In the last two posts I've talked about the balance of payments and their adverse effects on the Kenyan economy going forward if nothing is done to correct the dwindling trade balances. Note that import cover currently stands at approximately 44% i.e. the proceeds we get from selling goods and services to foreigners can only buy 44% of our imports. This is not an ideal situation, in fact it leads to heavy indebtedness.
Weakening by the hour.

Anyone who's been following the forex markets of late, with particular attention to Kenya, has been dismayed by its depreciation against all major currencies. With the dollar, the shilling has depreciated to Kshs 87.15/ dollar from Kshs 80/dollar at the start of the year. With the pound, the shilling was trading at Kshs 126/sterling pound in January, and now it has hit the 140 mark. In terms of the euro, the shilling has depreciated from Kshs 107/euro to a low of Kshs 123/euro. In percentage terms, the shilling has weakened by 8%, 12% and 14% to the dollar, pound and euro, respectively.

Some blame speculators, for hoarding on to foreign currency, thereby weakening the demand for the shilling. Others, put the blame squarely on the Central Bank's shoulders, as in the recent weeks, the CBK has been a buyer of foreign currency. 

The reason that they have been buying foreign currency is due to their falling forex reserves. By law, the CBK is meant to maintain 4 months of import cover, i.e. forex reserves equal to the value of 4 months of imports. This is roughly Kshs 3.9 billion, as per their estimates. Hence, the CBK at any one time will have to have the equivalent of 3.9 billion shillings in a basket of foreign currency held in reserve. If you go back to the first paragraph, you will read that Kenya's import cover is 44%. 

To make sense of all this data, the key points are simple. The balance of payments going forward will force the central bank to buy more and more foreign currency thereby weakening the shilling. A lack of sound agricultural policy will force Kenya to buy more and more maize, rice and wheat from foreigners weakening our currency. Kenya, faced with a declining export cover, will have to take on more debt from foreigners e.g. the IMF, The World Bank and Chinese lenders so as to finance our imports. The latter may initially represent itself as capital flow and thus demand for the shilling, but the debt payments that will come with it will represent demand for foreign currency, further weakening the shilling. (Notice, I haven't at all touched on the issue of fuel).

In short, my outlook on the Kenyan shilling is rather bearish. Unlike, South Africa, Zambia, Nigeria and other SSA countries, our economy is not based on commodities, therefore our currency is based on Kenya being competitive in terms of our industrial and agricultural output. I don't see these two variables improving. 

What to do? If you are worried about the shilling, like I am. Then the only thing to do is to bet against it, by putting your money in financial assets denominated in foreign currencies. For example, you could buy shares or bonds denominated in the South African Rand, or even in U.S treasury securities (although, the dollar is having its own problems, given that the US has maxed out its credit card). All in all, have a portion of your wealth stored in foreign currency, rather than expose yourself to the weakening Kenyan shilling. Unless, there is a drastic change in agricultural policy, or by mere luck, the rains become more consistent and predictable, then there is little hope for the shilling. 

Nonetheless, anything can happen with regards to currency movements, thereby making a mockery of my predictions. However, if the currency follows the economic fundamentals, then I am lead to believe that it will be a long shot to have a strong currency.