Crisis of dollar shortage and what it means

The Central Bank of Kenya (CBK) is the custodian of the country's foreign exchange reserves which ensures Kenya has enough money to pay for imports and foreign debt that are often denominated in dollars.

According to the Central Bank of Kenya Act, the regulator is expected to maintain adequate official foreign exchange reserves equivalent to the value of four months imports.

Aside from servicing the country's external debt, forex reserves are used to intervene when deemed necessary to smoothen erratic movements of the exchange rates and act as a cushion against external crises.

"The size of official reserves serves as a confidence signal to potential investors, rating agencies and those contemplating capital flight," explains the CBK in one of the documents outlining the country's forex policy.

"To ensure prudence in the management of reserves, the objectives of CBK reserves management policy are: Safety, Liquidity and Maximisation of Total Returns," explains the CBK.

Adequate liquidity

The bank adds: "The primary objective in the management of these reserves is capital preservation. With respect to income, the department invests the reserves to earn reasonable returns while maintaining adequate liquidity."

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According to data from the CBK, Kenya's usable foreign reserves stood at USD6.56 billion (Sh853 billion) as at March 9, 2023. This is equivalent to 3.67 months of import cover and less than the CBK target of four months.

In recent months, the depreciating value of the Kenyan shilling against the US dollar has seen the value of the country's foreign reserves erode significantly. This has been attributed to the effects of the war in Ukraine, the aftershocks of the pandemic and raising of interest rates by the US Federal Bank to curb rising inflation.

Data from the CBK further indicates that the foreign exchange reserves stood at USD$8.4 million (Sh1 trillion) in April 2022, equivalent to five months of import cover which was a further drop from USD$9.9 million (Sh1.2 trillion) as at the end of June 2021.

Free-floating system

Kenya currently pursues a free-floating exchange rate system, meaning there is no predetermined rate that the shilling exchanges with other currencies; the forces of supply and demand determine the value of the shilling.

The CBK may step in to even out extreme and undesirable fluctuations in the trading rate of the shilling. Such volatilities may occur due to speculative activities in the market or when the market is not able to clear seasonal upsurges on either demand or supply.

At the moment, global markets are experiencing jitters fuelled most recently with the collapse of Silicon Valley Bank and Signature Bank.

SVB had USD$209 billion (Sh27 trillion) in assets and USD$175billion (Sh22.7 trillion) in deposits and marked the third largest bank collapse in the country's history. The collapse sent shockwaves across global markets and has been likened to the collapse of Lehman Brothers that precipitated the 2008 financial crisis.

"It is noteworthy that the rates provided by the Central Bank are only indicative and that forex dealers, that's commercial banks and forex bureaus, may apply varying rates on their forex transactions," explains the CBK.

"It is expected that competition among the dealers will lead to reasonable or competitive margins being applied to forex transactions with customers."

As at yesterday, some commercial banks and forex bureaus were exchanging US dollars at rates above the CBK indicative rates, an indication of a mismatch between the apex bank's policy guidance and current realities in the market.

It remains to be seen whether the CBK will step in to intervene and what policy tools the monetary regulator will deploy.