Jan 7, 2024
In the first week of the year the Kenyan Shilling experienced a 0.6% depreciation against the US Dollar, closing at Kshs 157.9 as of January 5, 2024, compared to Kshs 156.9 at the beginning of the year. This adds to the 26.8%, 9.0%, and 3.6% depreciation in 2023, 2022, and 2021, respectively. Notably, this is the lowest the Kenyan Shilling has reached against the US Dollar. The ongoing depreciation is primarily fuelled by a stable dollar currency globally after gaining in 2022, a persistent current account deficit, negative trade deficit and lower inflows into the capital markets.
The interest rates have seen significant increases over the last one year with the 91-day treasury bill rates getting to a high of 16.0%. In the Euro bond market, the rates have been high with Euro bonds trading at rates of over 15.0% in December 2023. The high interest rates have increased due to increased demand for cash by government as they continue to run a fiscal deficit and as they seek to get cash to rollover the redemptions. The downgrade by the various rating agencies has worsted the situation. In May 2023, Moody's downgraded Kenya's senior unsecured debt rating, along with its long-term foreign-currency and local-currency issuer ratings, transitioning to B3 from B2. Similarly, Fitch Ratings downgraded Kenya's Long-Term Foreign-Currency Issuer Default Rating (IDR) from 'B+' to 'B' with a Stable Outlook in December 2022;
We have previously covered the topic as summarized below;
With the shilling having depreciated by 26.8% at the end of 2023 and the continuous upward readjustment on the yield curve, we saw the need to revisit the topic of currency and interest rates outlook, in order to shed some light on how the Kenyan shilling and the interest rates are expected to behave in 2024. In this focus, we shall be doing an in-depth analysis of the factors that are expected to drive the performance of the Kenyan shilling and the interest rates and thereafter give our outlook for 2024 based on these factors. We shall cover the following:
Section I: Historical Performance of the Kenyan Shilling
The Kenyan shilling has depreciated at a 10-year CAGR of 6.1% to close at Kshs 157.9 as of 5th January 2024 from Kshs 86.9 over the same period in 2014, Mainly attributable to challenges within the country’s macroeconomic environment. Over the last years we have seen the country run a fiscal deficit that is 8% of GDP which has led to the government borrowing both locally and internationally. The Country has also seen the currency depreciate due to the negative current account deficit currently at 3.5% of GDP. The current account deficit is largely due to the high imports of petroleum products and the manufacturing equipment. In 2023, the shilling depreciated for the sixth consecutive year, closing the year at Kshs 156.5 against the US Dollar as compared to the Kshs 123.4 at the beginning of the year translating to a depreciation of 26.8%. However, the shilling’s steady decline over the past two years could also be seen as a correction from overvalued levels. The chart below illustrates the performance of the Kenyan Shilling against the US Dollar over the last 10 years:
Source: Cytonn Research
The following are the factors that have continued to support the shilling;
Source: Central Bank of Kenya
Source: Central Bank of Kenya, * figure as of November 2023
However, the shilling has been put under significant pressure by;
Source: Kenya National Bureau of Statistics (KNBS), * figure as of October 2023
Section II: Evolution of the Interest Rate Environment in Kenya
In the FY’2023, interest rates were on an upward trajectory with rates on the 91-day paper rising steadily by a cumulative of 651.4 basis points to close the year at 15.9%, up from the rate of 9.4% recorded at the beginning of the year. The significant increase in interest rates is attributed to the governments increased borrowing needs. In addition, Kenya experienced a deterioration in its credit ratings with Fitch, Moody’s and S&P Global downgrading the country’s outlook from stable to negative following the liquidity challenges and limited access to the international markets amidst the upcoming Eurobond maturity of USD 2.0 bn due in June 2024. The downgrades of Kenya’s credit score have affected the country’s ability to access cheaper loans in the international financial markets, prompting investors in the domestic market to demand higher yields.
Over the last 10-year yields on government papers have remained steady for the most part, with the yields on the 91-day paper averaging 8.7%. However, Kenya’s interest rates witnessed high volatility in the years 2015 and 2016 with the 91-day paper hitting a record high of 22.5% in October 2015 attributed to the tight monetary policy stance adopted by the Central Bank of Kenya, with the Monetary Policy Committee (MPC) raising the CBR to 10.0% in June 2015 from 8.5% in order to anchor inflationary expectations and curtail demand pressures in the economy. In addition to raising the CBR, the MPC also enhanced its open market activities to withdraw excess liquidity from the market. The chart below highlights the trend in the 91-day T-bill weighted average yield for the last 10 years:
The Kenyan macroeconomic environment remains subdued mainly as a result of the elevated inflationary pressures and aggressive depreciation of the Kenyan Shilling that have suppressed business production levels as evidenced by the Purchasing Managers Index (PMI) which averaged 48.1 in the year 2023. As such, we expect revenue collection to lag behind the revised target. The revised budget expenditure stands at Kshs 3,931.4 against revenue collection projection of Kshs 2,894.9 bn for the FY’2023/24.
