CREDIT NEGATIVE

Weakening shilling could be attributed to high inflation–Fitch

The local has been on a steady depreciating wave for the past two weeks

In Summary
  • According to the agency, higher inflation is generally credit negative for sovereigns, but presents particular risks for emerging markets.
  • This is because as they often face higher and more volatile inflation than developed markets (DMs), and are exposed to greater currency instability
A display of tomatoes at Kangemi Market
A display of tomatoes at Kangemi Market
Image: MERCY MUMO

Kenya's unstable shilling could be attributed to the high inflation rate in the country, global rating agency Fitch has said.

According to the agency, higher inflation is generally credit negative for sovereigns, but presents particular risks for emerging markets (Ems) such as Kenya.

This is because as they often face higher and more volatile inflation than developed markets (DMs), and are exposed to greater currency instability, the agency notes.

The Kenya shilling has been on a steady depreciating wave for the past two weeks and has been trading above 112 units against the greenback since November 12.

Forex traders have attributed the weakening shilling to high importer demand for the dollar surpassing supply.

Yesterday local was trading at 112.55 units to the dollar, according to the Google currency trader.

A weaker shilling means importers, spend more to bring in goods such as petroleum products and raw materials for factories.

This in turn translates to an increased cost of living(inflation) as the importers pass on the cost of imports to consumers, noting that Kenya is an import dependent country.

Kenya’s inflation eased slightly to 6.45 per cent in October from 6.91 in September on eased Covid-19 restrictions, Kenya National Bureau of Statistics data shows.

In August, the cost of living had hit an 18-month high of 6.57 per cent on increased cost of food, power and transport.

Fitch believes global goods price pressures will ease from early 2022, but inflation could remain elevated in many markets if services prices pick up.

Inflating away debt does not constitute a default, but defaults are correlated with high rates of inflation.

The Central Bank of Kenya (CBK) in September warned that the country may default on its debt in the next two years if the current rate of borrowing continues.

This means the country's inflation rate could remain elevated.

Higher inflation is a negative factor in Fitch’s Sovereign Rating Model, reflecting the risk of economic overheating, as well as growing macroeconomic imbalances in labour or asset markets or in the external accounts.

It may also raise concerns about macro policy credibility, especially in EMs.

The impact of higher inflation for public finances however can vary, Fitch notes.

This is because both revenue and spending will be affected and may be subject to policy responses.

Fitch however notes that EMs that are less able to issue debt in their own currency may be vulnerable to inflation-driven depreciation that raises the burden associated with their foreign-currency debt.

Monetary policy can also be impeded by high levels of dollarisation.

The capacity to anchor medium-term inflation expectations when faced with an inflation shock varies across EMs, but is generally weaker than in DMs.

In sovereigns with poor central bank transparency, patchy records of complying with inflation targets, or monetary authorities that are perceived by investors to lack sufficient policy credibility, inflation shocks may take longer to dissipate.

High inflation can have more disruptive political effects for EMs than in DMs, which can weigh on sovereign ratings.

Further, fiscal moves to shelter populations from the impact of inflation may also hurt public finances.