Of all the roles that Central Bank of Kenya (CBK) Governor Kamau Thugge inherited from his predecessor Patrick Njoroge, custody of the shilling is proving to be the most demanding.
Less than six months into the job, the shilling’s exchange rate volatility has already earned him a summons from Parliament, just as it did Dr Njoroge, and Prof Njuguna Ndung’u before him.
Last month, MPs threatened to push Dr Thugge and Prof Ndung’u —now the Treasury CS— out of office if the shilling will not have stabilised against the dollar by January, citing the negative effect of the depreciation on the country’s external debt.
The shilling has depreciated against the dollar by 19.5 per cent since the beginning of the year, exchanging at 153.73 units to the greenback on Friday as per official CBK data.
In the case of Prof Ndung’u, the threat by MPs is not a new one. He faced a similar call in February 2012, when the shilling’s slide to a low of Sh107 to the dollar from Sh80 in the space of 12 months had MPs draw the knives out on him.
The CBK tamed the rate volatility via a large hike in the base rate, which was pushed to 18 per cent in December 2011 from 6.25 per cent in July 2011.
Dr Thugge, who admitted that the current round of depreciation has gone beyond the true value of the shilling, has adopted a similar stance with the 200 basis point hike in the Central Bank Rate (CBR) to 12.5 per cent in the December 5 Monetary Policy Committee (MPC) meeting.
Dr Njoroge’s stint saw less volatility in the exchange rate, especially in the latter years when the currency outperformed peers in the region during the Covid-19 pandemic period.
His management of the currency in that period is, however, being criticised by both Dr Thugge and Prof Ndung’u, proving that in the case of the shilling, it has become a case of being damned if you do and damned if you don’t.
On matters shilling, Dr Njoroge took a firm line with a variety of players including banks, the media, and even the International Monetary Fund (IMF), batting away any suggestion of the currency being overpriced.
Even the suggestion of the emergence of a parallel exchange rate was batted away by the regulator, despite banks quoting rates that were significantly removed from the official rate published by the CBK and the market suffering a dollar supply hiccup.
In an interview ahead of the December MPC meeting, Dr Thugge said the CBK had spent $2.8 billion (Sh430 billion) worth of foreign exchange reserves to artificially prop up the shilling between 2020 and early 2023, despite Dr Njoroge’s long-held denial of ever propping up the shilling.
After Dr Thugge took over in June, the regulator took a different approach to the shilling, allowing it to weaken progressively to correct what the governor has lately termed as artificial strength supported by the use of the country’s forex reserves.
An overcorrection has, however, opened a new headache for the governor, as well as inviting the attention of MPs due to the spillover effect of the exchange rate into the cost of living and public debt costs.
It is this excess volatility that the CBK is hoping to control via a new round of monetary tightening, indicating just how hard it is to get the balance right with the currency in an environment of weak fiscal foundations.
“We have engaged commercial banks since June on how to resuscitate the interbank forex market…the latest one is the electronic matching system where the banks should be able to buy and sell foreign exchange on an electronic platform, something that was not there before. This has been put in place in the last three to four weeks,” said the governor on December 6.
“We have intervened in that sense, but we have not sold foreign exchange into the market since June 2023. The actions that we have taken to raise the CBR by 200 basis points should also help reduce pressure in the exchange rate.”
The governor further highlighted the fiscal weaknesses that have underpinned the currency’ continued depreciation in recent years, a view supported by economists who argue that the monetary regulator is being asked to solve problems that are rooted in poor fiscal policies.
The current CBK team will, for instance, find it harder to contain volatility compared to a decade ago, primarily due to the country’s large pile of expensive external debt that eats up forex reserves that would otherwise help in the defence of the shilling.
“Monetary policy alone is not enough - it works with fiscal policy like a pair of scissors,” said Prof XN Iraki, an economist at the University of Nairobi.
“Have we tried to reduce the budget deficit? Have we stimulated exports? Have we factored in the political sentiments? Once we build confidence in the economy, the shilling will stabilise.”
Other problems include underperforming exports, which combined with an ever-expanding import bill means that balancing dollar demand and supply becomes a problem for the monetary regulator.
Kenya’s ratio of exports of goods to gross domestic product (GDP) has consistently declined from 12.5 per cent in 2011 to 6.5 per cent in 2022, while external debt service costs as a ratio of GDP in 2022 was at three per cent, up from 0.8 per cent in 2011.
Investment inflows (foreign direct investment) as a percentage of GDP have also dropped, standing at 0.7 per cent of GDP in 2023 compared to a peak of 4.8 per cent in 2011.
These underlying weaknesses in the economy, according to economists, will make it harder for the central bank to retain a firm grip on the exchange rate, even as the monetary policymakers try different solutions to calm the market.
