Trade Deficit

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.
Trade Deficit
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:

  1. Foreign Direct Investment (FDI)
  2. Portfolio flows to the capital markets
  3. 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.
Diaspora Remittances
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
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.
Implications
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.

Budget Deficit-Mortgaging Future Revenue

Moving away from economic models, what is it that most developing economies suffer from? There is a general outcry over high taxes being levied which begs the question why? Well, taxes go up as the government looks for revenue to pay for its operations or finance its fiscal policy. This becomes an issue since there are governments that spend more than they collect in revenue. They, therefore, have to borrow to cover their expenses. Over time, this increase in borrowing needs to be paid back. This can be done in two ways if the application of the funds did not have an impact on the economy in terms of growth; more borrowing or increasing taxes.
For the next two weeks, we will look at budget deficits and trade deficits. We will start with a budget deficit. A budget deficit is a situation where a government spends more than it collects in taxes. A government budgeting cycle is inverse to that of a normal corporation or an individual in that the expenses come first followed by finding money to fund the expenses. In a normal situation, a person looks at what they have and then plans their expenses accordingly.
Whenever a government spends more than it will collect, the gap between revenues and expenses has to be bridged. This is normally done through debt.

From the above graph, the average budget deficit for Sub-Saharan Africa countries has been around 4% and worsened during the covid pandemic. At first glance, one might think this is all good. However, the problem is that using GDP as the denominator is prone to manipulation as an adjustment to the figure would make it look like you are living within your means.
Since GDP is not equivalent to revenue, the value to focus on should be the gap between actual revenue and expenditure. On average in Africa, revenue is only about 25% of GDP, further showing that GDP is not a proxy for revenue.
Let us take Kenya for example:
Whilst Kenya has had a budget deficit to GDP that averaged 8% in the first term of the current government, the real elephant in the room is that, on average, Kenya’s expenditure is 35% higher than the revenue it collects as shown below.

Source: Central Bank of Kenya Statistics


What does this mean? Well, it means that every year, Kenya has had to borrow an additional 40% of the budget value to meet its expenditure for the last 6 years. This totals to KES 4 trillion and effectively puts the country in a vicious debt trap as the government has to keep borrowing to survive.
While one might say the government will pay it back, the problem is that in as much as revenue has been increasing in absolute terms – and not necessarily in real terms – a majority of it goes to offset the budget deficit. Simply put, the government is mortgaging future revenues, which means mortgaging future development. The dangers of budget deficit include: Increase in national debt, higher debt interest payments, future tax rising and spending cuts, crowing out of the private sector and inflation.
How does the future of your country look like? Don’t be fooled by the deficit to GDP values. Look at your country’s revenue versus expenditure numbers.

Bottom up Vs Trickle Down – Governance

Today we deal with part 3 of the bottom-up vs trickle down debate. To briefly recap the aim of part 1 and 2 of this thread was to highlight the following:

  1. What are the problems that need to be addressed?
  2. What are the viable solutions given the current state?

Economic models are only but vehicles which should be discussed after the above two have been addressed.

In the final part of this thread, we look at the importance of who is driving the vehicle. If you have answered question 1 and 2 and agreed the best vehicle (model) to deliver it, the question moves to who is driving the vehicle. A formula 1 car in the hands of an uber driver versus a formula 1 car in the hands of Hamilton will achieve a completely different results and the problem is not the car but the driver.

I had the privilege of attending the fearless leadership summit during the past week,

Fearless Summit Founder – Pst Muriithi Wanjau hands over a Fearless 2021 Award to Mr Joseph Warungu for effective mentorship in the media sector. This was during the Fearless Summit 2021 virtual conference which attracted 3,163 participants from across the globe.

where there was a presentation of different leaders in their own right and space and the impact that they where making. The key take away for me from that summit which ties very well with this last piece is how a church in Uganda was able to scale and grow but with very few permanent members of staff. This brought out a number of key elements:

  1. Leadership should bring in efficiency
  2. Leadership is driven by service and not profit
  3. Leadership without mentoring is half leadership

You might be wondering how does this tie to economic models. Governance has been defined as “the manner in which power is exercised in the management of a country’s economic and social development”. The leaders we give power to determine whether there will be economic success or not, depending on how they use that power in the management of a country’s economic and social development.

