Shortly after Kenya’s 2022 elections, the shilling depreciated rapidly against the US dollar – the country’s main currency for international transactions – fuelling a wave of political discontent.

More than a year later, the Central Bank of Kenya (CBK), taking its cue from the International Monetary Fund (IMF), said that the run on the shilling was a market correction for a currency that had been overvalued by between 20 percent and 25 percent.

By early this year, the shilling recovered. Finance scholar Odongo Kodongo answers our questions about Kenya’s exchange rate fluctuations.

How is the shilling’s exchange rates determined?

Kenya operates a floating exchange rate regime. This means that the value of the shilling is, in principle, determined by market demand and supply. Market demand and supply are affected by movements of money across national borders.

Movements of money into the country are driven by forces such as the value of exports and transfers from abroad (such as diaspora remittances), and the value of investments from abroad.

For example, if Kenya exports more goods at higher prices, this increases the shilling’s demand as Kenyan exporters convert their dollar receipts to shillings. The shilling appreciates, all else equal.

On the supply side are the value of imports and outbound transfers (like pensions of retired expatriates), and the value of investments abroad. For example, to buy shares abroad, Kenyans must sell shillings to buy foreign currencies. This increases the shilling’s supply, causing it to depreciate, all else equal.