Taming the dollar as regional currencies take a beating

East African central banks are now making plans to protect their shillings from a free fall that has already induced inflationary pressure and increased the cost of servicing debts for governments and corporates. TEA GRAPHIC | NATION MEDIA GROUP 

By ALLAN OLINGO, The EastAfrican

In Summary

• CBK's Monetary Policy Committee calls for emergency meeting that could lead to a tighter stance that would make loans more expensive, going against the Kenyan government’s push for cheaper credit.
• Tanzania also announces that it is changing rules on how much foreign currency lenders can hold in a bid to end the speculative trading in its shilling, while Uganda has increased its benchmark lending rate.
• George Bodo, the head of financials at Ecobank Capital Kenya, said the global strengthening of the dollar and the expectation of interest rate hikes by the Federal Reserve System are among factors driving depreciation across the region.

The strengthening of the dollar against other currencies has sent East Africa central banks back to the drawing board, after enjoying two years of stability.

Central banks are now making plans to protect their shillings from a free fall that has already induced inflationary pressure and increased the cost of servicing debts for governments and corporates.

Last week, the Monetary Policy Committee of the Central Bank of Kenya announced that it had called an emergency meeting for Thursday, in the wake of the shilling hitting a low of 98.95/99.05 to the dollar, a level last seen in November 2011.

That meeting could lead to a tighter stance that would make loans more expensive, going against the government’s push for cheaper credit. Ideally, the meeting should have been held in July, but concern over the falling shilling led to an earlier date being set.

Tanzania also announced that it is changing rules on how much foreign currency lenders can hold in a bid to end the speculative trading in its shilling, while Uganda has increased its benchmark lending rate.

By Friday, the Kenya shilling was trading at 97.75 against the dollar; analysts warned it could create new risks for regional economies and companies.

Meanwhile, the Tanzanian unit is trading at a low of Tsh2,068.90, while the Ugandan currency is at Ush3,042, levels last seen in August 2011. By contrast, the Rwandan currency has gained one per cent against the dollar to trade at Rwf688.5, from Rwf722.58 in early May.

In an interview with Bloomberg, Kenya’s Central Bank Deputy Governor Harun Sirima said that the MPC will be meeting to review recent developments in the market.

“Following significant changes in some key macroeconomic indicators, we will meet to, among other things, consider appropriate policy action to keep inflation within the targeted path,” Dr Sirima said.

Bank of Tanzania director of economic research and policy Joseph Masawe said they have reduced commercial banks’ net open position from 7.5 per cent to 5.5 per cent of liabilities, in order to reduce the amount of foreign currency banks can hold as well as limit their activities in the interbank market.

“We are also going to raise the statutory reserve requirement from 8 per cent to 10 per cent of total deposits from the start of June so as to remove speculative tendencies,” Mr Masawe said.

This year, Tanzania’s currency has fallen by 16 per cent against the dollar. In the first quarter, Tanzania sold $339 million to support the shilling, reducing its foreign-currency reserves to $4.1 billion from $4.4 billion at the start of the year.

Kenya’s shilling has fallen by 5.26 per cent this year. By the end of April, the Central Bank had sold $563.65 million, reducing its foreign reserves to $6.86 billion from $7.2 billion in February.

George Bodo, the head of financials at Ecobank Capital Kenya, said the global strengthening of the dollar and the expectation of interest rate hikes by the Federal Reserve System are among factors driving depreciation across the region.

“There are also structural issues, with the key one being the continued weakening of the foreign exchange-earning capacity of the economies, with export earnings increasingly financing a declining proportion of imports,” Mr Bodo said.

READ: EA currencies slide against strong dollar

High interest on loans

Regional economies and companies are also facing a rising burden of meeting interest and principal payments on foreign currency-denominated loans because of the poor performance of their currencies against the dollar.

Kenya’s stock of foreign currency-denominated loans accounted for 24 per cent of total debt at the close of 2014, given increased borrowing to fund infrastructure projects.

By the end of June, it is projected that Kenya’s external dollar-denominated interest repayment will stand at $297 million, of which $167 million will be interest on the $2.5 billion sovereign bond. The stock of Uganda’s foreign-denominated loans, as a percentage of total loans, has doubled from 22 per cent in 2009 to 44 per cent by the end of 2014.

READ: Regional currencies to face added pressure as demand for dollar rises

“Kenya’s Central Bank bringing forward its MPC meeting could mean it will raise base lending rates to about 12 per cent to support the shilling in the medium to short term,” said a currency trader with a leading commercial bank.

Gerishon Kinori, a treasury dealer at Bank of Africa, said the MPC is likely to maintain liquidity management efforts to support the Kenya shilling, which in turn should help slow inflation.

“I don’t foresee them injecting more dollars into the market as they have been doing, because that is a temporary measure. I am expecting them to increase the base lending rate in order to tighten liquidity,” Mr Kinori said.

In April, the Bank of Uganda raised the CBR from 11 per cent to 12 per cent, which saw Stanbic Bank, ABC Capital and Diamond Trust Bank raise their prime lending rate from 21 per cent to an average of 23 per cent.

Bank of Uganda Governor Emmanuel Tumusiime-Mutebile said they are increasing the base lending rates to stem volatility in the shilling.

“The forecasts showed volatilities and a high likelihood of increases in core inflation in the medium term. We hope that this raise will help strengthen the shilling against the dollar,” Mr Mutebile said.

Pressure on the shilling

The Ugandan currency is trading at Ush3,042, and has lost 10 per cent to the dollar. The geopolitical situation in Burundi and South Sudan has also exerted pressure on the shilling by shrinking Uganda’s export market.

Stephen Kaboyo, the managing director of Alpha Capital Partners — a Ugandan forex trading company — said the Uganda shilling is feeling the effects of an unfavourable economy because of its weak trade balance.

“We expect the dollar to strengthen further against the shilling, especially as we approach the 2015/16 financial year budget release where the markets will take defensive positioning in anticipation of new fiscal policy measures by the Treasury,” Mr Kaboyo said.

“We also have to understand the limitations the Uganda central bank faces in the market, especially the careful balancing act they have to do in managing the weakening shilling versus the high interest rates. They have been proactive in mopping up the dollars, but very limited in the forex market,” he added.

Ravinder Sikand, the financial advisory director at Deloitte East Africa, said the downward trend was expected to continue in the medium term with a further reduction in foreign-exchange reserves as central banks try to shore up local currencies.