Iran war tests the shilling as risk of costly imports rises

Before the war started on February 28, the shilling had traded in a tight band of Sh129.00 to Sh129.05 against the dollar — the most widely used currency in global transactions— for eight weeks.

This included a 19-day run at an unchanged rate of Sh129.02 between February 3 and February 27, which marked one of the longest periods of zero movement in the exchange rate in years.

In the past four weeks, however, the shilling has progressively weakened by small incremental margins to touch Sh129.89 on Friday, as per official rates published by the Central Bank of Kenya (CBK).

In the spot interbank market on Monday afternoon, the dollar was trading at Sh129.96, looking poised to break into the Sh130 level for the first time since August 2024.

The movement from the prolonged peg of Sh129.02, while not as pronounced when compared to other currencies globally, signals that the shilling is starting to feel the heat of the Middle East crisis, given the importance of the region to Kenya’s trade, energy imports, and remittance flows.

Higher oil prices present the most immediate risk for the currency, given that fuel is Kenya’s largest import item.

There is also the secondary effect of higher fuel prices on the cost of other imported goods (due to the transport cost factor), which would effectively widen Kenya’s current account deficit and pile pressure on the exchange rate.

“In the context of this war, one of the notable developments has been the strengthening of the dollar. As Kenya’s currency is effectively aligned to it, such an appreciation transmits directly into the Kenyan economy,” said the Institute of Economic Affairs (IEA), a think-tank, in a note on the ongoing Iran crisis.

“The consequence is twofold: exports risk diminished competitiveness in global markets while imports, particularly from the non-dollar countries, become comparatively less expensive.”

The think-tank added that in a scenario where the war lasts for up to two months, Kenya would likely see sustained fuel and electricity price increases, inflationary pressure, and shilling depreciation risk. Beyond two months, the country would start to experience fiscal pressure and reduced investor confidence, on top of the high food and fuel prices.

The war also poses a risk to the portion of Kenya’s diaspora remittances that come from the Middle East, which have risen in recent years thanks to a growing number of Kenyans taking up jobs in countries such as Saudi Arabia and the UAE.

Remittances are Kenya’s largest source of foreign exchange, helping keep the shilling stable by supplying the market with dollars to counter import and debt service-related outflows.

In the 12 months to February 2026, Kenyans in the Gulf countries of Saudi Arabia, the UAE, Qatar, Bahrain, Oman, and Iraq sent home a combined $491.76 million (Sh63.9 billion) in remittances, which accounted for 9.7 percent of the country’s total inflows of $5.051 billion (Sh656 billion) in the period.

Read: Kenya stares at new inflation pressure from Israel-Iran war

Saudi Arabia was the leading source of remittance dollars from the region at $271.68 million (Sh35.3 billion), followed by the UAE at $129.53 million (Sh16.82 billion).

Only the US at $2.7 billion (Sh351 billion) and the UK at $375.07 million (Sh48.7 billion) accounted for larger volumes than Saudi Arabia globally.

A decline in remittances, allied with a higher import bill, would likely see the demand for foreign currency begin to exceed supply, risking further depreciation of the shilling.

“In such circumstances, the CBK would be compelled to intervene in the foreign exchange market, selling reserves and purchasing shillings to sustain the prevailing exchange rate. This defence of the currency, while stabilising in intent, would necessarily entail a drawdown of foreign exchange reserves over time,” added the IEA.

Previous global shocks, such as the start of the Russia-Ukraine war in 2022, which caused an increase in inflation due to higher food import costs, or the Covid-19 pandemic in 2020 that dried up dollar earnings from tourism, also presented a test for the shilling.

As global inflation rose and the dollar strengthened in 2022 due to the Ukraine war, the CBK was reportedly selling dollars in the local market in order to protect the shilling from rapid weakening, draining its forex reserves in the process.

Ultimately, the official rate fell out of sync with the market rate, causing a dollar supply crisis as banks were reluctant to trade forex outside of the official rate out of fear of reprisals from the regulator.

To revive the interbank market, the CBK took the handbrake off the exchange rate from 2023, resulting in a weakening of the shilling to an all-time low of Sh161 to the dollar by February 2024.

This time round, the CBK has built up its forex reserves to record highs through a mix of market purchases and acquisition of proceeds of the government’s external dollar loans, giving it a stronger hand in dealing with any volatility that emerges from the Iran war without distorting the market. “Even as the dollar gains globally, we haven’t seen wide movement for the shilling, save for a minor wobble.

This speaks to the state of the local interbank market,” said Churchill Ogutu, an economist at IC Group (Mauritius).

Official forex reserves stood at $14 billion at the end of last week, enough to cover six months’ worth of imports, having doubled from $7.1 billion (Sh922.3 billion) or 3.8 months of cover in May 2024.

In addition to reviving the interbank market in 2024, the government also addressed the dollar demand side by entering into a government-to-government fuel import agreement with Saudi and UAE national oil companies.

Oil marketers used to raid the forex market for up to $500 million every month to fund import costs, but under the G2G deal, Kenya’s fuel imports are procured under a six-month credit cycle.

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