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Why flagging shilling keeps me awake at night

Financial Standard
 Inflation is the public enemy number one. The weak shilling could be a reflection of political uncertainty.  [iStockphoto

As a schoolboy in the early days of the late former President Daniel arap Moi’s reign, I recall seeing a headline in one of the dailies: “Shilling devalued by 25 per cent.”

That was in the days of the fixed exchange rate.

It was only years later that I came to understand what currency devaluation was all about when I decided the grass is greener on the other side of the fence, shifting away from studying relativity or quantum mechanics to laws of supply and demand or econometrics. 

Simply put, by devaluing the shilling, you needed more shillings to buy other currencies like the dollar or sterling pound.

That made imports more expensive, while exporters made more money. Currency devaluation is different from depreciation, the latter is more about supply and demand.

Devaluation is usually a government policy pronouncement, more so when the currency is not floated. In the early 1990s, the shilling was floated, meaning its value was determined by the laws for supply and demand.

If more dollars are flowing into the country, there will be demand for the shilling and its value will, in turn, rise. 

Economic fundamentals

This is unlike in the past when the government decided the value, at times based on political sentiments, not economic fundamentals.  

This begs the question: why is the shilling losing its value? Should we worry?

By the way, where did the name shilling come from? Why not a local name? 

Let’s start with the second question. The worry should be over rising prices, which result from a depreciating or weakening shilling.

Inflation is the public enemy number one.  

An unstable currency makes it hard for people to do business. How do you quote your prices when you can’t predict the exchange rate?

Think of importers, tourists or even parents paying fees abroad.

Entrepreneurs and investors hate uncertainty. Given the worry, why then is our beloved shilling weakening? There are several pointers.  

One is the rising interest rate in the West. This makes such markets attractive. As investors seek higher returns on their money, they must change it into dollars, driving up demand.

This, in turn, sees the greenback gain value at the expense of the local currency. Does it surprise you that the weakening of the shilling is going hand in hand with low stock prices? 

 The weak shilling could be a reflection of political uncertainty.  [iStockphoto

The high-interest rates in the West are having unintended consequences like the closure of Silicon Valley Bank.  By the way, who cheated you that the government has no “business in business?” 

The West is very focused on taming inflation by raising interest rates.

We are the collateral damage, literary importing inflation with a weak shilling. Why has our rise in interest rates not helped the shilling?  

Two is the war in Ukraine, which has raised the cost of our key import - oil. We need dollars to buy oil.

The demand for oil leads to the appreciation of the dollar against the local currency. We import other items like machinery and lately, foodstuffs. 

Three, we do not have enough dollar inflows to create demand for the shilling leading to a spike in its value. Remittances from Kenyans abroad and tourism plus exports are less than imports.  

Four, some have speculated that relative peace in our neighbouring countries weakens the shilling because of less humanitarian aid, which is denominated in dollars. More dollars drive the value of the shilling.  

Five is politics. The weak shilling could be a reflection of political uncertainty. Unsure of tomorrow, we hoard hard currency as a store of value.

This leads to a shortage of dollars, weakening the shilling further.

To coax hoarders to bring out the dollars, its value goes up. Speculators come into play, weakening the currency further.

Some are even bolder, suggesting that the rising prices as the shilling weaken will exhaust citizens, making them better political followers.  Six, are there hidden factors that are not open to the public, and will the shilling stabilise? 

Occasionally, central banks can intervene by releasing more dollars to the market if reserves allow.

Some suggest a weak shilling is not bad, it will help reduce the balance of payment. We shall import less because it’s more expensive and export more.  

We can start by creating political and economic certainties. That is within our control. We can confront other factors later.

Remember that a weak shilling makes us feel weak economically and politically.  When the rains come, we shall export more and get more hard currency. We export many basic commodities.

In the long run, we must improve the productive capacity of our economy to create wealth, and create demand for our goods and services, which will, by extension, lead to a strong currency.

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