There is really no denying it: We have a full-blown currency crisis on our hands. The shilling is headed for its historical low of 107 per dollar and will likely move to a never-before-reached level.
In the past few months, the CBK has raised interest rates and taken a number of other measures to drain cash and reduce liquidity in the banking system to help stabilise the local currency.
However, any measures by the apex bank to boost returns on domestic currency assets is being offset by a worsening Current Account Deficit (CAD), the main source of the local currency’s current woes.
At almost 10 per cent of GDP it will require over $6 billion to finance it. This, before we even take into account foreign borrowings by government and private sector that need to be repaid or refinanced.
If all this, plus the current capital outflows, is to be financed out of our existing $6.3 billion in official foreign-exchange reserves, the kitty will soon dry up.
We are getting punished because we have a big external funding gap at a time when the US Fed is getting ready to raise short term rates and reduce the glut of excess dollars.
If the situation does not improve in the coming months or if any US rate rise leads to further problems in the global economy, we could be in serious trouble.
The higher interest rates engineered by CBK since July to save the shilling have backfired. This column had argued in the past that curbing liquidity and effectively raising the cost of money will be of little help in the current circumstances. This is exactly what has happened.
The shilling continues to weaken and CBK has ended up tightening the interest rates, which are bound to affect growth prospects.
The apex bank may choose to formally once again raise policy rates to defend the shilling, but that too is unlikely to work. Money is not leaving us for higher yields elsewhere but is flowing back to safer haven.
Furthermore, with the shilling in free fall, global investors are unlikely to be lured by our domestic government bonds and other local investments, even though their return looks more attractive than the return on comparable dollar investments. Investors will be attracted to Kenya only if they can get a positive return after hedging the currency risk.
The high cost of protection against a shilling collapse, however, means hedging costs are too high and hence the effective return is not worth the risk.
We have to realise that Haile Selassie Avenue’s intervention to tighten monetary policy hasn’t worked and CBK has little options left.
The only thing the CBK can do now is to deal with speculative demand for the dollar against the shilling by the commercial banks. Speculators don’t start a trend but what they do is to take advantage of a trend especially when it is a downward one and that only adds to a currency’s problems.
It is like stealing from helpless accident victims. To minimise currency speculation, the CBK should may be consider reducing the overnight Net Open Position (NOP) limits of the commercial banks for the dollar from current 10 per cent of capital to as low as one per cent until the currency stabilises.
So the ball is now in Harambee Avenue’s court. It is time it moved in to take charge of the shilling. But what can it do? They can’t increase exports overnight to deal with the CAD problem.
It is not also as if we can cut imports of essential goods like oil, capital goods or other things we don’t produce without impacting on the living standards of the citizens.
Furthermore, our current CAD reflects an underlying economic trend, which may be desirable (and therefore not necessarily bad) at this particular point in time.
Countries with insufficient capital equipment typically run large trade deficits to ensure they gain access to best-practice technology which underpins the development of productive capacity.
So, the irony is we need to import to build the infrastructure we need to export later and cure our CAD disease. Short term pain, long term gain.
The government can, however, consider some immediate stop gap measures that can help stabilise the currency. Whereas we need to increase exports in the long run, in the near term, the government has to encourage more sticky dollar flows.
Short term capital flows or hot money, as it is also referred to, is extremely volatile and is one of the main reasons for the shilling’s current steep decline.
We must look at other more stable and sustainable ways that will help us attract hard currency into the economy.
The quickest and most effective short-term option may be the issuance of long-term dollar denominated infrastructure bonds targeting Kenyans in the diaspora.
This will help rake in much needed dollars to boost CBK coffers and shore up the shilling. Millions of Kenyans in the diaspora should be tapped to plug this deep CAD and help prop up the shilling by committing long-term cash for yields they would otherwise not get in their countries of residence.
Other than debt, we can also raise funds via long term bank dollar deposits specifically designed to help attract cash from Kenyans living overseas.
Interest on these deposits should be tax exempt to incentivise those in the diaspora to invest. Foreign currency denominated fixed deposits will allow Kenyans in the diaspora to invest in a foreign currency, say US dollars, and get their money back in the same currency.
They would be able to earn a higher interest rate than their local banks in the US or UK would offer without taking any currency risk.
Both these options will help reduce our reliance on hot money as Kenyans in the diaspora would most likely reinvest the returns and the principle from their foreign currency deposits and investments in the country.
Remember, for the Kenyan in the diaspora (including yours truly), home is Kenya and the shilling is effectively the “domestic currency” meaning there is lower chance of capital flight.
These are weapons that have been successfully used in the past by other countries. In the midst of a balance-of-payments crisis in 1998, India issued five-year bonds, raising more than $4 billion from its non-resident citizens otherwise known as NRIs.
In 2000, it raised $5.5 billion through five-year dollar deposits; India Millennium Deposit scheme, specifically tailored for the NRIs.
Simply put, we have been relying on foreign investors to finance our CAD that’s been getting worse and worse. And since foreign investors now want their money back, we have got to find a way to cover the shortfall.
That is where the army of Kenyans working abroad come in. Otherwise the administration will have little choice but to go back to the International Monetary Fund for loans.
That would be a painful replay of the Moi days and would be humiliating for an administration that is about to go back to the voters for a second-term mandate.
Mr Wehliye is a senior vice-president, Financial Risk Management, Riyad Bank, Saudi Arabia.