History paints bleak future for the shilling, with 100-plus level set to be ‘new normal’

The weakening of the shilling against the dollar over the course of the last decade — and especially the drastic drop in 2015 — has had an effect on every Kenyan in one way or another.

And now, with the US increasing its interest rates from a historic low of near-zero to 0.25 per cent last week, there are many questions, opinions and concerns on what will happen to the local currency.

Many analysts expect no change and are of the opinion that the shilling will remain stable, with the current exchange rate of 102 to the dollar thought to be a true reflection of the current economic position.

And then there are the optimists. They see a gradual strengthening of the shilling to levels below 97 units to the dollar. This is based on the fact that some of the key sectors of the Kenyan economy — such as tourism and agriculture — are on the rebound, with the much-needed dollar inflows expected to start streaming in.

Finally, there are the pessimists who look into the crystal ball and see the shilling weakening even further as the US economy powers ahead of a slowing global economy — especially since the Chinese economy is set to grow at its slowest pace in the last six years at 6.9 per cent.

Down memory lane

But a deeper approach to the ‘What next?’ question on the shilling requires a look at the currency’s gains and falls against the dollar in the last decade.

It is said that history tends to repeat itself, yet, those who cannot remember the past are condemned to repeat it, as the philosopher George Santayana said.

These varied movements of the shilling — from a decade high of 61 units to the dollar in November 2007 to the current levels of 102 — have brought opportunity and losses.

The biggest lesson over time, however, seems to be that the Kenyan economy, and its currency, is just but a player in the global economic landscape.

Because Kenyans import more goods from other countries than they export, the country is set to run a current account deficit — which means the value of what it buys from other countries (machinery, computers, cars and so on) exceeds what it sells (coffee, tea and flowers) — for the foreseeable future.

This means that the country needs to find a way to attract more dollars into the local market.

Just last week, the International Monetary Fund’s executive board noted that, “Kenya’s growing integration in global financial markets had not only created significant opportunities, but also made the country more exposed to global market developments”.

While the external current account deficit was projected to decline to 8.5 per cent of GDP in 2015 (from 10.4 per cent in 2014), it remains high, requiring significant foreign capital inflows to be financed, the IMF executive board said.

The IMF has walked the talk on this, providing Kenya with a Sh67.5 billion precautionary loan in June this year, which was meant to help the Central Bank of Kenya (CBK) defend the shilling’s position against the dollar.

CBK seems to be building on all fronts to defend a weakening currency, especially since it knows raising interest rates is a double-edged sword.

This year was not the first time that the shilling has traded at 102 units to the dollar over the past decade. It traded at similar levels in October 2011.

But the biggest difference between then and now is that the shilling has currently traded above the psychological 100-units level to the dollar for four consistent months — that is from September to December.

If history serves us right, then the shilling at levels above 100 is the ‘new normal’.

Every time the shilling has depreciated and traded at a certain level for four consistent months — it has happened in the past when the shilling traded above 80 units to the dollar in 2010 for four months — it has not got back lost ground. From 2010, it weakened to 90, and then to 100 units against the dollar.

Biggest concern

In 2011, the shilling only traded for one month above the 100 level to the dollar before CBK intervened with an interest rate hike by increasing the Central Bank Rate to 18.5 per cent, which helped strengthen the local currency.

The biggest concern now is that CBK does not have that many tricks in its bag, especially raising interest rates. Still, foreign exchange traders expect the regulator to defend the 102.50 position by selling dollars, which it has been doing in the past few weeks.

This, therefore, means Kenyans may have to adjust to a life where the shilling is trading at 100 and above to the dollar.

And this is coming against a backdrop of a stronger US economy, which means interest rates are likely to increase even further each year, as the Federal Reserve — the US equivalent of CBK — stated in its statement last week.

The US rates have remained at 0.12 per cent for about six years, but policy experts say this latest increase was critical to ensure the American economy does not overheat even as it recovers.

The dollar has also been propped up by a flight to safety from the Eurozone region, following the Greek crisis, and more recently by the economic cooling and subsequent realignment in China, following the devaluation of the yuan.

Over the last decade, much of the shilling’s woes and fortitude have been tied to the US economy.

It all started in the years after the dot com bust, when the Fed decided to keep interest rates as low as possible to encourage consumption that would get the US economy back to its feet.

