Evaluation of the responsiveness of the foreign exchange rate towards interventions by the Central Bank of Kenya

Abstract

The foreign exchange market was liberalized in Kenya so as to increase market efficiency, so that it would reflect all available information. However, with the high and persistent volatility in the market, the cost of doing business increased and thus it become necessary for the Central Bank of Kenya (CBK) to intervene in the foreign exchange market. Attempts by the CBK to intervene are either too little or too late with the monetary policy maintaining a “watch and see attitude” as it allows the market to distribute liquidity amongst itself and allow the rates to control its levels. This study sought to measure the level of volatility over the years and determine if the foreign exchange market volatility was responsive to the CBK intervention. The study used Primary data from guided interviews from 35 respondents from 4 of the tier one banks in the country and secondary data from the CBK weekly bulletins over a period of five years from January 2010 to December 2014. The research applied a GARCH model to measure the level of volatility of the foreign exchange market and a multiple regression model to measure the responsiveness of foreign exchange rate volatility to CBK intervention. The results revealed that the GARCH (1,1) value was negative over the years, showing the volatility fluctuations in the foreign exchange rate. Responsiveness of forex volatility and CBK intervention had a beta value of -1.003 for indirect intervention and -1.041 for direct intervention. This implied that the rates were more responsive to direct than indirect intervention. The study recommends that CBK should explore avenues to enhance capacities within the commercial banks for managing foreign currency risk exposure and assist the major stakeholders to understand what really causes the central bank of Kenya to intervene and the level of responsiveness so as to avoid speculation since it increases market volatility.