It is in my opinion that if a country does not get the right leadership, execution of the solution to an identified problem with whichever economic model will fail. In Africa civil service is not driven by the desire to serve but to profit, people do not run for public office out of the desire to serve their country but as ways of making money and that is why we have rampant corruption.

Failure of institutions like parliament to legislate and be scored on the legislations produced whether they up lifted people out of poverty, safe guarded economic gains, liberty and freedoms rather than which MP gives the most handouts or has built the most toilets. Parliaments return to its core mandate is paramount as it sets the tone for all the other constitutional bodies as laws are the framework in which everything works or operates through.

Without proper governance there will be leakage of resources through two main ways:

  1. Corruption
  2. Misallocation of resources

The above two problem areas are not economic model problems, but are purely leadership problems. So as you choose your local member of parliament, remember its not the most eloquent, its not the one who pleases the crowds, its not the one who looks handsome or beautiful, it is the one who will be able to bring efficiency, service and bring up other leaders it should be the one who will exercise power with you in mind in the management of a country’s economic and social development.

Bottom Up- Capitalist in Socialist Clothing

As we look at economic issues as they should be, today we continue with the bottom-up vs trickle-down model debate. As mentioned in the previous blog, the two are not economic solutions but vehicles to deliver a solution to a problem. The issue here is that we have leaders debating a vehicle (model) when they do not have a solution to deliver since they have not diagnosed the problem they seek to solve. Everyone – whether bottom-up or trickle-down – is trying to grow the economy, either from the bottom or from the top, and the question is why? In answering this question, the leaders will all say it is to create jobs. However, on further prodding on why there’s a need to create jobs, the answers start getting absurd.

Regardless of the camp one subscribes to, the idea that the measure for progress in growing the economy is output growth is a fallacy, which is where the foolishness in both camps comes from. Basing the success of policy on output numbers and growing job numbers only is spinning on a hamster wheel. Any economic model that does not have the improvement of health, education, living, and social standards as its main measurement tools and hides behind GDP numbers or blanket job numbers is bound to fail and its proponents are delusional.

One of the two problems identified in the last blog was that Kenya has an income poverty problem. This problem is not unique to Kenya as it is one faced globally. This problem has caused a huge inequality problem where the rich continue to become richer and the poor get poorer. The proponents of the bottom-up model continue to talk about putting money in people’s pockets, promising that they will bring down inequality. However, bottom-up proponents are just capitalists in socialist clothing deceiving the populace about providing more money at the bottom to grow the economy, which is hugely delusional.

Why do I say so? The proponents of the bottom-up model, whether in the US or Kenya, are all talking of investments in cottage industries. These are investments to make the operating environment conducive for SMEs to grow and hence employ more people. Noble as it is this is, it will not cure the elephant in the room: income poverty.

The main reason we have income poverty despite growth in GDP in the continent is that the income growth rates to the various owners of productive resources have not been even. They have been skewed towards the owners of capital. The productive assets people can hold to earn income are land, labor, or capital. All these earn an income, and the growth of that income determines whether there will be upward mobility. Land earns rent, labor earns wages, and capital earns interest or dividends. Only land and capital have capital gains. Unfortunately, if you look at the graph below, the annual growth for labor wages has been negative for the African continent for the last 7 or so years. Even when it was positive, it rarely went above 5%. For Kenya, this figure is -1.5% from 2008-2017.

However, if you look at the growth of land rent or values, yields on the continent range from 9% – 14% in most major cities in Africa. Whether this is productive or not, one can buy a piece of land which then gains in value depriving a country of resources to grow while the owners of land continue to earn. If you use the debt and stock markets as a proxy for rent accruing to the owners of capital, average interest rates in Africa also range from 9% – 35%. And you wonder why banks continue being the richest businesses around.

As mentioned in the last blog, Kenya is a labor-intensive economy. This means that the only major resource from which people must earn an income is their labor. But from the above, one can see that wages have been stagnant and not growing. What does that mean? It means that most Kenyans who are employed mainly in the agricultural sector become poorer every year

So, is bottom-up going to solve this problem? The answer is no. Investing in cottage industries and making ‘the business environment’ conducive for SMEs to grow is simply putting money in the hands of those who own capital already and the rich will become richer even under the bottom-up model. If any economic model does not address how to redistribute wealth or reward labor more than land and capital especially in Kenya and Africa at large, then poverty is going to be with us for way longer.

