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Kenya’s economic outlook bullish despite current difficulties

It appears the prevailing difficulties in the Kenyan economy are just but a passing cloud. At least this is what a recent report from the World Bank suggests. The international institution forecasts that Kenya’s economy could register the fastest growth in Sub-Saharan Africa over the next 15 years. This notwithstanding, a lot could happen over the course of fifteen years and Kenya will need to promptly and definitively address key areas of weakness, specifically now that the economy has grown tepidly over the past year.

Kenya’s economic growth decelerated marginally in the second quarter of 2014 to 5.5 percent from 6 percent a year earlier. This modest slowdown was attributable to a number of factors, most notably the deepening difficulties in the tourism sector, which is a mainstay of the Kenyan economy. Due to a wide range of misperceptions, Kenya has been subject to several unfair travel advisories from its source markets such as the U.K., which accounts for around 30 percent of overall international tourist visits to Kenya. The U.S., another source market, also issued advisories. Although the U.K. recently lifted its advisory, this did not come in time to mitigate the damage that the advisory had visited upon Kenya’s tourism sector prior to its lifting.

The weakness in the tourism sector has not just affected tour firms, but also other businesses in the sector such as hotels. 23 hotels along the coast have shut down in the past year, a situation that las led to the loss of over forty thousand jobs. Accordingly, the accommodation and restaurants sector grew at a rate of 0.8 percent in the second quarter of the year compared to 19.3 percent in the same quarter of 2014. This development, which was highlighted in the latest data from the Kenya National Bureau of Statistics, indicates that a greater sense of zeal and urgency is demanded to oversee a full tourism recovery.

If the difficulties in the tourism sector were to be overlooked, Kenya’s economy would perform considerably better. However, if it is any consolation, other major economies in Africa are also going through their own turbulent motions, though for reasons different from Kenya’s.

The end of the commodity super cycle, which has manifested in the form of lower prices of key commodities such as oil and copper, has affected many commodity-driven African economies. Consequently, growth rates across Africa are expected to decline this year. World Bank predicts that growth will slow down in 2015 to 3.7 percent from 4.6 percent in 2014, reaching the lowest growth rate since 2009.

To understand why Africa is slowing down, it is imperative to gain some insight into what the commodity super cycle is and how Africa fits into it. The commodity super cycle is generally understood as the astronomic and sustained rise in prices of commodities such as oil and copper after the year 2000 due to heightened demand from emerging economies, most notably China. The super cycle placed Africa in a favorable position since the continent is a key exporter of commodities.

Now that China is growing at a slower pace and other emerging markets are struggling too, the commodity super cycle is believed to have come to an end. Commodity demand and, consequently, commodity prices have dropped significantly, with the current stagnation of low oil prices serving as the best example. Export revenues for commodity driven African economies have therefore declined in correspondence to the decline in commodity demand and prices. This has affected growth rates throughout the continent.

Because Kenya is not heavily exposed to the global commodity market, at least not in the same way as other African countries, the end of the commodity super cycle, which as earlier stated was largely inspired by China’s slowdown, has not affected Kenya in a major way.

On the contrary, the slowdown in China has opened a different kind of opportunity for Kenya, and World Bank predicts that the East African economic heavyweight will register the fastest growth in SSA over the next fifteen years. Kenya will grow at an average rate of 6.2 percent all the way to 2030, the World Bank says.

New opportunity

The decline in demand for commodities in China is not accidental but rather deliberate. The Asian economic stalwart is undergoing what economists refer to as ‘rebalancing’. That is, it is shifting from an investment led economy to a consumption led economy. This, of course, means that wages are raising to sustain consumption. Conversely, the cost of doing business is going higher and businesses are scaling back on investment, a development that succinctly explains the general decline in demand for commodities.

In shifting away from investment to consumption, new opportunities are emerging in China as old ones disappear. The African economies that depended on high demand and high prices for commodities from China are being compelled to go back to the drawing board. Those, however, that are in a position to serve China’s new inclination toward consumption are looking at a huge opportunity in the form of a market of more than 1 billion consumers. Kenya is one such African country, World Bank says, adding that it will benefit from opportunities to export agricultural products and attract Chinese tourists.

Trade relations between Kenya and China have long been skewed in favor of the Asian country. Kenya imported goods made in China worth Sh248 billion last year compared to exports of Sh6.5 billion. But with China’s rebalancing, Kenya is now in a better position to sell some of her agricultural produce to China, most notably flowers.

China’s shift toward consumption provides a good market for flowers and a chance for Kenya to expand beyond its core European floral market. Similarly, China also provides a ripe market for processed foods, opening up the possibility of exporting processed foods. This is ideally what Kenya should aim for as local processing, in contrast to exporting of raw foods, keeps jobs at home and benefits the economy in a greater and more sustainable fashion.

