Pressure on the Kenyan shilling to persist - Capital Economics
Africa Economics

Pressure on the Kenyan shilling to persist

Africa Economics Update
Written by Virag Forizs

Kenya’s current account deficit will probably widen in the coming quarters and could reach as much as 6.5% of GDP over this year as a whole. We expect the shilling to continue to depreciate against the dollar and Kenya’s heavy dependence on less stable forms of external financing and sizeable short-term external debts leave the currency vulnerable to even sharper falls.

  • Kenya’s current account deficit will probably widen in the coming quarters and could reach as much as 6.5% of GDP over this year as a whole. We expect the shilling to continue to depreciate against the dollar and Kenya’s heavy dependence on less stable forms of external financing and sizeable short-term external debts leave the currency vulnerable to even sharper falls.
  • Kenya’s persistent current account deficit had narrowed considerably in recent years, from more than 10% of GDP in 2014 to “just” 5.6% last year, largely on the back of an improvement in the goods trade deficit. The shortfall narrowed further in Q1 as imports dropped while exports remained steady.
  • The current account balance appears to have improved further at the height of the coronavirus crisis in Q2. The slump in oil prices helped to pull down Kenya’s fuel import bill; petrol imports were down by 83% y/y in May. And non-oil imports dropped as virus-related containment measures triggered a slump in domestic demand.
  • Admittedly, Kenya is one of the most vulnerable African economies to a downturn in the tourism industry as well as a decline in remittances inflows. But, given that goods exports continued to hold up relatively well, we don’t think that these developments were sufficient to keep the current account position from narrowing.
  • Looking ahead, we think that the recent improvement in Kenya’s external position will reverse over the coming quarters. The rebound in oil prices and recovery in domestic demand will push up imports, while subdued external demand will limit export growth. And we suspect that tourists will be slow to return despite the resumption of international flights this month, weighing on tourism receipts.
  • Overall, we think that the current account deficit will reach around 6.5% of GDP over 2020 as a whole. (See Chart 1.) Kenya also has relatively large external debts that are due to mature over the next twelve months, equal to around $2.8bn (2.8% of GDP), on an original maturity basis. The result is that the country’s gross external financing needs surpass $9bn or close to 10% of GDP.
  • Relative to foreign exchange reserves, Kenya’s gross external financing needs are worryingly large. According to the Central Bank of Kenya, FX reserves stand at $9.2bn. And while the authorities have secured $740mn in emergency financing from the IMF which should provide some reassurance, it certainly doesn’t leave Kenya with much room for manoeuvre.
  • What’s more, Kenya’s dependence on less stable forms of external financing is a cause for concern. Foreign direct investment inflows, which tend to be relatively stable, are low at $1.3bn (1.4% of GDP). Portfolio inflows and so-called “other” investments, which tend to be more volatile, amount to $2.3bn (2.3% of GDP) and $4.4bn (4.4% of GDP) respectively.
  • The upshot is that the shilling, which has weakened by 6.2% against the dollar so far this year, will probably come under further pressure. We expect that the currency will weaken from the current 108/$ to 110/$ by end-2020 and further to 115/$ by end-2021. (See Chart 2.) But Kenya’s large external vulnerabilities mean that the shilling is vulnerable to even sharper falls in the event of another shock or general deterioration in investor risk appetite.

Chart 1: Current Account Balance (% of GDP)

Chart 2: Kenyan Shilling (vs. $, Inverted)

Sources: Refinitiv, CEIC, CBK, KNBS, Capital Economics

Sources: Refinitiv, Capital Economics


Virág Fórizs, Africa Economist, virag.forizs@capitaleconomics.com