CBK's Patrick Njoroge faces catch-22 in taming shilling free fall

Of the many functions performed by the Central Bank of Kenya (CBK), regulating the foreign exchange market has been close to the heart of the current boss Dr Patrick Njoroge.

Yet, the shilling has been on a free fall. It has suffered the longest nose-dive in recent times, with one dollar fetching 115.7 units of the local currency in the foreign exchange (FX) market.

This is a bit disconcerting for a country that needs dollars to purchase its fuel, fertiliser, machinery, and wheat from outside its borders; or to pay foreign lenders their debts or shareholders their dividends.  

How could this happen right under the nose of a man who has been quick at sniffing out any whiff of speculative behaviour by FX traders?

It is also true that it is on Dr Njoroge’s watch—especially before the outbreak of the Covid-19 pandemic in March 2020—that the country’s exchange rate has had an unusually good run.

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But, there is some method to this madness. There was a reason the shilling remained strong to the extent of appearing as if it had been massaged, an allegation that CBK denies even after the International Monetary Fund (IMF), in a paper, repeated it.

Wahoro Ndoho, the chief executive of Euclid Capital and former director-general of public debt management at the National Treasury, notes that after a cocktail of events piled pressure on the country’s external reserves, Dr Njoroge had no option but to let the shilling depreciate.

Mr Ndoho reckoned that while the regulator’s role of formulating monetary policy includes mainly controlling inflation (the increase in consumer prices) and exchange rate, it is the latter that has pre-occupied the CBK boss.

“In Kenya, we have such a big debt burden that of the two, CBK would be more interested in controlling the exchange rate,” he said.

A depreciation of the shilling has the effect of pushing up the size of the country’s external debt, a big chunk of which is in US dollars.

For example, since December 2021, Kenya’s external debt stock of $36.9 billion (Sh4.1 trillion) has swelled by Sh97.7 billion after the shilling weakened from an average of 113.13 to 115.77 by the end of Thursday last week.

“That is money you have removed from aggregate demand,” explained Mr Ndoho.

If keeping the shilling steady, at least for the sake of the country’s debt mix, was one of Dr Njoroge’s job descriptions when he was hired in June 2015, he seems to have done a stellar job.

“Thanks to your (Njoroge’s) hard work and commitment, our shilling has remained fairly stable and competitive,” said President Uhuru Kenyatta on December 11, 2018.

But then, the economy has recently been devastated by a locust invasion, the Covid-19 pandemic, drought and now the war in Ukraine.

All these events have conspired to put a lot of pressure on the country’s little reserve of dollars and other foreign currencies.

Fewer dollars are flowing into the country’s pot, but more are flowing out. This has culminated in the current shortage.

This shortage of dollars then drives up the price of the greenback in the FX market. Ideally, CBK would have jumped in to calm the market by selling dollars to commercial banks at a subsidised price—and banks have been pushing for this.

But CBK remains tone-deaf. This time around, Dr Njoroge will sit back and watch as the exchange rate takes its course. But this is no excuse for FX traders to engage in some monkey business.

The regulator recently penalised Ecobank for what it said was currency manipulation.  

Economists—particularly liberal ones who take offence with the tinkering of market prices like the exchange rate—reckon this is the right thing to do when the external reserves come under pressure. Allow the shilling to weaken.

Unfortunately, it seems like CBK’s pace of allowing the local currency to weaken has been falling behind market expectations, according to EFG Hermes, an Egyptian-based investment bank.

This can get worse in what EFG described as a “thin FX market” like Kenya’s, resulting in more cautious behaviour from market players.

“Sellers of FX tend to be slower in selling their holdings of foreign currency, while buyers tend to exaggerate their demand in order to secure larger amounts of FX (as a way of a hedging).”

The bank said the country’s external accounts came under pressure after the Ukraine war, which pushed up the price of imports such as wheat, fertiliser and fuel.

Moreover, the resurgence of the economy after countries started to roll back the containment measures against Covid-19, translated into a surge in demand for oil and thus a higher price for Kenya’s single largest import.

This ate into the country’s “thin” reserves of dollars at a time when the flow of tourist and export earnings were yet to return to the pre-pandemic levels.

Dollars sent by Kenyans living and working abroad as well as debt inflows from the World Bank and the International Monetary Fund (IMF) have, to some extent, helped stabilise the local currency.  

When Covid-19 broke out in the country, there was a capital flight as foreign investors evacuated their wealth from the Nairobi Securities Exchange (NSE).

The silver bullet, according to IMF, is for CBK to stop propping up the shilling.

Instead, IMF has asked the financial regulator to let the exchange rate be used as a shock absorber.

“The CBK appropriately allowed the shilling to act as a shock absorber during the pandemic and should continue to do so while using forex interventions only to minimise excessive volatility,” said the IMF. Forex interventions should only be resorted to minimise excessive volatility, said the Washington-based institution.

According to conventional wisdom, flexible exchange rates insulate economies from external shocks such as the Covid-19 pandemic. When a currency is devalued, its demand also goes down.

Under the aegis of the Kenya Bankers Association (KBA), commercial banks are now saying there is elevated dollar demand by companies to pay dividends and meet their overseas obligations in the wake of a strong Covid-19 recovery.

“We have been in constant contact with the Central Bank of Kenya to address the strong demand for dollars in the market,” said the bankers’ lobby in a statement signed by Chief Executive Habil Olaka last week even as it denied reports that the regulator, has been interfering with the foreign exchange (FX) market.

“The Central Bank, having the best view of the market situation, has assured us that the market is well balanced in terms of supply and demand of dollars.” CBK’s best view of the market, so far, is to let the forces of demand and supply play out.

So far, said EFG Hermes, the weakening of the shilling does not seem to be having a significant impact on consumer prices, with CBK expected to maintain this increase, technically known as inflation rate, at between 2.5 per cent and 7.5 per cent.

“We think the CBK is wary of the impact on fiscal and debt dynamics if it weakens quickly,” said the firm.