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Boon or Boom: Central Bank of Kenya’s Balancing Act The Tie Breaker In Rescuing Kenya’s Shilling

  Jun 5, 2015

Contrary to the tell-tale signs foretold by the global currency trends, the shilling may actually be headed to an up-hill, should the Central Bank of Kenya give an ardent eye in stabilizing the recent market shock accorded by the shilling. The shilling, currently weighing 0.96 against the dollar, is a reflective response of the global trends recorded by the improving value of the Dollar. This trend is being experienced at both a regional and global level, an appreciation resonating with the rival of the US economy over the past few months.

This has restored confidence in the US economy, which means that investors are more willing to invest in US financial instruments, like US Treasury bill and US treasury bonds, and in other dollar dominated assets. The European Economy is also recovering but much more slowly, picking up from the Euro Zone Crisis. In fact, it has appreciated more than the regional currencies, and also against the Euro. This depreciation witnessed by the local currency has been influenced largely by global trends as compared to local economic imbalances.

It is a worrying trend to some extent, because it means that costs of imports, which are composed of consumer goods will increase, feeding into the inflation of the economy. At the moment, the Central Bank and its monetary policy statement of December 2014 set a target of 5%, plus or minus 2%, to about 7.5% which is the limit.

So, if inflation increases, then the Central Bank of Kenya Monetary policy Committee would probably have to increase interest rates, which would have other consequences as well. On the other hand, exporters are up for benefits, as our goods will be considered cheaper from the point of view of foreigners, and so goods that are responsive to decreased prices, such as tourism and horticultural products, could see some recovery.

For many decades our import value has consistently exceeded the export value. We have had a deficit on the current accounts, which the major components, is in the trade balance. This is not a reason for concern if it’s something that happens occasionally, but it can be a reason of concern if it is persistent. If we have a persistent current account deficit, then that could mean that there is a challenge on the competitiveness of our export.

Coherently, the balance of payments and current account deficit has to be financed by drawing down on reserves or by borrowing. Should it be financed by borrowing, then that increases indebtedness of the country. Facilities like the International Monetary Fund which provides specific support for balance of payments, can come to call especially in getting emergency monetary assistance to stabilize the Shilling. This cannot be a suitable option in the long run.

The other option will be to raise the interest rates. This might seem like the way to go but it is key to remember that in regulating the country’s interest rate, there is need to balance between growth and inflation. If the interest rate is too high, we may stifle growth. This may address inflation, but on the other hand create a problem in terms of reducing growth levels, which could increase the rate of unemployment. The Central Bank always has difficulty in balancing and that is why they have maintained a stable rate of 8.5%. The only time they will increase the rates, would be only when the inflation rate goes up substantially, probably over 10%.

The IMF recently had a prediction that Kenya next year is expected to grow by 7% for the first time since 2007. In line with this, should Central Bank topple over a rational decision, Kenya will lose grasp of the “golden goose”.

Dr. Robert Mudida is a Senior Lecturer and Academic Director in the Centre for Public Policy and Competitiveness at Strathmore Business School.

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