In our last blog, we looked at a budget deficit and its impact. We also looked at the conventional measure – the deficit to GDP ratio – and its limitations as a metric since it could be misleading due to how easily GDP numbers can be manipulated. Today, we examine trade deficits that also affect future taxes and the borrowing of a country.
A trade deficit occurs when a country imports more than it exports. What does this mean? When you are importing, you are sending money (in this case dollars) out of the country. When exporting, you are receiving money into the country. As a country, importing more than you export means that you are sending out more money than you are bringing in. The difference between the two is called a trade deficit. Just like the budget deficit, this gap has to be financed e.g. through borrowing.
It is important to note that exports are not the only source of money inflows. A country can also earn foreign currency through:
- Foreign Direct Investment (FDI)
- Portfolio flows to the capital markets
- Diaspora remittances
The sum of the above, in addition to exports, would then give a true picture of the foreign exchange inflows and outflows of a country, with any deficit being covered by borrowing.
Let us look at some data for Kenya:
Kenya has had, on average, an import to export ratio of 277% over the last 5 years. This means that Kenya imports 2.7 times more than it exports or it is spending 2.7 times more on imports than it is earning from exports. This is further confirmed by Kenya’s terms of trade as shown below.
The terms of trade improved in 2020 due to a reduction in imports attributable to COVID 19 logistical nightmares. However, they suffered a huge deterioration between 2017 and 2018 and didn’t seem to recover.
In essence, Kenya has to cover a gap of KES 1 trillion annually for it to finance its imports. The total amount needed in the last 5 years was KES 5.3 trillion.
Foreign Direct Investment
UNCTDA defines FDI as an “investment made to acquire a lasting interest in or effective control over an enterprise operating outside of the economy of the investor. FDI net inflows are the value of inward direct investment made by non-resident investors in the reporting economy, including reinvested earnings and intra-company loans, net of repatriation of capital and repayment of loans.”
Looking at Foreign Direct Investment as a source to bridge the gap, Kenya’s figures look as shown below:
FDI in Kenya has been erratic. From the graph above, the highest it has peaked was KES 162 billion in 2018. Even with this level of annual FDI, Kenya is still short of KES 840 billion in its trade deficit.
Another major source of foreign exchange as noted above is diaspora remittances.
On average, Kenya has been getting KES 245 billion ($ 2.4 billion) in remittances a year. Remittances further reduce our KES 840 billion trade deficit to KES 605 billion.
Tourism is another major source of receipts for Kenya. On average, tourism earned the country KES 107 billion in the last 5 years before 2020. Including this figure in our calculation, the deficit reduces further to KES 505 billion a year. This amount is financed through foreign borrowing.
One problem with importing more is that local businesses are denied the much-needed consumer purchasing spend. This leads to slow growth and the death of many industries. Another danger of running deficits is slow to stagnant employment growth.
As discussed in the two blogs, Kenya has a twin deficit problem; a budget and a trade deficit. The country’s borrowing has not gone into long-term productive sectors to ensure we will generate future revenue to enable us to repay our debts.
Ladies and gentlemen, this is a ticking time bomb.