The Effects of the Global Financial Crisis a Case Study of Kenya

8/6/2019 The Effects of the Global Financial Crisis a Case Study of Kenya

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THE EFFECTS OF THE GLOBAL FINANCIAL

CRISIS: A CASE STUDY OF KENYA

FRANCIS MWEGAUNIVERSITY OF NAIROBI


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INTRODUCTION (1)

The objective of this paper is to examine the effects (so far) of the global financial crisis, possible impacts; and the scope and limitations of current policy responses.

We therefore look at several issues:(a) Elements of the global financial shocks, which focus on the

types and magnitude of shocks(b) Shocks at the national level, which identifies the effects so far

on trade, international capital flows, remittances and aid.(c) Effects on growth, investment, poverty and inequality and debt.(d) Policy implications


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II. ELEMENTS OF THE GLOBAL

FINANCIAL CRISIS (1)

There is currently a relatively large literature

of the global financial crisis (e.g. Krugman2008, Senbet 2008).

It is agreed that the epicentre of the crisis isthe US.

Senbet for example attributes the USfinancial crisis to five factors.


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ELEMENTS (2)

First, the housing boom and the sub-

prime lending. Second, excessive risk-taking by banks and

other financial institutions. Third, easy money and hubris (overconfidence)

affecting participants in the financial sector. Fourth, rating agencies and grade inflation

Fifth, complex and opaque securitization.


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ELEMENTS (2)

The burst of the housing bubble as a result of theabove factors led to a shutdown of the creditmarkets and failure of major financial institutionssuch as Lehman Brothers, Merrill Lynch, AIG, and soon.

This created a crisis of confidence: global panic, flight to quality from even traditionally safe assets such as

money market funds and commercial paper; drying up private capital

This US-originated financial crisis has spreadthroughout the world.


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ELEMENTS (3)

SSA countries are barely integrated into theglobal financial system.

Would they be spared of the global financialcrisis?Already, the crisis is anticipated to derail the

high growth that SSA has been experiencingin last decade (of about 5%). The available

estimates (e.g. IMF) already point to economicslowdown in Africa. This paper analyses the case study of Kenya.


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National Shocks(1)

There has been a big debate on the likelyimpacts of the global financial crisis onKenya.

According to the Prime Minister, the Kenyaeconomy will be badly affected.

On the other hand, Ministry of Finance andCentral Bank official postulate that theimpacts will be indirect and most likelysmall.


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National Shocks (2)

According to CBK, Kenya is primarily a rural agro-based economy with only a small minority of the

population directly interfacing with the developedworld.

The main sectors likely to feel any significantimpact include tourism and commercially- orientedagriculture such as horticulture, tea and coffee.

Other effects might be felt through foreign

exchange volatility, cost and availability of inputsand also the credit and trade restrictions.


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Direct effects (1)

It is argued that, in general, African banking sectorsare insulated from foreign finance.

The sectors rely on domestic deposits and lending anddoes not have derivatives or asset-based securitiesamong their portfolio.

Even though some banks have significant foreignownership, the parent banks are typically not from the

US and the foreign ownership share relatively small 5% compared to 46% for developing countries.


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Direct Effects: Banking system (1)

A look at some indicators show the Kenya banking

system is fairly sound.

The capital adequacy ratios:

Minimum core capital: 225-250 million

Core Capital/Total Deposit Liabilities (Minimum 8%)

Core Capital / TRWA (Minimum 8%)

Total Capital/ TRWA (Minimum 12%).All the banks meet the four minimum capital requirements.


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Banking system (2)

The ROA in Kenya generally declined in the

late 1990s but has shown an upward trendsince 2002

The NPL/Assets ratio has decreased from a

high of 22.6% in 2001 to a low of 4.3% in

2007, an indication that the banking systemsasset quality has improved.


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Banking system (3)

In terms of ownership structure, foreign banks

comprise about a quarter of all banks in the

country, with 11 foreign banks out of 42

commercial banks in 2007.

