THE EFFECTS OF THE GLOBAL FINANCIAL CRISIS: A CASE STUDY OF KENYA

FRANCIS MWEGA UNIVERSITY OF NAIROBI

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

II. ELEMENTS OF THE GLOBAL FINANCIAL CRISIS (1)

There

is currently a relatively large literature of the global financial crisis (e.g. Krugman 2008, Senbet 2008). It is agreed that the epicentre of the crisis is the US. Senbet for example attributes the US financial crisis to five factors.

ELEMENTS (2)
First,

the housing boom and the subprime 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.

ELEMENTS (2)

The burst of the housing bubble as a result of the above factors led to a shutdown of the credit markets and failure of major financial institutions such as Lehman Brothers, Merrill Lynch, AIG, and so on. 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 spread throughout the world.

ELEMENTS (3)

SSA countries are barely integrated into the global financial system. Would they be spared of the global financial crisis? Already, the crisis is anticipated to derail the high growth that SSA has been experiencing in last decade (of about 5%). The available estimates (e.g. IMF) already point to economic slowdown in Africa. This paper analyses the case study of Kenya.

National Shocks(1)
There

has been a big debate on the likely impacts of the global financial crisis on Kenya. According to the Prime Minister, the Kenya economy will be badly affected. On the other hand, Ministry of Finance and Central Bank official postulate that the impacts will be indirect and most likely small.

National Shocks (2)

According to CBK, Kenya is primarily a rural agrobased economy with only a small minority of the population directly interfacing with the developed world. The main sectors likely to feel any significant impact include tourism and commercially- oriented agriculture such as horticulture, tea and coffee. Other effects might be felt through foreign exchange volatility, cost and availability of inputs and also the credit and trade restrictions.

Direct effects (1)

It is argued that, in general, African banking sectors are insulated from foreign finance. The sectors rely on domestic deposits and lending and does not have derivatives or asset-based securities among their portfolio. Even though some banks have significant foreign ownership, the parent banks are typically not from the US and the foreign ownership share relatively small 5% compared to 46% for developing countries.

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.

Banking system (2)

The

ROA in Kenya generally declined in the late 1990s but has shown an upward trend since 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 systems asset quality has improved.

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 for 9.2% of the core capital of the banking system in 2007 (10.2% in 2006).

Banking system (4)

In

addition there are six foreign but locally incorporated banks so that they are partially owned by the locals. These accounted for 31.7%% of the core capital of the banking system in 2007 (34.0% in 2006). Hence foreign banks account for about 40% of commercial banks core capital.

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, agriculture and trade. During 1997-2006, agriculture received an average of 9% of the total private sector credit, manufacturing an average of 19% and trade 17%, though displaying a declining trend during that period..

Banking system (6)

As

Table 3.3 shows however, assets of the banking system are dominated by loans and advances, government securities and cash reserves at CBK. Kenya commercial banks keep minimal derivatives or asset-based securities in their portfolios. They mainly purchase government securities.

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 to withstand the global financial crisis.

Direct Effects: Capital Market (1)

Portfolio

flows have however adversely affected the stock market, with foreign sales exceeding foreign buys in many counters, as foreign portfolio investors diversify from the market (Kibaara, 2008). The NSE 20-share index has taken a hit since mid2008 on the back of the post-election violence and the global financial crisis. In 2008, the NSE-20 index slumped by 35%, 25% since July 2008.

Capital Market (2)

But

according some analysts, the worst is over. According to Jimnah Mbaru: Most foreign portfolio investments on the Nairobi Stock Exchange (NSE) have been liquidated by the fast moving and unpredictable hedge funds who had invested on the NSE". The NSE-20 index however declined by 7.3% in January 2009 alone.

Capital Market (3)

The

decline in the stock market makes it more difficult to borrow from the capital market. The public listing of Cooperative Bank of Kenya in 2008 only managed an 81% subscription even after scaling down the target amount from Kshs10 billion to KShs 6.7 billion, the first under subscription on the NSE in the recent times.

Indirect Effects: Tourism

About

75% of Kenyas tourists come from North America and Europe. However the US accounted for 5.9% of the number of tourists. According to some estimates, if the number of tourists from North America and Europe were to be halved, the loss would be in the range of $316 million. There has been a substantial decline in tourist earnings, caused by 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%.

Commodity exports
Commentators

have mainly focused on

a few products: tea, cut flowers and to a lesser extent, coffee These are Kenyas main commodity exports.

Tea (1)
The

auction tea prices have substantially declined (by 60%) since September 2008, with major 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 realistic price 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 of Kenyan tea (it took 28% of the tea exports).

Tea (2)
Pakistan also entered into a free trade arrangement with Sri Lanka, hence buying more tea from that country. Other major buyers are Egypt and UK, which may be severely affected by the global financial crisis and hence the demand for tea. In 2007, Kenya produced 369 million kilograms of processed tea. In 2008, the country was expected to produce a smaller output of 335 million kilograms due to the drought in the country.

Cut flowers
Some

expect cut flower exports in decline because cut flowers are 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 planned introduction of direct flights between Kenya and the USA.

Total exports
More

generally a large proportion of Kenyas exports are sold in the region. COMESA accounted for 31.4% of Kenyas total exports in 2007 These are mainly essential manufactured products and are 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.

Remittances
The

reduction of incomes and the loss of jobs by Kenyan in the Diaspora is expected to reduce remittances. According to CBK, remittances actually increased by 6.6%, from US$ 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 other sources give the remittances for 2007 to be US$1.3 billion, almost triple the CBK data.

ODA
Aid

flows may also reduce, due to the massive bailouts at home. Kenya is however not considered to be a high aid-dependent economy. At its peak in 1989-90, net ODA inflows averaged 14.6% of the gross domestic income, declining to 2.52% in 1999 and were 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 of projects in the country in 2009

Macro impacts (1)

Reduced capital inflows including a reversal/ reduction of portfolio capital have aggravated the macroeconomic imbalances in the economy such as the current account and budget deficits. According to the 2008/9 budget, the government was expected to incur a budget deficit of Kshs 127 billion (18.1% of government expenditure), with a component of Kenyas 2008/9 budget to be financed from abroad. This has been affected by the financial crisis. A $500 million sovereign bond was postponed while the Kenya Revenue Authority has not been able to achieve its targets.

Macro impacts (2)

These

imbalances have also caused a depreciation of the 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 import covers at January 15, 2008 to 3.26 months of import cover as at January 15, 2009.

Third-party effects
First,

high fuel prices that peaked in July 2008 fueled 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 and increasing food production.

Impact on growth
All

these effects have adversely affected the Kenya growth 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) due to 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).

Policy issues
Kenya

has set up a Task Force to look into ways of cushioning Kenyas economy from the effects of the global financial crisis. It is comprised of officials of the ministry of finance and planning as well as the central bank.

Some suggested solutions:

Lower interest rates. CBK has already lowered the cash ratio from 6% to 5% and the Central Bank Rate from 9% 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 which are currently quite high. Etc

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