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Opinion & Analysis

Kenyan economy headed for uncertain times

So, how should we expect domestic interest rates to behave now that the Federal Reserve has hiked interest rates in the United States?

For almost a decade, the Americans have kept interest rates at almost zero as they battled with recession. It all played to the advantage of people in the developing world.

Indeed, low interest rates in the US are why we have experienced an exponential surge in capital flows to countries like ours in recent years.

Kenya has been a big recipient of these portfolio flows, exemplified by the domination of foreign investors trading in both equities and fixed- income securities.

There have been interesting trends witnessed during this period of low interest rates in the United States. For instance, we have seen mutual funds, insurance companies and pension funds taking over from banks as the main cross-border investors.

There has also been a flip side. The new portfolio investors trooping into the developing world to take advantage of high interest rates in these countries have tended to  be footloose and edgy types – investors who are more sensitive to bad news.

The bear run we suffered in the middle of this year was largely as a consequence of an exodus by portfolio investors reacting to uncertainties around implementation of the Capital Gains Tax.

Clearly, one of the most enduring consequences in the surge in capital flows into emerging markets during the period of  low interest rates in the United States has been extreme market volatility.

The questions, therefore, are the following: should we expect to see an exodus by portfolio investors out of our markets?

What must developing countries do to mitigate a likely stampede of these footloose investors out of our markets?

And, do these developments pose risks to our commercial banks and capital market institutions?

Methinks that the exodus of portfolio investors might not happen. Economies that are well-managed and which have strong fundamentals will be spared.

But is Kenya a well-managed economy? Are our fundamentals strong?  Without a doubt, ours is a very resilient economy as we saw during the 2008 international financial crises. Our economy has proved capable of surviving worse international market conditions.

In any event, if you look at recent movements in prices – interest rates and the exchange rate – it would appear that the domestic market here had long anticipated the rise in the Fed Rate and have been gradually adjusting to be able to accommodate conditions of high interest rates in America.

Although opinion is almost unanimous that the local currency will face some pressure, a steep fall is not expected.

And even though interest rates are expected to start trending upwards, most pundits believe that a sharp rise to crisis levels witnessed recently when the Treasury Bill hit 23 per cent is unlikely.

Still, and the truth be told, the macro- fundamentals clearly indicate that we are headed for uncertain times.

Our external position has weakened, with the deficit in our balance of payments current account worsening by 22.7 per cent to $5,992 million in the year to May 2015 from a deficit of $4,882 million in the year to May 2014.

As a share to GDP, the current account deficit in government finances amounted to 9.8 per cent from 8.9 per cent over the same period. The deficit in the government’s books is at 9.4 per cent of GDP, the largest in years.

Gross public debt is at 47.9 per cent of GDP. Worse still, revenue collection is below target. Clearly, recent attempts to talk up the economy fly in the face of some rather stubborn economic indicators.

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