About a quarter of Kenya’s exports are at risk this year, and could lead to limited flows of hard currency as many analysts and multilateral donors say that the eurozone economy will contract by at least 0.5 per cent.
Data show that many European economies have begun to contract or decline in the fourth quarter of last year and some institutions such as Citigroup are predicting this decline might go as far as 1.2 per cent for this year.
Already Britain saw its GDP decline by 0.2 per cent in the fourth quarter of 2011 while Spain shrank by 0.3 per cent in the same quarter. The economy of the Netherlands – a major buyer of Kenya’s cut flowers – began its decline in the third quarter of last year when it shrank by 0.2 per cent.
The International Monetary Fund (IMF) predicts that European economy will shrink by 0.5 per cent and has already predicted that as a result the Chinese Gross Domestic Product, on which many African economies are increasingly depending for commodity exports, will itself go down by four percentage points.
Christoph Evard, investment manager for Nairobi-based regional office for German development and financial organisations KfW/DEG, said that “the immediate impact on Kenya will be “less demand for its exports and overall lower commodity prices as European recession or even a Euro breakup will have material adverse effects on the world economy.”
Mr Evard said the key issue is that “too much austerity [as is being pursued by a number of countries] will lead to higher unemployment and risks choking off economic recovery. There is a real risk of a vicious circle and a self-fulfilling prophecy, leading to the insolvency of some European countries.”
The gloomy predictions for the European economies are being made against the possible escalation of the sovereign debt crisis in the region that has traditionally been a major buyer of African commodities.
Because of the significant trading values, the slowing European growth is a major issue for the Kenya shilling that saw its value swing at values between Sh81 to the dollar and Sh107 in the last 13 months.
Though top bank executives have recently waxed optimistic about the Kenya shilling in a Central Bank of Kenya (CBK) survey, they said the European sovereign debt crisis remained a key risk factor.
As chairman of the Monetary Policy Committee, CBK governor Njuguna Ndung’u has noted the risks posed by the European crisis for the Kenya shilling and the economy. He betrays the fact that monetary authorities are painfully aware of what the retreat into the hard currencies – including the dollar and gold – is likely to have on frontier and emerging market currencies.
Mr Evard noted that Europe is currently performing a delicate balancing act to re-stabilise the region. The focus is now on countries whose sovereign debt has become increasingly unsustainable while the private banking entities are facing chances of their capital being eroded by a haircut on bonds they took from Greece in the days the country was on a spending spree.
And there is the whole question of economic and political governance of the European Monetary Union to ensure that members adhere to the agreements that have been signed.
“On the one hand, reliable GDP growth is needed to ensure tax income to increase government liquidity and to lower unemployment. Unemployment rates are stubbornly high in many European countries – Spain has had a youth unemployment rate of over 40 per cent for the past year – which is both extremely costly because of welfare payments and lack of income taxes to government, and can also lead to social unrest,” said Mr Evard.
On the other hand, he said, austerity measures are needed to decrease overall government spending, increase competitiveness of key industries and give capital markets comfort about budgetary deficits in order to minimise interest rates for debt that governments raise. But there is a limit to austerity, Mr Evard notes.
Even from a continental perspective, according to World Bank’s Africa chief economist, Shantayanan Devarajan, 37 per cent of Africa’s non-oil exports go to Europe, making the resolution of the Eurozone crisis all the more imperative. In an interview a few months ago, he said that any recession in Europe would affect Africa negatively through trade with this being translated into pressures on the local currency. With regard to the US, Mr Devarajan said its economic recovery is dependent on what would happen in Europe. For Kenya, the US is now market to a much lower value of exports but is source of most of remittances to Kenya and other sub-Saharan African countries.
Now reports of a slowdown are rising by the day and causing reactions in some of the African currencies. When news emerged that Britain’s GDP had fallen by 0.2 per cent compared to 0.6 per cent growth in the third quarter of 2011, the South Africa rand immediately fell as investors and speculators retreated in hard currencies.
According to the Wall Street Journal, the American economy is likely to remain under the weather for the next 35 months to the extent that the “the Federal Reserve said it was not likely to raise interest rates until the end of 2014, adding 18 months to the expected duration of its response to the slump.”
Some analysts of the global economy say that they do not see an easy or quick resolution of the crisis and indeed predict that Greece will eventually default. The situation is not made any better with fears that Portugal is heading the Greek way.
“The broader euro crisis can only continue because policymakers still haven’t addressed the underlying cause – current and future imbalances in the euro area and who pays for them. Only full fiscal transfers can keep the euro area together in its current form and there is evidently no political appetite for that,” said Dario Perkins, director of global economics at Lombard Street Research, as quoted in UK’s Business Insider.
Risk to tourism
While some Europeans such as Germans have managed their finances prudently and are net exporters, other have chosen to borrow from year to year, widening the fiscal and current account deficits. With the risks escalating in some, this has only driven interest rates to higher and higher levels.
