Is Kenya headed into economic recession?

Last week, the Central Bank of Kenya (CBK) raised interest rates by 50 basis points to 13 percent. This is expected to translate into higher borrowing costs for Kenyans, higher yields on bonds, and lower lending to the private sector. As a result, the CBK expects the Kenya shilling exchange rate to stabilise against the dollar and consumer prices to ease.

While raising interest rates can be an effective way of tackling high inflation, there are concerns that the Central Bank may be overtightening the economy which may lead to a recession. An aggressive hike in interest rates may take somewhere between 12 to 18 months to have its full effect on the economy. This means that the current rate hikes may be fully felt in the fourth quarter of 2024 and extend to the second quarter of 2025.

In the last five years, Kenya’s inflation rate has averaged 6.208 percent per year. This means that the average prices have gone up 35.12 percent. For anyone whose income didn’t increase by a similar amount or higher, their household budgets are stressed and the overall demand has weakened.

Weak aggregate demand impacts businesses with lower sales revenue, leading to lower production and restructuring. When firms begin restructuring and firing staff, we say we are in a recession.

This is often reflected in negative gross domestic product (GDP) across two consecutive quarters. What are the signs of looming recession in Kenya?

First, we consider the yield curve inversion, which has accurately predicted most recessions in history. Yield curve inversion refers to a scenario where investors are more willing to lend to the government for shorter periods than longer periods.

As of February 7, the two-year government bond is yielding 17.084 percent compared to the 20-year bond which is yielding 16.948 percent, according to data from the World Government Bonds. One and 10-year bond yields have not inverted yet but there is an 88 basis point spread between the two bonds. This is the first sign of investors not having confidence in the government’s ability to honour debts in the long run, preferring to lend for a short period.

Second, we consider the real GDP growth projections for Kenya in 2024. According to the February Monetary Policy Committee (MPC) media briefing presented by Central Bank governor Kamau Thugge, the real GDP growth in 2023 was estimated at 5.6 percent and is forecast to increase to 5.7 percent in 2024.

However, a key economic driver, agriculture, grew by 6.6 percent in 2023 and is projected to contract marginally to 4.9 percent in 2024. This is a red flag to watch closely since the key inflation driver in the last five years was food prices, which have a direct impact on low agricultural production.

Kenya being a net importer, a key recession indicator would be focused on import prices and current account deficits. According to the Central Bank, Kenya’s current account deficit is expected to worsen from -3.9 percent of GDP in 2023 to -4.0 percent in 2024. Imports are largely affected by forex rates, especially considering that Kenya shilling lost an estimated 27 percent to the US dollar in 2023 having started the year at 123.65 and closed at 157.44. As of Monday, the Kenya shilling continues to lose to the dollar and is now trading at 160.32.

A further slide in the shilling is expected to make imports more expensive, discourage foreign direct investments, and increase capital flight from Kenyan companies. We have already seen multinationals such as Bayer East Africa, Proctor & Gamble, and GlaxoSmithKline announcing plans to exit from Kenya, which may lead to higher unemployment if more firms follow suit.

In 2023, Kenya’s goods imports dropped 11 percent from $19.136 billion to $17.106 billion as a result of low domestic demand. Only food and live animal imports increased in 2023. Chemicals and related products declined from $3.277 billion in 2022 to $2.896 in 2023. Machinery and transport equipment declined from $3.76 billion in 2022 to $3.252 billion in 2023. In addition, manufactured goods, which include paper, fabrics, iron, and steel, declined from $3.469 billion in 2022 to $2.654 billion in 2023, according to the February MPC briefing.

These products are majorly purchased by manufacturers based on their projected production over the following year or more. If manufacturers are reacting to low aggregate demand in the economy and planning to cut production, it is within reasonable expectation that they are also planning to cut jobs, freeze hiring, and in effect lead to a recession by the end of 2024.

How do we react to the threat of recession?

When you find yourself in a hole, the best approach is to stop digging. So, to stop job losses and the exit of international corporations, Kenya needs to ease the conditions of doing business. This includes addressing the skyrocketing electricity prices, lowering interest rates to boost liquidity and stimulate aggregate demand, and supporting local manufacturers that substitute imports.

The private sector has been subjected to a flurry of new regulations and increased tax rates over the last year. This has affected their productivity, and ability to expand production, and discouraged foreign investors from investing in Kenya’s private businesses. This needs to be reversed to avoid the looming recession.

The reason that the government has been aggressively borrowing locally, hiking interest rates, and raising taxes is because of its size of deficit spending and recurring obligations.

As time goes by, the State is becoming too heavy for Kenyans to carry, leading to more debt. Addressing the government size and expenditure would reduce the pressure on taxpayers, leaving them with sufficient purchasing power that stimulates aggregate demand. Without a powerful consumer, businesses are bound to cut production, cut jobs, and lead to an economic recession.

The writer is a Lead Market Analyst, FXPesa; [email protected]