Weak shilling creates losers and winners

The continued weakening of the shilling is expected to result in a higher cost of living and interest rates and a tough business environment especially for import-oriented enterprises.

According to analysts, the weakening is putting a damper on prospects of higher economic growth, which the government has set at more than 5 per cent this year.

Last Thursday the shilling appeared headed to its lowest level of 100 units against the greenback. Last seen in November 2011, this level continues a worrying trend that has been blamed on dwindling export earnings following declines in tea, coffee and tourism earnings.

At the end of trading on Friday, forex dealers quoted the shilling at 97.65/97.75 to the dollar compared to Thursday’s close of trading at 97.75/97.85. This is after the CBK intervened by selling dollars to tighten liquidity.

A widening current account deficit, measured in terms of increased import expenditure against export revenues has also put pressure on the local currency owing to the rising demand for the dollar to support imports.

Experts also cite a widening fiscal deficit arising from increased budget pressure amid a slowdown in government revenues, a trend that has increased state borrowing from the domestic market.
According to ABC Capital’s corporate finance and advisory manager Johnson Nderi, entrepreneurs targeting local markets (excluding the government), producers who import raw material, investors and creditors are among the losers.

Employers are also likely to suffer due to anticipated industrial action fuelled by employee demand for higher wages as a result of the rising cost of living.

Winners include exporters and foreign contractors doing business with the government and expats who are paid in dollars. Exporters of commodities such as tea, coffee and horticulture products are also set to earn higher revenues as the prices are usually quoted in US dollars.

MAJOR RISKS
Forex dealers, who have been cautioned against speculation, said the worsening current account deficit, decline in forex earnings, increased imports and insecurity are key risks to the local currency.

“As long as we are importing too much and exporting too little – and the economy remains imbalanced – the shilling will always remain vulnerable to shocks. We are also running a big fiscal deficit and government borrowing is a big negative for the currency’s value, said Mohamed Wehliye, senior vice-president, Financial Risk Management at Saudi Arabia-based Riyadh Bank.

It is also feared that a weaker shilling will lead to instability in the domestic economy and a surge n inflationary pressure. Inflation is already at 7.08 per cent, a level close to the government’s upper limit of 7.5 per cent.

Analysts say with the rapid weakening of the shilling the country’s foreign debt––which is larger than that of the Kibaki administration––will come at a greater cost. Financing the foreign debt will be more expensive as the country will now use more Kenya shillings to make the payments in dollars.

RAISE MPR

Analysts anticipate that the Monetary Policy Committee will raise the benchmark lending rate at its June 9 meeting to tighten liquidity in the market and stabilise the shilling against increased volatility.
Mr Wehliye further said it would be irresponsible if the CBK doesn’t raise interest rates at the special sitting.

However “this would further hammer domestic businesses, which are already in poor shape and probably increase bank bad debts”, he points out. 

This, however, means borrowers will face more pain as commercial banks are likely to respond in equal measure by raising their lending rates.

In response to a rapidly weakening shilling the CBK raised the key lending rate by 11 percentage points to 18 per cent. Commercial banks responded by more than doubling their lending rates by the end of 2011 from 13 per cent.

While a hike in interest rates may be painful to borrowers, the same would attract mostly the foreign investors seeking higher yields in the fixed income market.

The flight of foreign investors from the Nairobi Securities Exchange (NSE) over the confusion surrounding implementation of the capital gains tax has seen market activity decline significantly with the investors selling their shares since the start of the year.

The NSE 20 share index, which measures trading activities of large listed firms, had by the end of last Friday, declined by 6.5 per cent from the start of this year. Continued exit of foreign investors from the securities exchange is further expected to hit stockbrokers’ and investment bankers’ earnings.