“The interest rate effects are significant and can already be seen in Europe, where Denmark and Germany were able to secure negative real interest rates for their debt, in effect taking a fee for taking money. On the other side of the scale, some countries are forced to pay double-digit rates that put even more pressure on their budgets,” Mr Evard said.
The impact of the European economic slowdown appears to be widely shared. “Given weak growth in the euro area, still a key trading partner, there are potential risks to tourism inflows, as well as horticulture and floriculture exports,” says a November 2011 report by the StanChart economists.
At the end of the day, many Americans and Europeans will find it difficult to buy flowers or take holidays to African destinations because these are luxury items that can be easily done away with in times of recession and high unemployment. For Kenya’s horticulture and tourism, a recession in western countries would dampen prospects if the 2008-09 experience is anything to go by. Kenya’s economy slowed to 1.6 and 2.6 per cent in 2008 and 2009, respectively, due to combined effects of post-election violence, drought and recession in the developed countries.
In the CBK survey, Kenyan bankers cited “uncertainty in the resolution of the eurozone debt crisis” as the biggest risk to the shilling’s stability, no doubt because of the fact that hard currency shortage is expected in such a situation even if the shilling appears to have strengthened for now. This is also the position taken by policy authorities.
Kenya’s Monetary Policy Committee says “the continued turbulence in the global financial markets due to the debt crisis in the eurozone presents a potential risk to the exchange rate.”
Europeans banks, for example, are finding it quite a hard proposition to take a “haircut” on the bonds they hold because of the wider implications on their balance sheets.
The haircut basically involves the loss of value of the Greek bonds that are mostly hold by banks in many European countries. This loss, initially put at 50 per cent, has in some cases been put at an effective rate of 70 per cent. The strategy is that if the bonds are valued lower, then Greece will have lower debts it can service in the coming years and it therefore does not need to default.
A major reason for the resistance to the deal is that it has the possible impact of driving the weak banks to bankruptcy and for pension funds, it will drive pensioners’ wealth dramatically down with implications for old age welfare.
But on the other hand, the dramatis personae in what is increasingly becoming a theatre of the absurd are painfully cognisant of the fact that a complete default by Greece will leave them holding worthless paper. Striking a compromise is therefore the aim of those seeking some deal.
In the meantime the Kenya shilling has strengthened on the back of aggressive increase in the Central Bank Rate to 18 per cent. Downward pressures however remain, arising from high international prices for oil while high inflation limits the extent of increasing exports as foreign buyers (on the basis of one price or purchasing power parity) see Kenya exports as expensive.
A major problem is that as crisis persists in Europe, there is a retreat to the dollar and other safe haven currencies. Not surprisingly the other countries that are considered to have safe haven currencies have been out defending their currencies to ensure that they do not strengthen in a manner that endanger their competitiveness at international trade.
Retreat to the dollar in particular has implications for countries that have no choice but to convert their currencies first before they can buy anything from its trading partners. They have to face an increasingly expensive or stronger dollar thereby weakening their local currencies.
When a country has limited forex reserves as is the case for Kenya, then its currency will react to anything that might affect those reserves. Since 2010, Kenya’s official forex reserves have not been able to cover the statutory four months of imports, even though they are at a level above what the authorities have agreed on with the IMF.
World economic leaders seem to appreciate the extent of the danger ahead even though they are making little progress in finding a resolution.
Olivier Blanchard, the IMF’s Economic Counsellor, recently said in Washington that “the world recovery, which was weak in the first place, is in danger of stalling. The epicentre of the danger is Europe, but the rest of the world is increasingly affected.”
The president of the IMF, Christine Lagarde has said that the organisation is seeking to increase its lending resources by up to $500 billion in order to be in a position to help in any liquidity crisis. If need arises, these resources would be used to supplement the European Central Bank, which is fast becoming a lender of last resort for European banks.
A recent World Bank update showed that economic growth tends to be lower during or immediately after election years compared to non-election years.
Remain in CBK’s vaults
When you combine the fears of residents and those of non-residents, the pressure on the currency may remain strong to the end of the year or up to early next year.
Besides agricultural exports, it is expected that Treasury’s sourcing of $600 million from international banks will also buoy the local unit. Since the money is intended for infrastructure, there are high chances that the imports of some of the required materials and payments of contractors will erode some of the amount that Kenya will bank. That implies that what will remain in CBK’s vaults or foreign currency accounts is less than the entire amount of the forex loan.
Foreigners will still continue to consume Kenyan tea and coffee – Kenya’s being of particularly premium quality – and even vegetables. These, being basic goods, have lower income elasticity of demand, meaning that their demand is not highly affected by the changes in income in countries that buy them.
But unfortunately these products do not generate enough foreign exchange to affect the shilling’s value considering that possible reduction in earnings from tourism and cut flowers will have adverse effects on the balance of payments.