Bottom Up Vs Trickle Down- Cutting through the political rhetoric and economic conmanship.

There has been a lot of talk about how to grow economies globally under the Building Back Better strategy. The US administration has been championing a middle-out economic growth strategy with a hint of bottom-up philosophy as well. Joe Biden is quoted saying, “Wall Street didn’t build this country… You, the great middle class, built this country.” He declared that his infrastructure plan would “build a fair economy that gives everybody a chance to succeed, and it’s going to create the strongest, most resilient, innovative economy in the world.”

Biden said this as he announced a $2.2 trillion infrastructure plan, a $160 billion American jobs plan, and the $1.8 trillion American families plan as the anchors of the middle-out strategy.

In Kenya, there has been talk of bottom-up economics as the country prepares for the 2022 elections. It is important to note that the main goals of any economic policy are uplifting the lives of the populace, alleviating poverty, and improving the human development indicators of the citizens. Therefore, any discussion about economic model needs to be in the context of the current economic and social situation of a country to determine which model has the greatest, most suitable impact in resolving its problems.

Let us begin by stating some facts about the Kenyan economy:


What does the above highlight?

From the above, one can see that Kenya has a very thin labor force with 29% of the population in the age of productivity. This cohort has a serious skills gap limiting the mobility of labor to higher productivity sectors. This is highlighted in the 18-and-above age group where 43% of the 25 million people either never went to school or didn’t finish school. Of the 45% that finished school, the majority (61%) have pre-primary or primary as their highest level of education.

Another major highlight from the above statistics is that of the 28.3 million people below the age of 24, 14 million are in primary or secondary school. This means that half of this age group will be entering the labor force at various stages in the next 8 years. The economy, therefore, needs to have grown immensely to absorb this group.

The data above also brings out the informality of the business space in the country. 40% of the 5.85 million unlicensed MSMEs operate with no structure i.e. in the open. This excludes digital firms. 25% of the MSMEs operate in temporary structures. The majority of the licensed and unlicensed MSMEs are in wholesale and retail trade which mainly involves importing from outside and reselling. Only around 11% are involved in manufacturing.

What does it mean for the next government?

No economic policy, whether termed as bottom-up, trickle-down, middle-out, or abracadabra, will move Kenya forward unless it addresses the future based on the current status.

To summarize the current status:

  1. Kenya suffers from an Income and Rural Poverty.
  2. The rate of upward mobility is either very low or stagnant

 The areas that will have the greatest impact in addressing the above points I the coming years will be:

  1. Agricultural income growth and transformation that is paramount to alleviate poverty with great impact. Growing value chains, increasing production yields, mechanization (opportunity for local manufacturing of agri-equipment for local and regional consumption), dealing with land subdivision issues, and research and development. All these need an enabling environment to do that and less regulatory impedments. The top 7 food importers are the US ($158 billion), China ($ 136 billion), Germany ($98 billion), Japan ($70 billion), Netherlands ($67 billion), UK ($63 billion), and France ($61 billion) totaling $653 billion. With these numbers bound to increase, every industry should revolve around agriculture as we have natural advantages, such as climate, soil, and a port.
  2. Investment directed at ensuring the operating environment for MSMEs is conducive for growth. This would present a vehicle that could catapult employment growth with great impact in Kenya. Since a majority of the people are employed in the unlicensed MSME sector, diversifying this sector from retail buying and reselling to being export-oriented is also key. There is also a need for investment in capacity, increased market access (SMEs will not grow if they can’t get access to larger regional markets), and provision of long-term patient capital.
  3. Transformation of the education system to reflect 21st-century requirements. Investment in the right training will ensure a high transition from each stage of education. We cannot be churning out more people with business and social related skillsets and less IT, engineering, and scientist skills in this day and age and expect to grow, modernize and diversify the economy.
  4. Indirect taxes.  The informality of the economy means direct taxation might not be effective in increasing coverage, making indirect taxes a better short-term strategy.
  5. Complete debt restructuring both in terms of tenure and interest rates. If the debt over hang is not delt with then there is a serious constrain in implementation of any economic policy.

