Global bank Citi expects renewed pressure on the Kenyan shilling as higher fuel prices create a wider current account deficit in the wake of the Iran war.

The global lender sees the new Middle East crisis as a test for the Central Bank of Kenya (CBK) which is tasked with minimizing extreme volatility on the exchange rate system as part of its policy.

Citi has suggested that the apex bank could allow the shilling to weaken as a shock absorber to the Iran crisis, a move which could cushion Kenyan exports by making local goods cheaper in international markets at a time when demand could be weakened as global growth slumps.

The Kenya shilling has remained stable despite heightened geopolitical risks with the CBK attributing the continued strength of the local unit to diversified foreign exchange inflows, increased coincidence in the economy and adequate foreign exchange reserves.

“Theoretically, when 25 percent of your import bill is oil, your current account is going to widen, and you are going to have to see some pressure on your currency. This is going to be a big test,” said David Cowan, Citi’s Chief African Economist.

Kenya’s current account balance which measures a country’s net trade in goods, services and earnings in addition to net transfer payments with the rest of the world worsened through February on account of a wider trade deficit where imports had grown faster than exports.

CBK has projected a wider current account deficit in 2026 at three percent of GDP in contrast to an estimate of 2.4 percent due to the impact of the conflict in the Middle East. A slower growth in remittance flows especially from Gulf Countries has also been blamed for the expected deterioration of the current account balance.

“The projected wider current account deficit in 2026 reflects the direct impact of the US-Israel-Iran war on the goods balance via commodity prices, supply chain disruptions and reduced global demand and a higher oil import bill due to higher oil prices,” CBK said.

CBK quoted the Kenya shilling at Sh129.04 against the US dollar at the close of trading last week as the exchange rate kept within the long-established narrow-bound trading range of Sh129 to Sh130.

Citi Bank says the local unit appears to have found its level as the economy demonstrates the wide availability of hard currency, reversing an FX crunch seen in 2023 and early 2024 but argues it’s difficult to establish whether the developments represent an economic equilibrium.

“I think it’s quite difficult to understand where the Kenya shilling lies, but the reality is that on the ground in Nairobi, at this point, there are no FX shortages and there is ample liquidity in the FX market,” added Mr. Cowan.

“I however don’t think there are many gains to an African government allowing a large currency appreciation. I understand that there is a sentiment logic that you might want to shock the market somehow and show that an African currency is not a permanent depreciation bet, but I still wouldn’t have allowed it (the Kenya shilling) to come back to 130.”

The Kenya shilling hit a low Sh160.75 against the US dollar at the height of the FX crunch on January 30, 2024, when investor jitters on a potential sovereign default were at their peak.

The shilling would rally from mid-February 2024 after the CBK undertook an early buyback of Sh258 billion ($2 billion) Eurobond notes whose maturity in June of the same year had caused investor concerns.