Nairobi — The Central Bank of Kenya has linked the rapid depreciation of the Kenyan shilling against the world reserve currency to overvaluation that had the local currency remain "artificially strong" for at least six years.
CBK Governor Kamau Thugge explained that data from the International Momentary Fund (IMF) and World Bank suggested that Kenya's exchange rate was overvalued by between 20-25 per cent in six years dating back to President Uhuru Kenyatta's reign.
Appearing before the National Assembly Finance Committee led by Molo MP Kuria Kimani where he was tasked to explain the decline of the shilling against the dollar, Thugge said the move strained reserves.
"So at one point, we had reserves of 5.5 months of import cover now we have currently we have 3.7 months on the import cover is still sufficient to address any emergencies but there has been that decline in the level of reserves to try to defend perhaps overvalued exchange rate," Thugge said on Tuesday.
Misaligned rates
The Central Bank Governor mentioned that due to the overvaluation of the shilling, the exchange rate was misaligned as compared to foreign deposits leading to a significant increase in the shilling's depreciation.
"I have to say that we can just maintain an overvalued exchange rate it's not possible. You're going to lose all your reserves," he explained.
"And the diet medicine will be even worse. Because imagine, you try to maintain a lower value the exchange rate and our level of reserves right now is as I said, it's just about almost $7 billion," he pointed out.
Thugge pointed out that the shilling's overvaluation came to the limelight in 2022 after the United States raised its interest rates aggressively following increased inflation in the country which now stands at 3.4 per cent.
The expansive monetary policy by the United States was however not accommodated by CBK which did not raise its rates leading to a gap between the foreign interest and domestic interest leading to capital outflows.
"And that affected the exchange rate and because there was already a lower valuation, maybe our currency depreciated a bit higher than, for example, the currencies in the within the region," said Thugge.
Eurobond repayment uncertainity
Thugge further pointed out depleting foreign reserves that caused pressure to the shilling was partly attributed by misunderstanding among foreign investors on the payment of the Eurobond debt set to mature in June 2024.
Thugge explained that foreign investors were reluctant to invest in the country due to uncertainty about Eurobond repayment as they questioned whether there will be enough foreign exchange.
He exuded confidence that engagements between Kenya and foreign investors during the annual World Bank and IMF meetings had deflated the uncertainty on the economy as interest rates on a Eurobond dropped from 20 per cent to 14.2 per cent within days.
"The interest rates dropped because there was a better understanding by foreign investors. So that is one window of where the foreign exchange can come in through portfolio because these people are now satisfied that the economy better than other economies," Thugge noted.
A weak local currency means Kenya requires more shillings to pay back the same amount of debt, translating into higher foreign loan repayment costs.
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By the end of January 2023, slightly more than 51.2 per cent of Kenya's Sh9.18 trillion public debt constituted external public debt.
Straight months of steep depreciation of the shilling will see the country spend more to service the debts when the government purchases the respective currencies to pay back its creditors.
The public debt stood at 60 per cent of the GDP at the end of 2022, the Treasury said, citing a debt sustainability analysis prepared by the IMF and the World Bank.
The Treasury has also doubled down on its efforts to swap the country's short-term debt with longer-term issuances as uncertainty in the movement of interest rates leads to a contraction of new debt on short-term maturities, thus increasing the refinancing risk.
