Unravelling the Kenyan Shilling’s Depreciation: Causes, Implications, and Future Prospects

By Kerubo Nyagaka, Junior Investment Analyst.

The recent depreciation of the Kenyan shilling against the US dollar has stirred considerable unease among economists, policymakers, and the public. The acknowledgment by the Central Bank of Kenya (CBK) of the shilling’s overvaluation by up to 25 percent has sent shockwaves throughout the financial markets.

According to CBK governor Kamau Thugge, the Kenyan shilling had been overvalued for several years. The overvaluation became apparent when inflation in Kenya surpassed previous records and the Fed substantially increased interest rates.

Consequently, the shilling has depreciated by 22% against the dollar since the year’s commencement, exceeding the depreciation experienced in 2022 by more than double.

Unravelling the Shilling’s Slide: Causes & Implications.

The decline in the value of the Kenyan shilling against the US dollar is a complex issue shaped by a blend of domestic and global elements. Let’s delve into the underlying reasons for the Kenyan shilling’s downward trajectory, the consequences of this depreciation, and the potential outlook for the currency.

Demand-Supply Imbalance and Global Influences.

A major contributing factor to the shilling’s depreciation is the persistent disparity between the demand for and supply of foreign exchange.

The demand for foreign exchange, especially in the manufacturing and energy sectors, has consistently surpassed its supply, resulting in the devaluation of the shilling.

The global strengthening of the US dollar, driven partly by the tightening of policies in major economies, has also impacted the shilling’s value. This has resulted in exports to major economies taking a hit while at the same time high oil and food prices pushed import costs higher.

Capital Outflows and Exchange Rate Dynamics.

The shilling’s depreciation has been compounded by capital outflows, influencing the exchange rate. These outflows can be attributed to lower risk appetite in global markets and interest rate hikes that pushed investors away from the region towards safer and higher paying USD assets.

Data from the CBK reveals that the official exchange rate of the shilling against the dollar recently surpassed the KES 150-unit mark, signifying a significant milestone in the ongoing depreciation.

The reopening of the interbank dollar market in April and the removal of a CBK rule that previously capped daily deviation from the indicative rate at 20 cents has enabled the exchange rate to adjust through the dynamics of demand and supply. While the interbank market encountered hurdles previously, structural enhancements have led to a narrowed spread between the retail and official selling prices of the dollar.

CBK governor Kamau Thugge’s recent statements indicate that the current pace of depreciation is a consequence of allowing the shilling to attain its appropriate value without excessive intervention unless there is significant volatility.

This adjustment process is viewed as a corrective measure to rectify historical policy misalignments that have influenced the shilling’s value over the past few years.

Regional Comparison, Economic Challenges and Anticipated Support.

In comparison to other regional currencies, the depreciation of the Kenyan shilling against the dollar is particularly noteworthy. While the Uganda shilling has experienced minimal depreciation of 0.96% against the greenback since January, the Tanzanian unit has weakened by 6.8%, and the Rwandan Franc has appreciated by 14% against the US currency.

The depreciation of the shilling against the dollar has resulted in increased costs for importers and merchant traders, while the country’s external debt burden has significantly escalated from a local currency perspective.

In response to these challenges, the CBK anticipates substantial financial support from institutions such as the IMF and the World Bank, which is expected to bolster the shilling and stabilize the economy. Additionally, the shilling is anticipated to benefit from expected foreign currency inflows from diaspora remittances and tourism.

Navigating Future Uncertainty.

In conclusion, the depreciation of the Kenyan shilling against the US dollar is a complex issue influenced by a combination of domestic and global factors. While it has already experienced a significant decline, the precise trajectory of its future depreciation remains uncertain.

The government, in collaboration with international financial institutions, is implementing measures to strengthen the shilling and stabilize the economy. However, the effectiveness of these measures hinges on the ongoing global economic landscape and Kenya’s ability to effectively manage its fiscal and monetary policies. The journey to ascertain the true value of the Kenyan shilling continues, with its future remaining a subject of intense interest and concern.