Feb 26, 2017

The government has declared drought a national disaster, appealing for aid through the National Drought Emergency Fund, in a bid to mitigate the effects of the ongoing drought that has seriously affected different parts of the country. The number of people in need of food assistance has more than doubled to 3.0 mn in February 2017, from the 1.3 mn in August 2016, according to the National Drought Management Authority (NDMA), highlighting the magnitude of the crisis. This write up aims to analyse the potential effects of the drought on the economy.

Kenya is generally a highly drought prone country with only 20.0% of the country receiving high and regular rainfall, with the remaining 80.0% being arid or semi-arid.  Previously, the country has experienced severe droughts over the past 10 years, most notably, (i) in 2011, when  the United Nations (UN) termed the drought that had hit parts of the Horn of Africa, as the worst in 60 years, with 13.2 mn Kenyans affected, especially in Northern Kenya, (ii) in 2005, when the government declared drought a national catastrophe, following the drought that had affected 2.5 mn in Northern Kenya, and (iii) in 2004, when the country witnessed depressed rainfall in the second quarter of the year, and the resulting crop failure ended up leaving 2.3 mn Kenyans affected. Despite this, the economy has proved resilient and managed GDP growth of 6.1%, 5.9% and 5.1% in 2011, 2005 and 2004, respectively.

While drought is known to affect the agricultural sector, which contributes about 23.0% to the Kenyan economy, as a result of crop failure and in turn reduced food security, poor rainfall has the potential effects of (i) hampering hydro-electric power generation which results in power rationing. The government has assessed options of using geothermal power in the recent past, with the high initial costs of setting up a processing plant and maintaining the same, proving to be the main obstacles; and (ii) reduced water supply and in the process water rationing ends up affecting households and industries heavily dependent on the resource, impacting on production and hence putting a strain on the economy. In such tough times, companies find it hard to sustain production and in turn lead to lay-offs as was witnessed in various parts of the country in 2011.

The two major rainfall seasons in Kenya are (i) the long rains that come in between March and May, and (ii) the short rains witnessed in the months between October and December. The Kenya Meteorological Department (KMD) earlier in the month revealed the country is expected to witness depressed rainfall in the period between March and May 2017, with the food security situation expected to deteriorate in most parts of the country.  This is due to the La-Nina phenomenon which follows the El-Nino rains, resulting into dryer than normal conditions in East Africa and the greater Horn of Africa. The government has been tipped to step in to alleviate the impending food situation in the country, with reports suggesting that the government has approved the importation of 5.0 mn bags of yellow corn from Ukraine. Despite this, the country is still at manageable levels when it comes to import dependency, a measure of dependency on importation for domestic consumption and self-sufficiency, which is the capacity to meet consumption needs from production, in terms of food, vegetables and animal products, as demonstrated in the graph below.

Source: KNBS Economic Survey 2016

Kenya’s dependency on imported food has improved over the last five years, with the import dependency ratio on food products, vegetable products and animal products having declined by 0.8% points, 0.9% points and 0.3% points, to 28.3%, 31.7% and 0.8%, from 29.1%, 32.6% and 1.1%, respectively. The country’s ability to cater for its food needs without external assistance has also improved over the last five years, with the country’s self-sufficiency ratio on food products, vegetable products and animal products having risen by 0.6% points, 0.6% points and 0.1% points, to 75.2%, 72.1% and 100.0%, from 74.6%, 71.5% and 99.9%, respectively.

Despite the data pointing to the country being self-sufficient, coupled by the fact that the situation was anticipated, past and current events, mostly due to poor planning by the government, will mean that the ongoing drought is bound to affect the economy in the following ways;

• Agriculture - The agriculture sector has been the most affected following a run of two consecutive poor rain seasons, with tea production expected to underperform this year following last year’s bumper harvest of 426,000 metric tons, which will have an adverse effect on the country’s forex income, given Kenya is a major tea exporter,
• Energy - Areas hosting power dams are expected to be affected by the drought, though Kenya Power has stepped in to assure that power rationing may not be required, as the electricity reserve of 27.1% from its energy mix is expected to supplement any shortcomings. However, should the situation become untenable, this could force the government’s hand,
• Water Supply - The water shortage has hit the country, with the Nairobi City Water and Sewage Company (NCWSC) having published a water rationing program, that will see several industries that are heavily dependent on the resource get cut down and in turn bear down on productivity in these sectors, and the economy in general,
• Currency - The government is exploring options of importing food so as to fill the expected food deficit in the country and massive importation of food, coupled with a reduction in forex income as a result of reduced tea production, may serve to deplete the country of its forex reserves and in turn put pressure on the shilling that has so far stabilized since the turn of the year,
• Inflation - The food situation in the country has deteriorated and this has had a massive impact on inflation, as the food component of the Consumer Price Index (CPI), which carries a weighting of 36.0% has been on a gradual increase over the past three months, clocking month on month changes of 1.2%, 1.3% and 1.7% in November, December and January 2017, respectively,

Following initiatives by the government to cure for the deteriorating food situation in the country, where it has set aside Kshs 2.0 bn per year in the budget for the National Drought Emergency Fund, we believe the government can do more to improve the food situation in the country through (i) putting up measures to stimulate the agricultural sector by reducing over-reliance on rain-fed agriculture, such as the implementation of garden projects, (ii) increased focus on food storage programs and water harvesting schemes, and (iii) the implementation of contingency plans, such as deployment of water tanks.

Despite the drought having a contagion effect on most of the economic sectors in the country, we still maintain that the economic growth this year will be strong. We therefore expect 2017 to deliver a GDP growth of between 5.4% - 5.7%, a slowdown from the 6.0% expected for 2016.

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only, and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.