Why the shilling is in free fall

Kenya’s love affair with imports has come home to haunt the country as the shilling is at its weakest against the dollar in 17 years.

Policies intended to rein in inflation by increasing food production and reducing over-reliance on fossil fuel-generated power will play a key role in managing the currency which experts now say is likely to slide to lows of Sh110 to the dollar.

The Central Bank of Kenya on Friday said turmoil in global markets was the principal cause of the decline of the shilling towards the Sh100 mark – on Thursday it closed at Sh99.20/10 to the dollar.

The euro zone debt crisis, which has seen countries like Greece, Portugal and Spain flirt with default on repayment of government debt, could trigger another cycle of global economic meltdown. (READ: Eurozone crisis piles pressure on shilling)

It is the fear of this that makes investors (local and foreign) sell their securities (shares, bonds) to buy dollars as a safer haven.

But the main factor putting pressure on the shilling is the increasing demand for dollars to pay for the country’s imports.

The steady growth of population to the current 38.5 million is also raising demand for finished consumer products.

This has seen the county import about 10 times the value of the goods it exports.

Available estimates show that the value of imports is Sh380 billion ($4 billion) against exports of only Sh38 billion ($0.4 billion).

In an interview in the middle of last month, Prof Michael Chege, an economic advisor at the ministry of Planning noted: “So-called speculation in the Kenya shilling springs from the anxiety about fear that dollars/euros will be even more expensive later given the additional sums for imports we need. But frankly, some people have made money holding dollars for a while and then releasing them into the market for more shillings.”

But he noted that structural factors–reliance on imports, high inflation and low foreign exchange reserves–were largely to blame for the weakening of the shilling.

The bulk of Kenya’s imports are machinery, transport equipment, petroleum products, motor vehicles, iron, steel and plastics.

There are also several clusters of imports in electronics, foodstuffs, and clothing all of which are consumed at household levels.

The impact of a weak shilling will almost immediately send the price of such imports higher.

Although the import of some items is essential, the fact that Kenya imports agricultural-based commodities like sugar and maize, which it can easily produce, places the country at a disadvantage in case of such currency fluctuations.

Approximately 40 per cent of the imports are dollar-denominated, hence the demand for the currency in trade.

This has seen the country’s current accounts deficit grow over the years.

In his communiqué to the market on Friday, Central Bank of Kenya governor Prof Njuguna Ndung’u said the growing balance of payments problem will be the immediate focus of discussions between Kenya and her multilateral development partners.

The annual fall meetings of central bank heads and finance ministers with World Bank and International Monetary Fund are under way in Washington DC.

Among the issues under discussion are country specific financing needs.

Kenya has already asked the IMF to front load forex aid to help the country stem shilling depreciation against other foreign currencies.

Consumers of imported goods and services will soon have to bear the additional costs in view of the uncertainty of the exchange rate.

Already, several industries have indicated that they will increase prices to cover for additional production costs based on the price of imported raw materials.

In the property market, for example, developers importing finishing materials for their projects are already feeling the pinch.

Import business

“This is definitely hurting anyone in the import business. Those who rely on extended credit facilities are paying the biggest price, given that they are repaying using the current exchange rates,” said Mr Dudley Stannah, Subaru Kenya marketing director.

But as importers face the brunt of higher exchange rates, exporters are benefiting as the shilling continues to make its way closer and closer to the Sh100 mark.

“We source our cars in the dollar and yen denomination zones. This has cushioned our business, given that the two currencies have remained stable. However this means that the man on the street has to carry the burden of the prices which are currently up by about 20 per cent,” said Mr Anthony Percival, general manager for sales and marketing at Toyota Kenya.

Cost of living

This state of affairs is set to push inflation even higher. It which stood at 16.67 per cent in August, and economists predict that the cost of living could rise 20 per cent before the end of the year.

The effect of this is the expected negative impact on overall economic growth with the African Development Bank saying on Friday that it was scaling down its 2011 economic growth projection for Kenya to 3.5-4.5 per cent from an earlier forecast of 4.5-5 per cent.

“Holding enough surpluses in foreign currency reserves for a rainy day is the best and most sustainable manner to deal with fluctuations. That way (as you can see in China) no currency speculator will ever touch you!” Prof Chege advised.