Row on shilling pits CBK boss Njoroge against former employer

CBK boss Patrick Njoroge. He has accused IMF of using unconventional models to price the local currency. [File, Standard]

The purchasing power of the Shilling has dropped tremendously. In 2006, US consumers could use about $2.57 to buy a litre of petrol (gasoline). Back then, a motorist with the $2.57 at the prevailing exchange rate of 72 would buy 2.3 litres of petrol in Kenya. Today, things have changed for the worse.

The price of a litre of petrol in the US has since dropped to $0.76. Should a motorist convert $0.76 into local currency at the current exchange rate of 102 - they can barely get a litre of the fuel. In fact, you will buy 700 millilitres of petrol.

The trend applies to various items as well as imports. This is the story of the shilling’s free-fall. Not only is the shilling weakening against the greenback but is also losing its purchasing power or the purchasing power parity conversion rate.

While consumers in countries’ such as the US have reaped the dividend of plummeting oil prices, Kenyan consumers have continued to pay dearly for this input, a situation that has seen the cost of living rise steadily.

The result has been a decrease in Kenya’s currency’s valuation on the foreign exchange market. “The purchasing power of the Kenyan shilling has decreased by 78 per cent between 1998 and 2018,” Head of Banking Research at Ecobank Capital George Bodo said on Twitter.

Erosion of the shilling has happened at a fast speed that more than half of the Kenyan population has never used five, 10 and 50 cents.

And even a shilling coin, which De La Rue, a British currency printing firm, continues to mint is as good as dead.

The World Bank notes that Kenya has moved from a period when the value of the shilling’s purchasing power parity grew substantially, only for it to begin a descent in 2006. 

Purchasing power parity conversion factor is the number of units of a country’s currency requires to buy the same amounts of goods and services in the domestic market as the US dollar would buy in the US.

However, this conversion factor is for the Gross Domestic Product (GDP) which means that in an economy where GDP is reliant on infrastructure spending such as the Standard Gauge Railway, individuals have a far less purchasing power.

For the better of this year, the shilling has been stable - trading an average of 102 against the dollar. Kenya, a net importer and with a colossal external debt stock in US dollar, has benefited from this state of affairs.

A strong shilling has meant the country is not paying more for its imports and its dollar-denominated debt does not surge. But a strong shilling has also made Kenya’s exports to the region expensive, curtailing its competitiveness. Exporters of tea, coffee and horticulture have missed out on the party due to a strong currency. 

The shilling has become a diplomatic battle between Kenya and the world and its custodian - the Governor of the Central Bank, Dr Patrick Njoroge, has not shied away from this politics.

The governor dedicated his recent press briefing to throw barbs at the International Monetary Fund (IMF), the institution he worked for from 1995 to 2005, as a senior economist.

He ostracised his former bosses for demanding transparency in his efforts to guard against shilling volatility and their evaluation of what the local currency is estimated to be actually worth.

“The IMF put out a document that indicated or suggested miss-alignment by a particular figure. If we look at several variables including fiscal consolidation, information on the balance of payment we see only less than five per cent extent to which there can be a miss-alignment,” said Dr Njoroge.

The governor, whose first term ends in June next year, knows well how important the value of the shilling will be in getting a new term. Top officials of the CBK are allowed to serve an additional four-year term, but the renewal is pegged to their performance.

In 2011, however, former President Mwai Kibaki renewed the then governor’s term, Prof Njuguna Ndung’u, even after he was ranked the worst performing in Africa.

This was due to his inability to stem the free fall of the local unit, which at one time slid to historical lows of Sh107 against the US dollar. On Dr Njoroge’s watch, however, the shilling has not crossed this psychological mark.

The shilling has kept stable at between 100 and 103 units against the greenback on lack of pressure due to a sedated economy, low oil prices and dollars inflows from Kenyans living abroad. It has also for a very long time benefited from an IMF currency insurance that has given the market confidence that the country has access to dollars if the currency ever faced volatile pressures.

The shilling has also held steady despite the shocks of IMF facility withdrawal and raising of the US Federal Bank rates by 0.25 eight per cent to 2.25 per cent. The local unit is a sensitive subject for the country’s authority since with every percentage devaluation, the size of external debt grows.

Lack of demand

For every shilling borrowed for dollar loans such as the Eurobond in 2014 at around 87 units, a dollar will be paid back at 101.2 units a dollar currently, or higher if it depreciates further.

When the economy has cooled off, there is little expansion and inflation remains in check so there is little pressure on the currency. “Non-food, non-fuel remained stable because there was lack of demand pressures which will stay within the target,” said Dr Njoroge.

But it is oil prices that have been the biggest threat to the shilling when it rose sharply on the expectation of US sanctions on Iran, the shilling buckled under the weight, rising to a 12-month high when it touched 103 units against the dollar.

“Imports had actually slowed down on the decrease in food and machinery imports. However, rising oil prices through October posed a challenge but that changed dramatically at the end of October. Murban oil which we import stood at Sh8,830 ($88.2) a barrel on October 4, but by November 26, it had come down to Sh6,000 ($59.9) a barrel,” Dr Njoroge said.

Kenya, being a net importer is especially exposed to global price fluctuations since it receives fewer dollars.

Among its traditional sources of dollars, only diaspora remittances have been increasing. Coffee has declined while tourism, horticulture and tea have only risen marginally.

