Equilibrium Exchange Rate and an Assessment of the Currency Misalignment in Kenya 

This study estimated Kenya's equilibrium exchange rate and measured the misalignment gap using quarterly data covering the period 2009-2025. The analysis employed descriptive analysis and empirically estimated the long-run behavioural equilibrium exchange rate model using the autoregressive distributed lag model. The descriptive analysis revealed that Kenya's main trading partners account for about 60 percent of total trade and have remained largely the same over the study period. Despite Kenya's minimal trade with the United States of America, the US Dollar remained the main international invoicing currency and a key driver of the nominal effective exchange rate. The trend appreciation of the real effective exchange rate was attributed to a slowdown in the consumer price index during 2019-2022. The empirical model confirmed the existence of a long-run equilibrium relationship and the role of macroeconomic fundamentals in driving Kenya's exchange rate. The results showed that higher government expenditures, openness, and positive terms of trade led to a real depreciation, whereas net foreign assets and interest rate differentials caused a real appreciation. The study further revealed episodes of currency misalignment, which coincided with periods of external shocks and domestic policy shifts. In 2023, the misalignment gap was estimated at 11.3 percent, subsequently declining to 6.6 percent and 3.3 percent in 2024 and 2025, respectively. The study recommends a combination of short-run and long-run policy measures to address the currency misalignment. Monetary policy should be used in the short run to stabilize the exchange rate and strengthen the foreign exchange reserves, while in the medium to long-run, structural policies should aim at enhancing productivity, export capacity, and external competitiveness.