Kenya's dollar market distortion eases after president's order
Thursday April 27 2023
Kenyan President William Ruto who on March 22 ordered for the revival of the interbank foreign exchange market in an effort to remove distortions in the country’s market that had exacerbated the shortage of foreign exchange. PHOTO | DIANA NGILA | NMG
The biting dollar shortage in Kenya has eased following the revival of the interbank currency market on orders from the country’s state house.
Bulk buyers of dollars have witnessed increased availability of the greenback in recent days, a marked departure from market conditions that saw banks run out of the US currency on some days as others imposed a daily cap on dollar purchases of as little as $5,000 (Ksh678,750).
The changes followed a directive from Kenya’s President William Ruto on March 22 for the revival of the interbank foreign exchange market in an effort to remove distortions in the market that had exacerbated the shortage of foreign exchange.
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The interbank market for hard currency has turned dormant in recent years, due to what traders said was aggressive policing by the central bank, which made it difficult to do deals.
The lack of a vibrant interbank foreign exchange market has partly been blamed for a biting shortage of hard currency that has even forced the government to seek longer credit periods for essential imports like petrol.
It has also given rise to a parallel market, with moneychangers quoting a different foreign exchange rate to the official central bank one, with a divergence of over Ksh10 per dollar.
Now, the spread between the official and open market rates has narrowed to an average of Ksh6 per dollar from Ksh13 in early March.
The widening of the spread had created a black market for dollars due to the low supply.
“There has been an ease in dollar availability. While the daily limit on dollar volumes has not been vacated, banks now have arrangements to fill customer orders,” said a top importer who spoke on condition of anonymity.
Buying below CBK quotation
At the same time, banks are currently buying dollars from customers at quotations below the official Central Bank of Kenya (CBK) rate, a condition that existed before the dislocation of the domestic forex market.
The Central Bank of Kenya. PHOTO | FILE \ NMG
“When the forex interbank market wasn’t working, there wasn’t price discovery happening resulting in the huge spreads. What we are seeing now is a better functioning exchange rate market,” noted Muathi Kilonzo, the Head of Equities Kenya at EFG Hermes, a securities brokerage and investment banking firm.
The widening spread followed the shortage of dollars and the near collapse of the interbank forex market, where foreign currency is traded among lenders and helped set an exchange rate that is closer to the CBK average.
The inability of banks to compare and compete on prices when selling to each other has left buyers at the mercy of sellers, which explains the widening variance in the dollar exchange rate.
Some are also being forced to buy dollars from their clients—depositors hold in excess of Ksh980 billion ($7.22 billion) worth of forex in their accounts—offering customers the power to set prices.
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Trading in dollars
Top firms had started trading in dollars among themselves, with hotels and aviation firms attracting interest from those in need of hard currency.
US dollars and Kenya shilling at a forex bureau in Nairobi. PHOTO | NMG
Those with dollars were finding they can get a better rate by bypassing banks and selling directly to individuals and firms in need.
The firms were buying the US currency at lower rates from their peers than those quoted by the banks.
This was creating a parallel shadowy market, which is in breach of the law and has the potential to trigger a range of economic problems including discouraging foreign direct investment (FDI), encouraging rent-seeking and reducing the interbank FX market.
A parallel exchange rate market develops in such circumstances and when the spread between the official and parallel rates is both substantial and sustained, says an International Monetary Fund (IMF) official working paper.
The dollar shortage becomes an issue of national concern due to the secondary effect of rising consumer prices and potential supply hitches of key imported commodities.
The concerns prompted Ruto to ask the CBK and commercial lenders to revive the interbank forex market.
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“I’m happy that the players in that sector including our banks are coming forward and are working with the CBK so that we can again take charge of our market and that it is not distorted by brokers,” Ruto said on March 12.
“For the people who work numbers, I’m giving you free advice that those who are holding dollars you shortly might go into losses. This market is going to be different in a couple of weeks,” he added.
Currency trading between Kenyan banks dwindled in recent years because of CBK pressure on commercial lenders to prevent the country’s shilling from weakening too quickly.
CBK Governor Patrick Njoroge has repeatedly denied undue interference in the market, saying the regulator was merely playing its role of enforcing discipline.