Over the past decade Kenya has proven East Africa’s great success story. The government’s policy of sustained investment in infrastructure and human capital have helped foster growth and encouraged national businesses to become more competitive on the world stage.
Yet despite rapid growth, the spectre of volatility has loomed large.
Kenya’s economy has frequently had to cope with periods of extreme variable exchange rate movement, with the Shilling marked by periods of rapid depreciation.
In order to better protect your earnings, we believe that it’s highly important for local businesses to fully understand both the internal and external dynamics which drive volatility so you can adequately model against it.
External Factors Driving Volatility In The Kenyan Marketplace
Kenya remains a net importer. Despite recent progress by the government in redressing Kenya’s negative trade balance and national deficit, a reliance on imports leaves it vulnerable to any external shocks that may affect direct trading partners and the wider global economy as a whole.
A Weak Shilling
At its core, Kenya’s trade imbalance means that demand for US Dollars by importers far exceeds what is received by exporters, placing a direct negative stress on the value of the Kenyan Shilling at times of global instability.
A recent example of this occurred in the summer of 2015. The combination of China’s devaluation of the Yuan, the possibility of Greece exiting Europe and the prospect of a US Federal Reserve interest rates rise, nearly caused a global financial crisis which spreading contagious volatility to across the globe.
Not immune from the crisis, the Shilling was beset by negative fluctuations and rapid depreciation, reaching an all time high of 106.15 against the Dollar in September 2015. Whilst the Shilling has since stabilized, it’s also failed to come below the symbolic ‘100’ mark this year and expectations remain that it will continue to gradually weaken further as 2017 approaches.
The Commodities Crisis
Kenya has thus far managed to avoid the worst effects of the crash which has hit both traditional and emerging market economies alike. In fact, in the short-term, Kenya has benefitted from the commodities crash due to low oil prices. However, as the slump in commodity prices continues in 2016, serious problems could come to the fore, again due to Kenya’s reliance on imports of manufactured goods.
The Central Bank of Kenya’s measure of holding the benchmark interest rate at 11.5% for 5 consecutive months has thus far managed to effectively safeguard the economy. However the IMF has now twice reduced its growth projections for Kenya (from 6.8% to 6% in 2016) and, as the overall slump in commodities continues, fears are rising that inflation will further undermine the value of the Shilling and cause exports to lose competitiveness and decrease earnings of foreign exchange.
Internal Factors Causing Volatility In The Kenyan Marketplace
Aside from the external causes of volatility, there are a number of domestic macroeconomic and political factors that contribute to the climate of economic instability in the Kenyan marketplace that businesses must also be aware of.
Kenya’s Declining Industries
A recent report by the World Bank highlighted that a decline in Kenya’s manufacturing and agricultural sectors over the past decade was a major cause of internal volatility.
Once the backbone of Kenya’s economy, agriculture has slipped from contributing 26.6% to GDP in 2006 to 22% in 2014. Similarly, Kenya’s manufacturing industry has stagnated to 11.8% over the same period.
This poor performance has been somewhat masked by the strong and rapid growth of Kenya’s service industry. Yet until more is done to arrest this decline in Kenya’s agriculture and manufacturing sectors, growth will remain sluggish and the economy will be susceptible to the unwanted effects of volatility.
A second internal source of volatility in Kenya can be directly attributed to political instability.
Foreign exchange markets are sensitive to the prospect of change and, with memories still fresh of the instability that surrounded Kenya during the 2007/08 election season, many expect further volatility and weakening of the Shilling as we approach a new campaign in 2017.
Of course, it’s not all doom and gloom. If Kenya can pull off a peaceful and calm elections, as happened in 2013, businesses can likely expect a rapid normalization of the Shilling. However, the fact remains that as we enter the long road of a Kenyan campaign trail businesses must expect internal pressures to cause volatility in the Kenyan marketplace.
How to Overcome the Challenge of Volatility in Kenya
For Kenyan businesses transacting in another currency or selling KES, managing foreign exchange risk is far from simple. It becomes even more complicated if you’re a business trading across multiple markets, each bringing with it a new set of challenges when implementing a trading strategy that minimizes the risk of volatility.
Yet despite these challenges, there are a number of different products and strategies which businesses can utilize to better manage their exposure to volatile market conditions, such as Spot Transactions and Forward Contracts.
Spot Transactions allow Kenyan businesses to trade instantly and take advantage of current market conditions. Use of a ‘Spots’ can be advantageous for businesses that have to fulfill their temporary need for foreign or domestic currency, whilst also taking advantage of the current levels of stability experienced by the Kenyan Shilling in 2016.
Forward contracts allow you to lock in today’s exchange rate for delivery at a later date, hedging against any future negative market movement. Fixing the rate can be advantageous as it eliminates currency risk due all foreign exchange costs being established in advance. There three variations of forward contracts available to Kenyan businesses that can help manage exposure to volatility; Open Forwards, Fixed Date Forwards and Non-Deliverable Forwards.
A Fixed Date Forward allows Kenyan businesses to secure an agreed rate of exchange for use on a specific date in the future. Open Forwards can provide you with greater flexibility & control of funds by allowing you to secure an agreed rate that can be used at any date in the future within an agreed period of time. Meanwhile, a Non-Deliverable Forward provides you with a cash settlement on the difference between a contracted fixed forward rate and the current spot rate.
It must be noted that whilst Forwards can be a beneficial tool in helping Kenyan businesses hedge against foreign exchange loss, they don’t eliminate risk entirely, due to the unpredictable nature of Kenya’s market volatility and currency movements.
Find out more about how Kwanji can help your business to integrate different hedging strategies that may limit your exposure to volatile market conditions: