We expect a continued depreciation of the shilling as well as an upward readjustment on the yield curve
Over the last 10 years, the Kenyan shilling has depreciated at a 10-year CAGR of 6.1% to an all-time low of Kshs 157.9 in as of 5th January 2024 from Kshs 86.9 over the same period in 2014, Mainly attributable to challenges within the country’s macroeconomic environment. Over the last years we have seen the country run a fiscal deficit that is 8% of GDP which has led to the government borrowing both locally and internationally. The Country has also seen the currency depreciate due to the negative current account deficit currently at 3.5% of GDP. The current account deficit is largely due to the high imports of petroleum products and the manufacturing equipment. In 2023, the shilling depreciated for the sixth consecutive year, closing the year at Kshs 156.5 against the US Dollar as compared to the Kshs 123.4 at the beginning of the year translating to a depreciation of 26.8%. The chart below illustrates the performance of the Kenyan Shilling against the US Dollar over the last 10 years:
Source: Central Bank of Kenya
Below are some of the factors that have been putting the Kenyan shilling under significant pressure;
- The existence of an ever-present current account deficit. It is good to note that there has been a positive trend with the Current account deficit coming at 3.5% of GDP in Q3’2023, from the 6.4% recorded in a similar period the previous year and 4.9% of GDP by end of 2022. The ever-present current account deficit reflects the country’s reliance on imports and with the high global commodity prices, it has resulted in increased demand for foreign currency which continue to put more pressure on the local currency.
- Dwindling forex reserves having declined by a significant 11.0% to USD 6.7 bn (equivalent to 3.6 months of import cover) in December 2023, from USD 7.5 bn (equivalent to 4.0 months of import cover) in a similar period in 2022. Notably, for the last five months, forex reserves have remained below the statutory requirement of maintaining at least 4.0-months of import cover. The drop is largely attributed to increased debt service obligations due to the continued depreciation of the Kenyan shilling,
- High global crude oil prices which had been worsened by the supply chain constraints leading to increased demand with fuel being a major input in most sectors in the economy. Consequently, this increased US Dollar demand by oil and energy importers, as well as manufacturers against a low supply of US Dollar currency.,
- The high debt levels in the country with the Kenya’s public debt having grown at a 10-year CAGR of 17.8% to Kshs 10.6 tn in September 2023, from Kshs 2.1 tn in September 2013, with external debt accounting for 53.5% of the total debt. This continues to put pressure on our foreign reserves due to the burden of increased debt serving costs and hence continues to weigh down on the Kenyan shilling, and,
- High debt servicing costs, there are couple of debt maturities happening now a good example is the Eurobond which is meant to be paid by June this year. The cost of paying for the coupons on the Eurobonds has also increased mainly as a result of continued depreciation of the shilling.
However, the following factors have supported the shilling from a further depreciation;
- Strong diaspora remittances, with monthly diaspora remittances having grown at a 10-year CAGR of 12.1% to USD 355.0 mn in November 2023, from USD 113.4 mn recorded in November 2013. In November 2023, the Diaspora remittances stood at a cumulative USD 3,817.4 mn which is 4.0% higher than the USD 3,670.6 mn recorded over the same period in 2022. The continued growth in diaspora remittance is mainly attributable to the recovery of the of the global economy, increasing Kenyan population in the diaspora and advancing technology that has facilitated easier transfer of money:
- The narrowing of the current account deficit due to the increased value and volumes of the country’s principal exports. The deficit narrowed to a deficit of 3.5% of the GDP as of Q3’2023, from a deficit of 6.4% recorded in similar period the previous year. Notably, in Q3’2023, the value of tea exports and horticulture contributed Kshs 50.1 mn and Kshs 48.8 mn, respectively out of the total value of exports of Kshs 269.4 mn, which is an increase from a contribution of Kshs 40.2 mn and Kshs 34.6 mn, respectively recorded in a similar period the previous year.
- Kenya has continued to receive financing from the International Monetary Fund and the world Bank which have supported the Kenyan shilling by boosting the forex reserves. Notably, the government received USD 1.0 bn from the World Bank loan under the Development Policy Operation (DPO) facility in May 2023, as well as USD 415.0 mn from the International Monetary Fund (IMF) in July 2023 under the 38-month Extended Fund Facility (EFF) and Extended Credit Facility (ECF) following the completion of the fifth review and is expected to receive USD 682.3 mn upon completion of the sixth review,
- The high Interest rates: The monetary Policy committee increased the Central Bank rate (CBR) to 12.5% signalling a tightening stance to support the shilling and tame inflation. . According to the MPC, the increment was made to tame the local currency depreciation, which the Committee noted had a significant contribution to the country’s inflation, contributing 3.0% of the 6.8% inflation rate recorded in November 2023, as well as the high cost of debt service. Interest rates on government securities remain high which are attractive to foreign investors especially the infrastructure bond which is also tax free.
