Recent shortage of US dollars a reflection of market sentiment
What you need to know:
- Why should there be a shortage of foreign currency while banks were in a surplus position?
- Why should there be a shortage to the extent that manufacturers are being turned away for lack of dollars to purchase?
Most of us are members of WhatsApp groups where discussions on a diverse range of topics are held. I am a member of one where we discuss politics, football, academics, current affairs and sometimes just jokes centering on our school days. This week one member posted two headlines in a paper that seemed to indicate a contradiction.
One said ‘Dollar shortage hits industrialists’, while the other read, ‘Foreign currency deposits in banks hit an all-time high’. What sparked the heated discussion was a disclosure by one of us who is involved in importation that he had not been able to access adequate dollars from his bank to meet his import obligations.
The two headlines were in apparent contradiction because the manufacturers were decrying the lack of access to forex from the banks, leading to their inability to settle their obligations to overseas suppliers in a timely manner.
At the same time, the banks were reporting all-time high levels of foreign currency deposits. Why should there be a shortage of foreign currency while banks were in a surplus position?
First, the apparent increase in dollar deposits is not so in real terms as it was not off-trend and it partly reflected the effect of the depreciation of the Kenya shilling against the dollar.
Foreign currency deposits are reported to have increased from Sh793.26 billion in January 2022 to Sh804.31 billion in February 2022. This change reflected a recovery towards the December 2021 levels, when forex deposits stood at Sh803.66 billion.
The increase in dollar deposits remained largely within the long-term trend, as the exchange rate of the Kenya shilling to the dollar rose from 113.57 in January to 113.83 in February.
The actual dollar holding in banks in February recovered partially towards the end 2021 level of USD 7.10 billion, to stand at USD 7.07 billion from USD 6.98 billion in January.
With these levels of dollars in the banks, why should there be a shortage to the extent that manufacturers are being turned away for lack of dollars to purchase?
The dollar deposits are generated mainly by exporters, who receive export proceeds in foreign currency, including tourism and remittances from the diaspora. Exporters whose operational expenses are denominated in the domestic currency usually sell the dollars in exchange for the domestic currency.
The dollars would, therefore, be available to those in need, principally the importers who need to meet their overseas obligations. Where the exporter (seller of dollars) and the importer (buyer of dollars) are in the same bank, the bank is able to match the two at the market price.
Where the seller and the buyer are in different banks, the needs of the buyer and the seller would be fulfilled through an interbank transaction at the market rate (interbank rate). The apparent shortage in the market has principally been because the buyers have outstripped the sellers.
The strong post-covid recovery being experienced has generated increased demand for dollars to meet the importers’ overseas obligations, in addition to the increased remittance of dividends for the 2021 results to the overseas shareholders of some of the listed companies.
The dollar inflows, on the other hand, have been intermittent, with the export proceeds being affected by the geopolitical events that have not spared Kenya.
On a positive note, though, this is projected to improve on the back of the strong remittances as reported by the Central Bank.
There has been speculation in the market on where the exchange rate of the shilling to the dollar would go. When the seller and/or buyer believe that the exchange rate is bound to go up, the seller is bound to hold on to the dollars and hope to get more shillings when the conversion rate moves up. Similarly, the buyer would try to stock up dollars so as to benefit from the current ‘underpricing’.
The actions of the two players have the effect of making the dollars scarce in the market. The longer the situation persists, the worse it gets because of the panic it creates in the market and becomes a fertile ground for speculators to make some gains out of the mispricing.
This situation can also be exacerbated by players who “predict” the domestic currency is about to depreciate against the foreign currency by a given factor and timeline then take a position in the market that they would gain out of if the market moves in their “predicted” direction.
The “prediction” causes the buyers/sellers to behave in the manner described above. The conduct of the players is regulated by the Central Bank in line with the stipulated rules and the overall policy framework.
The exchange rate policy is that the shilling is free-floating and the regulator only intervenes to smoothen any volatility that is not in line with the fundamentals and has therefore no target exchange rate for the shilling.
The summary of my message to the group was that consistent with a free-floating exchange rate policy, and in light of the mismatch in the demand and supply currently being witnessed, the price should be right for those holding their dollars to incentivise them to release the dollars to the market.
Typically, the price is driven by fundamentals and sentiments, and sentiments are dependent on the confidence in the market. The conduct of the players instills confidence in the market and this ensures stability.
Dr Olaka is the CEO of the Kenya Bankers Association