The making of a dollar economy amid scarcity

US dollar bills on background with dynamics of exchange rates in a trading and financial risk concept. [Getty Images]

The words “legal tender for one thousand shillings” on the back of the Sh1,000 banknote means that the currency must be accepted if offered in payment anywhere in Kenya.

However, if you buy cooking oil from a certain local edible oil manufacturer, then you might already have received a memo that weakens the power of your Sh1,000.

“We are faced with a situation where we may not have raw materials to be able to supply you finished products per your requirements,” said the company in a recent memo to its clients.

“We humbly request that we bill you in USD (US dollars) and that you pay us USD so that we can pay our suppliers and keep raw materials coming.”

The memo shows the extent to which the dollar has become critical to the Kenyan economy. Some observers say this raises fears of dollarisation of the economy following reports of dollar shortage.

Dollarisation, which happens when the US currency is used in addition to or instead of the domestic currency of another country, seems to have intensified in recent times as Kenya has been welded firmly into the global economy.

The dollar is the reserve currency in the global economy. It is held widely by governments, central banks and private institutions to conduct international trade and financial transactions. Other major reserve currencies include the euro, Japanese yen, Swiss franc, British pound, Canadian and Australian dollars, and the Chinese renminbi.

It is not just manufacturers who need dollars to buy commodities such as palm oil, fertiliser, petroleum products, wheat and rice from the global market; consumers also need the greenback to buy finished goods such as clothes, furniture, cars, mobile phones and drugs from outside the country.   

The government also needs dollars and other foreign exchange (forex) to repay its debts, half of which are denominated in dollars, as well as to import.

Companies listed at the Nairobi Securities Exchange (NSE) have also been paying dividends running into tens of billions of shillings to their foreign shareholders.  There have also been claims that banks have been forced to ration dollars, claims that have been refuted by the Central Bank of Kenya (CBK).

On being asked about the manufacturers’ complaints of dollar shortage, CBK Governor Patrick Njoroge was adamant that there was enough supply of the hard currency in the economy.

He said the forex market generated up to $2 billion  (Sh234 billion) every month while faulting manufacturers for not following rules.

“They should understand that they (manufacturers) are small in that sense and, sort of, go to the market like everyone else,” Dr Njoroge said.

“There are no favourites in the market. Follow the rules of the market and everything will be okay.” It was not immediately clear what rules the governor was referring to.

But one rule requires anyone, residents and non-residents, who want to buy or sell foreign currency of at least $10,000 (Sh1,170,000), to provide documentation to show the purpose and source of the cash.

Edible oil manufacturers have also been grappling with a shortage of palm oil.

The limited supply of palm oil - the main ingredient in production of cooking oil - has been triggered by unfavourable weather, infrastructure issues and the Covid-19 pandemic with a tonne going for $5,798 (Sh678,366) compared to $4,000 (Sh468,000) a year ago.

The dramatic increase in the cost of palm oil means that edible oil manufacturers around the world need more dollars to get hold of this critical raw material, whose scarcity has translated into a spike in retail prices of cooking oil.

Kenya imports palm oil — which is also used to manufacture cosmetics and soaps—from Malaysia and Indonesia.

The lack of dollars, analysts reckon, is forcing traders to resort to using it not only as medium of exchange but also as a store of wealth as the shilling loses its purchasing power.

Those with dollars such as exporters are holding on to the greenback for much longer, said Sunil Sanger, managing director of Orion Advisory Services.

This might have created an artificial shortage.

Artificial shortage, says the National Treasury, has also been created by alarmist comments by manufacturers led by their lobby, Kenya Association of Manufacturers.  It is not just the cost of imported palm oil that has skyrocketed, leading to a huge demand of dollars. Traders have also used more dollars to buy wheat, fertiliser and refined petroleum, whose prices have spiked.

The situation has been aggravated by reduced inflow of dollars and other foreign currencies due to poor tourism and export earnings.

Due to the lingering effects of Covid, the number of foreign visitors, though improving, is yet to return to the pre-pandemic levels, said the World Bank in its latest Kenya Economic Update.

When foreigners visit for leisure or business, they come with critical foreign currencies that they exchange into Kenya shillings at the prevailing rate in the forex market.

The US is currently exchanging at an average of Sh117 at authorised dealers such as commercial banks and forex bureaus, CBK data shows.

However, there has been talk of an emerging parallel foreign exchange market with traders quoting a higher rate, even 120, compared to the prices they are giving CBK.

These dollars will then be available to those who need them such as importers. But, as is becoming increasingly common, consumers might also use dollars directly to pay for goods and services. 

In 2019, one of the eight tenants who had been ejected from Garden City Mall revealed that one of the reasons they had difficulties was that the management required them to pay rent in dollars.

