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Cablegate: Kenya Shilling's Rise Against Dollar a Two-Edged Sword

VZCZCXYZ0000
RR RUEHWEB

DE RUEHNR #4645/01 3380902
ZNR UUUUU ZZH
R 040902Z DEC 07
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC 3733
INFO RUEHDS/AMEMBASSY ADDIS ABABA 9721
RUEHAE/AMEMBASSY ASMARA 5017
RUEHJB/AMEMBASSY BUJUMBURA 0298
RUEHDR/AMEMBASSY DAR ES SALAAM 5606
RUEHDJ/AMEMBASSY DJIBOUTI 4941
RUEHKM/AMEMBASSY KAMPALA 2428
RUEHKH/AMEMBASSY KHARTOUM 1710
RUEHLGB/AMEMBASSY KIGALI 4996
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS NAIROBI 004645

SIPDIS

STATE FOR AF/E, AF/EPS, AND AF/RSA

STATE PASS TO USTR FOR BILL JACKSON

TREASURY FOR VIRGINIA BRANDON

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV ELAB ETRD PGOV EAGR KE
SUBJECT: KENYA SHILLING'S RISE AGAINST DOLLAR A TWO-EDGED SWORD

SENSITIVE-BUT-UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY. FOR
INTERNAL USG USE ONLY.

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Summary
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1. (SBU) The Kenya shilling has appreciated 12.3% against the U.S.
dollar this year, from Ksh69.55 on January 1 to Ksh61 on November
27. Kenya is highly dependent on dollar-denominated horticultural,
tea, and tourism export earnings. Frightened exporters are
intensifying their pressure on the Central Bank of Kenya (CBK) to
help them, but the CBK attributes much of the shilling's strength to
the dollar's global weakness and the flow of foreign investment into
Kenya, and it has no intention to intervene. Kenya runs a large
merchandise trade deficit, so importers should benefit. Exporters
stand to lose despite savings on their imported inputs. They may
try to make the shilling's appreciation into an election campaign,
but it is unlikely the CBK will take action to support the dollar
out of fear that doing so would fuel inflation. End summary.

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Shilling on a Rapid Recent Rise
------------------------------

2. (SBU) After appreciating slowly from Ksh69.9 to the dollar in
January 2007 to Ksh67.0 in October, the shilling suddenly zoomed to
Ksh60.5 against the dollar on November 28, its highest level in
eight years. CBK Governor Njuguna Ndung'u citedthe weakening of the
dollar in international markets as a major cause of the stronger
shilling locally. Dealers cited low demand for the U.S. currency
from corporate clients as banks unwound their dollar positions.
Ndung'u noted that the situation has forced Kuwait and the United
Arab Emirates to abandon the dollar as a reserve currency, while
South and East African investors and central banks are putting less
of their money into the dollar. Dr. David Ndii, a leading Kenyan
consultant, economist, and scholar, concurred with the CBK governor
that the decline of the U.S. dollar has little to do with the
Kenyan shilling, but is caused by other global factors.

3. (U) The shilling has not experienced similar appreciation against
the currencies of its major trading partners. From January to
November 2007, the shilling depreciated 3.9% against the Euro, from
Ksh91.4 to Ksh94.9. The shilling appreciated by 3% against the UK
pound in the first nine months of 2007. During the same period, the
Ugandan shilling depreciated 5% against the Kenya shilling, and the
Tanzania shilling appreciated 1%.

------------------
Cashing in at Home
------------------

4. (U) The CBK Governor's analysis aside, local conditions have
also contributed to shilling strength and dollar weakness. Kenya is
enjoying hefty inflows of greenbacks due to improved foreign export
earnings, a booming tourism sector, and foreign participation in the
privatization of leading parastatals. An estimated Ksh60 billion
(over $980 million), some of it in dollars, is expected to flood the
local financial market following the recent investments by foreign
companies in Equity Bank and Telkom Kenya, and the upcoming sale of
shares in Safaricom, the country's largest mobile phone company
through an initial public offer (IPO). With these massive dollar
inflows expected towards the end of the year, market players are
predicting further shilling appreciation against the dollar.

5. (U) International organizations operating in the conflict areas
of the region -- Southern Sudan, Somalia, Burundi and Democratic
Republic of Congo (DRC) -- are also keeping all their dollars in
Kenyan banks. Jaindi Kisero, managing editor of the EastAfrican
weekly newspaper, claimed they have created an unprecedented
regional demand for the shilling. Kisero added that Nairobi's
Eastleigh Estate has become an informal hub for remittances by the
Somalia diaspora, transmitting millions of dollars every day from
Europe, Canada and the U.S. to Mogadishu. However, there is no
analytical work on the impact of these informal inflows on the
shilling's rise.

