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Friday, May 1, 2015

Why we should move fast to halt the shilling’s slide

Opinion and Analysis
 
A lady sells cereals at Nyeri market on April 13, 2015. In addition to the expected rise in the cost of living (inflation), a weaker currency has a wider impact on the economy, especially on interest rates. PHOTOS | FILE 
By GEORGE BODO

The rate of depreciation of the Kenya shilling against the US dollar this year has been unusually fast-paced.

Since the year began, the shilling has depreciated by 4.1 per cent, almost equalling the 4.8 per cent cumulative depreciation in 2014.
For a small open economy like Kenya’s, this trend is worrying because these massive depreciations in the currency end up increasing the cost of living and the cost of doing business.
For instance, today the exchange rate is a significant component of the pricing of petroleum products and utilities, which are eventually transmitted into the pricing of basic commodities. 
The current depreciative trend of the shilling against the dollar has resulted in several explanations being offered from official and non-official sources.
Some of the major explanations for the current depreciation of the shilling include:
1: Continued weakening in the foreign exchange earning capacity of Kenya’s economy, whereby export earnings are increasingly financing a declining proportion of imports, hence leading to a widening current account deficit (in fact, 2014 saw exports finance the lowest proportion of imports since independence).
2: Externalities, especially the recent strengthening of the US dollar globally as a result of the improving domestic absorption rate in the US economy, a net factor of quantitative easing (famously referred to as QE); and 3: seasonalities in demand for foreign exchange.
Apart from the structural issues, CBK’s interventions have often saved the shilling from further depreciation, which has been very commendable through addressing market volatility.
However, it seems these stop-gap measures haven’t yielded the desired results over the past couple of weeks (and April has now been the worst month for the shilling this year, after depreciating by two per cent against the US dollar.
But this doesn’t, in anyway, imply that CBK has run out of ammunition, which is why I believe the following ammunition could help augment the current sale of forex to market intermediaries and other open market operations in stemming further adverse depreciation.
First, any private sector import bill should be settled through margin (credit) accounts, which should be operated for a period not exceeding 60 days. Second, foreign currency-denominated loans should only be granted strictly to foreign exchange earners.
Third, collection and repatriation of export proceeds should be streamlined, to the extent that retention accounts, if there is any, should only hold as minimal proceeds as possible.
Fourth, to reduce any speculative components of the market, the tenor of foreign currency swaps involving Kenya shillings for non-resident counter parties should be increased to a minimum of 18 months, from the current 12 months.
Fifth, and still in a bid to curb further speculative activities, there is a need for a temporary “kill switch” where commercial bank dealers should halt trading whenever the shilling depreciates by more than one per cent intra-day in the interbank market
Finally, commercial banks’ net open positions should be narrowed to five per cent of core capital, from the current 10 per cent.

Since the last review in October 2011, banks have grown their core capital positions by 70 per cent, and are now having wide open positions in nominal terms.
These measures are temporary and should ideally be operated for the remainder of the year, subject to monthly reviews. The country cannot afford to have the exchange rate hitting levels of 100 again, as it did between September and October 2011.
Additionally, as it is, the current exchange rate levels are worsening the country’s balance of payments position since exports have failed to increase proportionately.
Mr Bodo is an investment analyst.

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