The Kenyan shilling continues to fall against the US currency spelling trouble for businesses in the country. Over the last 10 years, it has depreciated at a 10-year compound annual growth rate (CAGR) of 3.7% to an all-time low of Sh125.6 as at February 17, 2022 from Sh87.3 over the same period in 2013. This is attributed to various factors such as an ever-present current account deficit, increasing debt levels and the rising prices of commodities such as crude oil prices as Kenya remains a net importer.
The economic disruptions occasioned by the COVID-19 pandemic in 2020 significantly caused volatility of the Kenyan shilling which led to a depreciation of 7.7% in 2020 followed by a further 3.6% in 2021.
In 2022, the shilling depreciated for a fifth consecutive year, closing the year at Sh123.4 against the dollar as compared to Sh113.1 at the beginning of the year, translating to a depreciation of 9.0%. The weakening of the shilling was mainly attributable to increased dollar demand from commodity and energy sector importers as a result of the high global crude oil prices occasioned by supply chain constraints worsened by the geopolitical pressures at a time when the economy was recovering from the impacts of COVID-19 pandemic which had stifled demand in the economy.
In 2023, on a year to date (YTD) basis, the shilling has depreciated by 1.8% against the dollar, to close at Sh125.6, from Sh123.4 recorded on 3rd January 2023. The continued depreciation in 2023 is mainly attributable to sustained dollar demand by importers against a low supply of dollar currency leading to shortage of dollars in the Kenyan market.
Drivers supporting the currency’s performance
Remittances: Kenya has continued to record strong diaspora remittances, with monthly diaspora remittances having grown at a 10-year CAGR of 13.0% to Sh44.2 billion ($349.4 million) in January 2023, from Sh13.0 billion ($103.0) million recorded in January 2013. Additionally, the total annual diaspora remittances have grown at a 10-year CAGR of 13.2% to Sh505.6 billion ($4.0 billion) in 2022, from Sh151.7 billion ($1.2 billion) in 2012. The continued growth in diaspora remittance is mainly attributable to the increasing Kenyan population in the diaspora and advancing technology that has facilitated easier transfer of money.
Forex reserves: The Central bank of Kenya continues to hold sufficient forex reserves which have been above the statutory target of 4.0-months import cover in the last 10 years, with an average of Sh922.7 billion ($7.3 billion) and 5.1-months average import cover. However, despite the Forex reserves being adequate for a long time, they have dropped by 21.6% to Sh872.2 billion ($6.9 billion) (equivalent to 3.8 months of import cover) in February 2023, from Sh1.1 trillion ($8.8 billion) (equivalent to 5.1 months of import cover) recorded in January 2022. The drop is largely attributed to increased debt service obligations due to the continued depreciation of the Kenyan shilling.
Kenya has also continued to receive financing from the World Bank and other bilateral lenders such as the International Monetary Fund (IMF) which have supported the Kenyan shilling by boosting the forex reserves. Notably, the government received Sh94.8 billion ($750.0 million) World Bank loan facility in March 2022, as well as Sh29.8 billion ($235.6 million) and Sh56.6 billion ($447.4 million) funding from the International Monetary Fund (IMF) disbursed under the fourth and fifth tranches of the 38-month Extended Fund Facility (EFF) and Extended Credit Facility (ECF) in July and December 2022, respectively. Further, through the Special Drawing Rights, IMF disbursed an additional $14.6 million (Sh26.6 billion) as buffer from the drought effects, which supported the forex reserves despite the continued depreciation of the Kenyan currency.
Exports: The value of the country’s principal exports has continued to grow over time consequently increasing foreign inflows which support the local currency. Notably, in Q3’2022, the value of horticulture and tea exports contributed Sh40.3 million and Sh34.5 million, respectively out of the total value of exports of Sh200.5 million. The current account deficit as a percentage of the Gross Domestic product (GDP), has also continued to narrow with the deficit estimated to have narrowed to a deficit of 4.9% by the end of 2022, from a deficit of 5.2% in FY’2021.
