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.