In an unprecedented move in recent history, the Central Bank of Kenya (CBK) issued a cautionary guideline for commercial banks to ration dollars. This seems to have caught many businesses, dealers and analysts by surprise. Official data still project a healthy dollar reserve for the country, even above the East African Community import cover guide.
For many ordinary folks, such pronouncements mean little to them as only a small population ever deals in forex currencies. However, the consequences of this rationing have far-reaching effects at household or individual levels. In a globalised world, complex economic interactions are facilitated behind the scenes through the financial markets to make available basic goods and services to consumers at affordable prices.
For example, before second hand clothes, popularly referred to as mitumba hit the local market at say Sh100 a piece, complex financial decisions would have happened behind the scenes. The same happens to the imported maize, wheat, milk and related products popular on our dinner and breakfast tables.
However, from a broader and technical perspective, it is important to explore what could be necessitating such a move by the regulator. As I have argued here before, the economic discipline is not a caricature of abstract theories. It is a consummate practice that influences, and at times dictates individual, community or a nation’s socio-economic welfare.
Repeal of controls
At policy level, Kenya abandoned exchange rates controls in 1993 with the Exchange Controls Act repealed effective from December 27, 1995. The exchange business was then delegated to authorised foreign exchange dealers, mainly commercial banks and licensed forex bureaus. To facilitate smooth trade and curb illegal currency flows into and out of the country, the CBK issued Circular No 12, dated August 19, 1996 and Forex Bureau Guidelines of November 11, 1996.
Further protocols and policy guidelines are updated on a regular basis. Effectively, this makes the sub-sector one of the most regulated within the economy and for good reasons. The interdependencies of today’s economies has thrust decisions on foreign currency reserves and exchange rate regimes into the heart of macroeconomic policy choices. In international finance, this policy choice affirms the reality of the concept of the “impossible trinity”.
The impossible trinity presupposes that no country can have control over its monetary policy, balance of payments and exchange rates controls at the same time. Therefore, policy makers have to choose which one or which two of these macroeconomic parameters the government wants to control. The third one must be left to the market forces of demand and supply. The ideal preferred outcome for any government is to have absolute control over its monetary policy. Unfortunately, this can only be achieved by leaving the other two to market forces. Only the United States has been able to achieve monetary autonomy.
There are accidents of economic history that have enabled the US to attain the prestigious status of monetary autonomy. After the Second World War, former European powers lacked adequate capital with ravaged economies to steer the new post-war world economic order. The Bretton Woods Institutions - the World Bank, International Monetary Fund - and World Trade Organisation and the United Nations were established to midwife specific elements of the world economy. The World Bank was to mobilise capital, IMF was to oversee macroeconomic order, WTO to facilitate trade relations while the UN was to deal with politics.
As fate would have it, only the US had the money to provide seed capital to these agencies. Thus, the US dollar was pegged on the gold and became the reference currency for the rest of the world. On August 15, 1971, the then US President Richard Nixon announced the cessation of pegging the dollar against gold for lack of adequate gold reserves. That effectively ended the gold standard, with the dollar automatically assuming the role of the world currency.
It is out of this economic history that the US dollar has a significant role in global trade. In Kenya, the dollar is the dominant currency in our international trade transactions, public debt portfolio and foreign currency reserves. This forms the basis of the dollar ration guideline. While officially we have a free float exchange rate regime, the reality is that ours is a managed float, meaning that the CBK would intervene in the country’s foreign exchange market at various points to achieve certain desired macroeconomic outcomes.
The questions for us here are: One, while it is common practice to intervene in the exchange rate of the dollar against the shilling, what could be the underlying reason(s) behind this unusual limit on dollar trade? Two, what are the future implications into the future? Are their adjustments that we may need to make in the conduct of our daily business?
Ideally, there would be many things that could have distorted the demand-supply forces of the dollar necessitating the CBK intervention. Obvious culprits would be significant drops in tourist flows into the country, interruptions of horticultural exports and reductions in international trade flows occasioned by Covid-19. Diaspora remittances have largely remained the key supply of forex currency into the country.
As things stand, policy makers may easily get away with explanations around the health crisis and the Ukraine-Russia conflict. However, a careful review of recent trends of key macroeconomic variables may point to a bigger underlying problem that has built up over time. Four factors stand out: Balance of trade, public debt, economic health/growth rates and the current accounts deficits.
On balance of trade, the economy is heavily reliant on imports, including basic consumer goods like foodstuff, clothing, low technology tools, accessories and equipment. It is inconceivable that traders of basic commodities should be competing for dollars with oil importers, manufacturers that rely on highly specialised machinery, equipment and technologies. This is an indicator of policy failures and lack of long term strategic orientation of the country’s economic activities.
Second, if public debt growth rate outpaces economic growth, it can have ripple effects in the domestic foreign currency markets. The huge interest obligations and the presently maturing principal repayments under the “big push” infrastructure projects have put pressure on dollar demand.
Third is growing current account deficits that arise from importing more than we export to our trading partners. With the weakening of the shillings, imports have become more expensive with exports becoming more benefitial. In a well-structured economy, this would have triggered substituition of imports with local products and encourage exports.
Fourth is the mystery of a robust economic growth with no corresponding trickledown effect. This speaks of an unhealthy economic growth not balanced across all sectors of the economy.