Currency pain: Relief for Ghana and Tanzania; Nigeria in tight corner, but set to get worse in Kenya and Uganda

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Authorities have been pumping dollars into the market to support their currencies, but the strategy is unsustainable and risks depleting reserves

EAST African central banks are having little success in stemming a rout of their currencies despite taking ever-more aggressive monetary policy action; the Kenyan shilling (KES) is particularly vulnerable as industry analysts say the KES is approximately 20% overvalued.

Uganda, Kenya and Tanzania are among the worst hit currencies in Africa this year as heightened risk aversion prompts investors to move money out of emerging markets. As import-dependent economies, the East African nations are exposed to foreign-exchange reversals, while dwindling reserves mean policy makers have little ammunition to halt the decline.

The Bank of Uganda raised its benchmark interest rate by 150 basis points at an unscheduled meeting on Monday, the third increase this year. That follows the decision by the Central Bank of Kenya to raise its key rate by a total of 300 basis points in two consecutive meetings.

“Domestic policy will have very little impact on the currencies,” Aly-Khan Satchu, the chief executive officer of Rich Management Ltd., an adviser to wealthy individuals and companies, said by phone from Kenya’s capital, Nairobi. “It’s a strong-dollar story, a risk-aversion story.”

The Kenyan shilling has weakened 8.8% against the dollar in the past three months, Uganda’s currency has dropped 9.1% and Tanzania’s unit is down 8.4%. Only the Angolan kwanza is a worse performer in Africa in the past three months, slumping 12.8% against the dollar.

An industry brief to clients from Renaissance Capital indicates that in Kenya’s case, the slide is likely to fall even further: The Kenyan shilling is approximately 20% overvalued, inidicates the note authored by economist Yvonne Mhango, given the deviation of its real effective exchange rate (REER) from the 10-year average, and that its recent slide is smaller than the Euro/depreciation.

The analysts believe that recent policy tightening will slow the Kenyan shilling depreciation, but it will not halt it because weak exports, growing imports and a slowdown in financial inflows will weigh on the currency; as will US rate hikes that are due in the short term.

While Kenyan and Ugandan authorities have been pumping dollars into the market to support their currencies, the strategy is unsustainable and risks depleting reserves, Satchu said. Uganda’s reserves dropped 17% to $2.8 billion in May from a year ago, while Kenya reserves fell 9.8% to $6.6 billion since the beginning of the year to July 9.

Further weakness

“I expect further weakness in Kenya and Uganda units because the central banks are running out of ammunition and the dollar rally has still further to run,” Satchu said.

Kenya’s shilling gained 0.2% to 102 against the dollar as of 9.52 a.m. on Tuesday in Nairobi, while Uganda’s currency was unchanged at 3,280.

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But of the East African Community’s three biggest economies, Uganda’s currency is the most likely to revert to its ‘fair value’, when its REER is compared to that of Kenya and Tanzania. 

The analysis from Renaissance Capital shows that the Ugandan shilling (UGX) was fairly valued and had depreciated by a little more than the EUR/$ depreciation over the same period. Once the dollar stabilises, the analysts expect the Ugandan shilling to be one of the first of Africa’s undervalued currencies to retrace and move back towards its ‘fair value’.

The Nigerian naira is similarly overvalued by 20%, the brief indicates. But it is less vulnerable to sustained decline than the Kenyan shilling because its depreciation was better in line with the Euro/Dollar depreciation.

Still, given that Nigeria’s monetary policy is already exceptionally tight, there’s little scope for further policy tightening to defend the Naira.

On the other hand, the Ghanaian cedi and the Tanzanian shilling are most likely to retrace, with the analysts arguing that their recent depreciation was overdone as it exceeded that of the Euro against the dollar. In Ghana’s case, the cedi has already posted swift appreciation since June 30 when the International Monetary Fund gave it a thumbs up on its fiscal performance.

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