owino, an economist and CEO of the Institute of Economic Affairs. “That scarcity creates a depreciation pressure, part of that on the Kenyan shilling in general. We need to continue watching.” 

Hiked rates

Last month, the US Federal Reserve approved a fourth consecutive 0.75% interest rate hike to combat inflation, which a mixture of factors like high energy prices has fuelled. In December, the Fed opted for a smaller 0.5% increase, yet reiterated plans to maintain monetary tightening through next year. 

Countries like Kenya are tightening domestic monetary policy in response to their own inflationary pressures while trying to match the Federal Reserve hikes. The CBK’s increase of benchmark lending rates, now at 8.75%, means that borrowers face expensive bank loans.

We still believe that we have adequate [forex] cover to smooth out volatility that would come.

It remains unclear how high the rates will go. The CBK governor says he expects inflation to start cooling off in the first quarter of 2023, which could determine the next action by the monetary policy. 

However, persistent FX decline means that Kenya’s apex bank will struggle more to support the shilling against major currencies than it has done over the past months should fresh volatilities arise. The currency is currently trading at KSh122.7 against the greenback according to the official printed rates, but market data shows it is retailing at nearly KSh130 per dollar.

‘Not stressed’

CBK has, however, downplayed concerns around declining reserves, insisting that the bank can still sustain meeting most of its dollar-denominated payments in the market, especially servicing of external debts.

We still believe that we have adequate [forex] cover to smooth out volatility that would come. We are doing our best endeavours to ensure we get reserves. We are not stressed in terms of CBK continuing to perform its function in the market [domestic] and elsewhere,” CBK governor Patrick Njoroge said during November’s monetary policy briefing.

Most of Kenya’s commercial debts are maturing in May 2023, meaning that the apex bank will face a loan repayment burden that will eat a big chunk of the available FX and revenues. Kenya’s debt stood at KSh8.56trn in September. This excludes State-guaranteed debt and un-tapped loans, an amount that is set to surge further over the medium term due to the maturity of the ten-year Eurobond.

“With accelerating imports and gradual erosion of foreign exchange reserves, the shilling has remained under pressure [depreciating by 6.4% against the US dollar between end December 2021 and 6 October]. This has put an upward pressure on debt service as 68% of the external debt is denominated in US dollars,” World Bank said in an analysis of Kenya’s economic condition in 2022.

Kenya is, however, expecting its reserves to increase on diaspora remittances and the lined-up loan disbursement of $433m from the IMF and $750m from the World Bank.

Remittance slowdown

Even so, the boosts brought by these inflows are likely to be offset by the upcoming debt servicing, signalling more plunge in the dollar stock. A large portion of the repayments will go towards servicing China loans incurred under the Belt and Road Initiative (BRI) projects, including the construction of the Mombasa-Nairobi standard gauge railway (SGR), roads and bridges.

The World Bank has already warned that Kenya’s diaspora remittance inflows, the leading contributor to FX reserves, could be dampened by the projected decline in economic activities in Europe and America. A drop in economic activities in these countries, plus global inflation, is leaving the diaspora sector with little capital to send back home.

A slowdown in remittance could equally widen the country’s current account deficit to 6%

The US remains the largest source of remittances to Kenya, accounting for 55.8% in November when the cumulative diaspora inflows reached $4bn (KSh484bn).

A slowdown in remittance could equally widen the country’s current account deficit to 6% by the end of this year, according to the World Bank, a situation worsened by the high import bills caused by the fuel price.

The current account often measures the difference between a country’s forex inflows and outflows, with a deficit arising when the outflows are higher.

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