Kenya: Shilling on the Way Back But Risks Linger

After weeks of weakening against the dollar despite a series of back-and-forth reactions by the Central Bank, the Kenya shilling - a crucial unit for the East Africa region - appeared to stabilise last week. But is the trend long term and can the CBK finally rein in the feeble unit? At the current Ksh92 to the dollar and the recent interventions by the CBK, the currency still carries a message for the financial markets, businesses and households with it: A longer period of high interest rates enlarging government debt could hurt Kenya's economic prospects, analysts and policymakers said.

Fitch, an international credit rating agency, last week pointed at a lower credit rating for Kenya over rising inflation and the depreciating shilling, a development which could increase the government's borrowing costs and hurt investor confidence in the economy.
"There is a need to take some action just to ensure we restore some kind of stability on the monetary side and we are in discussions with the central bank to deal with this particular issue" said Finance Minister Uhuru Kenyatta.
"We are having stress in terms of our projected outlook because agricultural targets may not be met."
As the shilling struggled to rise from its worst turmoil in two decades, signs of big threats for the currency are multiplying by the day. The spillover effects of a gloomy forecast on global growth, the recent downgrade of US government debt, the unrelenting crisis in the oil-rich Arab world and continuing worries about the European debt crisis continue to shake the shilling.
But before Kenyans can get answers on what exactly happened to depress the local currency, another question is emerging: Is the stability temporal or will the shilling hit the Ksh100 mark before the end of the year and what must happen for the unit to start climbing down to last year's levels?
Market analysts predict further depreciation of the shilling as most of the shocks CBK blames for the pressure on the unit show no signs of easing any time soon.
"Negative sentiment in the forex market would need to stabilise for the shilling to start climbing down. The CBK could help this along, by selling forex - although this would be a short term measure," said Razia Khan, Africa economist at Standard Chartered Bank in London.
"To get back to Ksh70 to the dollar, we are probably talking about a multi-year period in which Kenyan assets are viewed more positively. So higher bond yields, improved equity market sentiment and a scaling up of aid flows might achieve this too."
But for others, the shilling could strengthen further in the coming days, helped by a surge in interbank lending rates since the CBK reviewed its overnight borrowing rules two weeks ago.
"Stability and avoidance of speculation and abrupt movements in the shilling can be underpinned by enhanced credibility of future events such as progress in embedding the Constitution, credible elections next year, and management of inflation," said Dr Mbui Wagacha, an independent economist.
Because of Kenya's role as an economic powerhouse in the East African region, the seemingly long-running currency crisis could have significant economic repercussions to Uganda, Tanzania, Rwanda and Burundi even as these countries battled weakening currencies and inflation.
The first half of 2011 delivered some unexpected shocks that have severely disrupted the pace of the global economic recovery, with a heavy impact on the Kenyan currency and other regional units but the re-emergence of financial tensions in the Euro-area appears the biggest risk.
"We now expect the shilling to weaken more quickly than earlier projected. We forecast that the currency will slide to an average of Ksh86.2 in 2011 and Ksh90.2 in 2012, before steadily drifting to Ksh102.5 by 2015," said the Economist Intelligence Unit (EIU) in its August report on Kenya.

The volatility of the shilling has sent the CBK into panic as it fights what Governor Prof Njuguna Ndung'u in March saw as only temporary shocks. The shilling hovered around Ksh92 last week as weighted average interbank lending rate rose to 24.25 per cent from 8.34 per cent on August 12, when CBK tightened its overnight borrowing. CBK's thinking is that cheap liquidity at the discount window was undermining the shilling while blaming banks for speculative trading. This is making it more expensive for commercial banks to access funds at the discount window.
"The weakness in the advanced economies due to an overleveraged US and EU may also moderate commodity prices, which would ease the fuel import bill and ease the pressure on the current account deficit. This would be positive for the shilling," said Yvonne Mhango, Sub-Saharan Africa economist at Renaissance Capital who favours stability in the coming days.