Tuesday, 31 July 2012

The Kenya Shilling Vs The US Dollar...The battle begins

A wise man once said that, one man's meat is another man's poison. I believe the vice versa is also true. As we noted last week, when it comes to business, many people tend to shy away. Specifically when those long economic terminologies are advanced and you wonder how as a layman you are supposed to figure them out and interpret their meanings. That is why Thika Live has adopted a simplistic direction in breaking down complex business jargon for the common Wanjiku to understand. Last week on such a day, we analyzed how interest rates affect you as a common mwananchi and we noted that there is a direct relationship between interest rates and consumer prices for those basic commodities.

Today we are shifting the focus to another aspect of the economy that many of us always ignore since we don't understand its basics. In the business news you will always hear of the performance of the Kenyan shilling against the dollar, the shilling was sold at 84 and sold at 83 in relation to the dollar and etc. You wonder how this affects you since literally you have never traded using the dollar. As long as the Kenyan shilling can be accepted over the counter in your local supermarket and as long as your employer pays you at the end of the month, then you have no business knowing how the shilling performed. But do you know that as a consumer this affects you directly. Quick reverse of gears to late 2011 when there were reports of the Kenyan shilling sliding to its historical lows. That was felt in all aspects of the economy. Let me start with a brief introduction on the Kenyan shilling.
After the abolition of the East African shilling in 1966, the Kenya shilling was adopted as the legal tender meaning that it was the legal unit of exchange in the country. The shilling's value is determined in relationship with other currencies mainly the Dollar,Euro,the Sterling pound, the Chinese Yen and others. Since1995, the Kenyan shilling has been a fair performer. In the early 1990s when the Anglo Leasing scandal hit the economy, the Kenyan shilling hit its lowest levels. The Anglo Leasing scandal caused the government to fork out billions in paying out non existent transactions. The effects of this massive economic rip out are still felt decades later.
Since the ascent of the Narc administration, the shilling gradually improved, coupled with positive growth of the economy to single digits figures. By late 2010 and early 2011, the shillings performance was at its best until hell broke loose in mid 2011. The shilling surpassed the psychological rate of 100 and plummeted to its historical lowest level. Economical tension gripped all the major spheres of the economy and a bout of blame game arose between the CBK, commercial banks, the NSE, importers and basically all the key players in the economy. CBK introduced policies aimed at curtailing this slide while Parliament started investigations to bring back the shilling to a common ground. Well, nearly 10 months after, the shilling is a bit stable.
As a consumer, what is the big issue about the shilling, Forex exchange and the slide of the shilling?
The relationship between the Kenyan shilling and other currencies is the exchange rate. This is the number of units that person A can get if his currency is converted into person B's currency. If you are buying an ex-UK vehicle you will need to convert your money into the selling currency. This conversion is governed by a rate: the conversion rate. The higher the rate to your disadvantage, the higher the price you will need to pay.  This rate is the link that our economy has with the global economy. The trade-ins between different currencies is called Forex exchange. So the Forex table that the News presenters read during business news is how the currencies interacted on that particular day.
So, when is the shilling weaker or stronger??
When the shilling is maintaining stable rates in relation to other key currencies,then its said to be strong and the vice versa is true. This means that when the shilling reached lows of 106 in 2011, then it was treading on weak grounds. Currently its trading at levels of 83 in relation to the dollar which means that its a bit strong. When its treading weakly, then the currency is considered devalued. Which means that if you have 1 dollar, after conversion you have around 106 shillings. This means that a Kenyan businessman who wants to buy a machine whose price is quoted in US dollars, will have to fork more when then the shilling is weak than when its strong.
So during the Forex meltdown last year, what the hell took place???
To answer this question, we have to first understand the type of economy that Kenya operates. The Kenyan economy is mostly consumer based. That explains why at mid month most of our bank accounts are very empty. Relatively the Kenyan economy is a heavy reliant of the manufacturing and agricultural sectors. Of all the countries in the East African Community, Kenya is the most vibrant as far as agriculture,manufacturing, technology and service sectors are concerned.
Lets narrow down to the manufacturing sector,
Most of the inputs into the manufacturing sector are mostly imports. Most of the heavy machinery and raw materials for most of Kenyan manufacturing firms come from Asia and Europe. This means that they are always valued in foreign currencies specifically the US Dollars. On the other hand, until recently Kenyan had no oil reserves. Even if we discovered oil in Turkana, that is more than 7 years from being viable. These oil imports from the Middle East, North Africa and Europe are globally priced in US Dollars. This means that our manufacturing sector is a heavy user of imported goods.
For the Kenyan manufacturer, he needs to purchase these imports using the US Dollars. If for one US Dollar he is expected to fork out 106 shillings, what if the cost of heavy industrial machinery is fixed at $45,000..that's is a cool Kshs 4.77M. What if the exchange rate is at 83.00, that translates to Kshs 3.735M
The more than 1 million difference is unfortunately settled by the manufacturer. You can then imagine for an economy that has daily imports worth billions.
If we shift to the agricultural sector which is Kenya's main sector, its worth noting that importation of fertilizers is inevitable. The fertilizer prices always quoted in foreign currencies will tend to be higher when the shilling is weaker, meaning that the Kenyan farmer will incur more when buying the fertilizers. Most of the agricultural products are either produced for the local market or export, meaning that to recover these higher importation costs then the farmers will have to raise the commodity prices for these agricultural products.
In the last two paragraphs we have talked of imports; these we acquire from other countries either because we don't have them or they are not enough. After production, Kenya will either use the generated products locally or export them.
But what happens to our exports with a weak shilling??
After importing fertilizers which was charged at a lower shilling in relation to the strong dollar, then the farmer incurs more..However after production of ,lets say coffee, he goes to the international export market where he is supposed to price the coffee in dollars. Then he will have a 500g packet of coffee valued at 600/= priced at only $ 5.66 when the shilling is weak at the rate of 106.00. However if the rate is at 83.00 it will fetch $7.22, a difference of $1.56 or Kshs165.36. The Kshs 165.36 is the Forex loss that the farmer undergoes as a result of the weak Shilling. Just imagine if he had a container of coffee for export, that would be millions of undeserved losses.
Basically, in international trade, when the import bill of any country is larger than its export bill, then the strain is felt on the country's currency. To bridge economic scarcities in any economy, its imperative that the export bill should be able to fully finance a country's import bill. No one loves the scenario where you buy a lot from someone while at the same time he is buying less from you. This, in economic terms is the current deficit, which is a key component of measuring a country's economic growth. This is where the latest discovery of oil comes as a relief, since all major economic components directly or indirectly are subject to oil prices.

