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Central Bank takes fight on shilling value to IMF’s door

By Dominic Omondi | December 8th 2019
Central Bank of Kenya Governor Dr. Patrick Njoroge.

Kenya’s stable exchange rate is supported by economic fundamentals, a rebuff of an earlier finding by the International Monetary Fund (IMF), which found that the shilling was overstated.

An assessment by the Central Bank of Kenya (CBK) has also found that there was an agreement between the exchange rate and stability of prices in the economy, even as it absolves the apex bank of propping up the currency.

The study titled, “An Assessment of Exchange Rate Misalignment in Kenya,” looked at the extent to which the country’s exchange has deviated from the ideal trajectory by looking at what is known as the real exchange rate (Reer).

Reer measures the price of foreign goods relative to the price of domestic goods. Mathematically, it is the ratio of a foreign price level and the domestic price level, multiplied by the nominal exchange rate. The shilling is currently trading at 101.9.

According to CBK, misalignment of the county’s exchange rate has been declining over time, from 4.1 per cent in the period between 2010 and 2013 to 2.6 per cent in 2014-2017, a perceived stamp of approval on CBK Governor Patrick Njoroge’s leadership at the apex bank.

The results for overvaluation were virtually similar even when alternative approaches were employed.

In its assessment, CBK used Behavioral Equilibrium Exchange Rate (Beer) framework, which uses econometric methods to establish a link between the real rate and relevant economic variables.

“Overall, misalignment of the Kenya shilling real effective exchange rate declined on average from 4.1 per cent in 2010-2013 to 2.6 per cent in 2014-2017, suggesting that the country’s exchange rate was largely consistent with economic fundamentals,” reads the report published on December 6.

Real exchange rate misalignment, said CBK, means that a nation’s currency is either under- or overvalued from its ‘ideal’ value.

“The ideal is some measure of equilibrium, which is the level of the real exchange rate that is consistent with the goals of internal and external balance, which encompass high economic growth, low inflation and a sustainable current account balance,” said CBK.

Misalignment of the real exchange rate can thus induce structural imbalances in the economy.”

CBK’s finding differ from those the IMF unveiled towards the end of last year. After looking at the country’s current account deficit, which has been improving lately, the fund found that there was an overvaluation of about 17.5 per cent of the real exchange rate.

There were no major changes even when the IMF used other approaches, with the IMF pointing an accusing finger at Dr Njoroge’s team for propping up the shilling and thus making it inflexible.

Njoroge at the time denied the claim, insisting that CBK only came into the market when there was a risk of volatility which could then affect the macro-economic outlook.  

“Reflecting limited movement of the shilling relative to the US$, MCM’s (Monetary and Capital Markets Department) 2018 report on exchange rate arrangement to be published in February 2018 will reclassify Kenya’s shilling from ‘floating’ to ‘other managed arrangement,’” read part of IMF’s review on the country’s economy.

IMF cited a policy gap for the anomaly, noting that the Reer approach also showed a similar size of overvaluation, equivalent to about 18 per cent.

“Again, the policy gap is marginal. Given the continued appreciation of the real exchange rate, the external position is assessed to be weaker than fundamentals,” it said.

Njoroge fired back, saying Kenya was being used as a guinea pig as the IMF used a new methodology that had only been in place since 2015 to reach that conclusion.

The formula, he noted, has been used on advanced economies and only now being applied to emerging markets despite its “well-known weaknesses”.

“We are being used as a guinea pig on the External Balance Assessment-Light methodology,” said Njoroge.

“The methodology was used in a black box method, which we cannot accept.”

Recently, the CBK has been active in the market through open market operations. 

CBK’s study noted that significant exchange rate movements raised concerns over consistency with economic fundamentals.

Stability in nominal exchange rates, said the report, relate closely with stability in prices, contradicting a study by Amana Capital, a fund manager, which found a disconnect between the exchange rate and inflation.

The company noted that while the value of the shilling in the local market had depreciated by 50 per cent in 10 years, its value on the global market had only declined by 20 per cent.

Amana said the shilling was over-valued by at least 30 per cent, with exporters feeling the pinch as a result.

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