There are five foreign banks that are not

locally incorporated. These accounted for9.2% of the core capital of the bankingsystem in 2007 (10.2% in 2006).


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Banking system (4)

In addition there are six foreign but

locally incorporated banks so that theyare partially owned by the locals. Theseaccounted for 31.7%% of the corecapital of the banking system in 2007

(34.0% in 2006).Hence foreign banks account for about

40% of commercial banks core capital.


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Banking system (5)

Private sector credit has increased since 2002, following a

reduction of the cash ratio from 10% to 6% in 2003.

The bulk of credit went to manufacturing, agricultureand trade.

During 1997-2006, agriculture received an average of9% of the total private sector credit, manufacturing anaverage of 19% and trade 17%, though displaying a

declining trend during that period..


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Banking system (6)

As Table 3.3 shows however, assets of the

banking system are dominated by loans andadvances, government securities and cash

reserves at CBK.

Kenya commercial banks keep minimal

derivatives or asset-based securities in theirportfolios. They mainly purchase government

securities.


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Banking system (7)

Overall, the Kenyas banking sector has improved

tremendously in the last six years or so.

During this period, only two banks have been put under

CBK statutory management (Prudential and

Charterhouse Bank), in comparison to the 1980s and

earIy 1990s when a large number of banks collapsed.

The banking system therefore seems poised towithstand the global financial crisis.


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Direct Effects: Capital Market (1)

Portfolio flows have however adversely affected thestock market, with foreign sales exceeding foreign

buys in many counters, as foreign portfolio investorsdiversify from the market (Kibaara, 2008).

The NSE 20-share index has taken a hit since mid-2008 on the back of the post-election violence andthe global financial crisis.

In 2008, the NSE-20 index slumped by 35%, 25%since July 2008.


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Capital Market (2)

But according some analysts, the worst isover.

According to Jimnah Mbaru: Most foreign portfolio investments on the

Nairobi Stock Exchange (NSE) have beenliquidated by the fast moving and

unpredictable hedge funds who hadinvested on the NSE". The NSE-20 index however declined by 7.3%

in January 2009 alone.


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Capital Market (3)

The decline in the stock market makes it moredifficult to borrow from the capital market.

The public listing of Cooperative Bank of Kenyain 2008 only managed an 81% subscription evenafter scaling down the target amount fromKshs10 billion to KShs 6.7 billion, the first undersubscription on the NSE in the recent times.


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Indirect Effects: Tourism

About 75% of Kenyas tourists come from North America andEurope. However the US accounted for 5.9% of the number oftourists.

According to some estimates, if the number of tourists fromNorth America and Europe were to be halved, the loss would bein the range of $316 million.

There has been a substantial decline in tourist earnings, causedby various factors including the post-election violence,increased oil prices and the global financial crisis.

In the first 10 months of 2008, tourist arrivals declined by 35%.


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Commodity exports

Commentators have mainly focused on

a few products: tea,

cut flowers

and to a lesser extent, coffee

These are Kenyas main commodityexports.


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Tea (1)

The auction tea prices have substantially

declined (by 60%) since September 2008, withmajor players staying away from the market. This has been caused by increased supply of tea

in the global market. They have been enticed by unsustainably high

prices (US $ 2.15 per kg compared to a realisticprice of under US$2 per kg, according to FAO). The decline has also been caused by political

problems in Pakistan which is a major buyer ofKenyan tea (it took 28% of the tea exports).


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Tea (2)

Pakistan also entered into a free trade arrangementwith Sri Lanka, hence buying more tea from thatcountry.

Other major buyers are Egypt and UK, which maybe severely affected by the global financial crisisand hence the demand for tea.

In 2007, Kenya produced 369 million kilograms ofprocessed tea. In 2008, the country was expected

to produce a smaller output of 335 million kilogramsdue to the drought in the country.


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Cut flowers

Some expect cut flower exports in decline because cut flowersare a luxury (Kibaara 2008).

