|Kenya’s economy: Infrastructure development and structural change to drive accelerated growth in the new decade|
|Written by Claire Furphy (1) Monday, 02 August 2010 08:09|
In July 2010, the World Bank launched its second Kenya Economic Update, the first being published at the end of 2009. The report, ‘Running on One Engine: Kenya’s Uneven Economic Performance,’(2) details the country’s strong recovery in 2010 after the economic shocks of the previous two years, while identifying the weak link in the economy, namely exports.
According to the World Bank, Kenya entered this decade with renewed momentum for strong and sustained growth. Economic growth in Kenya, East Africa’s biggest economy, is set to accelerate over the next two years as increased rainfall boosts farm output and stable power supplies help the manufacturing industry. However, failure to address the issue of declining exports may mitigate the momentum and contribute to the economy’s stagnation.
In addition to concerns over exports, most analysts agree the constitutional referendum, due to be decided on 4 August 2010, will affect the economy regardless of its outcome.(3) This discussion paper outlines the effects of the economic shocks and upcoming referendum on growth. In addition, a cursory glance at the World Bank’s analysis of the Kenyan economy in 2010, as well as the International Monetary Fund’s (IMF) suggestions for sustained growth in the future is taken.
The effects of the past economic shocks
In the past two years, Kenya’s economy has been hit by four consecutive economic shocks i.e. post-election violence, the global financial crisis, food and oil price increases, and lastly drought, causing a significant reduction in growth. Despite these economic shocks, the Kenyan economy reached a growth rate of 2.6% in 2009, exceeding average growth in sub-Saharan Africa for that year. Strong macroeconomic policies and Kenya’s relatively limited integration into the global economy shielded the country from the worst effects of the global economic downturn, apart from a steep decline in private capital flows, and subdued exports and tourism receipts.(4)
The domestic food crisis, resulting from the severe drought and compounded by weak governance and irregularities in the Government operated maize board, contributed to growth in the agriculture sector contracting by 2.4% in 2009, however. The drought also caused enduring electricity shortages, which negatively affected the manufacturing sector.
The poor were hit especially hard as average income dropped and the price of maize, Kenya’s staple food, rose to double world market levels. Fortunately, Government’s removal of maize tariffs in mid-2009 and increased maize imports saw a drop in the cost of maize, though it remained well above international prices. Favourable production in early 2010, after much welcome rain, has led to further decreases in maize prices.
While drought ravaged the country and caused declining growth in the agricultural sector, industry grew by 3.5% on the back of 14.1% growth in the construction sub-sector, which represents 4.2% of GDP. Growth in industry may have been impressive, but it is the services sector that continues to drive the Kenyan economy. Services grew by 4.2%, led by communications, transport and trade. Kenya’s tourism industry also rebounded strongly to approximately 1 million tourists in 2009. Domestic demand in these sectors grew at 4%, leading Kenya out of its economic crisis.
Despite gains made in 2009, Kenya's economic outlook is mixed. Not only are Kenya’s economic prospects tied to the fortunes of the global economic recovery, but most analysts also agree that the constitutional referendum, due to be decided on 4 August 2010, will affect the economy regardless of its outcome.(5) The proposed charter is the centrepiece of the deal signed to end the violence that followed the 2007 presidential election. Many traders and analysts expect markets to take enormous confidence from its peaceful passage into law.(6) On the other hand, certain observers claim that the adoption of a new constitution is now so widely anticipated that the market has already accounted for it, so its effect will be subdued.(7) The last time a decisive vote was taken on a proposed new constitution in 2005, the exercise was highly divisive, setting off a chain of political events, which ultimately led to the violence that erupted after the disputed elections in December 2007.(8) The post-election violence, in conjunction with the global financial crisis and drought, significantly set back growth.
Analysts and traders unanimously agree that poll violence is the worst outcome for Kenya's developing economy.(11) Following the post-election crisis in 2008, growth fell to a meagre 1.6% from 7.1% in 2007. Tourism was one of the hardest hit sectors: earnings fell 19.4%, after the best year in its history in 2007. Any new violence in Kenya will also negatively affect trade and transport with its land-locked neighbours, especially Rwanda and Uganda.
A positive outlook for 2010
The momentum provided by Kenya’s strong economic recovery in 2009 has been brought forward into this year. Kenyan President Mwai Kibaki reported that in 2009, a year of unprecedented economic difficulties for the country, Kenya had fared much better than had been expected and that it had emerged as a stronger nation.(12)
Together with the emerging recovery of the global economy, the recent rains, a relatively stable domestic environment and pro-active Government policies are giving rise to optimism that the Kenyan economy could grow by 4% in 2010 from the 2.6% in 2009 and 1.6% in 2008.(13) Accelerated growth is expected as growth of 5% is predicted for 2011. The 4% growth predicted for 2010 represents a robust recovery after the shocks the Kenyan economy experienced in the preceding two years.
