Kenya inches closer to full-scale dollarization

November 25, 2023November 30, 2023 Dredan Njau, Maryline Josephine and Kaunga Junior

The gradual shift towards dollar payments in Kenya, observed across various sectors, has raised concerns about the intensifying trend toward the dollarization of the country’s economy. This movement has been fueled by the persistent weakening of the Kenyan shilling against the US dollar over the past year, showing little to no signs of improvement.

Dollarization typically involves the need for a reserve of readily available US dollars to replace the existing monetary base and establish a liquidity cushion denominated in US currency. This cushion often amounts to approximately 20 percent of total bank deposits and serves as a safeguard against potential banking system crises or runs. Essentially, it replaces the traditional role of a central bank as the lender of last resort—a role that is significantly diminished or eliminated under a dollarized monetary system.

Fears of dollarization

From the start of the year, the shilling has experienced significant depreciation of 17.7 percent against the dollar, surpassing more than double the 8.3 percent decline recorded against the unit throughout the entirety of 2022.

The local unit was trading at Kes120.45 against the dollar last year but has since dropped to Kes152.69 according to Central Bank data. Consequently, traders, merchants, landlords, service providers, and others have frequently adjusted their prices to accommodate the costs associated with fluctuating foreign exchange rates and rising inflation.

The economic challenges confronting the nation, including soaring inflation, recent spikes in fuel prices, and escalating living costs, have cast a cloud of uncertainty over the prospects of recovery. Despite assurances from the Central Bank of Kenya that the shilling will eventually stabilize and prices will decrease, the ongoing struggles have eroded confidence in the local currency.

After more than a year of unfulfilled promises and hopes for improved economic conditions, some businesses have started losing faith in the Kenyan shilling. Consequently, they have begun setting their prices in the more stable and reliable US dollar.

While sectors like hospitality, horticulture exports, and fuel imports have traditionally operated in dollars, others have followed suit in an effort to mitigate currency risks. Kenya’s real estate sector, for instance, has seen a growing preference for rental payments in dollars among investors. Office spaces, apartments, and standalone homes are increasingly listing their prices in dollars, and billboards along the country’s roads display property prices in this global currency.

Even internationally recognized bed and breakfast service providers like Airbnb have adjusted their payment methods in favor of dollars due to the depreciating shilling. This shift serves as a protective measure for both service providers and investors against potential losses resulting from currency devaluation.

Global dominance of King Dollar

In some instances, developers strategically employ dollar pricing to attract a broader international clientele, acknowledging the global dominance of the US dollar. This approach also serves as a competitive advantage because quoting a price in dollars can be less intimidating to potential buyers compared to an equivalent amount in Kenyan shillings.

In an interview with Business Daily, developer Collins Chacha expressed this perspective, stating, “If I quoted a selling price of Kes250 million, this would be more intimidating than quoting a price of $20,000.” This example illustrates the strategic considerations and market dynamics driving the shift towards dollarization in Kenya’s economy.

Foreign exchange inflows play a pivotal role in supporting the shilling’s value. In Kenya, these inflows come from various sources, including diaspora remittances, exports, tourism, foreign direct investment, and foreign loan disbursements. When these inflows decrease or become unpredictable, it puts pressure on the shilling, making it vulnerable to depreciation. Additionally, the impact of higher global interest rates further exacerbates the situation, as it can lead to capital outflows and a reduction in foreign investments, both of which contribute to the shilling’s depreciation.

Salaries in US dollars

In Kenya, a shift is taking place in the employment landscape as both expatriate and senior Kenyan staff increasingly demand to be paid in foreign currency, particularly in the US dollar, British Pound, or Euros. The impact of the depreciating shilling is particularly pronounced for employees who allocate a significant portion of their income in countries with stronger currencies.

However, the preference for foreign currency salaries contradicts the Employment Act, which stipulates that employers must pay their staff in Kenyan shillings. Failure to comply with this provision carries legal consequences, including fines and imprisonment.

Despite these legal considerations, the demand for foreign currency salaries is gaining momentum, placing local employers under increasing pressure from their employees to make the switch. The primary driver behind this trend is the necessity to safeguard employees who have financial commitments abroad. Many Kenyan employees have obligations such as college fees, mortgage payments, investment schemes, or medical bills in agreements denominated in foreign currency.

As the shilling continues to weaken, it significantly impacts their purchasing power abroad. The depreciating value of the shilling makes it less advantageous for these employees to receive their salaries in a currency that is rapidly losing value. To alleviate this financial strain, they are seeking the stability and security offered by foreign currency salaries. For many, this shift has become a crucial factor in their employment negotiations and can even be a deal-breaker when considering job offers.

On the flip side, Kenya’s agricultural exporters, especially those in the tea, coffee, and horticulture sectors, are reaping the benefits of the depreciation of the Kenyan shilling. Since they primarily generate their revenue in US dollars, the devaluation of the local currency translates to higher earnings when converted.

Tea exporters earning big

Take Kapchorua Tea and Williamson Tea for instance. Kapchorua Tea Kenya experienced a substantial 87 percent increase in net profit for the half-year period ending September 30th, reaching $1.4 million compared to $762,240 in the corresponding period in 2022.

Similarly, Williamson Tea Kenya reported a notable 93 percent increase in net profit during the same period, reaching $3.1 million compared to $1.6 million in the previous year. The management of these Nairobi Securities Exchange-listed companies credited this robust performance to effective cost containment measures, the adoption of modern technology, and the impact of a weakening shilling.

This strong performance of green leaf exporters presents a stark contrast to the challenges faced by employees and underscores the intricate dynamics at play within Kenya’s economy.

One of the primary drivers of dollarization in the DRC is the persistent problem of hyperinflation and currency devaluation. The Congolese franc (CDF) has experienced significant fluctuations in value due to economic instability and political turmoil. Consequently, many citizens and businesses have lost faith in the national currency, seeking refuge in the stability of the US dollar.

Furthermore, the DRC receives substantial foreign aid and investment from international donors and organizations, often denominated in USD. This influx of US dollars into the country’s economy fuels dollarization, as recipients find it more convenient to use dollars for transactions and savings.

In addition, the DRC shares borders with nine countries, making cross-border trade a vital part of its economy. Many neighboring nations use the USD for trade, encouraging the adoption of the dollar in the DRC to facilitate regional commerce.

Moreover, commercial banks and financial institutions in the DRC often offer dollar-denominated accounts and services to attract customers and investors seeking a safe haven for their money.

Why DRC dollarised its economy

Moreover, commercial banks and financial institutions in the DRC often offer dollar-denominated accounts and services to attract customers and investors seeking a safe haven for their money.

While dollarization may provide stability and convenience in the short term, it introduces a set of challenges and potential risks. Dollarization restricts the government and central bank’s ability to control monetary policy. Essentially, the government finds itself in an awkward position where it cannot print dollars to stimulate the economy or respond to financial crises.

Moreover, dollarization worsens income inequality, as those with access to USD benefit more from economic stability than those relying solely on the national currency. Additionally, a dollarized economy remains susceptible to fluctuations in the exchange rate, as changes in the USD impact prices and living standards in the DRC.

The widespread use of the USD may exclude marginalized populations who lack access to dollars, perpetuating financial exclusion.

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