Others expect cut flower exports to be fairly stable because of

their emotive feel-good factor (Kenya Flower Council, KFC).According to the KFC, Kenya exported 93,000 tonnes in 2008, a

slight increase over the 91,000 tonnes exported in 2007.

Cut flower exports are likely to be boosted further by the plannedintroduction of direct flights between Kenya and the USA.


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Total exports

More generally a large proportion of Kenyas exportsare sold in the region.

COMESA accounted for 31.4% of Kenyas total exportsin 2007

These are mainly essential manufactured products andare unlikely to be unduly affected by the global crisis,at least in the short-run.

The European Union accounts for another 26.4%,mainly agricultural products.

The USA - less than 5% of the exports share.A depreciating currency has helped cushion export

earnings.


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Remittances

The reduction of incomes and the loss of jobs by Kenyan in theDiaspora is expected to reduce remittances.

According to CBK, remittances actually increased by 6.6%, fromUS$ 573. 6 million in 2007 to US$ 611.2 million in 2008.

Remittances were quite volatile in 2008 no clear pattern.

Data on remittances are quite unreliable. Some othersources give the remittances for 2007 to be US$1.3 billion,almost triple the CBK data.


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ODA

Aid flows may also reduce, due to the massivebailouts at home.

Kenya is however not considered to be a high aid-dependenteconomy.

At its peak in 1989-90, net ODA inflows averaged 14.6% ofthe gross domestic income, declining to 2.52% in 1999 andwere 2.94% in 2002, before increasing to 4% in 2006.

At 3-4% of GNI, Kenya dependence on foreign assistance is

low, compared to neighbouring countries.Nevertheless, Kenya receives much ODA from the

world Bank which has pledged to fund a number ofprojects in the country in 2009


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Macro impacts (1)

Reduced capital inflows including a reversal/ reduction of portfoliocapital have aggravated the macroeconomic imbalances in theeconomy such as the current account and budget deficits.

According to the 2008/9 budget, the government was expected to incura budget deficit of Kshs 127 billion (18.1% of government expenditure),with a component of Kenyas 2008/9 budget to be financed fromabroad.

This has been affected by the financial crisis. A $500 million sovereignbond was postponed while the Kenya Revenue Authority has not beenable to achieve its targets.


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Macro impacts (2)

These imbalances have also caused a depreciation ofthe Kenya shilling as well as a running down of foreign

exchange reserves. In 2008, the Kenya shilling depreciated by 22.6%

against the US$ and by 15.6% since July 2008.

The reserves declined from 4.94 months of importcovers at January 15, 2008 to 3.26 months of import

cover as at January 15, 2009.


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Third-party effects

First, high fuel prices that peaked in July 2008fueled inflation and increased current

account deficits. The subsequent tumbling of oil prices has

brought some relief. It is hoped that this is extended to other raw

imported materials such as fertilizers,reducing the cost of production andincreasing food production.


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Impact on growth

All these effects have adversely affected the Kenyagrowth rate.

In 2007, the country experienced a growth rate of 7%,the highest growth in over two decades.

In 2008, the growth was expected to be 4% (IMF) dueto the post-election violence in the first quarter of the

year, drought and the global financial crisis.

In 2009, growth is expected to be about 3% (AIG).


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Policy issues

Kenya has set up a Task Force to lookinto ways of cushioning Kenyaseconomy from the effects of the globalfinancial crisis.

It is comprised of officials of the

ministry of finance and planning as wellas the central bank.


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Some suggested solutions:

Lower interest rates. CBK has already lowered the cashratio from 6% to 5% and the Central Bank Rate from9% to 8.5% , although some contend these actions are

not enough to significantly reduce interest rates. Expand Expenditures e.g. acquisition of shares by the

government or its agencies to shore the stock market

Facilitate and lower the cost of remittance costs whichare currently quite high.

Etc


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The Effects of the Global Financial Crisis a Case Study of Kenya

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