An economic snapshot on Kenya by Charles Robertson, Global Chief
Economist at Renaissance Capital…………………………………..
Kenya’s economic experience in 2011 is worth watching in the context
of larger peers such as Turkey and India. In all three countries,
currencies have come under great weakening pressure. In all three,
inflation has risen strongly.
In all three, the central banks suffered criticism. But only in Kenya has policy changed so dramatically that
2012 is likely to be a quite different story.
What do Turkey, India and Kenya share? First, a dependency on energy
imports. The Arab spring pushed oil prices to an average near $110 in
2011 and this has benefited some like Russia, Nigeria and Angola, but
caused considerable economic pain to those who import oil. Second,
food prices have been volatile and this has particularly hurt Kenya
due to the poor rains in 2011.
Third, low interest rates as each
country exited the 2008-09 crisis, has encouraged very high credit
growth in each of the three. This proved to be something which central
banks were reluctant to crush. High credit growth can help drive
economic growth, push up government budget revenues, reduce the budget
deficit, and generally make life better.
Unfortunately, it can also
lead to excessive spending on imported goods, a widening gap in what
Kenya (or India or Turkey) buys from abroad and what it can sell
abroad, and a rises in asset prices that become hard to justify over
the medium to long-term. Eventually that puts currencies under great
pressure to weaken.
Each country has taken a different response to these pressures. India
started a cycle of gradually raising interest rates through 2010-11
which has only just ended. The process was too slow to please the
market and the Indian rupee has recently hit extremely weak levels.
In Turkey the central bank was reluctant to raise interest rates at
all, and has now embarked on a policy of very wide interest rate bands
(from 5.75-12.5% at the time of writing) in a bid to stop currency
depreciation whilst not killing growth. Again the market has not been
impressed, and the currency has been under great pressure.
Kenya has taken a different stance. A brave change of heart in October
2011 saw interest rates soar. This has had a radical effect on the
currency. From extreme weakness, the KES has strengthened
dramatically. What will happen in 2012 as a result? First, inflation
will be brought back under control. Second, credit growth will slow
sharply. Import growth should slow. In addition we expect oil prices
to weaken in early 2012 which should reduce the import bill too. The
gap between exports and imports, “the current account deficit”, should
shrink, which will help the KES stay strong if that’s needed.
From large rises in asset prices such as land, we might start to fear
falls in 2012, and growth may slow to 4% with risks of something lower
still.
The question for the central bank now is when they should cut rates?
In our view, the currency is now too strong. Kenya needs to build a
broader more competitive export economy and the experience of many
countries suggests that weaker currencies (eg closer to 100/$) rather
than overly strong currencies (eg 85/$) help most. A sharp slowdown in
the economy can also scare the markets, as India is now demonstrating.
Cuts in rates in 2012 if they are early enough and done at a measured
pace should allow the central bank to manage the currency, while
experiencing the benefits of low inflation, a better current account
position, without risking a crash in GDP.
It will not be an easy process to manage. Externally the global
economy is not in great shape. The Eurozone crisis may ease in coming
months (at least we hope so), but there are now fears of a hard
landing in China. Kenya cannot rely on foreign demand to help its
economy in 2012. Also Kenya like many emerging markets has a high
dependence on the weather being well behaved to ensure food price
stability. But the central bank has given itself credibility and we
believe it can manage the difficult challenges of 2012.