IMF now asks CBK to let the shilling depreciate
IMF now want Kenyan and other African countries to let their local currency depreciate to facilitate adjustment to external shocks
IMF now want Kenyan and other African countries to let their local currency depreciate to facilitate adjustment to external shocks.
The Kenyan and other central banks in sub-Saharan Africa with floating exchange rates are being urged by the International Monetary Fund (IMF) to allow their currencies to fall in value in order to boost domestic production and investments with an eye toward exports.
This occurs at a time when the value of the Kenyan shilling has already fallen to an all-time low, averaging 134.56 to the dollar, increasing the magnitude of the nation’s external debt and the price of importing vital goods like petroleum and fertilizer.
However, the IMF has attempted to ease concerns about a weaker shilling that would compel the Central Bank of Kenya (CBK) to support the local currency in a new note on the exchange rate.
Instead, the central banks in the so-called “non-pegged regimes” like Kenya, have been urged to just tame inflation by tightening the monetary policy to encourage capital inflows and implement austerity measures to tame the growth of debt.
The IMF has long been asking the CBK to let the exchange rate act as a shock absorber even as the local currency is battered by a myriad of shocks that have triggered an outflow of capital and a disruption in the global supply chain that has pushed up the costs of imports.
“As for non-pegged regimes, in most countries, letting the exchange rate depreciate is necessary to facilitate adjustment to external shocks that are durable, such as changes in terms of trade and higher interest rates in advanced economies,” said the IMF in a new note.
Non-pegged countries are those where the exchange rate is not fixed to another currency on a legal basis.
According to the IMF, exchange rate adjustments for a floating exchange rate provide price signals that help all agents in the economy, including the government, to adapt to new external realities.
“For example, exchange rate depreciations can persuade consumers to switch consumption toward more domestically produced goods and urge governments to prioritise their foreign-exchange-related spending and investors to invest more in export-oriented businesses,” added the IMF.
Last December, the IMF, which had in an earlier report accused CBK of managing the country’s currency, noted that Kenya’s exchange rate should function as a shock absorber.
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This, the IMF added, should be supported “by a well-functioning interbank FX market, with forex interventions (sales) limited to addressing excessive volatility.”
When a currency is devalued its demand also goes down, with the country’s exports fetching more in the global market.
The IMF is appreciating that letting the local currency depreciate will come with adjustment costs in terms of higher inflation and public debt.
“In countries where reserve buffers are low, currency depreciation and its associated costs are unavoidable. Policymakers can take several steps to mitigate the adverse impact and contain exchange rate pressures,” said the IMF.
Some of the measures that countries can take even as they let the currency depreciate are through tighter monetary policy that can keep inflation expectations in check and reduce exchange rate pressure by attracting capital from abroad and stem outflows.
Fiscal consolidation — or policies aimed at increasing revenues and cutting spending — will keep public debt sustainable and rein in external imbalances, particularly in countries where fiscal imbalances are key drivers of exchange rate pressures, explained the IMF.
“Cutting government expenditures that directly or indirectly affect imports can be particularly helpful to lower the demand for foreign exchange — for instance, eliminating fuel subsidies can reduce fuel imports,” said the IMF.
The IMF also reckons that strengthening the social safety net through well-targeted measures will support the poor, who are more adversely affected by the rise in prices.
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