THE KENYAN SHILLING TUMBLES TO ITS WEAKEST LEVEL EVER AGAINST THE DOLLAR.

 

In recent times, the Kenyan shilling has been on a somewhat appalling downward spiral. By the close of trading at the Nairobi Securities exchange on 3^rd November 2021, the Kenyan Shilling had plummeted to its lowest level ever against the dollar, closing the day at 111.49.October was the shilling’s fifth straight month of depreciation, according to data compiled by Bloomberg.

According to a recent Cytonn Investment report, in the just ended Q3’2021 financial quarter, the Kenyan shilling depreciated against the dollar by 2.4% to close at kshs110.5 compared to Q2’2021’s kshs107.9. On a Year to Date (YTD) basis, the Kenyan shilling depreciated against the dollar by 1.2%.

  What then is the reason for this depreciation?

Normally, there are four fundamental factors that affect currency performance namely; jThe balance of payments, government debt, a country’s monetary policy and the amount of forex reserves.

 The Current and Capital account balances influence the Balance of Payments (BOP) position. The current account factors in the difference between a country’s exports and imports. When a country’s exports are greater than its imports, it is said to have a current account deficit. On the other hand, when imports are greater than exports, the country is said to be running a current account surplus.

The capital account records the movement of short-term and long-term capital between a country and its trading partners such as a country’s investments abroad as well as its borrowing and lending.

 According to Kenya National Bureau of Statistics (KNBS) reports, Kenya’s BOP worsened in Q1’2021, registering a deficit of ksh59.4 billion as compared to ksh47.4 billion of Q1’2020. This weakening is ascribable to the 16.6% increase in the current account balance to kshs142.0 billion in Q1’2021, from kshs121.7 billion in Q1’2020 due to merchandise trade deficit and lower inflows from the services sector. Within the same period, exports increased by 6.2% to kshs190.9 million from ksh179.9 million. The report by Cytonn Investments projects that there will be a gradual increase in the export sector as Kenya’s trading partners continue to re-open their economies. However, the report predicts that the high import bill will weigh down on the current account balance due to an increase in merchandise trade deficit attributable to increased global fuel prices, persistent disruptions in supply chains and logistical challenges.

Since external loans to the Kenyan government are majorly denominated in foreign currency (mainly USD), external borrowing has an impact on the strength of the Kenyan Shilling. The report by Cytonn indicates that as at the end of September this year, the government was 63.4% ahead of its stipulated borrowing target of kshs164.4 billion having borrowed kshs269.1 billion and has maturities worth kshs78.8 billion. By May 2021, Kenya had borrowed kshs3.7 trillion which is 33.7% of GDP and 65.2% in USD denomination- a stark indication that the shilling is expected to experience pressure due to repayment of foreign-denominated debt. The report forecasts that the high debt burden will continue exposing the shilling to exchange rate shocks, and will in turn, exert pressure on the shilling to weaken during the repayment period. Moreover, the debt service to revenue ratio of 65.8% will mean that the government will have to borrow locally to settle external debt hence exerting more pressure on the shilling.

According to Central Bank reports, as at 30^th September 2021, forex reserves stood at USD 9.4 Billion (equivalent to 5.8 months of import cover), which is above the statuory requirement of maintaining at least 4.0 months of import cover. Cytonn Investments foresees that forex reserves will continue to be supported by; debt relief from other institutions, increasing diaspora remittance inflows and continued capital investor inflows. On the downside however, the heightened debt levels are likely to put the forex reserves under duress as most of it will be used to finance debt obligations.

 According to the report, it is expected that the shilling will remain under pressure as the demand for the dollar rises as a result of the decline in domestic investment activities as Kenya’s financial and capital assets become less attractive to foreign investors dues to their low rate of return.

The report by Cytonn goes ahead to finger three other factors that might have contributed to recent downward spiral in the strength of the Kenyan shilling against the dollar.

The first, is the rising uncertainties in the global market due to the ongoing covid-19 pandemic which has seen investors continue to prefer holding their investments in dollars and other hard currencies and commodities.

Secondly, the decline in COVID-19 infection rates across most countries as well as the availability of vaccines has led to the global re-opening of economies. This has in turn led to an increased demand of the dollar by merchandise traders in a bid to fortify their hard currency positions.

Thirdly, the upward surge in crude oil prices owing to supply constraints amid a spike in oil demand with the re-opening of economies.

 The report also reveals that in the period under review the shilling continued to be supported by forex reserves which stood at USD 9.4 Billion by the end of September this year. The reserves were propped up by the USD 1.0 billion proceeds from the 12-year Eurobond issued in July this year, an IMF disbursement of USD 407.0 million and the USD 13.0 million financing received from the World Bank on June, 2021. Additionally, the improving diaspora remittances came in handy, reporting an 18.8% year to year increase to USD 309.8 Million in September 2021, from USD 260.7 Million recorded over the same period in 2020. These remittances have continued to act as a bulwark against further depreciation of the shilling.