Exchange Rates & its role in Ensuring a Stable Macro-Economy: A Focus on East Africa
By Elvis Ongeti
Different countries have different currencies. There exists a need to purchase goods and services across borders especially with the vast extent of international trade in the twenty first century. The world has indeed become flat. Exchange of currencies is hence important in achieving goals of international trade. Most foreign firms bill their international clients in either US dollars or in their own local currency hence pushing importers to get either of the currencies. This then is the root cause of foreign currency exchange. Exchange rates have a role to play in ensuring a stable macro-economy with its impact touching on interest rates and inflation levels in the economy. It therefore becomes at the best interest of governments to ensure desirable exchange rate levels are attained to spur growth in the economy. To achieve this, governments have an option of choosing between floating otherwise known as fiduciary exchange rates and fixed exchange rate regime. The latter refers to the exchange rate regime mostly advocated for by Keynesian economists where there is intervention by the government in terms of the rate at which the currency of that country is trading at. This will result in devaluation or revaluation of the rate of exchange by the government depending on the prevailing market rate of exchange.
Something happened in one of the East African economies a few years back which might be a key learning point for the rest of the East Africa, Rwanda included. The Kenyan shilling was declared the worst performing currency (as of October 2011) with the nose dive it took particularly when paired against the US dollar. The shilling dangerously lingered above the KES 100/dollar mark when the average rate two months prior was KES 80/dollar. The Central Bank of Kenya was then taken to task to stabilize the shilling. In response, it engaged mainly in Repos i.e. repurchase agreements and the other traditional monetary policy intervening tools to ensure the rate of exchange was improved. Question is, was this effective? Were there other options available? I would want us to have a look at the main market fundamentals that would put any economy in such a precarious condition; well albeit for the majority of the locals except for persons paid in dollar terms. It has to be noted that some of these fundamentals are interrelated to some large extent to those touching on inflation. As a quick reminder, in a floating exchange rate regime, the forces of demand and supply dictate the rate of exchange. What it means is that the more your currency is demanded, the more value it gets. Here then comes the thinking; that we need to ensure East African currencies have a sustained demand when paired against the hard currencies of the world. World over, the US dollar is used for most international transactions. An increase in its demand by most East African importers simply means that its value will appreciate against the East African currencies. The root cause hence is the significant increase in imports.
Must we import?
Let’s get back to the position of exchange rates and imports: Every time a depreciating local currency is attributed to the increase in demanded imports, the question should then be: “what are we importing more that we were not importing previously?” The answer should only relate to items that economies cannot produce locally. The wrong answer would be: “We had to import some food products!” East Africa should have the capacity to be self-sufficient in terms of food production. Any trading in food items should be within the countries in the East Africa Community. This will potentially reduce the demand for the hard currencies and spur local production. Continued importation of goods that can be locally produced, trickles down to the level of inflation we feel as a country once the imported goods are marked up and sold to final consumers. We do of course envision a time when the East African Community would be a full Union that would have a common currency and hence streamline the intra trade.
East Africa is growing. Potential is rising. Economic empowerment is looming. The economies are expanding. To achieve appealing levels of full employment, low inflation, stable currencies and desirable exchange rates, the region needs to have full participation of government, para-government and private individuals and institutions. Private individuals and institutions will do well to bring forth ideas and capital innovation and investment while governments will provide a conducive atmosphere to do business that will spur more growth.
The ideas presented herein are the writer’s personal opinion and do not in any way represent KPMG’s views.
Elvis is a Senior Auditor with KPMG Rwanda.
About David Okwara
Africa, Africa brief, Africa challenges, Africa opportunities, African countries, challenges, development, East Africa, economic growth, economy, Ethiopia, exchange rate, FDI, financial services, Foreign Direct Investment, foreign investment, government, private equity, sub-Saharan Africa, World Economic Forum