UPDATE 3-Kenya central bank shows ready to defend struggling shilling

Mon May 26, 2014 10:20am EDT

Related Topics

* Shilling down 2 pct year-to-date

* Central Bank says ready to act to minimise volatility

* Tourism hurt by bombings, travel warnings (Adds market close)

By Richard Lough

NAIROBI, May 26 (Reuters) - Kenya's central bank has signalled its intent to defend the ailing shilling by selling dollars and says it has deep enough foreign reserves to cushion the currency against shocks.

The shilling has been on the back foot this year, hurt by lower than expected dollar inflows into the tourism and tea sectors. More recently, a spate of bombings has added to worries that if a slump in tourism continues and deepens it could shave a percentage point or more off growth, economists say.

The Central Bank of Kenya has persistently drained liquidity to shore up the currency in 2014, but on Friday it acted more aggressively, selling an undisclosed amount of dollars. Two commercial banks on Monday confirmed the sale.

"(The bank) gave the message that they're willing to cap the shilling at these levels," said Nahashon Mungai, a trader at Kenya Commercial Bank.

On Friday the shilling fell through the psychologically important 88 per dollar barrier to its lowest in 2 1/2 years, before the bank's actions hauled it back. On Monday, banks priced the shilling at 87.85/95 at the market close, a touch weaker than Friday.

Central Bank of Kenya Governor Njuguna Ndung'u blamed seasonal pressures, including the payment of corporate dividends to foreign shareholders for volatility in the currency over the past two weeks. He made no mention of the slowdown in tourism, an important source of foreign exchange.

The governor said the current level of foreign exchange reserves of $6.24 billion, equivalent to 4.4 months of import cover, gave the bank sufficient muscle to tackle what he called "temporary shocks".

"(The bank) stands ready to provide further support to minimise the volatility of the exchange rate," Ndung'u said in a statement on Monday.

Proceeds from a planned debut Eurobond issue before the close of the fiscal year on June 30 would raise reserves higher still, and the shilling could appreciate, Ndung'u said.

SECURITY PROBLEMS

The central bank does not reveal the size of its hard currency sales or purchases. A second trader called Friday's sale a "sizeable amount" to move the currency by 30 cents.

"They hit all the banks with quite large amounts," said I&M bank trader Abhinav Mathur.

The prospect of further sales of hard currency meant investors were now reluctant to break the 88 level again, Mathur said.

Even so, both traders forecast the shilling could weaken further this week as routine end-month dollar demand from corporate clients kicked in and with the government widely seen to be struggling to contain militant attacks.

The Somali Islamist militant group al Shabaab said last week it was "shifting its war" onto Kenyan soil. Tourists have left in droves, and travel agencies report cancellations following travel warnings by Britain, the United States and others.

"It does help to see that the central bank is willing to intervene and intervene in a strong manner," said Mungai. "But security concerns and (dollar) demand will keep the shilling on the back foot."

In January, the Kenyan Treasury estimated the economy, the biggest in East Africa, would expand by 5.8 percent this year, after a 4.7 percent expansion last year. But the government delayed announcing its official forecast last month, saying it needed more time for consultations.

The shilling is expected to trade in a range of 87.80 and 88.20 in the coming sessions.

The central bank governor's comments had little impact on Nairobi's stock market, where the benchmark NSE-20 Share Index closed down 0.5 percent on Monday at 4,899.92 points. (Editing by Edmund Blair and Susan Fenton)

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