IMF’s Interest Rate Projection Spells Continued Challenges for Kenyan Shilling

The Kenyan shilling is expected to face sustained pressure throughout this year, leading to further depreciation against major currencies well into the third quarter of 2024. The International Monetary Fund (IMF) recently updated its interest rate forecast for major economies from 2024 to 2028, indicating a peak in rates at the beginning of 2024, following a gradual climb in the previous year.

According to the IMF, the U.S. Federal Reserve is anticipated to witness interest rates peaking around 5.4%, with rate cuts expected in the third quarter. Since 2022, interest rates in the European Union, United Kingdom, and the United States have risen by at least four percentage points. This projection by the IMF suggests that any relief in the high U.S. Fed rate might not come soon, indicating a prolonged trend of shilling depreciation and a subsequent rise in the cost of living, although slightly lower than the peaks experienced in 2020-21.

The Federal funds rate, a crucial aspect of interest rate markets, not only influences the rates banks charge each other but also has a far-reaching impact on the broader economy. Changes in this rate affect the prime rate, impacting the rates banks charge clients for loans, as well as mortgage and loan rates, and deposit rates for savings.

Rising U.S. interest rates typically lead to increased interest rates across the economy, attracting investment capital from abroad. This, in turn, prompts global investors to shift investments from local currencies, like the Kenyan shilling, to U.S. dollar-denominated assets, resulting in a stronger U.S. dollar against local currencies.

Over the past year until January 2024, the US Fed rate has increased by about 17%, contributing to a much stronger dollar and intensifying pressure on the weakening shilling. The shilling has lost about 35 units of its value year-to-date, trading at 158.87 on Tuesday. Since its decline began in early 2020, the shilling has depreciated by approximately 58% against the U.S. dollar, impacting importers with increased costs.

This depreciation translates into additional expenses for importers, with the cost of buying a dollar for imports now being Sh58 more compared to early 2020. A weakened shilling is expected to strain the country’s forex reserves, currently standing at $6.8 billion (Sh1.07 trillion), below the desired minimum of at least 4 months of import cover.

Key imports such as petroleum products, fertilizers, edible oil, steel, clinker, and various raw materials for local factories are set to be affected by the weak shilling. The high prices of these imports can have ripple effects on the transport sector, farm production, manufacturing, and contribute to the growth of Kenya’s external debt burden, which is primarily dollar-denominated.