Our view is that the government should take the following measures to alleviate the strain on the interest rate:
Section 4: Currency Outlook
Driver |
Outlook |
Effect on the currency |
Balance of Payments |
• The deterioration of the country’s balance of payments is likely to put more pressure on the shilling. Notably, Kenya’s balance of payments position (BoP) deteriorated, registering a deficit of Kshs 131.5 bn in Q3’2023, from a deficit of Kshs 112.7 bn recorded in Q3’2022, and a reversal from the Kshs 152.9 bn surplus recorded in Q2’2023. This was caused by a wider deficit in the financial account due to the reduced capital flows following the country’s macroeconomic uncertainties, a trend likely to continue in 2024. As such, we expect a muted foreign direct investment leading to reduced inflows and hence weighing down the shilling. • We expect the country’s reliance on imports coupled with high global commodity prices to continue weighing down on the country’s Balance of payments. As such, with Kenyan being a net importer, we expect to see inflated import bill mainly as a result of the high fuel prices coupled with the continued depreciation of the shilling • However, we expect the gradual improvement in the export sector as Kenya’s trading partners continue to reopen will see the current account narrow as evidenced by the 42.1% narrowing of the current account balance deficit to Kshs 122.5 bn in Q3’2023 from Kshs 211.6 bn in Q3’2022.
|
Negative |
Government Debt |
• We expect the government to continue borrowing more domestically as it aims to bridge the fiscal deficit, which is projected to come in at 5.3% of the GDP in the FY’2023/2024. Domestic debt provides the government with a cheaper source of debt compared to foreign currency-denominated debts that have higher interest rates and have currency risk attached to them, • Similarly, external borrowing is expected to increase in 2024 given the need to service the upcoming maturities such as the 10-year USD 2.0 bn (Kshs 226.0 bn) Eurobond maturing in 2024. Notably, Kenya is currently under risk of high debt distress mainly as a results of increasing debt levels, rising debt repayments cost and slow revenue growth with the country’s debt to GDP ratio currently at 70.2%, 20.2% above the recommended IMF threshold of 50.0% for developing countries, • The high debt levels will continue to expose the shilling to exchange rate shocks and will, in turn, emanate pressure on the shilling to weaken during the repayment period. |
Negative |
Forex Reserves |
• As of December 2023, the country’s forex reserves stood at USD 6.7 bn (equivalent to 3.6 months of import cover) with the forex reserves having dropped below the statutory requirement of maintaining reserves equivalent to least 4.0-months of import cover, • Notably, the forex reserves have significantly dropped by 11.0% to USD 6.7 bn (equivalent to 3.6 months of import cover) in December 2023, from USD 7.5 bn (equivalent to 4.2 months of import cover) recorded in December 2022. The drop is largely attributed to increased debt service obligations due to the continued depreciation of the Kenyan shilling, • Additionally, the elevated debt levels witnessed in the country are likely to put forex reserves under pressure as most of it will be used to finance the debt maturities, • However, we expect the reserves to be supported by improving diaspora remittance inflows which came in at cumulative USD 3,817.4 mn as of November 2023, 4.0% higher than the USD 3,670.6 mn recorded over the same period in 2022 and the increasing exports especially in the agricultural sector with government having subsidized key inputs such as fertilizers. This will in turn support the stability of the Kenyan Shilling |
Negative |
Monetary Policy |
• Inflation rates have remained within the government’s target of 2.5% - 7.5% for six consecutive months despite the high fuel prices in the country following the recent tightening of the monetary policy. Notably, in its latest sitting, the MPC raised the CBR by 200 basis points a move which it termed as aiming to ease the pressure on Kenyan shilling. The impact of this is expected to continue easing inflationary pressures and as such support the shilling • Consequently, we may see slight upward pressure on the interest rates as the ripple effects of the increased CBR continue to reflect in economy in the short to medium term. |
Neutral |
From the above currency drivers, 3 are negative (Balance of payment, Government Debt Forex Reserves), while 1 is neutral (Monetary Policy) indicating a negative outlook for the currency.