Foreign Direct Investments: Before the onset of the Coronavirus pandemic, the country attracted huge foreign investment as evidenced by the foreign direct investments (FDI) flows into the country, which had grown significantly by 8-year CAGR of 16.0% to Sh139.0 billion ($1.1 billion) in 2019, from Sh37.9 billion ($0.3 billion) in 2011. However, after economic disruptions caused by the COVID-19 pandemic which resulted in reduced investor activities, FDI flows into the country have declined in two consecutive years to Sh88.5 billion ($0.7 billion) and Sh50.6 billion ($0.4 billion) in 2020 and 2021.
Monetary policy: CBK plays an instrumental role in determining price stability and the economic growth of the country. The Monetary Policy Committee (MPC) has hiked the central bank rate by a cumulative 1.75% points to 8.75% from the previous 7.00% in a bid to anchor inflation which has surpassed government’s target range of 2.5%-7.5% and also strengthen the Kenyan shilling from further aggressive depreciation.
Drivers pressuring the performance of the currency
Global commodity prices: High global crude oil prices attributable to the persistent supply chain constraints and high demand, with fuel being an integral input in most sectors in the economy has seen an increased dollar demand by oil and energy importers, as well as, manufacturers against a low supply of dollar currency. The high dollar demand has caused shortage of dollars in the Kenyan market further inflating the country’s import bill and consequently weakening the shilling. The existence of an ever-present current account deficit estimate at 4.9% of GDP in 2022, despite improving by 0.3% points from 5.2% recorded in 2021, signifies country’s reliance on imports and with the high global commodity prices, it has resulted in increased demand for foreign currency which weighs down on the local currency.
Balance of payments: According to the Kenya National Bureau of Statistics Q3 2022 Balance of payments report, Kenya’s balance of payments deteriorated by 283.9% in Q3’2022, coming in at a deficit of Sh112.7 billion, from a deficit of Sh29.3 billion in Q3’2021. The deterioration was brought by a 5.5% widening of the current account deficit to Sh193.4 billion, from Sh183.4 billion in Q3’2021, driven by a 15.8% deterioration in trade imbalance to Sh373.1 billion, from Sh322.0 billion in Q3’2021. Consequently, with Kenya being a net importer, the shilling has continued to weaken as a result of increasing import bill mainly attributable to the high global commodity prices.
Government debt: High debt levels and increasing debt servicing costs are affecting the performance of the currency, especially with Kenya’s public debt having grown exponentially at a 10-year CAGR of 17.7% to Sh9.1 trillion in December 2022, from Sh1.8 trillion in December 2012, with external debt contributing 51.1% of the total debt. Consequently, the increasing debt servicing costs mainly as a result of continued appreciation of the dollar and aggressive depreciation of the shilling on the back of the monetary policy tightening by United States Federal reserve have put pressure on forex reserves given that 69.3% of Kenya’s external debt was dollar denominated as of October 2022. Additionally, the projected amounts that is expected to be used for foreign debt servicing in FY’2023/2024 stands at Sh475.6 billion, which are likely to put more pressure on forex reserves as most of it will be used to repay the debts.
The Kenya Shilling is expected to trade within the range of between Sh130.2 and Sh134.4 against the dollar in 2023 based on the purchasing power parity (PPP) and interest rate parity (IRP) approach respectively, with a bias of a 6.4% depreciation mainly driven by the ever-present current account deficit with Kenya being a net importer, and the currently high global crude oil prices that have weighed in on the dollar demand from oil and energy importers.
Concerns remain high on the future performance of the shilling given the current pressures as well as the dwindling country’s forex reserves and the rising debt level. As such, there is expectation of continued depreciation of the Kenyan shilling which will consequently have a negative impact on the economy as a result of increased import bill. Additionally, despite the tightened monetary policy, we expect inflation to remain high in the short term given the high fuel and fuel prices.