5 Effects of the Kenya Shilling Strengthening Against the US Dollar

Over the last five years, the Kenyan Shilling (KES) has exhibited a weakening trend against various global currencies, particularly the US dollar. 

According to Forex data from Google Finance, the KES experienced a significant decline in value, trading at Ksh98.6 in February 2019 and depreciating to Ksh162.3 by early February 2023. This marked a substantial weakening of approximately 64.5% during that period.

Several factors contributed to the weakening of the Kenyan Shilling against the US dollar. These include lower foreign exchange inflows and global interest rate hikes following the pandemic. 

Additionally, a change in central bank policy, initiated after Dr. Kamau Thugge assumed office in June 2023, played a role. The new CBK Governor admitted to the Departmental Committee on Finance and National Planning of the national assembly that the KES was overvalued by up to 25% and that he took measures that helped the exchange rate to "find its own level through demand and supply."

However, in mid-February, a reversal in this trend occurred, with the KES beginning to strengthen against the dollar. The exchange rate shifted from a high of Ksh162.3 to a low of Ksh141.5, closing the month at Ksh147 against the dollar. 

This recovery was attributed to Kenya's sale of a new $1.5 billion Eurobond maturing in 2031, which would be used to buy back a significant portion of the $2 billion bond due in June. Additionally, the government's sale of a Ksh70 billion infrastructure bond, which received bids of more than Ksh288 billion, strengthened the shilling.

While the bounce in the Kenyan Shilling's value is undoubtedly welcomed after years of steady declines, it also brings about its own set of effects. 

It’s mid-March, and as of now, the dollar exchange rate is at Ksh135 against the dollar. This article will explore five effects of the Kenya Shilling strengthening against the US dollar.

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1. Decreased Import Costs  

When the value of the Kenyan Shilling strengthens against the USD, it takes fewer shillings to purchase the same amount of USD needed to pay for imports. This effectively reduces the cost of importing goods. 

Reduced import costs translate into lower prices for imported goods, making them more affordable for Kenyan consumers. This means that items such as electronics, clothing, and luxury goods imported from other countries will be cheaper.

However, local businesses and industries may face increased competition from imported goods as they become more affordable than locally-produced goods. 

As domestic businesses struggle to compete with imported goods in the long term, they may be forced to downsize or close operations. To prevent this and save local industries, the government might introduce supportive policies such as increasing import tariffs and taxes to level the playing field. 

2. Lesser Diaspora Inflows

Diaspora inflows, or remittances, refer to monetary transfers sent by Kenyans living abroad to their families or communities in Kenya. These transfers may include cash, bank deposits, or payments for specific purposes such as education, rent, healthcare, or savings/investments in Kenya.

Remittances are a vital source of income for many Kenyan households and a significant source of foreign exchange for the country. Data from the Central Bank of Kenya (CBK) shows that diaspora remittances in the 12 months to December 2023 increased by 4 percent, hitting a record Ksh671 billion ($4.19 billion). 

When KES strengthens against the US Dollar, diaspora individuals may perceive that their remittances have less purchasing power in Kenya, making sending money home for savings or investments less attractive. 

For example, consider a Kenyan nurse working abroad who regularly sends money home to her savings account in Kenya. Suppose she typically sends $300 to her Kenyan savings account each month to save for her future or invest in opportunities in Kenya. 

If the Kenyan Shilling strengthens against the US Dollar, the amount of Kenyan Shillings she receives for her $300 remittance will decrease. As a result, she may feel discouraged from sending as much money home for savings and choose to hold onto her US Dollars. This way, she can preserve the value of her funds and potentially take advantage of more favourable exchange rates in the future.

3. Your Purchasing Power Might Be Affected

When you save in USD and convert to KES to spend or vice versa, your purchasing power is directly affected by fluctuations in the exchange rate between the two currencies. If the KES strengthens against the USD, meaning it takes fewer KES to buy one USD, your purchasing power in terms of KES increases. Conversely, if the KES weakens against the USD, your purchasing power in terms of KES decreases.

Let's look at two examples. 

