Kenya Macro Update - The Shilling's Resilience and Ruto's Balancing Act - 09-Jul-24

By Jack Stanton

At first glance, Kenya's macroeconomic landscape over the past nine months appears remarkably positive, especially when considering the Kenyan Shilling in isolation. The final quarter of 2023 saw a dramatic appreciation of the currency, spurred largely by the early repayment of the maturing Eurobond—a move that, until then, had been shrouded in uncertainty. This event created what many viewed as a perfect storm for the Shilling’s surge, despite sparking concerns from the IMF, which considered the advance payment a potential misuse of funds. Nonetheless, the Shilling's resilience has been noteworthy, buoyed by increased foreign currency inflows and effective management by the Central Bank of Kenya (CBK). By Q1 2024, the Shilling had earned the distinction of being the world’s best-performing currency, with inflation reported by the CBK at 4.3% in July, comfortably below the 5% target. The relentless depreciation that characterized 2023 has seemingly been relegated to the past, opening the door for a potential rate cut later this year—a welcome prospect across a continent mired in a cycle of rate hikes.

However, beneath this veneer of economic stability, significant challenges are beginning to surface, testing the resilience of President William Ruto's administration. Central to Ruto’s fiscal policy has been an aggressive approach to taxation, exemplified by the controversial Finance Bill introduced on May 9th. While the bill aimed to secure the favor of international lenders, it sparked widespread public outrage, particularly over taxes on essential goods such as sanitary products and bread, as well as a 2.5% annual tax on vehicle value. The backlash culminated in a series of protests, dubbed the “Gen Z protests,” that shook the nation. Though Ruto eventually struck down the most contentious aspects of the bill, the political damage was done. The protests led to the dismissal of a significant portion of his cabinet, only for some ministers to be reinstated days later, and the appointment of an opposition finance minister—an indication of the political volatility. The episode, compounded by a Moody’s downgrade of Kenya’s sovereign debt further into “junk” territory, has triggered a fresh wave of Shilling depreciation, with the currency briefly hitting 136 to the dollar in late July.

The CBK has responded with assertive interventions, injecting dollars into the market to stave off further depreciation. While these measures have temporarily stabilized the Shilling, there is growing concern that such interventions could undermine market integrity, artificially strengthening the currency and potentially deterring foreign direct investment (FDI). The sustained strength of the Shilling, though beneficial for local businesses, risks making Kenyan exports less competitive. With foreign reserves hovering around four months of import cover—the minimum level mandated by the CBK Act—the margin for further intervention is shrinking. A market-driven correction of the Shilling’s value seems increasingly likely.

On the international stage, Ruto has worked hard to elevate Kenya’s profile, with his recent visit to the United States marking the first state visit by an African leader in 16 years. This visit, a clear diplomatic win, positions Kenya as a key ally of the U.S. on the continent, potentially opening doors for debt relief. With Kenya’s debt burden standing at $82 billion, any relief would be a welcome respite. However, relying on a U.S. bailout is speculative at best, and Ruto’s focus on international diplomacy has attracted criticism at home, where many feel he is neglecting pressing domestic issues. His decision to send 1,000 troops to support the peacekeeping mission in Haiti—a departure from Kenya’s traditional focus on African conflicts—has further fueled this perception.

Domestically, Kenya’s economic stability continues to rely heavily on diaspora remittances, which accounted for nearly 60% of foreign exchange reserves in 2023 and are expected to grow by 5% in 2024. However, Kenya’s import-heavy economy, particularly its reliance on petroleum products, has led to a widening trade deficit, which increased by Kshs 20 billion year-on-year in Q1 2024. To sustain long-term growth, Kenya must diversify its export portfolio. While traditional exports like tea and flowers remain strong, they are insufficient to support Ruto’s ambitious growth agenda. Despite these challenges, Kenya continues to attract foreign investment, with Indian billionaire Gautum Adani’s Adani Airport Holding Ltd proposing a nearly $2 billion upgrade of Jomo Kenyatta International Airport. However, the lack of a public tender process and Adani’s request to employ non-Kenyans on the project have sparked concerns.

As of late July, the Shilling’s sharp appreciation appears to have plateaued, with the currency correcting back to 130 against the dollar. The CBK’s earlier interventions to maintain stability in the FX market—such as buying up dollars during the initial rally from 165 to sub-130—seem increasingly unsustainable. If the CBK intends to keep the Shilling around the 130 level, it will face a tough battle with dwindling resources. In the long term, Kenya’s strategy must shift towards supply-side economics to attract FDI, strengthen its export market, and solidify its position as a thought leader on the continent and beyond.