Can the economy halt the unravelling political situation?

Originally published in the February 2008 issue

Kenya’s recent political crisis dealt an immediate blow to the country’s reputation for peace and stability, but the extent of the damage to east Africa’s leading economy has yet to emerge. Within days of the violence that swept Kenya over the disputed elections in late December, Finance Minister Amos Kimunya announced that the riots and bloodshed had cost the economy up to $1 billion in lost production. This excluded the destruction caused by looters who went on the rampage when President Mwai Kibaki was pronounced the winner of the 27 December vote.

“I expect whether it’s within the next couple of months or within a year … that people will be able to recoup all that,” Kimunya predicted, adding that the economy should still reach the 8% GDP growth forecast by the Central Bank before the elections. Most commentators will be sceptical of this line as long as the standoff between President Mwai Kibaki and opposition leader Raila Odinga continues.

Finding a solution

“Clearly, loss of investor confidence could have a far bigger impact on the economy over time and this is what we should avoid as much as possible by quickly finding a mutually acceptable solution to the current crisis,” Abdoulaye Bio-Tchane, a senior International Monetary Fund official, said in an interview with Reuters in early January. There were concerns, he added, that the violence would push up the cost of risk insurance premia in the manufacturing and transport sectors.

Bio-Tchane said the turmoil had disrupted supplies of key commodities, including petroleum, in Kenya’s neighbours Uganda, Tanzania, Rwanda and Sudan that are dependent on the port of Mombasa.

Ethnic divisions, the bitter rivalry between the two party leaders and the gap between rich and poor threaten Kenya’s status as an anchor stability and economic development in an impoverished and war-torn region. Worse still, they divert attention from the reforms that Kenya urgently needs: tackling corruption, improving infrastructure and reforming a flawed constitution.

In a sign that investors are worried, Standard & Poor’s cut Kenya’s long-term local currency credit rating to B+ from BB- on 2 January and said if the violence persists the foreign currency credit rating could be lowered as well. The economy had reached its strongest for two decades. For fixed investors, pulling out is impractical, but most will be reluctant to commit more investment in the current climate. Portfolio investors will take stock as development agencies and western donors express alarm at a crisis which has rocked an already unstable region. “It’s a pity – this economy was starting to boom. The danger is that if this uncertainty goes on, it will undo a lot of the gains of recent years,” says Rob Shaw, a Nairobi-based business analyst.

The IPO to privatise Safaricom is still scheduled for the first quarter of the year, helping to plug a widening budget deficit, because demand for shares in the lucrative telecommunications company is strong, but further IPOs must now be in doubt, Shaw believes.

In the initial dispute over the election result, neither Kibaki’s Kenya National Unity (KNU) party nor Odinga’s Orange Democratic Movement (ODM) showed any desire for compromise. Odinga accuses Kibaki of stealing the poll, a view supported by the vast majority of election observers, demanding that the result be overturned and a new ballot held. Kibaki dismisses the demand and says that this is a matter for the courts, whose impartiality is widely held in doubt. Kibaki snubbed the African Union mission, swearing in most of his cabinet as its envoy, President John Kuffuor of Ghana, arrived to mediate. It took the arrival of Kofi Annan, the former UN secretary general, to bring the two rivals even to meet face to face.

By mid-January, the death toll since the disputed election was around 650 people. The ODM says the government should be brought before international justice for brutal police suppression of its demonstrations. Human rights groups claim to have evidence that the ODM organised the bloody purge of the Kikuyu (Kibaki’s tribesmen) by Odinga’s fellow Luos shortly after the election, including the burning of a church full of fugitives. Kibaki has dug in by naming Kalonzo Musyoka (the third-placed presidential candidate in December) as vice-president, and bringing Mr Musyoka’s ODM-Kenya party into government, alongside the president’s Party of National Unity (PNU) and its various allies. The ODM is the largest party in the national assembly and could bring deadlock to the legislature or even a vote of no confidence in the government.

Negative sentiment despite positive signs

Both the ODM’s main tactics threaten the economy. The first is calling more mass protests to keep up the pressure on Kibaki, and possibly provoke more violence as the government bans public demonstrations. The ODM is also calling for a boycott on several leading companies with links to key government figures. The boycott includes Equity Bank, in which London-based Africa specialist fund Helios had recently taken a stake.

There are two reassuring factors for investors. The first is the resilience of Kenya’s economy, which is based on an entrepreneurial middle class and thriving private sector which has managed to isolate itself from the country’s corrupt politics.

The country’s geography is also helpful. Kenya is a gateway to landlocked neighbours – Uganda, Rwanda, Burundi as well as the eastern DRC. Most goods into and out of this region have to come through Kenya. The only rival port to Mombassa, Tanzania’s Dar Es Salaam, is too congested to be an alternative. As the most developed economy in the region, Kenya is indispensable to the supply chain for the Great Lakes. Although it doesn’t have a massive manufacturing base, this accounts for 30% to 40% of trade in COMESA (the Common Market for Eastern and Southern Africa) a bloc stretching from Egypt down to Zimbabwe. Nor is there a stock market bubble about to burst: the Nairobi Stock Exchange had a subdued 2007, in contrast to other African markets. Yet, negative sentiment weighs heavily on Kenyan businesses. Aside from the initial damage, Kenyans’ main concern for the economy is the need for a lasting political solution. “What you see is a polarisation – Kikuyu on one side, all the other tribes in Kenya on the other,” says Shaw. “Kibaki’s party control part of eastern Kenya, the rest is firmly opposed to them. The group around Kibaki have forced themselves back into power but lack electoral legitimacy. Kenya is a sophisticated society, so although the government have got away with it, everyone knows what they’ve done.”

Undermining a solution is widespread anger, Shaw believes that the polarisation is deepening. “Things will go back to normal on the surface, but under the surface the country is seriously divided. The Kikuyu have a powerful grip on the economy but they’re less than a third of the population.”

External donors and analysts’ comments have varied. “Unfortunately, even if the crisis was over soon, there is likely to be long-term damage to the economy,” said Bio-Tchane. Economic reforms, which have been a key driver of Kenyan growth, would also have to continue, and economic stability maintained, he added. So far the biggest economic impact had been on Kenya’s vibrant tourism sector. There wereconcerns, he added, that the violence would push up the cost of risk insurance premia in the manufacturing and transport sectors. Richard Segal, Africa fixed income strategist at Renaissance Capital in London, believes that “In the medium term, the outlook is not promising. January is a huge month for tourism. Aid flows will fall, FDI (foreign direct investment) flows will fall.”

However, some analysts say East Africa’s biggest economy could bounce back if the unrest ended quickly and had limited impact on tourism. Maybe there is some glimmer of hope.