- The Government measures to stabilize the foreign exchange market which include the Government-to-Government petroleum supply arrangement. According to the Draft 2024 Budget policy, this arrangement was mainly intended to address the US Dollar liquidity challenges and exchange rate volatility caused by the global US Dollar shortage and spot market reactions that were driving volatility and causing a false depreciation.
Going forward, we expect the Kenya Shilling to trade within the range of between Kshs 183.2 and Kshs 189.6 against the USD by the end of 2024 based on the purchasing power parity (PPP) and interest rate parity (IRP) approach respectively, with a bias of a 16.4% depreciation mainly driven by:
- The persistent US Dollar demand by importers, mainly in the oil and energy sector as well as manufacturers, while the US Dollar supply remains low resulting to a shortage of USD in the Kenyan market,
- The ever present current account deficit with Kenya being a net importer, which will increase US Dollar demand in the market
- The deteriorating forex reserves which have for the last five months remained below the statutory requirement of maintaining at least 4.0-months of import cover. The drop is largely attributed to increased debt service obligations due to the continued depreciation of the Kenyan shilling
Despite the fact that the current pressure on the Kenyan shilling is unlikely to abate in the near term, there are actionable steps that can be taken by the Government to mitigate further depreciation of the shilling. These include;
- Formulate policies to encourage Foreign Direct Investments (FDIs): The government should prioritize creating an attractive investment environment for foreign investments by improving transparency in all required regulations as well as reducing hurdles in the process. This would include targeting sectors that enjoy global interest like the Renewable Energy sector and Sustainable Energy Development Goals (SEDG), and could include incentives for the same. This would majorly increase the foreign exchange reserves thus reducing the pressure on the foreign currency in the Kenyan markets,
- Promotion of Tourism through Implementing robust marketing campaigns to attract international tourists and enhancing the tourism infrastructure which will help increase the inflow of dollars and hence boost our Foreign Exchange Reserves
- Dramatically cut Spending: The government should Contain expenditure by limiting expenditure to the core activities of the government as well as reducing wasteful spending at both the County and Central government levels
- Reduce corruption: The government should adopt measures to reduce corruption, improve transparency, and strengthen governance structures. A corruption-free environment attracts foreign direct investment, enhance economic efficiency, and instils confidence in the stability of the Kenyan Shilling.
- Stimulate our moribund capital markets to attract foreign investors: The government should focus on improving the capital markets by Implementing policies that encourage foreign investment, streamlining regulatory frameworks, and introducing investor-friendly initiatives. A vibrant capital market attracts foreign capital as well as enhances liquidity and diversifies investment options, contributing positively to currency stability.
- Maintaining a sustainable debt level: The government should find a harmonious equilibrium between engaging in foreign borrowing to boost foreign reserves and preserving a favourable credit standing with creditors. This delicate balance is crucial for maintaining the country's attractiveness to investors, facilitating capital inflows and financial stability. Consequently, the government should be proactive in meeting upcoming financial obligations, such as the impending USD 2.0 bn Eurobond maturing in June 2024,
- Reduction of commercial loans: There is need for the government to reduce the share of commercial loans in order to reduce debt servicing costs. This is mainly because commercial loans attract higher interest rates as compared to concessional borrowings. Reduced debt service amounts would greatly help to bring down demand for the US Dollar and stabilize the exchange rate
Interest rates environment in Kenya has witnessed high volatility as evidenced by the significant increase in yields on the government papers. The continued rise in the yields in government papers is as a result of investors attaching a higher risk premium to the country, driven by the elevated inflationary pressures, high public debt and currency depreciation that have put the country’s macroeconomic environment at risk.
Going forward, we expect a continued upward readjustment on the yield curve with our sentiments being on the back of:
- The government faces mounting pressure to address its budget deficit by increasing its domestic borrowing. The government is likely to continue accepting expensive bids and in turn continue destabilizing the interest rate environment, and,
- Uncertainties about the economy occasioned by elevated inflationary pressures which have resulted in high credit risk which hampers lending to businesses and individuals. Additionally, with the approaching USD 2.0 bn Eurobond maturity in June 2024 will likely push the yield curve upwards as investors attach high attaching higher yields due to the uncertainty on the government repayment. For more information, click the link below Currency and Interest Rates Review