Peter, a 33-year-old software engineer, wants to upgrade his laptop and has his eye on a model priced at $1,000. Initially, the exchange rate was Ksh167 against the US Dollar, but he couldn't afford it. Peter needed to exchange Ksh167,000 for $1,000 to purchase the laptop.

However, Peter's purchasing power increased since the exchange rate strengthened to Ksh147 against the US Dollar. Now, he only needs to exchange Ksh147,000 for $1,000 to buy the laptop, and his savings are enough to make the purchase. As a result of the stronger Kenyan Shilling, Peter saves Ksh20,000 on purchasing the computer compared to the original exchange rate.

While Peter benefited, the strengthening of the Kenyan shilling can present challenges for certain groups. Consider Agnes, a freelance video editor who earns US dollars but spends Kenyan shillings (KES). 

When the shilling strengthens, individuals earning in USD receive fewer KES when they convert their income. So, if Agnes makes $1,000 monthly, the strengthening KES by Ksh20 will reduce her income by Ksh20,000.

This effectively reduces her purchasing power, as the same amount of USD translates to a smaller amount of KES to buy essential goods and services. As a result, her spending might increase, and her saving rate would reduce.

Finally, if you save in USD and the KES strengthens significantly against the USD over time, the value of your USD savings when converted to KES will decrease. This erosion of savings occurs because you will receive fewer KES for each USD saved, reducing your purchasing power in terms of KES.

4. It May Necessitate CBK Intervention

The CBK may take various policy actions in response to a stronger shilling. For instance, if the stronger shilling leads to lower inflation in the long term, the CBK may lower its policy interest rates to stimulate borrowing and spending, thereby supporting economic activity. 

Additionally, the CBK may intervene immediately in the foreign exchange market by buying or selling foreign currency to stabilise the exchange rate. For example, when the KES posted its strongest single-day gain in 12 years in mid-February, the CBK bought dollars to prevent further volatility. 

According to reports in the Business Daily, if the central bank had not stepped in, the KES could have strengthened to Ksh130 against the dollar. In the report, CBK also said, "It only intervenes to smooth out volatility when the shilling is moving too fast in either direction."

5. Export-Oriented Sectors May See a Decline in Revenues  

Export revenues contribute significantly to Kenya's GDP growth, employment generation, and foreign exchange earnings. Export-oriented sectors include agriculture (e.g., tea, coffee, flowers), manufacturing (e.g., textiles, processed foods), and tourism (e.g., wildlife safaris, beach resorts). These industries rely heavily on foreign markets for their sales and revenue generation.

A stronger Kenyan shilling can make Kenyan products relatively more expensive in international markets compared to products from countries with weaker currencies. This might reduce the competitiveness of Kenyan exports, as foreign buyers may opt for cheaper alternatives from other countries. Exporters may struggle to attract buyers or maintain their market share. 

To illustrate how revenues can drop if the Kenyan shilling strengthens by Ksh10 against the US dollar using $10,000. Assume the initial exchange rate between the US dollar and the Kenyan shilling is 1 USD = 160 KES. Therefore, $10,000 is equivalent to Ksh1,600,000.

If the Kenyan shilling strengthens by Ksh10 against the US dollar, the new exchange rate becomes 1 USD = 150 KES. This means that $10,000 is now equivalent to Ksh1,500,000, representing a Ksh100,000 revenue reduction.

With reduced revenues in local currency terms, exporters may face pressure to maintain profitability. To offset the decrease in revenue, businesses may need to increase their prices to cover higher production costs, such as raw materials, labour, and overhead expenses. This can lead to higher prices for their products in international markets.

Read Also: 5 Things to Know Before Opening a Dollar Account in Kenya

WRAPPING UP

Strengthening the KES against the US Dollar can have benefits and downsides for your finances and the broader economy. As the Shilling gains against the dollar, consider reviewing and diversifying your currency holdings to mitigate risks associated with currency fluctuations. Additionally, monitor the exchange rate movements and economic developments that may impact currency values and make informed decisions based on market conditions.