CBK buys dollars to build foreign exchange reserves

CBK has switched roles to become a net buyer of US dollars. PHOTO | SHUTTERSTOCK

The Central Bank of Kenya (CBK) has switched roles to become a net buyer of US dollars with the view to building up foreign exchange reserves, the International Monetary Fund (IMF)has disclosed.

According to the CBK, foreign exchange reserves stood at $6.829 billion, equivalent to 3.7 months of import cover.

The Central Bank has a target of maintaining an import cover of at least four months.

Forex reserves give a country the ability to finance imports, pay foreign debt and maintain financial stability.

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While the apex bank has traditionally been the seller of hard currency or dollars in the market to ease demand-supply mismatches, the disclosure shows CBK has silently accumulated dollars amid a non-intervention stance in the foreign exchange market.

“The CBK has made small net FX (forex) purchases in recent months, reversing the periodic FX sales seen earlier in the programme in response to shocks,” the IMF noted.

Kenya’s official reserves, which are largely dollar-denominated and held at CBK have declined recently on the back of large debt service payments and the absence of major inflows of hard currency.

The CBK will traditionally buy hard currency directly from the market at prevailing rates silently but has on occasion disclosed plans for such transactions.

In March 2020, for instance, the CBK announced its intention to purchase $100 million (Sh10.1 billion at the then exchange) rate each month until June of that year to grow its usable foreign currency reserves.

The Central Bank in June 2023 stepped away from selling dollars to commercial banks in an attempt to defend the shilling from demand-driven dollar pressures as it allowed the local currency to reset from what the Treasury Cabinet secretary Njuguna Ndung’u and Central Bank of Kenya governor Kamau Thugge have described as the overvaluation of the local currency.

Despite stepping off from the hard currency sales, the official reserves have continued to come under pressure from higher debt service costs and rising import bills partly driven by the weakening of the shilling.

Moreover, the depreciation of the Kenya Shilling has been exerting pressure on the cost of living with an analysis by the IMF placing the effect of one unit move down in local currency to cause up to 0.4 percent jump in inflation.

The depreciation is expected to drive up inflation in the near term with the IMF warning that the rate could breach the 7.5 percent upper limit before June.

The reserves could remain under more pressure in the near term as the IMF recommends that the exchange rate be allowed to respond flexibly to market conditions.

Recent measures targeted at facilitating greater exchange rate flexibility including the implementation of an electronic matching system in the interbank FX market and the removal of the 20-cents spread limit in the market are expected to help ease market dysfunction in the currency market and support the build-up of reserves.

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However, the interventions which began with the re-opening of the interbank foreign exchange market in March seem to have begun on a slow note with the IMF noting that the interbank FX market has remained dormant while spreads in the bank-client market remain large despite some tightening recently. At the same time, there has been a continuation of strong excess dollar demand reflected by increases in FX deposit rates.

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