Kenya’s dollar volatility problem has a cure

By Citizen Reporter

Published on: November 14, 2023 02:51 (EAT)

On Monday last month, the shilling’s official exchange rate against the US dollar surpassed the 150-unit threshold.

This change comes after a prolonged phase of continuous decline, bringing the official rate closer to the retail selling rates of the dollar.

The recent revelation by the Treasury Principal Secretary that the exchange rate of the Kenya Shilling against the US dollar and other major currencies has been artificially high and overpriced, placing significant strain on Kenya’s foreign exchange reserves.

Kenya, in the vast landscape of developing nations, continuously contends with the capricious nature of its currency when juxtaposed against the dollar.

This unpredictable variance hampers the nation’s economic growth and sets forth an intricate maze for international business aspirants.

Venturing into business with other nations becomes particularly challenging because their currencies are often tagged as illiquid, infrequently traded on the global financial landscape, and prone to unexpected bouts of dollar volatility.

Such conditions make these currencies a costly and challenging commodity to acquire for business dealings.

This precarious scenario leads to a distinct trajectory wherein various entities, which include central banks, sovereign wealth funds, and even private investors, are progressively looking to diversify their portfolios away from dollar-centric assets.

The impetus for this diversification stems from growing apprehensions about the potential overvaluation of currencies in prominent markets.

These include stalwarts like the eurozone, the UK, Canada, and Australia.

The common sentiment among these regions is a shared reluctance toward further financial inflows, primarily due to beliefs that their respective currencies have reached or are nearing overvaluation.

In contrast, several Asian countries, spearheaded by economic juggernauts like China, are adopting a proactive approach.

By consistently intervening in the financial marketplace, they aim to forestall any significant appreciation of their currencies. Such dynamics lay the groundwork for a complex conundrum.

Significant divestments from the dollar could trigger an imbalance, catapulting floating currencies beyond their natural equilibrium.

The potential fallout could range from new global economic disparities to a marked slowdown in the global economic growth trajectory.

Amidst this backdrop, an innovative solution has surfaced, championing the creation of a substitution account housed within the International Monetary Fund (IMF).

This mechanism would serve as a conduit, allowing for the seamless conversion of excess dollars into Special Drawing Rights (SDR), an avant-garde international currency paradigm conceived by the IMF.

By July 2023, a substantial issuance of $34 billion worth of SDRs had been realized, with Kenya having over $1 billion in reserves.

This groundbreaking proposal found resonance among a diverse array of stakeholders.

These ranged from influential conglomerates in the private sector to key congressional figureheads and even the decision-making echelons of the IMF.

However, it’s worth noting that the trajectory of this initiative was challenging.

Contentious disagreements between economic powerhouses and the dollar’s resurgence following the Federal Reserve’s fiscal interventions between 2021 and 2023 temporarily derailed its momentum.

The operational blueprint of the substitution account is eloquently straightforward. Entities can strategically deposit their dollar surpluses in this specialized IMF account by sidestepping the conventional route of converting dollars into a mélange of currencies via market dynamics. They are endowed with a commensurate quantum of SDR or SDR-certified assets in reciprocation.

This methodology not only assures liquidity but also acts as a bulwark against undue fluctuations in the global money supply.

A profound analysis reveals that the inception of such an account could usher in an era of shared prosperity.

Nations grappling with disproportionate dollar reserves could seamlessly transition to a multi-currency asset model, reaping the dual benefits of instantaneous diversification and competitive market yields.

Concurrently, this model would act as a deterrent against the dollar’s undue depreciation, safeguarding against potential fiscal losses and insulating the global economic fabric from systemic shocks. For Kenya, the implications are profound. It offers a sanctuary from the looming specters of hyperinflation and a potential surge in interest rates.

The post-war such as the Ukraine-Russia era has been marred by dollar-induced crises.

These tumultuous times prophesied the IMF to innovate, leading to the birth of the SDR, envisioned as the linchpin of a new-age global monetary ecosystem that would transcend the limitations of a single-currency model.

The contemporary fiscal imbalances, typified by the rapid consolidation of dollar assets and the resurgence of fixed exchange rate systems, eerily mirror the antecedent conditions that catalyzed the SDR’s genesis.

While the substitution account isn’t a panacea, it is a beacon of hope in an uncertain dollar volatility landscape.

Many measures, such as diversifying exports, can be applied, shielding the nation from unpredictable global price shifts. Kenya reduces its dependence on a few commodities by broadening the export range.

Secondly, there’s a pressing need to boost domestic production. By promoting local industries, improving infrastructure, and offering incentives, Kenya can reduce its import reliance, conserving foreign currency.

Moreover, an investor-friendly environment, underpinned by reliable infrastructure and a

transparent legal system, can attract more Foreign Direct Investment, bolstering Kenya’s foreign reserves.

The diaspora holds potential, too; by introducing diaspora bonds and enhancing remittance opportunities, Kenya can tap into this resource.

Borrowing, while beneficial, needs foresight; Kenya must prioritize high-ROI projects. Monetary policies, including competitive interest rates and inflation management by the Central Bank, can further lure foreign investments.

Tourism, a significant revenue source, requires investment in promotion and safety measures.

Financial tools can help hedge against currency fluctuations, ensuring economic predictability. Strengthening ties within the East African Community can minimize dollar dependency in trade settlements. Embracing technological innovations like blockchain can present alternative trade and investment avenues.

Increasing dollar reserves will further insulate Kenya from economic shocks, while infrastructure development, encompassing ports, roads, and energy, can make Kenya a magnet for foreign trade and investments.

Dr. Odhiambo, Ph.D. is a Lecturer of Actuarial Science at Meru University of Science and Technology (MUST) and a Post-Doctoral Researcher at Umeå University, Sweden.


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