Business Daily (Nairobi)
Washington Gikunju
3 March 2008
The Central Bank has taken to selling dollars in the foreign exchange market in an effort to mop up excess liquidity in the economy.
This ingenious move is already paying dividends by cushioning the shilling from weakening against the US currency.
After watching the shilling's exchange rate to the dollar fluctuate in wild swings for one and a half months when the political environment remained volatile, CBK realised that it could kill two birds with one stone.
Over the last two weeks the bank has released $40 million (Sh2.8 billion) from its foreign exchange reserves in batches of $5 million and $10 million, and in the process mopped up excess shillings in the economy, while creating an oversupply of dollars.
The result, predictably, has led to the stabilising of the shilling to the dollar, standing between the Sh69.92 at the release of the first batch of dollars on February 15, and Sh67.60/70 as at Friday last week, a two and a half month high that was also largely buoyed by the signing of a power sharing agreement between the Government and opposition party ODM.
CBK maintains that the dollar sales are just a routine mop up exercise in line with the regulator's open market operations, but also admits that the auctions have helped to ease downward pressure on the shilling.
The local unit has gone through a steep slide and a period of sharp volatility since announcement of the disputed December 27 presidential poll, touching a four year low of Sh74 to the greenback from a high of Sh63.50 on December 24.
CBK governor, Njuguna Ndung'u, says the bank's participation in the forex market should not be misconstrued as an intervention, but rather as a liquidity management instrument.
Prof Ndung'u says that monetary policy is independent in a floating exchange rate regime, but CBK can develop innovative instruments for liquidity management to achieve the required monetary policy in line with inflation and targets.
He says that in such a scenario the exchange rate, through the foreign exchange reserves, becomes an indirect instrument of monetary policy just like the repurchase agreements (Repo) or others that the bank may develop.
He maintains that the bank is mopping up excess liquidity, but not intervening to influence the exchange rate.
"We are not intervening, we are just mopping up excess liquidity from the market using the forex spot sales, and that is why we auction them so that they go to the highest bidder," says Prof Ndung'u.
"Intervention refers to solving a supply or demand imbalance so that price is not a target, but stability of the price is the main target."
Weekly reports from CBK show that the bank has not been successful in its open market operation (OMO) that has been targeting mopping up excess liquidity through Repo operations.
Repos, or repurchase agreements, refer to contracts between CBK and commercial banks through which the bank mops up excess cash by selling securities to banks and buys them back (redemption) at a later date at a mutually agreed price.
Though by far the most common OMO, the Repo market functions through fresh mop ups and redemption of maturing securities, which has frustrated CBK's efforts with mop ups and redemption evened out.
This has left excess reserve money circulating in the economy, creating an excess supply of the shilling and hence its general downward trend against major foreign currencies.
In the week ending February 22, Central Bank's open market operations mopped Sh36.6 billion from the market through repurchase agreement securities against a similar amount of redemption in maturing securities.
As a result, the stock of repo securities holdings by commercial banks remained virtually unchanged at Sh34.8 billion.
Reserve money for the week ending February 20 averaged Sh149.7 billion and therefore remained above the target of Sh137.2 billion.
Last week, a total of Sh40.3 billion was mopped up through the Bank's OMO.
With Sh41.1 billion Repos maturing during the week, the average reserve money in the week was Sh147.1 billion or Sh9.8 billion above target.
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