It is therefore prudent to select areas with the greatest impact from investment when selecting an economic model. For example, investing in SMEs and MSMEs to increase capacity and investing in access to markets will lead to an MSME employing more people. A mama mboga will have additional new clients, she will purchase more tomatoes to meet demand, the farmer will have more orders and will have to increase production.  The farmer will begin to mechanize and buy equipment from a local manufacturer, who will then hire more people creating a ripple effect.

While this may sound simple, it is complex. However, with strategic targeted planning and proper execution, it can be done over a period of time. Governance has been defined as “the manner in which power is exercised in the management of a country’s economic and social development”, therefore for one to define how Kenya will grow they will have to be in government, it is important then to understand the thinking of anyone you give power as their management can either make or break a country.

OPEC- The Cartel (OIL part 3)

Today, we conclude our discussion on oil. Having covered the micro angle and what affects demand for oil on the global stage, it is important to mention the oil supply side and how it affects global oil prices.

As mentioned in the previous blog, oil is a commodity whose price is determined by how much people need to use it. Increased demand leads to increased prices subject to its availability (supply) staying constant. The reverse is also true. If fewer people demand oil, then its price will drop. This was a phenomenon witnessed in 2020 when the largest oil consuming industries were grounded to a halt. These included the air travel, manufacturing, and general energy consumption industries.

What Affects The Supply Of Oil?

The supply of oil on the global market is affected by various factors which include but are not limited to:

  1. Technological advancement in the extraction process
  2. Cost of extraction
  3. The Oil Cartel
  4. Supply chain from extraction to pump

Extraction

According to BP’s Statistical Review of World Energy, the globe has about 1.73 trillion barrels in economically recoverable oil as of 2020. This is oil that has not been extracted. The world consumes roughly 100 million barrels of oil per day or 3 billion barrels per month. There is clearly enough oil to go around for awhile as the global economy continues to grow at its current average rate of 3%.

If oil supply is then roughly known, why doesn’t the price of oil remain constant for as long as the reserves are not being depleted fast enough to distort its supply-demand equilibrium? Well, this brings us to the first two points; how much oil is being extracted, and how much it costs to extract the oil.

The cost of extracting oil increases with the age of an oil well. Older wells have reduced oil production which leads to an increase in price. New wells drilled into the earth have high levels of pressure which force the oil up without the need for sophisticated machinery. However, as the well ages, artificial pressure through water injection or gas lift is used to push the oil up to the surface. This increases the cost of extraction, therefore increasing the price of oil.

The average age of an oil rig from discovery to abandonment is estimated at 15-30 years for land drilling and 5-10 years for offshore drilling due to its high costs. According to Planete-Energies, after the third year of production, an oil well’s productivity reduces by between 1% and 10% per annum. It is therefore important to understand the age of the world’s largest oil rigs as a guide for the direction of the cost of extraction.  Understanding technological advancements in the extraction process is also important in determining whether supply will increase or decline, as this will in turn affect the global cost of oil.

The Oil Cartel

The factor with the biggest supply impact on oil prices is the cartel called OPEC. OPEC is a grouping of oil-producing countries that determine how much they will produce, in essence, directly affecting supply by the stroke of a pen. The top 10 oil producing countries account for 94% of the 1.7 trillion barrels of oil reserves and 40% of daily production.

Therefore, if any of these 10 countries decides to reduce supply, they will create an artificial shortage in the global market. For example, in the Saudi Arabia chart below, a drop in production led to a spike in global prices and vice versa.

It is therefore important to follow the outcomes of OPEC meetings for the set production levels for a period of time. This, together with global demand trends, would enable one to analyze and forecast if oil prices are likely to increase or decrease.

Supply Chain from Rig to Pump

Finally, the last factor impacting oil supply is the supply chain. The supply chain involves several factors but for the purpose of this blog, we will look at transporting oil from the refinery to the pump. As we have seen, the top 10 oil-producing countries are responsible for upwards of 40% of daily oil production. This means that any disruption in their ability to deliver oil would cause a huge supply shortage leading to prices skyrocketing.

For example, Venezuela went into a civil crisis in 2019 with the US imposing sanctions against Iran at the same time. These two events meant that the world’s largest and fourth largest oil suppliers could not deliver oil at their usual levels. This led to oil prices rising fast due to a supply shortage caused by interruptions in the supply chain. It is therefore important to follow events in the 10-largest oil-producing countries to determine their effects on the supply of oil.