In the 12 months to September 2018, dollars from Kenyans living abroad have increased from Sh180 billion ($1.8 billion) to Sh250 billion ($2.5 billion), tea from Sh135 billion ($1.3 billion) to 140 billion ($1.4 billion), horticulture from Sh815 million ($812 million) to $972 million while tourism dollars edged up from $927 million to Sh102 billion ($1 billion).

Coffee, on the other hand, has declined from $240 million to $225 million within this period.

Imports, for their part, remained elevated, with oil for the nine months to September costing the country Sh330 billion ($3.3 billion), machinery Sh443 billion ($4.4 billion), manufactured goods Sh292 billion ($2.9 billion) chemicals at Sh 242 billion ($2.4 billion) and others at Sh301 billion ($3 billion).

This means that the country needs more dollars than it can get from selling goods to be able to meet the demand of its imports. It is this fact that the IMF pointed out especially due to sharp changes in prices of the goods Kenya imports.

In a report that Treasury had kept under wraps but which IMF later released unilaterally, the Bretton Woods institution looked at the gap between exports and imports referred to as current account deficit, both cyclical and actual that are currently above normal.

According to the global lender, the shilling may be overvalued by up to 17.5 per cent.

IMF said given the sentiment that CBK used an iron arm whenever importers and banks wanted to buy and sell dollars, the shilling risked being classified as “managed” rather than operating on the forces of demand and supply.

“Reflecting limited movement of the shilling relative to the US dollar, Monetary and Capital Markets Department 2018 report on exchange rate arrangement to be published in February 2018 will reclassify Kenya’s shilling from floating to other managed arrangement,” said IMF.

This would be a resounding indictment on the CBK, which has maintained that the country has a flexible currency and that it only manages volatility rather than targeting a figure. In fact, the country had even jumped to position three from five last year in the second edition of the Absa Africa Financial Market Index following better rankings for running a free forex market. Kenya tied with Botswana at 65 per cent, behind South Africa at 93 per cent, in the index that measures the maturity of markets, transparency, ease of accessibility and investor friendliness.

The real effective exchange rate approach also shows a similar size of overvaluation, equivalent to about 18 per cent. “Given the continued appreciation of the real exchange rate, the external position is assessed to be weaker than fundamentals,” said IMF.

Kenya seems to have gone to extreme levels to avoid letting IMF specialists put the value of the shilling to scale by failing to disclose crucial data to assess the shilling’s real value. “Regarding the last approach, the external sustainability approach, it was not possible to use it, as the international investment position data is not yet produced by the authorities,” said IMF.

The Bretton Woods Institution noted that CBK engaged in periodic forex exchange interventions, typically unsterilised, to limit the shilling’s movement.

“Given the CBK’s credibility, well-anchored inflation expectations and adequate reserve coverage, there is scope for greater exchange rate flexibility,” said IMF. The empire struck back. CBK last week attacked the IMF assertions that the shilling was overpriced by up to 18 per cent and said all tested models had shown that the margin of error could only stretch to five per cent.

The governor accused the lender of using unconventional models to price the shilling which resulted in the huge variation. Dr Njoroge questioned why IMF applied the External Balance Assessment (EBA) which, according to him, is generally used for developed economies.

He said the model, which was developed in 2013 and launched in 2015, had not been applied in an economy like Kenya.

In fact, EBA, which takes into account a much broader set of factors including policies, cyclical conditions and global capital market conditions that may influence the current account and real exchange rate has only been applied to South Africa on the continent.

“How many peer countries have they used the model on? We are being used as guinea pigs with this model,” said Dr Njoroge, adding that there were well-documented problems about the model.

The governor also took issue with IMF’s demand that the apex bank offer more transparency on how it makes currency interventions. Dr Njoroge said they only release data if it is no longer market-sensitive, adding that it was a global practice. “We do not comment on currency interventions until we judge that it is no longer market-sensitive.

“Check anywhere, the bank of England, check how much information they reveal,” he said. The CBK boss added that the interventions are not done with “favourite players in the dark”.

Rather, said Dr Njoroge, it is done during open market operations with banks which know whenever CBK intervenes.

He also added that Kenya was a very open economy with no controls over the current account or capital accounts. CBK, he said, operated a flexible forex market not targeting any particular rate but allowing the market to price it.

Dr Njoroge said CBK only comes in when there is volatility which can destabilise the market and the economy if the exchange rate moves erratically.

Although CBK said it would put out its assessment of the shilling on its website, some analysts have questioned how he could attack the IMF model yet CBK has not demonstrated how it has been doing its own calculations.

“The IMF has made their models public why doesn’t CBK do the same,” a source who did not want to be named for fear of reprisals said.

The fallout between Kenya and the IMF has become apparent ever since the two parties failed to agree on an extension of the Sh150 billion standby facility. Since then, Kenya declined to release the IMF assessment on the state of the economy, prompting the global institution to unilaterally release the report in which it castigated Treasury’s debt management, saying it exposed the country to currency and interest rate risks.

Kenya and the IMF have also differed over the imposition of interest rate caps, with the Government even claiming that IMF was infringing on the country’s sovereignty. Mbui Wagacha, an economist and adviser in the Office of the President, termed the IMF’s recommendations on Kenya’s economic policies out of touch with local reality.