The World Bank has shown that the recovery in 2010 has come on the back of developments in a wide range of sectors.(14) Due to strong rains in early 2010 agricultural output of various commodities, including the staples maize and beans, increased thus lowering prices. The reclamation of 2007 tourist numbers registered 18.9% growth in the first quarter of 2010, compared with the same time last year. After reaching 5.6% in the last quarter of 2009, inflation fell to 4.6% in 2010, while the interest rate of the standard Treasury bill (91 days) has declined to an average of 6.2%. Credit also grew by 20% in the first quarter. In addition, the fiscal position remained strong and the fiscal deficit is likely to be lower at 4-4.5%, more than 2% below the budget. Revenue has also grown by 11.7%.
Finally, the Nairobi Stock Exchange (NSE) index rebounded, due primarily to foreign investment, indicating improved confidence in Kenya’s market. The NSE reached close to 4300 points in May 2010, up from a low of 2500 points in February 2009. The NSE has moved in parallel with the Dow Jones since the beginning of the financial crisis, then outperforming the Dow Jones in early 2010.
This positive growth trend represents an important improvement on sluggish performance in previous years, not least for ordinary Kenyans whose incomes will increase by about 1.3%. However, the World Bank characterises Kenya’s economy as running on one engine.(15) Kenya’s weak engine remains its exports, which have been declining sharply. At independence, exports represented 40% of gross domestic product (GDP). By the mid-1980s, the export share had dropped to 20%, recovering to the present 27%.
In its report, the World Bank raised concerns that an infrastructure deficit constrains exports. The report focuses on the port of Mombasa, probably East Africa’s most important infrastructure asset, as exemplifying Kenya’s infrastructure deficit. Despite some improvements, port reforms have not kept up with the momentum achieved in other African countries. It still takes 20 days to bring a container from Mombasa to Nairobi, a longer period than it takes to ship the same container from Singapore to Mombasa. In addition, the overall volumes handled in Mombasa are low by international standards, representing only 2% of the volumes handled by Singapore. It is in these “soft areas”, where the port of Mombasa could make the biggest gains. To address deficits, the World Bank suggests the establishment of a “landlord port” and the enabling of full 24-hour port operations.
In addition to exports, the manufacturing sector presents great challenges for Kenya’s economy. Stagnating at around 11% of the economy, the sector has dropped from second to fourth place in economic importance over the last decade. While tradable sectors, such as agriculture and manufacturing have performed poorly, non-tradable sectors, such as services and construction, have fared better. In 2004, transport & telecommunications became Kenya’s second largest sector and in 2007, wholesale and retail trade surpassed manufacturing as a percentage of GDP.
The IMF also suggests that if the Government’s vision of accelerating economic growth in the medium-term and making Kenya a middle-income country by 2030 is to be kept on target, additional investment in infrastructure is required. In addition, strong implementation of structural reforms is crucial to achieving these aims.(16) Fiscal policy implementation would be enhanced by the enactment of the Public Finance Management Bill, which aims to revise the legal framework for public finance management to ensure appropriate budget execution, accounting, and internal audit. In addition, enactment of the Public-Private Partnership Bill would establish a sound framework for regulating operations and managing associated risks.
Financial sector stability and development would furthermore benefit from faster progress in addressing shortcomings in the supervisory and regulatory framework of both the banking system and the capital market. The IMF suggests that enactment of the Banking Act (Amendment) Bill will strengthen the Central Bank’s position by authorising consolidated supervision and prompt corrective action. Capital market depth and regulation would be further enhanced by the enactment of the Deposit Insurance, National Payment System, and Demutualisation of the Stock Exchange Bills.
Kenya registered a sterling economic performance in the five years to January 2008, which was brought to an abrupt end by controversy over the election result, the onset of global economic recession, increased food and fuel prices and severe drought. The strong gains made in 2009 and the predicted growth of a healthy 4% in 2010 is evidence of the resilience of the Kenyan economy.
If Kenya is to achieve accelerated growth in the future, the issue of declining exports must be addressed, however. This can be done primarily through infrastructure development, particularly in the port of Mombasa. In addition, structural changes concerning fiscal policy and faster progress in addressing shortcomings in the supervisory and regulatory framework of both the banking system and the capital market will further benefit growth.
On the whole, the outlook for Kenya’s economy remains positive. After two years of low growth, in 2010 most Kenyans will again experience improving living conditions, as Kenya remains unchallenged as the commercial and diplomatic hub of the wider east African region.
(1) Contact Claire Furphy through Consultancy Africa Intelligence's Eyes on Africa Unit (