We engaged in too much conspicuous consumption and we must pay for it

Delegates from the International Monetary Fund are still in town holding discussions with the government.

The outcome of these discussions is eagerly awaited by financial markets.

It will provide a new roadmap on the likely movement of the shilling against the dollar in the medium term.

I gather that the discussion has so far focused on strengthening the conduct of monetary policy.

The suggestion on the table is how to back and interlock the Central Bank Rate with the open market operations, with the pumping in of liquidity through issuance of Repurchase Agreements (Repos), or the sucking out of liquidity through reverse Repos.

If the suggestion is taken up, the implication will be that whenever the Central Bank goes to the market to mop up liquidity, the price will more or less be pegged to the Central Bank Rate.

The intention is to make monetary policy transmit better. Until now, monetary policy has not been effective because the Central Bank Rate is only a signalling tool, which commercial banks can choose to ignore.

What is going to be more significant is whether the IMF will release additional resources in balance of payments support.

This would send a very powerful signal to the markets. What have we learnt from the shilling crisis? Whichever way you look at it, it has exposed the dire state of the fundamentals in this economy.

In retrospect, what has kept the economy going for the last 10 years is government borrowing, mainly financed by large budget deficits approaching 8 per cent of the GDP.

We borrowed heavily and spent it on building roads, expanding ports and airports, digging geothermal wells, building new rural electrification networks and rehabilitating power transmission systems.

Over time, we tilted the budget towards giving more money to the development budget. We all became Keynesian.

The policy of borrow and spend was to culminate in the move by Finance Minister Uhuru Kenyatta coming up with an economic stimulus package in 2009 when he provided Sh22 billion in small grants for building roads, health and education facilities in each parliamentary constituency.

Never before has this country thrown so much money into building and rehabilitating roads. We have learnt that when you spend money on infrastructure, the economy grows.

That is how years of sluggish growth under former President Moi were immediately transformed into years of buoyant growth under President Kibaki.

The policies we practised had a major downside, however. The buoyant GDP growth figures we were posting year in year out came with a steady rise in a balance of payments deficit.

When you spend big money on infrastructure, your imports also go up. You have to bring in hundreds of thousands of tons of steel and equipment as you build physical infrastructure.

For instance, the Chinese working on Thika Road have been importing even cement all the way from Shanghai. Kenya consistently imported more to fund its impressive growth figures.

And, the economy became too dependent on foreign capital. The current account deficit rose sharply. The rise of this deficit to double digits should have warned us that the impressive growth figures we were posting were not sustainable.

It was until the shilling crisis struck that the phoney nature of the impressive statistics became stark.

Without doubt, commercial banks will always try to exploit financial turmoil to make money and to protect themselves from losses, but the structural problems which put the shilling under pressure were not created by the banks. They were merely scapegoats.

Where are we right now? In the medium term, the emphasis will have to be put on controlling inflation and stabilising the currency.

For a long time, relatively low interest rates and high state spending kept the economy growing even if the underlying growth remained weak. The era of low interest rates is gone.

We have been forced to shift gears. The idea of aggressively pursuing growth must give way in the medium-term as the country seeks more sustainable ways to generate wealth.

We are paying the price of not restructuring our economy away from conspicuous consumption.

jkisero@ke.nationmedia.com