What happened then is that Americans borrowed money at very low rates, which also meant interest rates on savings were close to nil. They began looking for investments that would bring greater returns on the dollars they held.

Many ordinary citizens pumped their cash into investment funds that promised to look far and wide for favourable returns. This was before the 2008 financial crisis.

These global investors favoured emerging markets, such as Kenya’s, for their funds. With a new government in place after Mwai Kibaki was sworn in as president, and optimism swirling across the country, few Kenyans questioned how long the dollar inflows would last.

Today, with the benefit of hindsight gained from this time, many Kenyans are seeing similarities between what happened in the Kibaki era, and the local and international interest in Tanzania after the October election of President John Magufuli.

“Many of the foreign investors we are hosting are now passing through Tanzania first before they come to Kenya, or they are starting out in Kenya and then going into Tanzania,” said Eric Musau, an analyst with Standard Investment Bank.

“If the Tanzanians get everything right, they will most likely give Kenya very stiff competition for foreign investment.”

As it stands, one of the best ways to strengthen the shilling is to get more investors to buy Kenyan assets, such as shares, fixed-income products and companies.

However, the outlook this time round is not too clear because the scale of deals today is much smaller than what was witnessed in 2007, when Kenyan companies were attracting foreign suitors and the shilling was holding its own against the dollar.

In fact, two of the landmark acquisitions of the last decade — Helios buying into Equity Bank and France Telecom pumping money into Telkom Kenya — coincided with this period.

Perhaps then it is not a coincidence that Helios and France Telecom have exited their investments at a time when the shilling is taking a severe beating — with mixed fortunes.

London-based private equity firm Helios made an extraordinary return of four times the Sh11 billion it had invested in Equity Bank in December 2007 by selling its shares for Sh44.1 billion this year.

Including the dividends it has received from the bank, Helios made a compounded return of 24.3 per cent in seven years.

France Telecom, on the contrary, decided enough was enough and decided after years of losses to exit its investment in Telkom Kenya. The French firm had invested Sh24 billion for a 70 per cent stake.

Ironically, France Telecom has sold its stake to Helios in a strange and interesting twist of fate when the shilling has held a consistently weak position, yet the two firms came in when the local currency was at its strongest.

To take the shilling back to its former glory, many are of the opinion that the country needs an influx of foreign capital that stays put. And this foreign capital will be funded by cheap dollars.

The question then becomes: How will dollars become cheap, and are investments in Kenya attractive to foreign investors?

Withdrawing funds

With the increase in US interest rates, the possibility is high that many investors will consider withdrawing their funds from emerging economies — which are prone to various instabilities — and taking them back to the safety of the US.

To put this in perspective, US government debt is classified AAA by both Moody’s investor service and Fitch Ratings, and AA+ by Standard & Poor’s. This means the US is classified as high-grade debt.

On the other hand, Kenya’s debt is ranked B1 by Moody’s, while Standard & Poor’s and Fitch put the country’s credit rating at B+. This means Kenya’s debt is classified as non-investment grade and is highly speculative. Therefore, the US market is a much more attractive destination for investment.

If dollar withdrawals happen in Kenya, the country will need to adjust to buying US currency at levels above 100 for a long time to come — though the CBK has said it expects Kenya to ride out the storm that will result from this.

For importers of goods, this will mean an increase in the price of the products they bring in to adjust for changes in the exchange rate. Some companies have already increased their prices, stating that the cost of importing various materials for their products has gone up as the shilling weakens.

Because of limited manufacturing, Kenya imports many of the basic items it consumes, including toothpicks, tomato paste, pocket tissues, and so on, which is set to lead to price increases.

Further, plenty of listed firms are trading on profit warnings as the cost of repaying loans taken out in dollars eats drastically into their earnings. A lot of them will be forced to increase the costs of their products to meet operational expenses.

But while the shilling has lost about 12 per cent of its value so far this year, it has done exceptionally well compared to other economies.

“The shilling has performed well in what has otherwise been a sub-Saharan Africa bloodbath,” Aly Khan Satchu, the CEO of Rich Management, said. Ghana’s cedi slumped nearly 30 per cent in the first half of the year, for instance.

Still, 2016 does not appear to hold much hope for a stronger shilling — unless the volume of the country’s exports drastically increases, or cheap dollars find a reason to make Kenya their long-term home.

Additional reporting by KTN’s Adelaide Changole.

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