As a result, the rent would get expensive whenever the shilling weakened.

The requirement by developers to pay rent in dollars is not new, says Johnson Denge, commercial director at Pep Real Estate Development Services. “This is always the case in Grade-A commercial spaces and in most cases it is usually in the lease as a requirement,” he says.

This dollarisation, he adds, is more pronounced in foreign investment funds properties such as Garden City Mall, which was built by the United Kingdom-based private equity firm Actis.

Actis is also the owner of Thika Road Mall. Carrefour Supermarkets — which is one of the tenants at Garden City and is owned by UAE-based Majid Al Futtaim — also accepts dollar payments from shoppers.

It is the same with Turkish brand LC Waikiki, a multi-cultural fashion store that has branches in Garden City, Thika Road Mall and along Uhuru Highway, near Nyayo Stadium.

Airlines such as Kenya Airways, which have a lot of forex obligations, also accept dollar payments. Houses at Unity Homes in Tatu City, along Thika Road, are also sold in dollars.

Real Estate consultancy Knight Frank noted in a 2016 report that a large portion of the high-end residential tenants in Nairobi houses are expatriates, which explains the dollarisation in rent payments.

Foreign investors have invested directly in projects such as malls and residential houses, and also bought shares in firms at the NSE. The return for owning a stock is dividend.

Foreign shareholding

In his latest press briefing last month, Dr Njoroge admitted that the shilling might have come under pressure as companies paid their dividends to foreign investors.

Companies such as Safaricom, East African Breweries and numerous listed banks have significant foreign shareholding, which means that around April, they used a lot of dollars in dividend payments. 

However, in volatile times like these, some of the foreign investors sell their shares, convert the money into dollars and evacuate them to the safety of their homes.

In May, for example, foreign investors withdrew a net of Sh4.2 billion from the NSE, attracted by not just safer assets but also higher returns in the US. 

Export earnings — another foreign exchange earner have also not increased as fast as the country’s import bill.

Kenya’s major exports include tea, coffee, flowers, vegetables, fruits and titanium which together earned the country Sh207.8 billion in the first three months of 2022 compared to an import bill of Sh591.6 billion, official data shows.

This means that for every Sh100 worth of dollars that the country lost through import payments, it only gained an equivalent of Sh35 from export earnings. A bigger difference between the value of exports and imports — technically known as trade deficit — is not good to the country’s external position.

With the Russia-Ukraine conflict pushing up the prices of oil, fertiliser and wheat, the trade deficit must have worsened in the months of April and May. CBK is yet to release the data for these months.

Diaspora remittances

Kenya’s forex reserves would have been worse if it was not for increased remittances from Kenyans abroad and significant inflows from international financial institutions, said the World Bank.

As the dollar shortage debate rages, critics of President Uhuru Kenyatta have also blamed his administration’s huge appetite for external loans. The loans are mostly denominated in dollars.

As at June last year, 66 per cent of the country’s external debt was in dollars, an increase from 24 per cent in June 2014.

Payment for these loans have been growing faster than export earnings. For every $100 (Sh11,700) dollars that the country earned from exporting goods and services in June 2013, official data shows that the government only used $5 (Sh585) to pay external creditors.

Eight years later, this rose sharply to $26 (Sh3,042). All these factors have conspired to starve the economy of dollars. The war in Ukraine, the lingering effects of Covid-19 and the decision by the US Federal Reserve to increase interest rates has made things worse for the currencies of most emerging markets.

Sri Lanka is the latest country grappling with a serious shortage of dollars, which is compounded by its huge external debt services. 

Spooked by the weakening of the local currency and reports of dollar shortage, local investors and wealthy Kenyans have also desperately stockpiled dollars.

Official data shows that cash in dollar accounts held by Kenyans surged to a record high of Sh811 billion in March 2022, even as Treasury warned that claims of dollar shortage were pushing people to accumulate the hard currency.

When they raised the alarm, Pwani Oil reckoned that the only solution to this quagmire was for CBK to release its own dollar reserves to forex dealers. Yet the CBK is in agreement with the International Monetary Fund (IMF) and the World Bank that it should not to tinker with the exchange rate.

CBK wants to let the exchange rate act as a shock absorber by letting the shilling depreciate. The expectation is that the expensive imports due to a weaker shilling will be counter-balanced by cheaper exports, and thus more dollar revenue.   

Unfortunately, it seems CBK’s pace of allowing the local currency to weaken has been falling behind market expectations, according to investment bank EFG Hermes.

This can get worse in what EFG described as a “thin FX (forex) market” like Kenya’s, resulting in more cautious behaviour from market players.

“Sellers of forex tend to be slower in selling their holdings of foreign currency, while buyers tend to exaggerate their demand in order to secure larger amounts of FX (as a way of a hedging),” it said.