Shilling's weakening spells doom for economic growth

A country’s currency is like its shadow. Often, it is not an accurate representation of the object but it sure tells of the position of the object and the pressures it’s under. Ross Perot, an American businessman says: “A weak currency is the sign of a weak economy, and a weak economy leads to a weak nation”.

On the April 9, 2013, at the swearing-in of a new government, the Kenya currency was exchanging at Sh84.69 against the United States (US) dollar. The economy had survived the worst recession since independence, the worst election violence and the most painful drought in 2011, yet it held the promise of a stronger economy.

However, the shilling has seen a significant depreciation in the subsequent years hitting the bottom on September 17, 2015, at Sh105.7 against the US dollar, a 24.8 per cent drop in value.

Perhaps to understand what caused the currency depreciation one needs to go back to the underlying issues.

A currency’s foreign exchange rate is determined by a myriad of factors namely inflation, interest rates, balance of payments, relative strength of other currencies, speculation, national debt, government intervention and general economic performance as measured by the Gross Domestic Product (GDP).

The factors that caused the recent drop were inflation, interest rates, and a strong dollar. Unfortunately, a little has changed since. Interest rates are still comparatively high in a bid by Central Bank of Kenya (CBK) to minimise inflation while the dollar is getting stronger riding on the Trump wave.

MORE COMPLEX

The economic environment has gotten more complex in 2017. The national debt has skyrocketed and reached over 52 per cent of the GDP without backing by the capital account. The American economist Paul Krugman says that “advanced economies with stable governments that borrow in their own currency are capable of running up very high levels of debt without a crisis”, Kenya is neither advanced nor is it borrowing in its currency, yet it compares itself to these nations.

To correct an unfavourable balance of payment, a government will seek to increase local production and reduce imports. The flagship Galana-Kulalu irrigation scheme that was meant to increase food production, manage inflation and reduce importation of food items is yet to kick off.

More problematic however, is the government’s insistence on importing food items, including maize and sugar, as opposed to supporting or subsidizing local producers to increase capacity.

Vladimir Lenin, the Russian revolutionary president, said: “The best way to destroy the capitalist system is to debauch the currency”. Ironically, the capitalists are the ones debauching the currency.

It is expected that over Sh75 billion will be spent in this poll. While 40 per cent will go into the productive economy (media, printing, publishing manifestos, hiring consultants), a big chunk of the money will be used to give handouts to voters. This will drive inflationary pressures upward and CBK will raise interest rates to mop excess cash later in the year.

ALSO AFFECTED

Traditional sources of foreign exchange have also been affected. The European market for horticultural products has thinned off due to stringent regulatory measures against Kenyan flower producers, competition from Ethiopia and the slowdown of the Eurozone economy. With Brexit in progress, this can only get worse.

Additionally, tourism has not picked up after the government restored security in the country. Growth has been slow and it has become more inward looking after the plans to boost tourism numbers from the East failed.

One could argue that the government is intentionally weakening the currency to make Kenyan exports affordable internationally. However, I have observed that more companies are exiting Kenya citing high production costs. As such, weakening the shilling while our production is reducing further does not seem like a wise economic strategy.

What this means to the currency is that in the mid to long term, there is no hope for appreciation.

But what does a weak currency mean to the economy? A weak currency simply means the shilling no longer has the buying power it did. This translates to high inflation and social tension as well as less disposable income and by extension lower savings. All in all, it leads to a slowdown in the economy.

Ernest Hemingway says: “The first panacea for a mismanaged nation is inflation of currency”. If he is correct, then we are in for a very bumpy ride.

Odhiambo Ramogi is chief executive officer, Elim Capital.

Twitter: @odhiamboramogi