Kenya risks turning into a partially dollarised economy as more traders and corporates shun the troubled shilling in favour of the greenback for day-to-day transactions, experts have warned.
The trend referred to as dollarisation, where the use of dollars as a means of exchange informally gains currency for ordinary transactions like rent payments and other utilities, experts say, poses many risks to the economy.
Kenya is confronting a currency crisis involving the steep decline in the value of the shilling, which is causing negative ripple effects throughout the economy.
The surging US dollar has seen the shilling weaken, contributing to the skyrocketing prices of most basic commodities.
The shilling weakened nine per cent against the dollar last year and had as of January 30 this year lost 0.8 per cent against the dollar, according to the Central Bank of Kenya (CBK).
This is compounding financial distress for many Kenyans at a time when they are already facing food and energy crises tied to Russia's invasion of Ukraine.
The instability in the exchange rates means that with Sh1,000, many families can no longer buy as much as they used to get a few months back.
The shilling has been on a free fall, hitting an all-time low against the dollar in the recent past, signalling inflation and higher costs of imported goods.
CBK data showed the shilling exchanged at an average of Sh125.1882 against the dollar on Monday. However, some traders were exchanging it at Sh134 to the dollar. A weak shilling is harmful to the country given it is an import-driven economy.
Kenya imports various goods, including cars, petroleum, machinery, medicine and pharmaceutical products, vegetable oil, wheat, clothing and shoes.
A weaker shilling will keep the price of imports such as fuel elevated, inevitably pushing up the cost of goods and services and further pushing up inflation, which has remained stubbornly high at 9.1 per cent as of last month.
But if dollarisation - the preference for dollars - is not reined in, experts warned, the phenomenon could largely stifle growth as the country may not be able to effectively utilise its monetary instruments.
It could also influence economic activity and Kenya may gradually even lose competitiveness compared to its major trading partners. They warned that Kenya should be cautious not to walk this well-beaten path that has in the past hurt economies like that of Zimbabwe.
Zimbabwe's President Emmerson Mnangagwa earlier vowed not to revert to using the US dollar despite the country's new local currency plunging against the greenback since its introduction in 2019, fuelling inflation and economic hardship.
"We are effectively importing another country's monetary policy and pricing structures," said an analyst who sought anonymity as they are not authorised to speak on behalf of their organisation.
"For globally exporting industries such as those in Export Processing Zones, it wouldn't matter. But things like rental costs for domestic companies start to leak higher inflation into the domestic basket of prices."
In 2009, Zimbabwe "dollarised" the economy by allowing the US dollar and other foreign currencies to be used as legal tender in the country after hyperinflation decimated the value of Zimbabwe's sovereign currency.
The government ended dollarisation in June 2019 after it outlawed the use of foreign currencies in local transactions in a bid to defend a fledgling interim sovereign currency. This paved the way for the new Zimbabwean dollar, which formally entered circulation in 2019.
Although it was illegal to use foreign currency to buy local goods at the time, many people still took the risk and some businesses charged in both US and Zimbabwe dollars.
But later in March 2020, the Zimbabwean government allowed people with free funds to use foreign currency to pay for goods and services for easier transactions following the outbreak of the Covid-19 pandemic.
The use of the US dollar has since grown in the Zimbabwean economy. "When you're importing another country's monetary policy through dollarisation, your fiscal policy is also no longer your own. All the government's spending plans - Hustler Fund, Junior High School, UHC (universal healthcare) - will all be forced to a halt unless this dollarisation is curtailed fast," said another economist who also sought anonymity for fear of reprisal from the authorities.
Retail dollar buyers are paying up to Sh134 per unit in the banking halls as the demand for the greenback continues to surge. This is as the margin between the US dollar's printed rate by CBK and the market rate for customers quoted by banks and foreign exchange bureaus continues to widen.
Several large banks are now selling the dollar at between Sh133 and Sh134 per unit, while buying the same at between Sh118 and Sh123, with bankers and forex bureaus saying the higher prices have been driven by demand and the cost of accessing the hard currency on their part.
The higher effective rate for those buying dollars in the market had been highlighted last year by importers.
Access to the greenback had previously also proved difficult for some due to banks being unwilling to sell to each other, which made it hard for smaller players to fulfil their orders from clients.
Last year, manufacturers complained that a dollar shortage was forcing them to buy the greenback at a premium above CBK's official average exchange rate. The regulator, however, dismissed the possibility of a parallel exchange rate developing in the country, saying the market has enough dollars to meet demand from importers and corporates.
Flexible exchange rate
CBK earlier maintained it was committed to a flexible exchange rate and would continue on this path. The regulator - Kenya's first line of defence in maintaining the stability of a currency - has tried to offset the weakened shilling in part by increasing interest rates.
CBK recently projected Kenya's foreign exchange market will be stable this year, mainly due to an improvement in the current account deficit.
However, the shilling is projected to depreciate further against the US dollar and may come under additional pressure from a slowing economy and tighter global economic conditions, several projections show.
For instance, according to the African Development Bank (AfDB), the tightening of global financial conditions is set to continue destabilising the foreign exchange markets of most African countries, including Kenya.
"Most African currencies, especially in commodity-exporting countries lost substantial value against the US dollar in 2022 due to monetary policy tightening in the United States," says AfDB in its latest Africa's Macroeconomic Performance and Outlook.
The biannual publication is released in the first and third quarters of each year. "While depreciation rates are projected to slow in 2023 and 2024, currency weaknesses in Africa's more globally integrated economies (Algeria, Kenya, Nigeria, and South Africa) are expected to persist in 2023, due largely to continuing tight global financial conditions and weak external demand," explained the lender.
"The PMI (Purchasing Managers Index) values for Egypt and Kenya, and to less extent for Nigeria and South Africa, have generally been on a downward trend since March 2022, suggesting sustained softening economic activity in these countries, reinforcing their growth slowdowns.
The continued weakening of the local currency is expected to push up the cost of living, further hurting households already subjected to high fuel and food prices. Foreign deposits in local banks stood at the equivalent of Sh922 billion as of last November, according to CBK data.