The Kenyan shilling is nearly 20 per cent overvalued against the dollar in real terms rendering the manufacturing sector uncompetitive in the regional export markets, economists at Renaissance Capital say.
The analysts estimate the fair value of the shilling based on the real effective exchange rate (Reer) should be 119 units to the dollar. Reer takes into account the currency’s value relative to that of its trading partners as well as inflation levels.
In nominal terms, the shilling is exchanging at 101.35 against the greenback and the higher implied value means in terms of trade Kenyan goods are practically expensive for other countries to buy.
This is in comparison with those sourced from countries such as South Africa whose currencies are seen to be undervalued.
“The overvaluation is a cause for the low export to GDP (gross domestic product) ratio in Kenya, which has not been competitive in terms of manufacturing because of the strength of the currency over a number of years. This situation, which kicked in from 2006-2007, and since then the shilling has stayed strong relative to many other currencies,” said Renaissance Capital global chief economist Charles Robertson.
“We saw in the past that East Asian countries that made manufacturing work started off with weaker, not stronger currencies.”
Rencap analysis shows that Kenya’s ratio of exports to GDP has fallen consistently over the years, going from 21.6 per cent in 2011 to 16.9 per cent in 2014.
That of agriculture on the other hand, was consistent over the period, going from 29.3 per cent in 2011 to 30.2 per cent in 2014.
Latest data on the economy released by the Kenya National Bureau of Statistics (KNBS) last week shows that while the economy grew by 6.2 per cent in the second quarter of this year, manufacturing only grew by 3.2 per cent, compared to 5.1 per cent in the first half of 2015.
It lagged behind other key sectors such as construction (8.2 per cent), transport (8.8 per cent) hospitality (15.3 per cent), financial services (7.5 per cent) and agriculture (5.5 per cent).
“The performance (of manufacturing) was dampened by a contraction in processing and preservation of fish, manufacture of edible fats and margarine, production of soft drinks, processing of maize meal, manufacture of bread and processing of wheat flour…and was also curtailed by a decline in the assembly of motor vehicles,” said KNBS in the second quarter 2016 GDP and balance of payments report.
Going forward, the Renaissance economists say, the shilling will most likely remain stable in nominal terms, even as a number of other regional currencies either trend towards appreciation (Uganda shilling, S.A rand) or depreciation (Ethiopia birr, Nigeria naira).
The stability of the shilling is largely due to the fact that Kenya has been able to build up a strong forex reserves buffer, monetary policy has been firm and the International Monetary Fund standby facility of $1.5 billion, which reassures investors on the balance of payments.
However, the overvaluation in real terms means in case of some extraneous shock or abrupt change in macroeconomic policy, the currency would be highly vulnerable to weakening. A weakening would drive up the price of oil and production.
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Credit: Business Daily
