The Relationship between Inflation and Exchange Rate of Kenya Shilling

Inflation and Exchange Rate of Kenya Shilling

When a country maintains low inflation rates for a particular period, its currency’s value increases. Therefore, the purchasing power will also experience a rising trend compared to other currencies. In fact, the real exchange rate, in this aspect, is related to the purchasing power. On the other hand, countries with high inflation experience depreciation of their currency compared to their trading partners (Duarte & Stockman, 2002). For instance, Kenya has experienced higher inflation rates in the recent past, a situation that has weakened the currency against the U.S. dollar.

In Kenya, exchange rates are determined by the demand and supply of U.S currency. Therefore, the exchange rate between Kenya and U.S is influenced by interest and inflation rates. Because of the rising inflation rate in Kenya, the currency rate goes down, and the purchasing power of the Kenya shilling decreases as compared to the U.S. dollar (Otuori, 2013). If the currency is overvalued, its rate of exchange is high relative to other countries’ prices. When the currency is undervalued, the exchange rates are low compared with other currencies. Therefore, as the Kenya shilling loses its value, the U.S dollar gains, a situation that affects the exchange rate between the two currencies. In that context, the rate becomes high for Kenyan shilling relative to the U.S dollar.

During the period 2007-2011, Kenya witnessed high inflation rate. According to World Bank (2012), the exchange rates have been fluctuating; for instance, in 2007, the dollar was at 63.3, 78.0 in 2008, in 2009 it stood at 75.4, in 2010, it was 80.6, and in 2011, it was 80.6. The current exchange rate is above a hundred shillings for every U.S dollar. Several factors, including inflation, trigger those fluctuations. Although monetary (inflation and interest rate policies) and exchange rate policies are the strategic tools in management and the stabilization of the economy, the aspect of low international effectiveness and low inflation are the main policy targets.