Otiato Guguyu
The International Monetary Fund (IMF) advised the Kenyan government to avoid the temptation of defending the shilling because it is unlikely to bring down the price of consumer goods.
The Fund said models tracking Kenya’s exchange rates movement over decades showed that while prices shot up during currency depreciations, they do not come down when the shilling strengthens.
Kenya’s financial market has been treated to unexplained currency volatility following the announcement of the Eurobond buy back, an expensive tax free bond oversubscribed four times that is very attractive to foreigners and interventions from the Central Bank.
The shilling has moved from exchanging at 160 units for the dollar to 142 by yesterday in a series of massive gains attributed to improving fiscal sentiments, speculation and state intervention.
This has bolstered government position that President William Ruto have stabilized the economy. The momentum is building up expectations that consumer goods which were racing out of reach on imported inflation would ease and prices will come down.
“As exchange rate continues to act as an external shocks absorber, we find evidence of somewhat higher passthrough to inflation from exchange rate depreciation than appreciation, which, in the current context of exchange rate depreciation, calls for monetary policy to remain proactive in anchoring of inflationary expectations,” the IMF told authorities in the latest Selected Issues.
Previous IMF research has shown prices in Kenya are mainly driven by food or lack of it, and tends to spiral during years of drought and global shocks than from currency.
While depreciation of the shilling against the dollar also puts pressures on prices through energy and food imports, it tends to manifest after almost a full year meaning, Kenya is still likely to suffer from the depreciation for the foreseeable future.
Importers who have locked inventory at elevated prices are unlikely to reduce prices and those securing the dollars now are unsure of the direction of the currency in the long term and may also be cautious about lower prices.
“Combining the results, we find that exchange rate passthrough to inflation in Kenya generally range between 0.2 and 0.3 over a period of one year,” the IMF said.
The Fund advised Kenya to allow the shilling to fall and act as a shock absorber to ease balance of payment pressures.
Kenya has seen imports fall drastically cutting dollar demand, but exports which would have taken advantage of the depreciation has not picked up to improve forex supplies. Instead manufacturing for exports has dwindled on the cost of importing intermediate goods for manufacturing.
The Fund also admitted the ‘depreciation is not costless and could impact, for example, balance sheets, debt dynamics, inflation which would feed back into the economy.
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