Archives for category: Monetary Economics

There is an old joke in East Africa that the EAC (East African Community) will succeed only when Tanzanians learn English, Ugandans learn Swahili, and Kenyans learn manners. Fortunately language barriers and old stereotypes are not the main drivers of the current policy agenda. The priority is instead to speed-up economic integration and establish (actually, “re-establish”) a common currency –the East African Shilling – across the 5 EAC countries: Kenya, Uganda, Tanzania, Rwanda and Burundi. Is this is a good idea?

Let’s start with a little theory first –a primer on economic integration as I studied in my undergrads. Look at the figure below (source)

Stages of economic integration

Theory says that there are 5 steps to economic integration: you start with free trade area, which abolishes partially or completely the custom tariffs between member countries. In the second step, a Custom Union is formed when member countries agree to uniform external tariffs towards third countries. The common market adds the free movement of the factors of production, including services, capital and labor. In the fourth step, the economic union introduces a common currency as well as common monetary, fiscal and budgetary policy. Usually this is complemented by the harmonization of tax and welfare policies. Finally, the very last step is the full political integration with the establishment of a common government.

Where is the EAC?

The EAC established a customs union in 2005, a common market in 2010 and now it aims at the fourth step with the establishment of an economic union. I must admit that I am excited about the idea but also very worried. Here’s a list of my concerns:

First, the EAC is only half way through to the third step (common market), and it is jumping already into the fourth (economic union). The truth that everybody knows is that free movement of capital and labour is far from being achieved. Labour cannot move freely because of long-standing legal and regulatory barriers. Goods cannot move freely as well, especially because non-tariff barriers are still a huge burden. Just a silly example, I’ve learnt from personal experience that many bus companies ship packages from Uganda to Kenya, but not the other way around. Reason? I was told it was “a problem at the border with Uganda”. Who knows what that means…

Second, you cannot create a common currency without creating common fiscal and budgetary policies. The EAC governments seem aware of this issue, and in fact they proposed the establishment of an “East African Financial Services Authority”, “East African Surveillance and Enforcement Commission” and the “East African Statistics Bureau”. This all sounds wonderful, but the real issue is whether national governments are willing to give up sovereignty over such important matters. Let me borrow some sentences from an article on Columbia Communique:

Is the wish for closer relationships a good thing? Absolutely. Does it have to be achieved as fast as possible and through the handcuffs of a currency union? Absolutely not. Not only will this process take many years, it will also require full commitment. They can’t have their cake (the currency union) and eat it too (maintain sovereignty in all areas).

Currently the EAC countries have very different import-export mixes, making them vulnerable to changes in world goods prices to different degrees. Without strong fiscal centralization including a counter-cyclical mandate and no adjustment mechanisms such as inflation or devaluation, a currency union can have devastating effects on countries hit hard by an external shock.

My last point is that the EAC has to learn from the experience in the EU: a monetary union must be able to deal with both periods of economic growth as well as periods of crisis and recession. How will the EAC act in case of fiscal mismanagement? What will it do if a country enters a period of financial and economic crisis? Will the regional powerhouse (Kenya) step in and help the “periphery”?  I know that using these terms is quite a stretch in the EAC context. But the region cannot ignore the experiences in other parts of the world. And more importantly, the EAC cannot ignore that it already failed in forming a monetary union in the past – neglecting its own history would be the worst of the mistakes.

The Kenyan Shilling (KSh) reached a 1-year low against the US dollar last week (1 dollar=87KSh), probably because the Presidential Elections are approaching and everybody is worried about it. Bloomberg analysts predict that the value could go down to 89 KSh a dollar on election-day.

What I find interesting is that in December 2007 the Shilling also plummeted just a few weeks before the infamous elections that led to the violence. But the value in 2007 was 63 KSh a dollar, not 87 like last week. Here’s an excerpt from an article written in 2007 in the African Executive:

The Kenya shilling (Ksh.) has hit a nine years low against the US dollar at an average of US$1.00 = Ksh.63.50. The shilling has been gaining strength over the dollar for over two years now. This has come both as a blessing and curse to many Kenyans depending on which side of the divide they hail. For exporters, the strengthening of the shilling against the dollar has wiped out millions of earnings, making them to suffer losses.

So, what puzzles me is not just the “pre-election depreciation” but the long-term trend. Why has the Kenyan Shilling lost so much value in the last 5 years? Why did it appreciate back then? I am asking these questions to myself as well the informed readers of this blog. Take a look at the 5-years trend:

KShUSD 2007 2013

You see that 2011was an “annus horribilis” for the Kenyan Shilling, which lost a quarter of its value in less than a year. But the downward trend goes beyond that.  When it comes to the currency appreciation before 2008, the African Executive gave this explanation:

The shilling has become stronger because of huge inflow from donors, increased remittance by Kenyans in the Diaspora and the weakening of the US dollar.  Other reasons include the buying of 24.99% stake in Equity Bank by Helios Capital Ltd. at an estimated value of Ksh.11 billion, and the take over by 51% of Telkom Kenya by France Telecom, at an estimated value of Ksh.26 billion. Recently, the International Monetary Fund disbursed four billion shillings to the Kenya government. This has further increased the amount of dollars in circulation.

