Determinants of the Kenyan Shilling Exchange Rate Movement against the Chinese Yuan

Abstract

The general objective of this study was to analyze the determinants of exchange rate of the Kenyan shillings against Chinese Yuan. The research was guided by the following specific objectives: To determine the effect of interest rate on the exchange rate of the Kenyan Shilling against Chinese Yuan; To establish the effect of inflation on the exchange rate of the Kenyan Shilling against Chinese Yuan and to find out the effect of external public debt on the exchange rate of the Kenyan Shilling against Chinese Yuan. The study used both descriptive and explanatory research design and applied regression analysis to establish the effects of interest rates, inflation rates and external debt on the exchange rates. The study variables were interest rates, inflation rates, external debt and exchange rates and census sampling was applied. Data was obtained from the Central Bank of Kenya for a period of 12 years from 2007-2018. Exchange rate was calculated as an annual average based on monthly averages, monthly central bank lending rate was the measure of interest rate, Inflation rate was measured by use of the percentage change in consumer price index and external debt was measured as a percent of the GDP. The results of the first objective investigating the effect of interest rate on the exchange rate of the Kenyan Shilling against Chinese Yuan, revealed that the average annual Interest rates have been fluctuating throughout the study period, reaching highest annual average rate of 15.75% in 2012 and lowest annual average of 6.42% in 2010. The highest annual average increase of Interest rate was 7.35% which was recorded between 2011 to 2012. Correlation test results indicated a positive significant relationship between interest rate and the exchange rate at (p=0.006, r=0.229). The regression analysis further indicated that increasing interest rate by one unit; exchange rate will increase by 0.170. The second objective investigating the effect of inflation rate on the exchange rate of the Kenyan Shilling against Chinese Yuan, showed that Inflation rates have been fluctuating with the highest annual average inflation rate was recorded in 2012 at14.27%, and lowest in 2007 at 4.765%. Correlation test results indicated a negative relationship between inflation rate and the exchange rate but was not significant at (p=0.098, r=-0.138). The regression analysis further indicated that increasing inflation rate by one unit, negatively affects exchange rate by 0.055 units though the effect is was not significant. The third objective investigating the effect of external public debt on the exchange rate of the Kenyan Shilling against Chinese Yuan, revealed that the trend of external debt was fluctuating with the highest annual average external debt recorded in 2018 at 55.9% of the GDP, and lowest in 2010 at 18.2% of the GDP. Correlation test results indicated a significant positive relationship between external debt and the exchange at (p=0.098, r=-0.138).This was in agreement with regression analysis which supported that increasing external debt by one unit, exchange rate will increase by 0.086. Regression analysis further indicated that all the independent variables affects 27.6% of the exchange rate. The study concluded that interest rate and external debt have a significant effect on exchange rate of Kenya shilling against Chinese Yuan. However inflation rate had no significant effect on exchange rate. The study recommends that the government to maintain lending interest rate in order to prevent the depreciation of the exchange rate, the government to implement suitable policies to control and manage inflation rates to prevent its negative effects on foreign exchange rate as indicated in other studies and finally the government to pursue policies that encourage increase in borrowing to prevent depreciation of exchange rate.