Twelve months ago, you only needed about Sh108 to buy a dollar. Today you need almost 125 Sh and it could even increase. This broad erosion of the purchasing power of the Kenyan shilling is entirely self-inflicted and has nothing to do with geopolitics.
First, the gap between exports and imports continues to widen. In 2021, Kenya’s total trade volume was 2,287.2 billion shillings, of which exports were 643.7 billion shillings while imports stood at 1,643.6 billion shillings, leaving a trade deficit of 1 trillion shillings. Two decades ago, Kenya’s trade deficit stood at only 100 billion shillings. But do not get me wrong.
The trade deficit is not necessarily a bad thing. In international trade, it makes no sense to manufacture everything yourself if you can buy it from other countries that have a comparative advantage. You better focus on other things that you know how to produce better. For example, America no longer bothers to manufacture T-shirts or telephones.
They left that to China or Vietnam. Instead, they focus on things they’re good at producing like Kanye West albums or SpaceX rockets. Similarly, Kenya may not be able to compete with China in the manufacture of garments or heavy machinery, but has a comparative advantage over China in the production of tea leaves, cut flowers or flowers. distance athletes.
Nevertheless, you still need foreign currency to buy this shirt in China, mostly dollars. This foreign currency must be generated elsewhere. Basically, a country earns foreign currency in several ways: First, by selling its domestically produced goods to foreign markets (exports).
Second, citizens working abroad and sending money back to their relatives in the form of remittances. Third, tourists visiting the country and spending their foreign currency locally and fourth inviting foreign money to buy domestic assets.
These assets can be land, shares of listed and private companies, debt securities issued by government and private companies or even the establishment of new factories.
Apart from the United States, which has the unique advantage of having the world’s reserve currency, any country should always aim to reduce its trade deficit.
In the case of Kenya, a trade deficit of 1 trillion shillings simply means that more money is being externalized through international transactions than is coming into the country. And to reverse this situation, a long-term policy aimed at strengthening comparative advantages in production is essential.
The second point of self-infliction relates to the attempt by the Central Bank of Kenya (CBK) to break the economic principle of the trinity of impossibility. Since 2015, the apex bank artificially manages spot exchange rates.
The currency’s hold saw a nominal move from Sh96 to Sh107 against the dollar when CBK Governor Patrick Njoroge took office in mid-2015 and held between Sh100-Sh109 for the next five years ( almost crawling in a prescribed band). To some extent, this may be understandable.
Being a small open economy, the exchange rate channel remains a vital price and any weakening is easily transmitted to domestic purchasing power. However, it also opened a Pandora’s box and allowed the government to build up more foreign currency liabilities, issuing Eurobonds totaling $5.1 billion during the period.
At the same time, the CBK also kept domestic interest rates artificially low, helping the government to borrow domestically at favorable rates. For a very prolonged period, the government borrowed national currency for 20 years at less than 13%.
For a government that continues to add billions of shillings daily to the public debt register, that is quite small. Ultimately, it is simply impossible to simultaneously manage exchange rate movements while pursuing an independent monetary policy and having free international capital mobility.
The Central Bank must give up one and concentrate on the remaining two objects which will be paid for by ordinary people. Already, annual inflation accelerated to 7.9% in June 2022 and is expected to reach double-digit territory before the end of the year.
If the currency had been allowed to move a little more freely over the past seven years, it would have worsened the foreign currency debt measures early on and prevented the government from issuing too much foreign currency debt.
The final point of self-infliction is fiscal indiscipline, which is essentially the country living beyond its means.
Basically, Kenya has three points of self-infliction – a lack of domestic output, a central bank trying to sweep macro-economic imbalances under the rug, and disorderly public finances.