Economics For Everyone| Why Kenya is flying on one engine through economic storm

How would you feel if, after a normal take-off, you noticed one of the engines on your plane was not working properly? What if you then found out the other engine was overheating?

Now suppose the captain announces that you should buckle-up because the plane is about to meet an approaching hurricane?

This is what Kenya’s economy is currently going through. Why has the shilling been falling so much and so unpredictably?

The main reason is that Kenya’s economy is increasingly imbalanced: the country is importing too much and exporting too little.

In 2011, imports have soared (mainly to due to higher oil and food costs), while exports remained stagnant. The gap between imports and exports, now stands at above 10 per cent of GDP — one of the highest in the world!

Today, Kenya’s main exports do not even earn enough to pay even for its oil imports.

The money to pay for any additional imports needs to come from somewhere.

The money will not come from manufacturing exports: that is Kenya’s weak engine. Manufacturing stagnated a long time ago.

Ten years ago, manufacturing accounted for 11 per cent of this economy — and it is the same today, despite a decline in the share of agriculture from 30 per cent to 25 per cent.

Kenya’s growth has been in services, particularly transport and telecommunications, reflecting the resurgence of Kenya Airways and Kenya’s telecom revolution.

If you import a lot, you need enough dollars to pay for these imports. Ideally, exports will give you everything you need. When exports are not enough — which is the situation in Kenya today — the gap needs to be filled through other financial inflows such as remittances, private investment, and support from development partners.

Over the last six months, the share of short-term flows has increased substantially. This “footloose capital” makes Kenya even more vulnerable to shocks.

It often just takes a single event — even if it is completely unrelated to Kenya — to prompt these short-term flows to leave the country as quickly as they came in. This is Kenya’s overheating engine.

A weakening shilling is not necessarily bad for Kenya’s economy. It can help to rebalance Kenya’s economy in the medium term, by making imports more expensive and exports more competitive, thus adding to export earnings.

Unfortunately, high inflation has been eating away some of the benefits that it would get from a weaker exchange rate, thus creating additional pressure on the shilling.

If investors think their money will lose its value in Kenya very quickly — which happens when inflation is high — they tend to move it to countries where it will hold its value over the medium-term.

If policymakers are not careful, Kenya could well end up in a vicious cycle, where high food and fuel prices lead to higher inflation, which in turn weakens the exchange rate, which raises the cost of imports, which further increases inflation.

Even if international food and fuel prices decline — which they did since August — inflation can still go up: indeed, it reached a new peak at 17.3 per cent in September.

The economic storm which was already brewing in the first half of 2011 has now reached full force. The turbulence in Egypt meant fewer tea exports to one of Kenya’s main markets. The subsequent struggle in Libya increased global oil prices and the import bill.

Now, the next storm is approaching and it could become a hurricane, not just for Kenya: the Euro crisis and the apparent helplessness of European policymakers to deal with it.

Two of Kenya’s key exports and foreign exchange earners, tourism and horticulture, still depend largely on European markets. Flowers and vacations are luxury goods, and are among the first purchases that Europeans will cut-off if they go into a full-fledged economic crisis.

What should the pilot do if one engine is failing, the other one is overheating, and a hurricane is approaching?

Here’s what not to do: adopting strategies that have not worked in the past, such as adopting price controls or establishing parallel currency markets. They have been disastrous in many countries.

If I were in that plane, I would want the pilot to bring it down quickly and safely. While on the ground, the engines could be repaired, as the hurricane passes by; it will take you longer to get home, but you will live to reunite with your family.

Measures to get Kenya’s “economic plane” safely on ground include that taken by the Central Bank last week when it increased benchmark interest rates from seven to 11 per cent.

This can contribute to controlling inflation and the next weeks will tell if this measure was sufficient. The risk is that it will also cool the economy. While unpopular, such measures are needed to re-establish Kenya’s macroeconomic credibility in the medium-term.

This is the price to pay in order to retain investments and avoid a crash.

Wolfgang Fengler is the World Bank Lead Economist for Kenya, Rwanda, Somalia and Eritrea.

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About this column: The world’s economic geography is changing rapidly and profoundly. We are witnessing a tectonic shift of economic power from West to East and from North to South. Developing countries are increasingly driving global economic development and Africa is now part of this momentum.

Marcelo Giugale, World Bank Director for Poverty Reduction and Economic Management in Africa, and Wolfgang Fengler, World Bank Lead Economist for Kenya, Rwanda, Somalia and Eritrea share their thoughts on development issues and their impact on Kenya and beyond. Their blogs at Huffington Post and the World Bank’s Africa Can will also feature in these columns.