Jun 21, 2010
General
caxias
When economies in Europe, America, Japan and China sneeze, developing country’s like Kenya catch a cold. And so it happened last week when the euro climbed to a three-week high against the US dollar on Friday after a Spanish bond sale soothed worries about Madrid’s public finances, giving hope that the Eurozone currency is recovering from debt fears.
When economies in Europe, America, Japan and China sneeze, developing country’s like Kenya catch a cold. And so it happened last week when the euro climbed to a three-week high against the US dollar on Friday after a Spanish bond sale soothed worries about Madrid’s public finances, giving hope that the Eurozone currency is recovering from debt fears.

Increased demand for the dollar have been driving the value of the green buck against other currencies, including the euro and the Kenya shilling. A strong dollar and weak euro have been worrying some sectors of the Kenyan economy, particularly horticultural farmers who are paid in euros from Europe and local firms who had borrowed in dollars.

The Kenya shilling had hit a new five-year low of Sh82.20 to the US dollar on June 7 due to panic on uncertainty in global money markets and rising world demand for the greenback. This prompted Central Bank of Kenya Governor Njuguna Ndung’u to issue a statement to calm the local markets. The last time the shilling was at these levels was in September 2004.

“The fundamentals of the Kenya exchange rate and the economy are sound,” he said. “The current movements in the shilling against other currencies are as a result of international market developments not related to Kenya.” The recent turmoil in international foreign exchange markets was triggered by Greece after it emerged that it had borrowed heavily in the past decade.

As a result, the Greek economy could not recover from the financial crisis with its budget deficit rising to 13.6 per cent of GDP last year – more than four times the limit under Euro zone rules. Given the high level of debt and without a credible restructuring plan, investors doubted Greece’s ability to meet its obligations.

“Since investors in the international markets perceive that the problem might be pervasive in the Euro zone, the events in Greece have impacted on the common European currency, the euro,” said Mr Ndung’u. It is has been feared the Greek crisis may spread to other countries in the Euro Zone with similar fiscal constraints and debt burden, such as Spain, Portugal and Italy.

Consequently, investors stampeded out of the euro and euro-dominated assets, seeking to replace them with US dollars and the Sterling Pound, which were perceived as a safe haven. The immediate concern over a weak Kenya shilling is that the import bill, dominated by US dollar terms, is likely increase if the current exchange rates persist.

Retail imports are already more expensive; a $1 million import bill that required Sh65 million a few years ago when the local shilling exchanged at Sh65 per US dollar now requires over Sh80 million. Travel outside the country is also costing more for dollar-dominated air tickets.

Of concern too is the oil import bill. Oil firms will require more Kenya shillings to pay for petroleum imports in US dollars. And depending on the period the shilling remains weak, there’s is a possibility of this higher cost impacting on pump prices, pushing costs of transport higher, and inflation upwards.

Inflation had declined from 14.6 per cent in February 2009 to 3.9 per cent in May 2010. “The risk that might emerge from higher oil prices in the international markets will be mitigated by lower food prices and lower hydro-generated electricity prices,” says Mr Ndung’u.

Local firms that had borrowed in US dollars will suffer from forex exchange exposure risks. For instance, a firm with a $1 million loan incurred when the shilling traded at Sh70 to the dollar owed Sh70 million, but now that has risen to Sh80 million. Also suffering are exporters who earn in euros, such as horticultural farms.

However, exporters being paid in US dollars are lucky since they are earning more in shilling terms. They are also in a position to lower their prices, making their goods or services cheaper and therefore more competitive, especially if they value their exports in local currency. For example, an exporter targeting to earn Sh8,000 can charge an export price of $100 currently compared to $114.2 when the dollar was exchanging at Sh70 per unit.

Other immediate beneficiaries are those living in the diaspora whose remittances are affording more shillings to local dependants. Residents who are paid in US dollars, but spend in local currency and firms receiving foreign disbursements in dollars are also benefiting.

The Central Bank advises companies to ensure they hedge against the risk in changes in foreign exchange rates. “The bank expects that the private sector and firms have their hedge instruments in place to mitigate the current volatility in the foreign exchange market as they are temporary,” Mr Ndung’u said.

Hedging means taking a future contract position directly opposite to a position in the current market or today’s rates, called the spot market. The purpose is to reduce risk exposure by protecting yourself from unexpected foreign exchange changes.

But while hedging tools are for the big importers and exporters, small businesses are advised to keep watching the exchange rates and juggle their deposits in both US dollars ( local dollar bank accounts) and in local currencies. In the meantime, argues the CBK, the local economy remains sound and is expected to grow at between 4 to 5 per cent this year compared to 2.6 per cent last year.

Tourism has recovered fast since the January 2008 and exports are expected to recover in 2010 as increased demand emanates from the non-traditional destinations in the Far East and greater access to the East African Community.
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