(Bloomberg) -- A change in approach by Kenya’s central bank is helping revive the nation’s interbank currency market, the head of the nation’s largest lender said.

President William Ruto signaled last week that the central bank and commercial lenders are working to remove distortions in the interbank market that have exacerbated a shortage of foreign exchange in East Africa’s largest economy. Currency trading between Kenyan banks dwindled in recent years because of central bank pressure on commercial lenders to prevent the shilling from weakening too quickly.

The interbank market “failed to work because we were not working together,” Equity Group Holdings Plc Chief Executive Officer James Mwangi told reporters Tuesday in the capital, Nairobi. “The central bank initiative now is to bridge the gap between the two. We are working together. We have seen early signs that the market is starting to function.”

The improved functioning of the interbank market has coincided with an accelerated weakening in the Kenyan shilling, which is on course for its biggest monthly decline since the coronavirus outbreak was declared a global pandemic in March 2020. The currency has depreciated every month since June 2021 amid diminishing foreign-exchange reserves, a deteriorating balance of payments, and rising global interest rates that have raised the cost of debt servicing.

Last week, the central bank issued a foreign-exchange code that outlines standards for commercial banks and seeks to strengthen the functioning of the interbank market. The rules draw on the Global Foreign Exchange Code and reinforce principles including governance, along with the execution of transactions and compliance, according to the Kenya Bankers Association, an industry lobby group.

“The implementation of this code is expected to restore market trust and enhance the functioning of the foreign-exchange market, support the country’s flexible exchange rate regime in keeping with its true price discovery principle, and deliver other attendant benefits to the overall economy,” it said in a statement.

New Governor

The announcement of the code came two weeks after Kenyan lawmakers approved Susan Jemtai Koech’s appointment as deputy governor of the central bank. Koech is likely to serve as acting governor of the bank when current Governor Patrick Njoroge and his sole deputy, Sheila M’Mbijjewe, step down in June.

At her confirmation hearing, Koech called for a more vibrant interbank market to encourage the free flow of foreign currency.

Read: Kenya MPs Back New Central Bank Deputy Before Leadership Change

Demand for dollars by Kenyan importers has increased because of higher global prices of goods such as fuel, cooking oil and wheat caused by Russia’s war with Ukraine. At the same time, there’s been reduced supply of foreign currency from Kenyans living abroad, along with less farm exports and tourism.

The efforts by the central bank to improve the market’s functionality are expected to alleviate the shortage of foreign exchange in Kenya, International Monetary Fund Country Representative Tobias Rasmussen said in emailed response to questions.

“Dedicated efforts to reactivate efficient functioning and price discovery in the interbank forex market should help address reported pressures in sourcing foreign exchange,” he said.

Price Discovery

Kenyan manufacturers who import raw materials are already finding it easier to access foreign currency with the central bank “relaunching the functioning” of the market, Kenya Association of Manufacturers Chairman Rajan Shah said in a phone interview. “The interbank market has improved in the last week, there has been some flow and we’re seeing better price discovery.”

In an effort to ease pressure on the currency, Ruto’s administration is also implementing a plan to nationalize fuel imports. It’s striking deals with state-owned suppliers like Saudi Aramco and the Abu Dhabi National Oil Co. which will enable the Kenyan government to defer payments by at least six months. 

Read: Saudi Aramco, ENOC, Adnoc Win Kenya Fuel-Supply Tenders

Still, the nation’s widening current-account deficit and declining reserves mean the currency is likely to continue weakening, according to Nairobi-based brokerage Genghis Capital, which expects the shilling to trade as low as 161.40 per dollar by year-end.

The Central Bank of Kenya said it would respond to a request for comment at a briefing March 30 after its next monetary policy committee meeting. The bank is expected to announce a 25 basis-point increase in the benchmark rate to 9% on Wednesday, according to a Bloomberg survey of six economists.

--With assistance from Eric Ombok and Robert Brand.

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