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Edgy shilling sparks market jitters

By | March 8th 2011

By Jackson Okoth

The Shilling has already crossed the Sh80 to the US dollar barrier with this downward spiral expected to continue in the coming weeks.

The last time that the shilling traded within the Sh82 range was in August 2004. But while this trend could be disturbing, Central Bank of Kenya (CBK), Treasury and a section of analysts are already debating on the side effects of a weakening shilling.

"It’s not necessarily bad for the economy in the long-term, especially for exporters.

Although costs go up when the currency depreciates, local firms will need to be more competitive to create jobs in such an environment," said Eric Musau, a research analyst at African Alliance Ltd.

There is also another section of observers including the CBK Governor Njuguna Ndumg’u, who see this downward spiral as disturbing, as the country’s trade deficit widens.

Loose ground

Already, high crude oil prices pushed up by political problems in the Arab World and reduced tea exports is causing the shilling to lose ground against the US dollar.

"Instability of the exchange rate is obviously detrimental to Kenya. In particular, when the shilling weakens, imported intermediate inputs become more expensive," Ndung’u was quoted as saying in a section of the media.

Ironically, his views are contrary to Treasury Permanent Secretary, Joseph Kinyua who perceive the decline as nothing to worry about and good for the export sector.

These contradicting views by the country’s top economic managers, however, has left the market more confused as to the real impact of a weak shilling.

"The question is, is the Central Bank worried about weakness or volatility. I don’t disagree instability is detrimental, but where is it? By any currency standards this move is not volatile or unstable, just a gradual persistent upward trend, going weaker since January and quite orderly," one trader said in an interview with Reuters.

"I think his (Ndung’u) bigger worry is the impact on inflation that a weaker shilling and rising crude prices would have. But if the strengthening of the dollar is across most currencies, then there is no need to use the reserves to defend the shilling," reckoned a commercial bank official quoted by the news agency.

Available figures indicate that at the close of trading on Friday last week, the shilling was exchanging at 82.36 against the dollar, representing a two per cent fall since the year begun.

It was also trading at Sh134.90 to the Sterling pound, representing a 6.7 per cent fall since the beginning of this year.

The Shilling has been weakening against a basket of currencies in the last few weeks, extending a losing streak that started in the fourth quarter of 2010.

"This economy will not be able to create the jobs needed if we continue to import," said Musau.

On Friday last week, the shilling closed slightly above a six and a half year low, quoting at between Sh82.30-82.40 to the US dollar. At these levels, some analysts contend the local currency is beginning to flash amber.

Arab crisis

A weakening shilling is happening when the Arab crisis is causing an upward movement in fuel prices, also providing side shocks on cost of living index.

The inflation rate climbed to 6.5 per cent, the highest since October 2009, from 5.4 per cent the month earlier, said a recent statement from Kenya National Bureau of Statistics. Prices rose 1.3 per cent in the month, according to the bureau.

"There is an excess ordering of oil supplies worldwide, owing to the Arab crisis and this has reduced the available US dollars in circulation. There is also a slowdown in foreign exchange inflows in the local stock market as investors looking at the crisis in Libya, seek for refuge outside Africa," explained Kariithi Murimi, a risk consultant.

Further, a worldwide stockpiling on wheat supplies in anticipation of shortages is also causing stiff competition for US

Murimi, also a director of Kenya Private Sector Alliance (KEPSA), also attributes a weakening shilling to the prevailing political heat in the country.

"The ongoing political debates is having a negative effect on a number of donor funded projects, resulting in lesser foreign exchange inflows," said Murimi.

It is expected that local manufacturers of food items such as flour and cooking oil will continue to adjust prices upwards as they seek for more shillings to import raw materials.

"While tea, coffee and horticultural exporters will benefit from a weakening shilling, those manufacturers servicing a foreign loan will be hard hit," said Murimi.

Reduced forex

Education and public health are also listed as some of the sectors that will lose immensely with a weak shilling as prices of imported books and drugs increase.

"The social side of the economy will thus also be affected if the shilling continues to weaken against major currencies," said Murimi.

Analysts cite reduced forex earnings from tea exports to Kenya’s key markets of Egypt, South Sudan and Pakistan has put pressure on the shilling.

"But how weak the shilling will be depends on the import cover at the Central Bank of Kenya, which provides it with a cushion against movements in other world currencies," said an officer at Sterling Investment Bank.

In the end, factors keep balancing out between proceeds from exports, outflows from imports as well as internal normal business activities that result in inflow and outflow of foreign currency.

At present, there is an increased demand for the greenback from oil firms as well as foreign investors repatriating dividend payments.

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