Kenya’s economy is on a tightrope this year. Policymakers have to walk a fine line between stabilising the economy and generating growth.
In recent months, inflation has declined and the fiscal position improved. This macro-economic stability gives hope for 2012 and 2013 and the World Bank projects that growth could reach five per cent.
With lower inflation, interest rates may also eventually fall, which would allow the exchange rate to return to more competitive levels and spur overall economic activity.
However, another oil price shock, poor harvest, contagion of the eurozone crisis or political instability could easily create renewed economic turbulence which might slow down economic growth to 4.1 per cent in 2012.
The recent stabilisation of the economy has been due to three main reasons. First, the government’s determined action to increase interest rates and cut back public spending sent the right signals to the market.
Second, the gradual decline in international food prices helped ease inflation in the domestic market. Third, Kenya’s service sector expanded strongly — with good results in tourism — which shored up economic growth to 4.4 per cent.
Looking ahead, Kenya’s macro-economic policies look favourable as debt levels have been reduced to below 47 per cent of GDP. If Kenya were part of the European Union, it would be one of its least indebted members.
But Kenya’s economy is still very vulnerable and is becoming increasingly unbalanced, raising concerns for medium-term economic prospects. There are three ways to demonstrate this.
First, export performance has been disappointing. Today, Kenya’s merchandise exports can only pay for 39 per cent of its imports, yet between 2002 and 2003, exports could pay for 64 per cent.
This is a significant decline in just eight years.
Second, the large and widening current account deficit means that Kenya is living beyond its means. Today, the country’s growth is mainly driven by consumption, which is driving demand for imports.
Domestic savings are too low and Kenya is largely dependent on international resources to finance investments. A change in global market sentiments could create a difficult situation.
For instance, if oil prices increase to $120 (Sh10,320) per barrel in 2012, the current account deficit could reach 15 per cent of GDP. This scenario would put the shilling under renewed pressure and trigger another series of macro-economic instability.
Third, the changing structure of production also reflects the increasing economic imbalances. Non-export sectors are growing much faster than export sectors.
To illustrate this point, we compare the performance of manufacturing and wholesale and retail trade. At the beginning of the decade, manufacturing contributed more to GDP than wholesale and retail trade, but by the close, a gradual change has taken place and trade now contributes more to GDP than manufacturing.
A similar pattern can be observed if we compare manufacturing with transport and communication. The structure of production shows that it is more profitable to invest in non-export sectors like real estate and construction, which are also driving the demand for imports.
Kenya needs to undertake reforms to re-balance the economy and establish the foundations for long-term growth. Tax and expenditure policies can be used to promote investment in the production of goods and services for export markets, which are also employment generating sectors.
It also requires incentives to increase domestic savings. Monetary policies alone are not sufficient to re-balance the economy. Complementary tax and expenditure changes would also be required.
The recent oil discovery in Turkana could help in re-balancing Kenya’s economy, but it could equally aggravate the challenges if the prospective revenues are not managed properly.
If commercially viable, Turkana oil will improve the country’s trade balance. In 2011, it spent $4.1 billion (Sh352.6 billion) on oil imports, equivalent to approximately 100,000 barrels per day.
For Kenya to become a net oil exporter, the resources in Turkana would need to be similar to those of Sudan or Chad.
However, for oil to catalyse development, it will have to overcome the special macro-economic and governance challenges associated with natural resources. Kenya can use the lead time to lay the right foundations for a successful oil economy.
Ms Kiringai is a senior economist while Mr Randa is an economist at the World Bank in Kenya.