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20 June, 2011

Is Ksh. under speculative attack?

Recent rapid depreciation of the shilling tends to raise the question, is the Kenyan shilling under speculators attack? The CBK floating exchange rate system has been susceptible to unusual volatility that had forced the central bank to intervene from time to time to shore up the shilling, but lately CBK has decided not to intervene and let the market forces dictate the shillings fate.

Currency speculation exists whenever someone buys a foreign currency, not because she needs to pay for an import or is investing in a foreign business, but because she hopes to sell the currency at a higher rate in the future (in technical language the currency "appreciates"). This is nothing more than the old rule of buying low and selling high—only with foreign money.

Sometimes currency speculation might be necessary especially when exporters wants to exchange their currencies to local currency so as to offset local expenditures,Hence the need to engage forex traders who might charge a commission for the exchange and in most cases speculate on the foreign currency hopping to get a higher value from the market.

Speculators sometime use very sophisticated metrics to measure their risks and in most cases engage in guess work to influence depreciation or appreciation of a certain currency.The data they rely on may not in some instances reflect the reality on the ground hence affecting implementation of essential government policies and financial upheaval as we are currently witnessing.

Most speculators are Banks,just a few days ago CBK warned banks engaged in currency speculation they would face certain undisclosed disciplinary actions and within a few days the shilling started to appreciate.The involvement of banks in currency speculation explains why policies which reduce the short-term profitability of financial and industrial businesses triggers the selling of a currency, while policies that expand or open profit opportunities influence the buying of a currency.

Currency speculation is quite a lucrative business, a trader can make huge profits in a matter of minutes.If you look at financial reports of several large bank you would notice increase in Foreign exchange/treasury or other incomes over the years, which indicates currency speculation is rife in the banking industry.

CBK might be partly to blame for the current crisis hitting the shilling this is because its IMF funded dollar reserves might have sent signals of insufficient Foreign exchange reserve and absence of exchange controls.The problem might also be exacerbated by its constant borrowing and participation in the currency market as exemplified by its recent purchase of the Euros.

CBK latest moves although meant to maintain stability in the market might in actual sense result in the following negative outcomes:

(i)Destabilize exchange rates and asset prices as we are witnessing currently.

(ii)Results in serious losses of output,investment and employment bringing increased poverty.

As I had indicated earlier CBK knows who the speculators are and I dont know why measures are not been taken to bring them under control.As things stand, the speculation on the shilling is risking the lives of poor Kenyans as fears of increased inflation grow.Taxes or controls should be instigated against speculators to curb the menace.The tax will not only benefit the economy in terms of development but also bring down currency speculation.

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