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June 2003

Shilling in rare bullish trend

Deremo Maiko

Pressure is piling on the export-driven Kenyan economy as the domestic currency maintains an unprecedented bullish trend. With the economy estimated by the Central Bank of Kenya (CBK) to be expanding at a sub-zero 0.9 per cent, fears are growing that Kenyan exports will be rendered uncompetitive especially in the all-important regional Common Market for Eastern and Southern Africa (COMESA).

And more worrying, goods from the COMESA free trade area members, more so Egyptian manufactures, could easily swamp the Kenyan economy. Most of the gains made against the hard currencies are mainly attributed to optimism arising from the departure from power after 24 years of former president Daniel arap Moi, expected return of international financiers but also on sluggish demand for imported goods.

Most analysts concur that the change in the value of the shilling is hardly founded on sound fundamentals, and tend to agree with CBK that the strengthening of the shilling is largely driven by speculators. They are in addition not ruling out the fact that significant repatriation of capital, which had fled during the political transition in December, could be material.

Paradoxically, the forex movement has come at a time interest rates are slumping and inflation rising. More intriguingly, the government has announced that it is faced with a historic deficit of Sh57 billion ($791.6 million) as at the end of the current financial year.

Bizarre speculation has, however, not been absent in explaining the fate of the shilling. Recent introduction of the post-independence currency notes featuring founding president Jomo Kenyatta has even been cited. Kenya had a rigidly controlled currency regime in the 15 years of his rule, which was misconstrued to mean macroeconomic stability.

From the beginning of the year to mid last month, the shilling gained some 13 per cent on the globally battered greenback while the sterling pound lost 12 per cent in value vis a- vis the Kenya shilling. But more worrying to exporters, singularly of manufactured goods, is the performance against the Ugandan and the Tanzanian shillings. The domestic currency firmed 18 per cent on the Tanzanian currency and 17 per cent on the Ugandan currency.

The two countries hugely reliant on Kenyan manufactures are the most important trading partners. At one point inter-bank trading had to be stopped as jittery exporters declined to trade.

A substantial loser has been the Sh25 billion ($347.2 million) tourism industry, which is largely reliant on euro-denominated earnings. But as luck would have it, global strengthening of the euro as the US economy wobbles has meant that the shilling has only gained 3 per cent since the start of 2003. The industry has in addition been pummeled by travel warnings issued by Western governments, Britain and the US in particular, following the threat of terrorism in the region.

Kenya s main source of tourists is the European Union and Britain. The relative strength of the euro on the other hand comes as a respite to tea, horticultural products and coffee exporters whose main market is the EU.

The present firming of the shilling represents the first major volatility since it was floated simultaneously with implementation of a raft of other liberalisation measures at the instigation of the International Monetary Fund and the World Bank in 1993. At the time it was exchanging at Sh36 as opposed to current Sh72.50 to the US dollar. In October 2002, it was exchanging at Sh79 to the dollar.

When president Kenyatta died in 1978, it was exchanging at Sh7.50 but was subsequently devalued; the Kenyatta regime continuously resisted attempts to devalue the shilling, even in the face of falling export earnings and increasingly expensive exports, principally because of fear of inflationary pressure.

The 1993 deregulation of Kenya shilling exchange control bureaucracy was such big business that after it was eliminated, CBK had to rent out the 36-storey Times Tower as it had no use for it was the second time Kenya was travelling the floated regime path. Before independence from Britain in 1963, the three East African countries had a common floating shilling under the East African Currency Board. But as the newly free states drifted from each other, three Central Banks were created in 1966 with Mr Duncan Ndegwa becoming the first governor in Kenya. Thus the Kenya shilling and other currencies were born.

CBK has largely maintained a hands-off policy on the Dollar since the repeal of Exchange Control Act in 1993: A position that has quickly been reaffirmed by the new Governor Dr Andrew Mullei. The Governor has all the same indicated that the regulator is studying trade-competitive level of the shilling, which has been read as meaning that CBK could intervene in the money markets. CBK intervention in the past has been confined to buying and selling of the hard currency at various times.

One reason why the new government would want the shilling to remain buoyant is to help it in liquidating its huge foreign exposure. It is estimated to be about 60 per cent of the total public debt standing at over Sh600 billion. Influential users of the imported intermediate goods are again happy with the shilling s strength.

The direction Kenya shilling takes is set to be determined by the national financial deficit. If donors agree to fund the budget as widely expected, Kenya shilling is set to remain strong in the near term. But again if the economy turns up in the near future, it is expected that demand for imported luxuries and inputs could pressure down its value.

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