Section III: Factors Expected to Drive the Interest Rate Environment
The monetary policy committee has continued to play a crucial role in determining the interest rates levels in the country. In 2023, notable changes in interest rates began in July when short-term government securities were at the rates of 11.9%, 11.9%, and 12.2% for 91-day, 182-day and 364-day papers respectively. This upward trajectory gained momentum following the Central Bank's decision to increase the base lending rate by 100 basis points to 10.5%, from the existed 9.5% and maintained the same rate in its August and October meetings in a move to contain inflation which stood at a high of 7.9% as of June 2023, 0.4% points above the target range of 2.5%-7.5%. In its latest meeting held in December, the MPC raised the CBR further by 200.0 bps to 12.5%. The policy rate influences the cost of borrowing for banks and consequently, affects the rates at which they lend to businesses and individuals. This, in turn, creates a ripple effect on the overall interest rate environment, including the yields on government securities. Since then, the rates for short-term government papers have soared, reaching 15.9%, 16.0%, and 16.1% for 91-day, 182-day, and 364-day papers, respectively as of December 2023. The Central Bank is expected to continue with the restrictive monetary policy stance in the medium term with the intention to maintain inflation within CBK’s target range of 2.5%-7.5%. As such, we expect to see continued upward pressure on the interest rates as the government compensates investors for the increased risks posed by currency depreciation and elevated inflation. The following is a graph highlighting the Central Bank Rate for the last 5 years;
The government continues to put in place measures to broaden the revenue base and rationalize expenditures in order to reduce the fiscal deficits. In June 2023, the National Treasury presented Kenya’s FY’2023/24 National Budget to the National Assembly highlighting that the total budget estimate for the 2023/24 fiscal year increased by 8.7% to Kshs 3.7 tn from the Kshs 3.4 tn in FY’2022/23 budget. According to the Draft 2024 Budget Policy, the budget execution during the first four months of FY’2023/24 progressed relatively well with revenues recording a growth of 13.0% in October 2023 compared to a growth of 11.9% in October 2022. The FY’2023/24 budget focuses mainly on providing solutions to the heightened concerns on the high cost of living, the measures put in to accelerate economic recovery as well as undertaking a growth-friendly fiscal consolidation to preserve the country’s debt sustainability. Notably, the government projects to narrow the fiscal deficit to 5.4% of GDP in FY’2023/24, from the estimate of 5.8% of GDP in FY’2022/23. However, the upward revision of taxes comes at a time when the business environment remains subdued, underpinned by the elevated inflationary pressures and the aggressive depreciation of the Kenyan shilling that has suppressed business production levels weighing down on the projected revenue performance. As such, we expect this will significantly affect revenue collection necessitating borrowing to plug in the budget deficit. Below is a chart showing the revenue collections and domestic borrowings over the last 10 financial years:
The MPC lowered the Cash Reserve Ratio (CRR) to 4.25% from 5.25% in their March 2020 sitting, which has since remained unchanged aimed at supporting the economic recovery from the ripple effects of Coronavirus pandemic. As a result, liquidity in the money market has remained relatively favourable as evidenced by the interbank rates at an average of 9.8% in 2023, compared to an average of 4.9% in 2022, with average interbank volumes increasing by 16.1% to Kshs 21.6 bn in 2023, from Kshs 18.6 bn in 2022. In an ideal situation, ample liquidity in the money market, the lowering of commercial banks’ lending, and deposit rates would lead to increased money supply in the economy and an increase in consumers’ purchasing power. The low Cash Reserve Ratio has played a big role in maintaining favourable liquidity in the money market as well increases the supply of money by commercial banks. We expect liquidity to improve in 2024 driven by increased access to credit as banks gradually increase their lending to the private sector and the continued adoption of risk-based lending by banks. However, due to uncertainties in the economy occasioned by elevated inflationary pressures, there still exists a high credit risk which hampers lending to businesses and individuals.
Outlook:
Driver |
Outlook |
Effect on Interest Rates |
Fiscal Policies |
• The government is expected to continue borrowing in order to offset the budget deficit and finance debt maturities. The total T-bonds and T-bill maturities so far stand at Kshs 161.7 bn and Kshs 462.2 bn, respectively for the year 2024 which will in turn put pressure on rates |
Negative |
Monetary Policy |
• We expect the MPC to continue with the tightening of the monetary policy in the short term in a bid to stabilize inflation within the government’s target and anchor the Shilling from further depreciation. This is evidenced by the recent actions taken by the MPC where it increased the CBR by 200 basis points to 12.5% from 10.5%. • As such, the yields on government securities are likely to adjust further upwards as investors attach a higher premium to meet their required real rate of return, |
Neutral |
Liquidity |
• We expect liquidity to continue being supported by the Low Cash Reserve Ratio (CRR) currently at 4.25% from 5.25% previously. • Additionally, we expect liquidity to improve in 2023 driven by increased access to credit as banks gradually increase their lending to the private sector and the continued adoption of risk-based lending by banks. This will in turn push up the interest rates due to increased competition between the private sector and the government. • The huge maturities from government securities are expected to increase liquidity |
Neutral |
From the above indicators, 1 of the drivers is negative (fiscal policies), and 2 are neutral (Monetary policies and liquidity). We therefore believe that the interest rate environment remains uncertain and will likely adjust upwards.
Section IV: Conclusion and Our View Going Forward
Based on the factors discussed above and factoring in the uncertainties in the Kenyan macroeconomic environment;
Concerns persist regarding the future performance of the Kenyan shilling, fuelled by existing pressures, dwindling foreign exchange reserves and escalating levels of national debt with the approaching maturity of the USD 2.O Eurobond in June 2024. Anticipating a continued depreciation of the currency, we foresee adverse consequences in the economy, marked by an augmented import bill. Despite the implementation of a tightened monetary policy, with MPC increasing the rate to 12.5% in December 2023 from 10.5%, short-term inflation is expected to remain elevated, mainly because inflation in the country is mainly cost driven rather than demand driven, as the money supply remain stable. Although the current strain on the Kenyan shilling is unlikely to ease in the immediate future, there are proactive measures that the government can adopt to alleviate further depreciation. These measures encompass strategic interventions and policies aimed at stabilizing the currency and fostering economic resilience. They include:
Disclaimer: The views expressed in this publication are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.