Issue No. 23

The Politics of Currency Valuation and Central Banks 

After months of decline, the last week has seen a sudden strengthening of the Kenyan Shilling (KES) against the United States Dollar (USD). Over a series of days, the KES posted a 2% day-on-day value increment to reach 1 USD to 145.50 KES at the time of writing. Speculation is rife over the cause, but there is widespread belief that the Kenyan government has a hand in facilitating the currency appreciation. Nairobi has denied this, instead insisting that speculators distorting the 'true' value of the KES are being flushed out. Still, social media has been awash with theories surrounding what has caused the sharp hike against a generally gloomy economic backdrop.

At the recent 37th African Union Heads of State Summit, Brazilian President Luiz Inácio Lula da Silva was a prominent attendee. Since his re-election in 2022, the Brazilian president has been vocal in calls for the 'de-dollarisation' of global trade. African leaders, such as Kenyan President William Ruto, have lent their voices for intra-Africa trade to be denominated by local currencies rather than the USD. There has been an understandably growing rejection of the dollarisation of African economies, couched in pan-African terms. These sentiments are also tied to a preference for restoring a degree of economic sovereignty and self-determination apart from external creditors and influences. 

Today's economic crises and the currency valuation dilemmas facing African administrations follow years of low-interest borrowing, allowing governments to pile on debt. As of 2023, African debt accounted for slightly above USD 1.8 trillion-- an eye-watering sum. But this number is dwarfed by a single Western country, such as Germany for example, which last year held debt of USD 2.9 trillion. The average ratio of debt to GDP in Sub-Saharan Africa stands at around 58%, far lower than the US figure of 124% in 2023. Yet, 8 of the 9 countries currently listed by the International Monetary Fund (IMF) as facing 'debt distress' are African.

Although it is clear that some governments have invested unwisely with borrowed funding, African countries' debt is largely held by private external creditors. These creditors routinely charge higher interest rates than domestic ones and are more reticent to allow for restructuring and reshaping of debt. Debt is also overwhelmingly held in USD, creating problems when an administration lacks sufficient foreign exchange reserves, as with Ethiopia. A depreciating currency may make a nation's exports more appealing, but it also cuts the other way, hurting domestic consumers' ability to buy foreign goods. This unenviable choice is inescapable for countries dependent on the USD. 

Different administrations have adopted various strategies in the Horn of Africa to respond to the growing political pressure of devaluing currencies and rising debt. While Djibouti has adopted a fixed exchange rate, Kenya has asserted that it wields a floating one. Ethiopia has historically imposed strict currency controls, characteristic of a command economy, but will likely be forced to significantly devalue its currency, the Ethiopian Birr (ETB), during negotiations with the IMF this year. Somalia, meanwhile, has a de facto dollarised economy; no money has been printed there in decades. 

While these administrations have adopted differing tactics, they all come up against the same backdrop of African countries facing net imports, with trade denominated in USD and subject to problematic currency exchange valuation. In addition, primary exports such as coffee and other agricultural goods are particularly vulnerable to fluctuations in the global market, with African economies often unable to protect themselves against these swings. 

Central banks are at the heart of resurgent currency valuation debates. Depending on a country's policy approach, the central bank’s primary role is increasingly pre-determined by their government. While most central banks are nominally independent of the executive branch, they almost inevitably assume a quasi-political role when attempting to deliver on the economic promises of the government of the day. For instance, the Banque Centrale de Djibouti works to prevent a black market currency from emerging. Kenya’s central government has sought to shape the country's exchange rate by pumping in USD to back its economic optimism. A stable or strengthening local currency is typically seen to reflect that the government is doing well financially and that the economy is growing.

However, the politicisation of central banks poses another type of dilemma. Rather than serving the economic interest of a country like Kenya by raising interest rates at moments of high inflation, the central bank often faces political pressure to act in a government's short-term interest, as asserted by analysts such as those following the current KES appreciation. Whether or not this is the case in Kenya, central banks can demagogue to please the political elite. 

In the context of rising debt and widening balance of payment deficits, central banks, which previously enjoyed greater independence during the days of low-interest and manageable debt, are now facing immense political pressure, both domestic and international. Countries in the Horn are not the only ones grappling with this dilemma, with the Bank of England and the US Federal Reserve also coming under increasing pressure amid a bleak global economic outlook. 

Insulating central banks from political pressure is clearly unappealing to capitals across the Horn, but these measures are often in a country's long-term financial best interest. And despite talk of 'de-dollarisation,' the USD is here to stay, at least for the foreseeable future, and with it the politics of currency valuation will remain.

By the Horn Edition team