Kenya’s foreign exchange market weathering sustained Shocks

Almost two years into the Covid-19 pandemic and the significant economic shock it has spawned, it is understandable that external balance assessments of different economies including Kenya’s have come back into sharp focus.

These assessments are important in determining the relative performance and misalignment of currencies and the resultant trade competitiveness across countries, more so, for economies such as Kenya, which are open and continue to integrate into the world economy.

In this regard, a raft of commentaries on the performance of the Kenya Shilling has undoubtedly come to the fore in recent weeks. Indeed, the future direction of the exchange rate as well as related market stability concerns dominate a fair amount of conversations at industry forums lately.

However, most of the commentaries provided thus far have not always provided the appropriate balanced analysis that showcases the remarkable stability that continues to be witnessed in Kenya’s foreign exchange market throughout the ongoing pandemic-driven macro-economic shock.

Across most metrics, the Kenyan foreign exchange market has demonstrated notable resilience and stability.

Undergirded by a strong prudential framework that guides daily foreign exchange dealing including market conduct, normal activity in the foreign exchange market has continued throughout the pandemic unperturbed and so far the banking industry continues to service all customers needs and commitments with relative ease.

Compared to its peers, Kenya Shilling continues to demonstrate relative competitiveness. Year to date, the Shilling has depreciated by a meager three per cent.

In contrast, the Nigerian Naira and South African Rand have depreciated by four per cent and seven per cent, respectively, even as other regional currencies continue to post mixed performance during the period.

Typically, the movement of currencies in either direction is to be expected from time to time as respective domestic objectives of fast growth with low inflation are pursued amidst a dynamic external environment. Actions by the United States around the dollar itself can drive currency responses across the world.

Even as 2022 dawns and the path to Covid-19 “endemicity” remains predictably uncertain, it may be useful to take stock of how far the Kenyan foreign exchange market has travelled and perhaps offer thoughts on its potential path going forward. Such a reflection invariably bears out at least the following three key themes.

The stability of the Kenyan foreign exchange market remains firmly anchored on sound prudential guidelines including principles of good market conduct that continue to inform foreign exchange dealing in the inter-bank foreign exchange market.

Licensed foreign exchange dealers are bound by a model code of conduct through a self-regulating dealers’ association in firm consonance with international best practice.

Additionally, the foreign exchange market is well developed with strong infrastructure and institutional capacity supportive of all market micro-structure objectives including an effective price discovery mechanism; ensuring that the exchange rate is reflective of other macroeconomic fundamentals.

In addition, each bank has established foreign exchange risk management frameworks with net open positions tied to respective bank balance sheet strengths and capacity.

Indeed throughout this Covid-19 period, the inter-bank foreign exchange market has continued to remain open daily to facilitate the much-needed support to the country’s businesses as they gradually re-open from the pandemic shutdown.

This continuity and stability will be even more essential in the coming days as the economy charts its path to full recovery.

As KBA, we laud the Central Bank of Kenya for their vigilance and continuous engagement with all market participants towards ensuring a stable and sound foreign exchange market.

Secondly. and singularly pertinent is the fact that the foreign exchange markets’ resilience, as well as the shilling’s relative competitiveness, continues to be underpinned by a fairly decent balance of payment outcome despite the sharp contraction of output in 2020.

After an undesirable contraction in exports performance owing to the closure of destination markets at the peak of the pandemic that led to a slight widening of the country’s trade balance, Kenya is steadily fighting its way back with recovery in traditional exports including horticulture and other agricultural exports.

Throughout the ongoing public health crisis, foreign exchange receipts have, against expectations, improved. Diaspora remittances have steadily grown averaging about $310 million per month.

Additionally, there have been improvements in the capital and financial flows including receipts from development partners such as the International Monetary Fund and the World Bank.

However, for close to two years and for the duration of the pandemic, service receipts from tourism and travel have somewhat dissipated in the absence of international travel.

Furthermore, owing to developments in the global energy markets, the import bill also rose in the period as oil prices shot up dramatically.

Due to these developments, some occasional demand-supply mismatches resulted in pockets of temporary illiquidity in the spot foreign exchange market.

These pockets of heightened demand, which have seen responsive adjustments of the exchange rate, have been addressed with improvements in supply conditions.

As it stands presently, official foreign exchange reserves are at USD 8.7 Billion, equivalent to cover about 5.3 months of imports and well above the statutory target of four months of import cover.

Relatedly, foreign currency holdings by residents have continued to rise. A strong reserves position provides some buffer to the market in the event of a shock. All considered thus, despite the magnitude of the Covid-19 macro-economic shock the country’s overall balance of payments position continues to demonstrate welcome stability.

Thirdly, and more fundamentally, it is obvious that the durability and stability of the foreign exchange market will remain predicated on the strength of the economic rebound in the short term and the eventual success of the economic recovery strategy in an endemic Covid-19 scenario in the medium-term.

Given the uncertainty around the exact path of the pandemic going forward, this is undoubtedly the most difficult theme to discern. Foreseeably though, the 2021 economic rebound appears strong anchored on a steady recovery of services riding on the back of better management of the public health risks through enhanced vaccination efforts.

As at half-year, economic output rebounded by about 5.3 per cent with a notably strong performance in the key sectors of education, transport and storage, health as well as information and communication.

This strong rebound, and its potential sustenance into 2022, provide the necessary anchor to long-term macroeconomic stability, conferring benefits on the internal and external balances with direct implications for the stability of the exchange rate.

As an industry, the banking sector will remain vigilant to the evolution of both the local and global foreign exchange markets. This will be especially necessary with the onset of the expected policy recalibration by developed markets in response to what now appears to be more permanent inflationary threats than previously thought.

Our assurance is that the Kenyan banking sector remains stable and sound, and embodies the requisite capacity to respond to any emergent supply and demand shocks within the established prudential guidelines.

The writer is the chairman of the KBA  and the Group MD of NCBA Group PLC.