CBK Kenya Exchange Rates June 2011

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A Media Briefing by

Prof. Njuguna Ndung

u, CBSGovernor, Central Bank of Kenya

June 23, 2011


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OutlineOutline

1. Introduction

2. The Exchange Rate Policy.

3. Supply and Demand for Foreign Exchange

a. Normal requirements

b. Speculation/Arbitrage

4. Market Outcomes

a. International events including impact on neighbouringcountries

b. Oil pricesc. Cross Rates

5. The CBK Actions and Policy Response

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1. Introduction1. Introduction

y Food and fuel crisis affect domestic inflation while currency depreciation is anaddition.

y The crisis in the Euro Area is having an impact on currencies and moneymarkets around the world. However, with the tight monetary policy stance,depreciation cannot affect inflation given that money supply growth isconstrained.

y Central Bank analyses indicates that intervening in the current environmentthrough injections of foreign currency will only lead to loss of foreign reserveswithout solving the problem.We need a sustainable solution.

y Analyses conducted at the CBK show that the current level of the shilling isbeing exacerbated by arbitrage and speculation on the future value of theshilling as well as the current level of reserves together with expectations onthe food and fuel supply.

y

Consequently, the current level of the shilling does not reflect the true value ofthe Kenya shilling, so it will still recoup its true value once the crisis is over.

y Despite the shocks on the exchange rate, private sector confidence in theeconomy remains high.

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2.The Exchange Rate Policy2.The Exchange Rate Policy

y In a floating exchange rate regime, monetary policy isindependent and will affect relative prices including theexchange rate.

y It allows for a continuous adjustment of the exchangerate in line with the demand and supply conditions of

foreign exchange in the economy.y In addition, the market adjusts through the exchange

rate movements rather than the level of foreign reserveschanging.

y Consequently, external shocks and internal imbalances

are reflected in exchange rate movements rather thanreserve movements.

y For this reason, the exchange rate is an automaticstabilizer.

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3.Supply and Demand for Foreign Exchange:3.Supply and Demand for Foreign Exchange: ThereThere

is adequate supply of forex in the marketis adequate supply of forex in the market

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Forex holdings averaged USD 5.133 Billion in the last six months. CBK isholding on average USD 3.904 Billion and Commercial banks are holding onaverage US $ 1.229 billion. Forex holdings are even much higher than during the global financial crisis.This shows that the impact of the current crisis is being exaggerated.

Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Average

Total Forex Holding 4,907.1 4,878.6 5,296.4 5,238.4 5,232.0 5,248.0 5,133.4

Central Bank 3,786.3 3,808.1 3,932.9 3,921.9 3,991.4 3,985.2 3,904.3

Commercial Banks 1,120.8 1,070.5 1,363.5 1,316.5 1,240.6 1,262.8 1,229.1

Total Forex Trade 2,142.7 1,916.8 1,912.8 2,216.0 1,878.4 2,013.3

Exports - Goods & Services 860.9 704.6 762.6 814.0 749.8 778.4

Imports - Goods & Services 1,281.9 1,212.2 1,150.2 1,402.0 1,128.6 1,235.0

Oil Import Bill 275.7 336.0 287.3 365.2 280.8 309.0

Oil as % of Total Imports 12.9 17.5 15.0 16.5 15.0 15.4

Commercial Bank Forex transactions 1,933.9 1,851.3 1,787.7 2,030.8 1,766.8 1,874.1

Oil as % of Bank Transactions 14.3 18.1 16.1 18.0 15.9 16.5

Foreign Reserves and Trade Statistics (USD Million)


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3.Supply and Demand for Foreign Exchange:3.Supply and Demand for Foreign Exchange:CurrentCurrent

account balance improving on account increasing forexaccount balance improving on account increasing forex

inflowsinflows

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-400.00

-350.00

-300.00

-250.00

-200.00

-150.00

-100.00

-50.00

-

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

2010 2011

USDmillions

CURRENT ACCOUNT BALANCE (USD Million)

Improving current account balance expected to ease pressure onthe exchange rate.


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3.Supply and Demand for Foreign Exchange:3.Supply and Demand for Foreign Exchange:

Normal requirements of foreign exchangeNormal requirements of foreign exchange

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The normal demand for foreign exchange is steady: Outflows of forexare minimal; Heavy imports of machinery will come down, but isstable.


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Arbitrage in the Forex MarketArbitrage in the Forex Market

y Over the week, 9th to 16th June 2011, five banksexported over USD 260 million. We are updatingthe data on a regular basis.

y During the same period, the volume of borrowingfrom the Central Bank by strong banks went up suggesting arbitrage opportunities.

y Speculation comes in when at the same time theydrive the bids in the domestic currency market.This is what we have observed as well.

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Arbitrage in the Forex MarketArbitrage in the Forex Market

y Four large banks have been noted to be holdingvery large overseas positions.

y These positions do not seem to reflect trading

fundamentals.y This type of exposure will put pressure on the

exchange rate.

y Their positions are largely associated with their

group companies overseas.y We will restrict them from any arbitrage using

the domestic currency.

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4. Market Outcome:4. Market Outcome: Exchange rate weakening experienced inExchange rate weakening experienced in

main EAC countriesmain EAC countries

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On a broader level, other countries in the EAC region have been experiencing similardifficulties, hence there is need for a coordinated policy response. However, SouthAfrica, with a comparably higher foreign reserves level has maintained a strongcurrency.

Daily Normalised Exchange Rates to the US Dollar for the Kenya Shilling and NeighbouringComparators (1st Jan 2010=1)


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4. Market Outcome:4. Market Outcome: Easing of world oil prices expected toEasing of world oil prices expected to

reduce pressure on the exchange ratereduce pressure on the exchange rate

The decline in world oil prices since May 2011 expected to ease oilimport bill.

Import bill on oil will respond and so will demand for forex to financethe imports.


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4. Market Outcome:4. Market Outcome: Flight into other strongFlight into other strong

currenciescurrencies

The second round Greek crisis has caused flight into other currenciessuch as the Swiss Franc, and Australian and Canadian dollars indicatesdiversification of portfolios..


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5. The CBK Actions and Policy Response5. The CBK Actions and Policy Response

1. There is adequate foreign exchange reserves in the market.The Bank is continuously analysing exchange rate volatilitybut can only intervene to stem volatility but not to defend alevel or direction of the exchange rate.

2. Consider further tightening of monetary policy to tame

future inflation and stabilise the exchange rate.3. In future, allow all institutions licensed to trade in foreignexchange to make bids when CBK is buying or selling thiswill remove the dominance in the market and make forextrading competitive.

4. Take appropriate and corrective action to make sure the

forex interbank market is truly driven by market events andfundamentals as should be the case and as the Euro crisisseem to be getting closer to resolutions.

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Documents

CBK Kenya Exchange Rates June 2011