---------------------------------
While Exporters Fear Crashing Out
---------------------------------

6. (U) Some Kenyans recognize the strong shilling will cut Kenya's
import bill for capital goods and crude oil, and ease foreign debt
repayment. Others worry that the shilling's precipitous rise will
impact negatively on companies which earn their revenue in dollars
and other international currencies. They believe the drop in the
dollar is bound to affect the earnings of a number of listed firms,
and could even lead to job losses. These companies have seen their
share prices fall on the Nairobi Stock Exchange. Kenya's national
airline, Kenya Airways, recently revealed that its revenues declined
by Ksh728 million (over $11.7 million at current exchange rate of
Ksh61) between September 2006 and September 2007 as a result of the
shilling's appreciation. The airline earns most of its revenues in
foreign currency. A property consulting firm estimated that 10%-20%
of Kenyan property leases are denominated in dollars, some at a
fixed rate. The firm estimated that some property owners have
already suffered a 10%-15% drop in rental earnings from the
shilling's appreciation, especially for offices, shopping malls and
retail outlets, whose property lease terms are irrevocable for six
years.

7. (U) CBK itself took a Ksh9.3 billion ($129 million) foreign
exchange loss on its official reserves in the fiscal year ending
June 31, 2007. Official foreign exchange reserves of $2.82 billion
were worth Ksh182.5 billion at the end of September. When the
shilling peaked at 60.35/USD on November 27, the value of reserves
dropped to Ksh170.2 billion. The book loss of Ksh18.3 billion means
that CBK will not be able to pay a dividend to Treasury. Over the
past year, the CBK has accumulated usable official reserves of $2.8
billion as of July 2007, equivalent to at least 4.4 months of import
cover.

8. (U) Tiku Shah, the chairman of the Fresh Produce Exporters
Association of Kenya, contends that the gain in the Kenya shilling
has thrown the local exporting sector into jeopardy. A strong
shilling erodes local earnings from horticultural, tea, coffee and
other agricultural exports, which account for 49.8% of the total
domestic export earnings in 2006. His counterparts in the tourist
industry are equally alarmed. Kenya's tourism sector has witnessed
tremendous growth, earning the country about $803 million in 2006.
The number of American visitors grew 17.6% in 2006 to 86,528, making
the U.S. Kenya's second largest source of visitors. The strong
growth continued in the first three quarters of 2007, and the
Tourism Board reported that Americans are, on average, the highest
spending visitors to Kenya. However, a weak dollar may dampen
earnings for industry players. According to Kenya Association of
Hotelkeepers and Caterers Coast branch chairman Mohamed Hersi, big
hotels in the country could lose about Ksh30 million (about
$492,000) if the shilling continues to gain against the dollar. He
claimed tourist hotels that signed contracts with travel agents when
the dollar was at Ksh66 stand to lose 30% of their revenue.

------------------------------
Reprieve for Importers for now
------------------------------

9. (U) Importers are having an easier time as their
dollar-denominated import commodities are coming in more cheaply.
With rising energy and capital goods import bills, the stronger
shilling is expected to slow down inflation generated by high crude
oil prices. According to its Economic Survey 2007, Kenya in 2006
imported goods worth Ksh521 billion (over $7.2 billion) compared to
Ksh228 billion (over $3.0 billion) in 2005. Kenya would save about
$1.3 billion for a similar import bill in 2007 if the current
exchange rate is sustained.

--------
Analysis
--------
10. The shilling's appreciation against the dollar hurts
agricultural exporters, favors urban consumers, and has a mixed
effect on industrial firms depending on a company's export
orientation. Exporters who earn dollar revenues will feel the
squeeze as the shilling value of their earnings falls, and the
dollar cost of their labor and local inputs rises. Those that
import their inputs for dollars but earn shilling revenues will
conversely benefit. Horticulture, tea, and coffee exporters face
a choice: Reduce their local costs, including their staff and/or the
wage bill, or ask their largely European customers to switch to
Euro-denominated payments. Importers in COMESA, Kenya's biggest
export market, are unlikely to be able to switch to Euro payments.
Exporters within the country's Export Processing Zones (EPZs), whose
high costs of production already hurt their competitiveness, may
leave. AGOA garment exporters may be especially vulnerable. They
import most of their inputs from Asia and pay in dollars. If their
Asian suppliers raise their prices to protect their local currency
profits from the dollar's depreciation, it would further reduce
Kenya's competitiveness against Asian garment producers.

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Comment
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11. (SBU) If shilling stays in the Ksh60/dollar range or
appreciates even further, companies whose revenues are largely
denominated in dollars will face a grim fourth quarter. Few Kenyans
appear to be thrilled about their shilling's newfound muscle. The
CBK will face continued pressure from exporters to establish some
special exchange rate program, or to buy more dollars. This would
be problematic, however, because it would expand money supply
precisely at a time the CBK is trying to restrain money growth as
way to control inflation, which remains stubbornly high. Thus, even
if the shilling's appreciation becomes an election campaign issue,
we doubt very much the CBK will take action to support the dollar at
this time.

Ranneberger

© Scoop Media

 
 
 
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