So what brought the crisis?
When the Kenyan shilling hit low bottom, its volatility increased and as an investor you will tend to choose the least volatile currency. A volatile currency is not reliable for any investor. This volatility sent cold shrills down the spines of investors in Kenya. So what did they do..when it hit psychological levels of 100,speculators mainly banks and other investors held their investments in dollar currency accounts which in economic terms is known as hoarding dollars. This was in preparation for the big kill that lay ahead. It was obvious with such a historical drop,it was more likely that the shilling would still depreciate to lower levels before CBK counter action took full effect. When the shilling hit the 102.00 mark, the offloading started meaning that if you had bought dollars at 85.00 and you were now selling at 105.00, then that was a cool 20 dollars. What if you had bought reserves of like $ 500,000 or Kshs 42.5M when the Kshs was trading at 85.00 ..Then that was around $ 5M, then convert back to Kshs at the rate of 105..Just do the calculation and you get to know how Millionaires are made in minutes.
From the day the shilling hit 100, it was official that the economy was short of dollars. If you visited any bank wishing to exchange shillings into dollars, you were told, 'we do not have any dollars'. So where did the dollars disappear to. Answer, they were in peoples dollar current accounts just waiting for the shilling to go down and they would make millions. In foreign exchange, its called speculation and its legal until it creates shortages in the economy like it did in 2011.
At this point this meltdown of the Kenya shilling had reached the retail prices and bank interest rates,  electricity bills were coming in thousands of shillings, while prices of commodities had shot up.
Gladly, Central Bank intervened, although many fiscal experts argue that it was too late..First it restricted online and automatic trading by banks. All Forex exchanges, would only take place over the phone and only through Central Bank. This means that for the above case, where one is selling $500,000, then you had to go through Central Bank who would decide how much you will get. Additionally with no dollars in the economy and with dollar import prices hitting sky levels, something had to be done. The Central Bank therefore upped the Base Lending Rates for commercial banks.You remember the post about interest rates ?. Bretton Woods aka IMF also proposed a bail-out package. With time the Kenya shilling performance improved and it's surprising and pleasing to note its now trading at  margins of 84.00
So who were the winners in this fluctuations and devaluations of the shilling..Reminds me of the saying, one mans meat is another mans poison..That is food for next Tuesday!
Images courtesy of Google


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