Charged political climate a threat to forex business

The direction which our politics has taken must be a concern to all of us and worrisome to investors, whether local or foreign.

This kind of politics if left unchecked will impact our exchange rates, our economy and our standards of living adversely.

No investor would transact with a country in turmoil. Already, we have a time bomb in the form of youth unemployment and adding political turmoil to that is contaminating.

A serious citizen would be worried about exchanging Sh200 for one dollar, but with these political problems that must be our destination.

That is what happened in Mozambique during the civil strife and recently in Zimbabwe.

Foreign currency is like any other asset whose price depends on demand and supply.

The more the demand for the dollar, the higher its value. If there is an excess supply of the dollar, then its value must fall.

Up to 1980’s Kenya was under a fixed exchange rate regime.

There was no foreign exchange market as such because the Central Bank of Kenya decided on how many shillings were needed to buy a dollar or the pound or yen.

During that period, the exchange rate was flat. The market is now open. It is up to buyers and sellers to agree on the price of the foreign currency they are to transact. The foreign currency market is one of the biggest global markets with prices moving and currencies trading every second of the day.

Effectively, foreign exchange transfers purchasing power between countries, helping them obtain credit for international trade transactions, making it possible to manage risks associated with exchange rates.

As a market player, you have to decide where you want to be, but out there are bank and non- bank foreign exchange dealers, individuals and businesses conducting the forex business.

All these players are in the business of making money. It is important to understand who does what in the foreign exchange market.

Foreign exchange dealers make a market in foreign exchange, specifically buying and selling currency in the wholesale market and resell or re-buy it at a profit.

The dealers make this market liquid. Liquidity is a major component of an efficient market - where you get value for your investment.

Brokers bring dealers together, either because the dealer(s) do not want their identity revealed until after the transaction, or because the dealers find that brokers can make money for them at low transaction costs.

Individuals and firms conducting international business are largely importers and exporters, making direct foreign investments and investing in securities in other countries.

All these require foreign currencies. They buy or sell foreign currency. Speculators and arbitragers transact in foreign exchange for profit - they buy or sell based on which direction, they believe a currency’s value will change.

Central banks and treasuries buy and sell foreign exchange for intervention into the marketplace. There is direct intervention, in which the Central Bank buy or sell its own currency in the market with its foreign exchange reserves to correct mispricing of foreign currency.

Inflation affects the exchange rate. High inflation reduces the shilling’s purchasing power, and this induces a drop in the value of the local currency relative to foreign currency.

If inflation is high, you will need more shillings to buy a dollar. This means imported medicine becomes costly.

We know what happens to citizens when imported medicine becomes expensive.

When interest rates increase, lenders will have their financing cost increase and subsequently report low profits and low returns to the shareholders in the borrowing firm.

However, if lenders are foreign investors, the demand for the local currency will go up and hence its value.

This is the catch, when the foreign investors come in, their demand for the Kenya shilling goes up and this can impact adversely on foreign trade.

However, the current problem is the current account deficit.

A deficit arises when a country’s imports exceed its exports such that the country has to borrow from other countries.

The result of a huge current account deficit is that investors will reduce their investment, and the value of the shilling will fall. And without investment, we will become poorer.

Now inflation is going up possibly due to large public debt.

The paradox is that inflation is going up but there is no money in the hands of citizens, yet the Kenya shilling is becoming stronger!

The government has been advised to reduce its appetite for debt, because any slightest indication that the State is likely to default in her foreign debt obligations will see foreign investors withdrawing their investments in Kenya, and local currency will lose value.

If that happens, then we will need Sh200 to buy a dollar. Nobody wants to be there.

Exchange rate’s impact on business growth, level of employment and ultimately our living standards.

A strong local currency allows citizens to import but could discourage exports and translates into a reduction in foreign liabilities and debt serving costs with debt liabilities and debt servicing cost down the country becomes attractive.

Many people want to hold the dollar because it’s strong and stable. But a strong currency could reduce our international trade competitiveness again.

This leads to more imports and fewer exports translating into an adverse balance of payments. Let us tame our politics for the purpose of our comfort.

-The writer teaches at the University of Nairobi