The Ticking Time Bomb – Is Kenya at the Brink of Stagflation?

July 27, 2023 0

Kenya’s economy has been on a roller coaster in recent years, recovering from multiple crises since 2013. In 2022, GDP growth softened to 4.8% from the previous year’s strong rebound of 7.5%, but remained in line with the country’s long-term growth trajectory according to a report by the World Bank.

The service sector was a key driver of growth, contributing around 80% of the increase in total GDP. The financial services, tourism, and transport sectors performed particularly well, helping Kenya’s GDP growth to outpace that of Sub-Saharan Africa as a whole.

However, despite strong headline GDP growth, Kenya has continuously faced significant inflationary pressures amid commodity price volatility and tightening global financing conditions. The country’s exchange rate and foreign exchange reserves have been under pressure, exacerbated by the worst drought in four decades.

To address these challenges, macroeconomic policies were implemented in 2022, including greater exchange rate flexibility, fiscal consolidation, and a tighter monetary policy. Fiscal consolidation efforts, aimed at addressing mounting debt sustainability challenges, continued in 2022, contributing to the reduction of external and domestic imbalances.

The 2023 medium-term growth outlook for Kenya remains positive, with the economy expected to grow at around 5% in line with its pre-pandemic trend and estimated potential GDP growth rate. Real per capita incomes are projected to grow at approximately 3% in the medium term, and there are positive signs of poverty resuming its pre-pandemic downward trend.

However, the economic outlook is not without risks. Externally, Kenya is exposed to potential weaker growth in Europe, elevated global commodity prices that can increase the country’s import bill and inflation, and further tightening of financial conditions in advanced economies. Domestically, spending pressures to reduce the high cost of living and potential slowdowns in tax revenue collection pose additional challenges.

The intensifying global food crisis is taking a toll on Kenya’s economy, contributing to the surge in food price inflation both locally and internationally. This trend has been further exacerbated by the post-pandemic and Russia-Ukraine war-related shocks and trade frictions.

Kenyan supermarkets and food traders have raised prices of basic commodities due to increased taxes, shortages of essential items and increased costs of energy. Farmers are also feeling the pressure, grappling with unpredictable weather patterns, high input costs, and labor shortages. Many have been forced to exit the industry, which may lead to a drop in production this year.

The Kenyan government faces the daunting task of stabilizing the economy and mitigating the impact of rising food prices. The Finance Bill, 2023, has been passed to expand the tax base and raise revenues to meet the government’s ambitious budget for 2023/2024. However, critics argue that short-term reforms may not be enough to address the deeper complexities of Kenya’s food system and economic challenges.

As Kenya’s economy faces a myriad of challenges, concerns are rising about the possibility of stagflation. This dreaded economic condition is characterized by high inflation and low economic growth, and it can lead to a host of problems, including increased poverty, unemployment, and political instability.

There are a number of factors that could potentially push Kenya towards stagflation, with the most significant being the ongoing global food crisis, which was triggered by post-pandemic shocks and the war in Ukraine. Both factors have greatly contributed to the soaring global food prices, putting immense strain on Kenyan consumers and businesses alike. As a nation heavily reliant on food imports, Kenya has been particularly vulnerable to the ripple effects of these crises.

Not to mention the severe drought that has been experienced in some parts of the country, which has hampered agricultural production and led to food scarcity, driving up food prices further. For a nation where a significant portion of the population relies on agriculture for their livelihoods, the drought’s impact has been deeply felt, threatening both the economy and people’s well-being.

Kenya’s large fiscal deficit has also been a major contributing issue, resulting to increased international borrowing and inflationary pressures due to the government’s revenue shortfall compared to its expenditures. The mounting fiscal deficit has put immense pressure on the country’s currency, making it challenging to control inflation effectively.

The risk of stagflation is imminent for Kenya and the consequences could be devastating if no practical and impactful short-term and long-term economic reforms and policies are implemented. The already fragile economy could witness a decline in living standards as prices rise while economic growth stagnates. The country is already facing a surge in unemployment as businesses struggle to cope with rising costs, and this has led to job losses and increased hardship for many citizens. Stagflation has the potential to fuel political unrest, already being witnessed in Kenya by the anti-government demonstrations as people become frustrated with the government’s inability to address the economic challenges effectively.

While Kenya has not yet entered stagflation, it is crucial for the government to take immediate and proactive measures to avert such a scenario. Addressing the challenges of the rising global food crisis and the drought requires targeted support for the agricultural sector. Increasing food production and stabilizing prices can alleviate the pressure on the overall economy.

To tackle the fiscal deficit, the government must find ways to reduce spending responsibly. By prioritizing critical investments and optimizing public expenditures, it can gradually narrow the deficit and avoid further inflationary pressures.

By carefully managing interest rates, the Central Bank of Kenya (CBK) can help temper inflation while ensuring that the economy retains a conducive environment for growth.

The risk of stagflation is a serious one for Kenya, but it is not inevitable. The nation’s vulnerability to external and internal shocks necessitates comprehensive and multi-faceted approach, as well as proactive and decisive action to address the root causes of the country’s economic challenges, including inflation, food shortages, and high production costs. The government must work in unison with stakeholders to address the root causes of these challenges, ensure food security, and pursue prudent fiscal and monetary policies.

Being an agricultural powerhouse in the region, Kenya has a significant role to play in global efforts to decarbonize economies, while ensuring an inclusive approach that supports both development and productivity growth. By taking urgent steps to bolster the economy’s resilience, Kenya can navigate through these challenging times and secure a more stable and prosperous future for its people and agricultural sector.

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