Shillings begin to look shinier (The Africa Report n°39 – April 2012)

October 2011 was a terrible month for East African central bankers as local currencies dropped to record lows against the US dollar. Between January and October the Kenyan shilling plummeted 32% against the US dollar while the Tanzanian and Ugandan shillings were down 20% and 25V%, respectively. This prompted central bank bosses to intervene in the currency market despite long-held positions that market forces should determine exchange rates. They supported the dollar supply by selling them directly to commercial banks. They also tightened monetary policy, with Ugandan and Kenyan authorities raising the benchmark rate to tame inflation. The results were good. By 24 February the Kenyan shilling had risen 23% from its low of KSh107 to $1 in October; while the Tanzanian and Ugandan currencies were up 13% and 20%, respectively. « These actions brought in dollars as local securities became attractive to offshore investors, » says Duncan Kinuthia, a senior dealer at the Bank of Africa. He added that the high lending interest rates cut demand for imports, with reduced demand for dollars.

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Analyst’s view Razia Khan, head of Africa research, Standard Chartered Bank

For much of last year, east African currencies were amongst the worst-performing frontier African currencies. In an environment of robust demand, sevens drought caused higher food and fuel imports, putting pressure on currencies and creating an additional feedback loop into inflation. Concern over the debt crisis in the euro area also weighed heavily. East African currencies have nonetheless experienced a dramatic turnaround. Central banks tightened monetary policy significantly in response, making it expensive to short East African currencies, which no doubt helped.

In Uganda, the central bank raised policy rates to a peak of 23% from July 2011, making yields on Ugandan debt instruments more attractive. Foreign portfolio inflows poured in, with the Ugandan local currency market attracting the highest level of foreign investor involvement since the 2008 crisis. The Bank of Uganda has already resumed an easing cycle, creating a significant bond market rally.

With inflation showing signs of peaking in Kenya, local bankers hope the shilling will see a similar surge. Kenyan and Tanzanian central banks reacted to the pressures by successfully reducing banks’ net open positions. Judging when to lift these restrictions will be hard, given concerns in Europe and potential oil-price volatility.

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