Since 2021, the Kenya shilling has fallen against the US Dollar (USD).
The steep decline has elicited panic and the Central Bank of Kenya (CBK) has in a sense lost influence over the exchange rate. I don’t think we are in panic territory yet, and the situation appears manageable, but there is no easy path forward.
The decline appears linked to the increase in USD interest rates from 0.25 per cent in 2020 to 2.96 per cent in 2021 to 5.15 per cent this year, strengthening the greenback against the shilling as CBK holds interest rates.
Kenya acquired additional significant International Monetary Fund (IMF) debt in 2021 as growth, investment and foreign exchange earnings were insufficient to manage the dollar to keep up with its strengthening.
Debt repayment became more expensive, and inflation and import prices increased. While it’s a plus that interest rates are higher than inflation, the latter is concerningly high, over eight per cent a month in 2023 and close to double digits.
There are nonetheless good reasons for a weaker currency. For starters, it keeps asset, tourism and export prices attractive.
Inversely, there are good reasons for a stronger currency. It lowers import costs and foreign currency debt repayments. Presently, the shilling needs to strengthen against the dollar. The shilling has a floating exchange rate, which means its value depends on supply and demand as opposed to a pegged exchange rate, fixed against another currency and less able to take shocks.
The exchange rate set by CBK is indicative and influential, not decisive or final. Therefore, the burden falls on the government to act. The government is in an extraordinarily difficult position due to inheriting high foreign currency debt and high recurrent expenditure combined with insufficient growth and foreign exchange earnings and political considerations.
Generally, three basic options arise. One would be to increase interest rates to strengthen the shilling. Two would be to borrow – a short-term risky solution, in particular, if Kenya borrows to repay foreign currency-denominated debt, risking a foreign currency debt spiral. Three would be sovereign default, whereby the State defaults on its debt, which makes subsequent borrowing very expensive, hurts growth and investment and hammers the country’s reputation.
But it’s not fatal as demonstrated by Greece. So what solutions are there, and what should the mix and balance be?
Less conventional but regularly visited options would be a parallel commodity basket-backed digital currency, which some may moot as a hedge.
The government could also identify a commodity basket to back the shilling, for example by formulating a policy that debt should not exceed seven years output of the commodity basket. Some Gulf states use this option, which means volatility in commodity price and demand would affect currency volatility but it could strengthen the shilling.
The State can also adopt a policy that all or certain raw materials cannot be exported raw and mimic mining agreements by most West African countries.
This is a protectionist measure that will impact the type of purchaser available and be market demand dependent.
The policy must be accompanied by incentives to process raw materials locally and train Kenyans. Externalities need to outweigh buyer restrictions. Growth over time remains the key factor.
This creates demand for the shilling, thus strengthening it. There is much the government can do to incentivise business domestically and internationally by policy and aggressively setting stalls in every bazaar through coordinated Embassy action.
-Ashminder Kaur is a legal and finance expert