Twelve months ago, you only needed about Sh108 to buy one dollar. Today, you need almost Sh125 and it could even get higher. This broad erosion of the purchasing power of the Kenya shilling is all self-inflicted and little to do with geopolitics.
First of all, the export-import gap continues to widen. In 2021, Kenya’s total volume of trade stood at Sh2,287.2 billion, out of which exports were Sh643.7 billion while imports stood at Sh1,643.6 billion, leaving a trade deficit of Sh1 trillion. Two decades ago, Kenya’s trade deficit stood at just Sh100 billion. But make no mistake.
Trade deficit is not necessarily a bad thing. In international trade, it doesn’t make sense to make everything on your own if you can buy it from other countries that have comparative advantage. You are better off focusing on other things that you are better at producing. For instance, America doesn’t bother with manufacturing T-shirts or phones anymore.
They have left that to China or Vietnam. Instead, they focus on the things they are good at producing like Kanye West albums or SpaceX rockets. Similarly, Kenya may not be able to compete with China at manufacturing clothes or heavy machinery, but has a comparative advantage over China at producing tea leaves, cut flowers or long distance athletes.
Nonetheless, you still need foreign currency to buy that shirt from China, mostly the dollars. That foreign currency has to be generated from elsewhere. Broadly, a country earns foreign currency through a number of ways: First, selling its domestically-produced goods to foreign markets (exports).
Second, citizens working abroad and sending back money to their relatives in form of remittances,. Third, tourists visiting the country and spending their foreign currencies locally and fourth inviting foreign money to buy domestic assets.
Those assets could be anything from land, stocks of listed and private companies, debt instruments issued by the government and private firms or even setting up new factories.
Apart from the US, which has the unique benefit of having the world reserve currency, it should still be the goal of any country to narrow a trade deficit.
In Kenya’s case, a trade deficit of Sh1 trillion simply means that more money is being externalised through international transactions than is entering the country. And to reverse this situation, a long term policy around enhancing comparative advantages in production is critical.
The second self-infliction point is all to do with the Central Bank of Kenya (CBK) trying to break the economic principle of trinity-of-impossibility. Since 2015, the apex bank has artificially managed spot exchange rates.
Holding down the currency saw a nominal movement from Sh96 to Sh107 to the dollar when CBK governor Patrick Njoroge, assumed office in mid-2015 and held between Sh100-Sh109 for the next five years (almost crawling in a prescribed band). To an extent, this can be understandable.
Being a small open economy, the exchange rate channel remains a vital price-point and any weakening is easily transmitted into domestic purchasing power. However, it also opened a can of worms and allowed the government to build more foreign currency liabilities, issuing eurobonds totalling $5.1 billion during the period.
At the same time, the CBK also kept domestic interest rates artificially low, helping the government borrow domestically at soft rates. For a very prolonged period, the government was borrowing 20-year domestic money at below 13 percent.
For a government that keeps adding billions of shilling into the public debt register on a daily basis, that’s quite soft. In the end, it is just impossible to simultaneously manage exchange rate movements while running an independent monetary policy and having free international capital mobility.
The Central Bank must surrender one and focus on the remaining two objects be paid by ordinary folks. Already, annual inflation accelerated to 7.9 percent in June 2022 and is set for the double-digit territory before year-end.
If the currency was allowed to move a bit more freely over the last seven years, it would have worsened the foreign currency debt metrics early on and blocked the government from issuing too much foreign currency debts.
The final self-infliction point is fiscal indiscipline, which is essentially the country living beyond its means.
Broadly, Kenya has three self-infliction points — a lack of domestic production, a central bank attempting to sweep macro-economic imbalances under the carpet and disorderly public finances.
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