Kenya currently processes only 16 percent of its agricultural produce, exporting the rest in its raw form. Agro-processing, especially with a view of accessing huge markets such as China, should therefore be on Kenya’s priority list. In this regard, it is encouraging that plans to set up a $2.5 billion agro-processing industrial district are already underway in Mombasa County. Among the commodities to be processed include palm oil, rice, cotton, fruits and vegetables.

The Chinese shift to consumption should also prompt Kenya to deepen its tourism marketing efforts in China. It is vital for Kenya to broaden the scope of its tourism marketing efforts beyond the western world. These countries have in the past been fast to issue advisories. Conversely, China is less political in its engagements and also has wider scope for growth in terms of tourism.

All this notwithstanding, reeling in Chinese tourists will not be a walk in a park. The number of tourists from the Asian country dropped over the past two years to 92,100 from a high of 114,000 in 2012. The recently instituted direct flights between Nairobi and Guangzhou will help reverse this, but more can still be done. More importantly, Kenya will also need to learn from the experience of others as China is generally a very sensitive tourism market in terms of its response to pricing and other potential barriers such as documentation. South Africa, for instance, suffered a 32 percent decline in Chinese tourist arrivals last year after it unveiled new visa rules requiring birth certificates for any children under the age of 18. This is according to official tourism and migration figures from Statistics SA.

The prevailing economic developments in China position Kenya favorably among its African peers. It also helps that Kenya is increasingly gaining a favorable standing in the global geopolitical scene at a time when foreign relations and diplomacy strongly dictate the economic trajectory of countries and, indeed, regions.

Kenya recently hosted U.S. President Barack Obama for the Global Entrepreneurship Summit; which was the very first time in the event’s five year history that it was held in SSA. The choice of SSA indicates that Africa’s engagement with the world has changed from one of aid to one of business. And in this new dispensation, Kenya has secured her place as the foundation upon which Africa will tread ahead. This suggests that Kenya can leverage on the sway that it has acquired on the global scene for the benefit of her economy. In this respect, it is time to embrace the concept of economic diplomacy. This simply means that the country should leverage on her global position to improve its economic position.

A good platform for economic diplomacy would be December’s World Trade Organization 10th Ministerial Conference, which will take place in Nairobi; the very first time for Africa to host the high profile international meeting.

Areas of weakness

World Bank’s outlook that Kenya will be the African economy to watch over the next 15 years seems to be sufficiently supported by prevailing developments. Yet, to say that all is well would be imprudent, much less to place certainty in a distant future that is subject to the ever increasing incertitude in the world.

There are still some areas of that Kenya needs to address in order to ensure sustainable economic growth. A lot of infrastructure is needed to support the kind of plans that Kenya has envisaged. For Kenya to become the factory floor of the world, for instance, the cost of energy needs to decline appreciably. Similarly, road networks have to be improved. This will allow manufacturers to get imported inputs from the port much easier and cheaper, encouraging growth and job creation in the manufacturing sector.

Fortunately, Kenya is acutely aware of the need to overhaul infrastructure in preparation for future economic growth. It has taken some commendable steps, including commencing construction of the standard Gauge Railway as well as undertaking vast road construction projects in various parts of the country. The only bottleneck, however, for Kenya is financing.

Getting the funds to finance infrastructure projects is the conundrum that the country is facing. Borrowing is currently not the best option as both the World Bank and IMF have warned that the country’s debt to GDP ratio, which is close to 50 percent, is unsustainable. In addition, the vast amount of money needed for the infrastructure projects suggest that the country will have to look to international capital markets if it so wishes to borrow. International capital markets are not always too flexible when it comes to interest rates, especially for developing countries.

This means that revenue collection through taxes will be of particular importance in the years ahead. Sadly, revenue collection is one of the areas of weakness for Kenya. Compliance is still an issue, especially among Small and Medium-sized Enterprises, which form the bulk of the Kenyan economy.

The government will have to get creative—but in a just way—in its attempts to expand the tax base. Measures such as Value Added Tax (VAT), which seem to bring quick results, have not proven to be as effective in the past. They have made the prices of basic items higher and reduced the purchasing power of Kenyans.

Similarly, VAT tends to discourage foreign investment, which Kenya needs in view of the fact that domestic savings, which are around 12 percent of GDP, cannot match the country’s ambitious investment plans of about 25 percent of GDP.

The assertion that VAT acts as a disincentive for foreign investments and lowers the ease of doing business is one that is backed by academic research. In a recent paper, Tim Besley of the London School of Economics found that the average rank of countries with a value-added tax in 2006 in the World Bank’s annual Ease of Doing Business Survey was 23 places lower than that of countries without one.

This notwithstanding, VAT is a vital plank of public finances in many countries where income taxes are hard to collect. Ultimately, there is always a dilemma about what right taxes are and what they are not. High taxation may hamper the incentive to invest, but a low tax rate can also hurt the business climate if it means governments do not have enough revenue to pay for essential infrastructure, education and health care. The issue of how to collect taxes is therefore one that requires an extensive and critical interrogation of available options. It is also one that Kenya needs to treat with urgency in order to grow sustainably.