Effect of politics on Kenya’s economy

Arguably, an important factor that could hang over the shilling, and even the overall prospects for a new economic boom in Kenya, is politics.

One definition of an emerging market is one in which politics matters as much as economics, and Kenya does certainly seem to fit the bill in this respect. When talking about the importance of politics on the economy, there seem to be two distinct schools of thought.

On one hand is the argument that the importance of politics is overplayed in Kenya. Supporters of this viewpoint argue that although there was no explicit violence during the boom years of 2003-07, the political scene was still extremely tense, and corruption a problem, yet the economy grew rapidly.

We think this is very true up to a point and that the commercial sections of the Kenyan economy can continue to thrive even with the current political uncertainty (although this situation is probably not optimal).

Coming years

Many local businesses, as elsewhere in Africa, are able to distinguish between political hyperbole and reality and know how to effectively deal with weak governments.

Having said that, if Kenya was to undergo another major economic boom in the coming years, it is very hard to avoid entertaining the idea of some sort of political déjà vu in that, just at the peak of that potential boom in 2012, the economy is blown off course by a new political crisis as a result of the elections that are due in December of that year.

In this case, the argument would be that the government of national unity simply papered over much deeper political tensions in the country that could come to the surface once again in the febrile political atmosphere surrounding the poll.

The reality, of course, is usually somewhere between these two extremes, but much will depend on how the political scene plays out in the coming 12-18 months.

In particular, we see two key issues that have to be resolved. The first is probably the more straightforward, the passing of a new constitution. Having been approved by Parliament, this is due to go to a referendum initially scheduled to be held in August. At this stage, various opinion polls indicate that it will be approved by a considerable majority and, if passed, most political analysts would consider it a positive step forward.

The second contentious political issue to be resolved is how the proposed trial at the International Criminal Court (ICC) of leading politicians who were allegedly involved in the post-election violence in Kenya in early 2008 will play out. The ICC chief prosecutor is supposed to begin his formal investigation into the case in mid-2010, which implies that charges could be laid out in late 2010.

The ICC also has to decide at what point it will reveal the list of senior politicians implicated in the violence that it has been handed by Kofi Annan, the chief external mediator of the crisis.

A positive outcome to both these issues potentially points to a brighter political future for Kenya. Naming several high profile politicians to face trial at the ICC could clearly help break the culture of impunity for political actions that has existed in the country for decades.

In addition, a new constitution, and the fact that the incumbent president cannot stand for re-election, could further reduce political tensions and allow a closely contested poll in 2012, whose result will be more widely accepted than was the outcome of the 2007 election.

But a negative scenario cannot be ruled out. A prolonged trial of several high profile politicians at the ICC could spark a new round of political violence, which, even if only limited in nature, could lead to the storing up of a huge amount of political rancour. This could in turn spill over into wider and more disruptive violence around a closely contested election in late 2012.

Once again, in the middle of these two scenarios is a muddle-through one, where the constitution is passed and rising political tension spills over into sporadic acts of violence around the ICC trials.

This could continue up to the elections themselves, but the elections could still be held and, despite claims and counter claims of fraud and vote rigging, these are contained enough that the poll produces a result that is broadly acceptable. While clearly not an ideal outcome, we suspect that it would be widely accepted by most Kenyans and the international community.

Does this muddle-through outcome make any differences to our economic outlook? Clearly, outbreaks of violence would cast a cloud over the tourism industry. But the domestic engines of growth would likely remain strong and an outbreak of violence, especially if only temporary, would unlikely impact on the long-term investment plans of a Kenyan-based company.

More concern

But, perhaps of more concern is that if there are periodic outbreaks of violence this would impact on the shilling in an environment where the economic fundamentals underpinning the currency are a little more uncertain than in the 2003-07 boom on the external front.

In particular, they could impact more significantly on shorter-term capital flows into the country, such as the “errors and omissions” items, which are crucial to the financing of the current account deficit.

The implication of this more uncertain political period is that, even if the economy does enter a new boom driving a period of shilling appreciation, not only will the appreciation likely be weaker than in the last boom due to changed underlying economic fundamentals, but the volatility of the currency may be higher in what are more uncertain times on the political front.

Ironically, just as inflation starts to stabilise, it is possible that currency volatility becomes a much greater concern to the Central Bank.

David Cowan is currently a director at Citi and the economist responsible for the bank’s economic research on Africa (excluding South Africa)