That cannot be the only reason, however, considering that both foreign direct investment and the net inflow of portfolio equity increased between 2008 and 2011. Official development assistance increased as well. Perhaps, another possible  explanation is the one proposed by Wolfgang Fengler, lead economist for Kenya at the World Bank, who wrote that the current account deficit (imports higher than exports) is the structural cause behind the downward trend of the Kenyan currency:

The main reason is that Kenya’s economy is increasingly imbalanced: the country is importing too much and exporting too little. This makes it vulnerable to shocks.  The gap between imports and exports needs to be financed by financial inflows other than export earnings. In 2011, imports have soared (mainly due to higher oil and food costs), while exports remained stagnant. The gap between imports and exports, also called current account deficit, now stands at above 10% of GDP – one of the highest in the world! Today, Kenya’s main exports don’t even earn enough to pay for its oil imports, not to mention other imports beyond oil (figure)!  The money to pay for any additional imports needs to come from somewhere.

I bet there are plenty different explanations that I don’t know about. Feel free to comment if I missed out something.

Exactly one year ago, everybody was talking about the messy state of the Kenyan economy. The Kenyan Shilling lost a huge percentage of its value (over 25% in one year), inflation spiked to over 20% and the Central Bank Governor took the bold decision to increase interest rates by a massive 11.75% in 3 months. This move was criticized for being too late and too sudden, and because it made loans unaffordable for a large part of the private sector.

Though, looking at the situation now, things seem to have turned out the right way:

  • One euro is worth 108 Kenyan Shillings (against 141 of last year)
  • Between July and August, interest rates were cut by 500 basis points down to 13% (it was 18% until 3 months ago). However, this could affect negatively the value of the Kenyan Shilling.
  • After reaching a peak of 20% last November, inflation dropped incredibly fast. It is at 6.1% now, and predicted to go down to 3% in 2013

More here

When I first came to Kenya in 2007, 1 Euro was worth 96 Kenyan Shillings; today, in 2011, it is worth 141. As you can see in the graph below (borrowed from the very useful Google Finance), over the past 5 years the Shilling has dropped its value by 54%.  Why has the Kenyan currency dropped so sharply? And what is the impact on the local economy?

Exchange Rate Euro to Kenyan Shilling (2006-2011)

This devaluation is provoking an economic earthquake, especially because it was completely unplanned. What is most striking is that we are witnessing an unexpected divergence between “emerging markets” (especially Brazil, Indonesia, South Africa and Thailand) and the so-called “Frontier Markets”, such as Kenya, Nigeria and Ghana.

For a good part of 2011, major financial newspapers talked about the “currency war” affecting BRICS and other emerging economies, and the sharp rise of the Brazilian Real, South African Rand and the Indonesian Rupia. Frontier’s market currencies were expected to follow a similar pattern. But  contrarily to the analyst’s forecasts, the opposite is happening today.

Check out the graph below. It compares the exchange rate of  the Kenyan Shilling (blue line), Brazilian Real (yellow line) and the South African Rand (red line) with the Euro. The graph starts in November 2008, just a few weeks after the collapse of Lehman Brothers and the beginning of the global financial meltdown.

As you can see, whereas the Euro depreciated compared to the Real and the Rand, the Kenyan shilling has followed a completely different pattern. Why is this happening?

There are two major explanations given by analysts. In the World Bank’s blog “Africa Can.. End Poverty” Wolfgang Fengler points out the strong trade imbalance in the country:

The main reason is that Kenya’s economy is increasingly imbalanced: the country is importing too much and exporting too little. This makes it vulnerable to shocks.  The gap between imports and exports needs to be financed by financial inflows other than export earnings. In 2011, imports have soared (mainly due to higher oil and food costs), while exports remained stagnant. The gap between imports and exports, also called current account deficit, now stands at above 10% of GDP – one of the highest in the world! Today, Kenya’s main exports don’t even earn enough to pay for its oil imports, not to mention other imports beyond oil (figure)!  The money to pay for any additional imports needs to come from somewhere.

The other typical explanation refers to the financial mismanagement by the Kenyan Central Bank. This argument appears especially in the local financial newspapers, such as the excellent Business Daily.

I will leave comments to future posts. However, let me just say that one of the important lessons is that Kariobangi matters. I do not mean just the neighborhood itself, I mean that the role of local manufacturing clusters in Kenya must be enhanced. It is them who provide local economies with necessary goods and services and it is them who provide employment to local communities. The idea of Africa as the next consumer market is not feasible without a simultaneous development of local production. The consequences of such trade imbalance would not only touch the labour-force, as many economists argue, it touches also money markets and the economy as a whole.

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