What will 2013 look like for Kenya’s economy?

The dawn of a new year is a good time to reflect on the past year and look ahead. As it turns out, 2012 was a pretty average year for Kenya, mainly because the much anticipated national and regional elections, which will determine the course of the nation and its economy for years to come, were postponed to March next year.

Why do I say that 2012 was such a normal economic year for Kenya? Let’s rewind 12 months back. Kenya was facing major macroeconomic challenges: inflation stood at almost 20 per cent, the exchange rate was volatile and public debt increased markedly due to the weakening shilling. Economic pessimists predicted a global economic storm as the challenges in the euro-zone seemed unmanageable.

Today, Kenyans find themselves in a much more comfortable position. Inflation declined continuously during 2012 and by end November it fell to a very low 3.5 per cent. The Central Bank’s “shock therapy” (an increase in interest rates by almost 10 percentage points at the end of 2011) clearly paid off and the Government’s fiscal prudence contributed to restore economic confidence.

Bringing the country back to sounder macroeconomic fundamentals was not cost-free. With higher interest rates, activity slowed down: as a result, economic growth will most likely not reach the five per cent mark in 2012 (instead the World Bank’s forecast is 4.3 per cent, which is very similar to 2011).

With a disappointing first half of the year and the third quarter at 4.7 per cent, Kenya will need a strong finish at 5.8 per cent to reach this moderate target. In summary, 2012 was a mirror image of 2011 (see figure): that year the economy started out strongly, but the engine stuttered in mid-course. Then the shock therapy saved the economy but it took almost a full year for it to reach full potential again.

A strong finish in 2012 will give the economy momentum as it enters the New Year when it should achieve five per cent growth. This would depend on peaceful elections.

Figure – Kenya’s economy: 2012 was a mirror image of 2011(Click on the graph to see it larger)

Source: World Bank, Kenya Economic Update, December 2012

The last time, Kenya’s growth rate fell by a staggering 5.4 percentage points (from 7.1 in 2007 to 1.7 per cent), on the backdrop of the post-election violence. Other domestic shocks have clouded Kenya’s economic outlook over the last years. In 2009, a severe drought continued Kenya’s economic stagnation; in 2011 and 2012 another drought and macroeconomic instability exerted their toll on the economy.

Kenya’s capacity to mitigate shocks — political and economic — will thus be the single most important determinant if East Africa’s largest economy will achieve sustained high growth for the remainder of this decade.

It is unlikely that Kenya will regress to the poor performance of the 1980s and 1990s. This will create some degree of economic stability, but too little to achieve economic transformation. If Kenya remains stable then there are three main reasons why Kenya’s economic performance should be stronger in 2013.

First, Kenya’s macroeconomic fundamentals are sound. With inflation below five per cent and a stable exchange rate, investors have found renewed confidence in Kenya’s economic policy making. Many are already positioning themselves to invest after the elections.

Second, consumption will continue to drive economic activity. Lower interest rates will boost consumer confidence and pre-election spending will also drive aggregate demand. In 2007, before the last election, the country experienced a consumption boom and grew at 7.1 per cent – the highest growth rate in more than two decades.

Third, Kenya stands to benefit from Africa’s growth momentum. While global economic conditions remain very difficult, the economies of Sub-Saharan Africa are expected grow at a healthy 5.2 per cent (up from 4.8). By deepening its ties and integration with its neighbors Kenya can partly shield itself from the global economic turbulence.

So, should Kenyans who popped champagne on New Year’s Eve look forward to a smooth ride in 2013? Not so fast. Hard realities remain — Kenya’s growth rate is still below potential and the country has been consistently underperforming its peers and EAC neighbors.

The economy is also not generating enough modern sector wage jobs.  For Kenya, five percent growth should be the minimum in any given year (in China that would feel like a recession). With better infrastructure and investor-friendlier policies Kenya could add a few percentage points on top of it, but that will mean hard work, focused policies and above all a peaceful election, which I know is the greatest wish of most Kenyans for the New Year.

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More information on Kenya’s Economic performance and outlook can be found in the latest Kenya Economic Update of the World Bank (www.worldbank.org/kenya/keu) which was co-led by John Randa and Gabriel Demombynes.

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Follow Wolfgang Fengler on Twitter@wolfgangfengler.