This brings us to a close on why and how your pump prices change and what it means for you. Feel free to refer to part 1 and part 2 if you need to.

Oil Black Gold or Mute Assasin Part 2

In this week’s blog, we continue with our discourse on oil. In the last blog, we looked at the impact of oil prices at the local level, how oil prices change, and the impact of these changes on the economy. Today, we look at the causes of changes in oil prices on the international scene, how to anticipate these oil price changes, and, armed with knowledge from the previous blog, what impact this will have on you.

Definitions

First, let’s define what oil is. Oil is a naturally occurring commodity that is refinable into different types of fuels. The key word in this definition is ‘commodity’. Why so? A commodity is any raw good used as an input in the process of making other goods. This is important because oil as a commodity derives its value from the growth of output of other goods. Oil in itself has no utility.

Secondly, let’s define what the oil industry looks like. The oil industry is divided into various sectors, which are:

  1. Exploration – This is the process of finding oil reserves, determining the quality of the oil, and how large the reserves are.
  2. Extraction – This is the process of drilling into the ground to bring the oil to the surface.
  3. Refining – This is the process of transforming oil into the various useful products we know such as petrol, diesel, kerosene, etc.
  4. Transporting – This is the process of moving oil from the refineries to the global markets.

Causes of Changes in Oil Prices

With the two definitions above, we can now look at what causes oil prices to increase and decrease from two angles; one of demand and the other of supply.

Demand

The level of demand for oil plays a key role in the increase or decrease of the price of this commodity. What affects oil demand? Looking at the definition of oil as a commodity, we noted that it is an input in a process. This means that oil demand is a function of the demand of the processes that use oil. Therefore, if oil is used as fuel to power airplanes, then the demand for oil will increase as the demand for flying increases. The inverse also holds true. It is therefore important to know the major processes that have oil as an input as growth or decline in these areas will have an impact on the price of oil. The use of alternative forms of energy also affects oil prices.

Below is a non-exhaustive list of the major users of oil:

  1. Transport sector – road, rail, sea, air
  2. Manufacturing sector
  3. Mining sector
  4. Households

Anticipating Oil Price Changes

To determine whether the price of oil will increase or reduce, one has to look at the growth trends in some of these sectors. An increase in mining activity without the use of alternative fuels or improvement in innovation will lead to an increase in oil demand and, with it, the price of the commodity. The same concept applies to transport, manufacturing, and household consumption. These sectors grow or decline in tandem with the economic growth of the various regions and countries in the world. This is why when most countries went on lockdown in 2020 due to Covid 19, the processes that depended on oil reduced activity leading to a drop in global oil prices from $50 to $20 a barrel. As the economies began to open up in the latter half of the year, the prices began increasing and currently stand at $76 per barrel.

Brent Crude Oil Prices

Source: www.macrotrends.net

It is also important to monitor the growth trends in the aforementioned sectors in the regions below. These are the largest oil consumers and any change in their economic momentum significantly affects the price of oil.

The 10 Largest Oil Producers And Share Of Total World Oil Production In 2020

CountryMillion Barrels per DayShare of World Total
United States18.620%
Saudi Arabia11.0112%
Russia10.511%
Canada5.296%
China4.935%
Iraq4.164%
United Arab Emirates3.794%
Brazil3.784%
Iran2.813%
Kuwait2.663%
Total top 1067.5272%
World total94.24

Source: International Energy Statistics, Total oil (petroleum and other liquids) production, April 1, 2021

It is, however, paramount to state that the above analysis of oil demand and its impact on oil prices only makes sense if supply remains relatively constant. In the interest of keeping it short, look out for part 3 of Oil – Black Gold or Mute Assassin where we will discuss the supply side.

Oil – Black Gold or Mute Assasin

Oil is a commodity that cuts across every area of our lives directly or indirectly. Oil is used to power electricity generators, motor vehicles, airplanes, and the by products used in grease machines. It is therefore important to know the price trends of this commodity, what affects its prices and what to look for to be able to understand what it all means. 

For the African region, the main indicator to look at is the global brent crude price. There are other prices that you will find, such as WTI crude, OPC Blend and Mars Blend all applying to the US market. The price of brent crude currently stands at $72 a barrel and has risen from $38.55 a barrel since June 2020. The price is measured using barrels as this was the traditional storage of oil. One Barrel is equivalent to 159 liters (about half the volume of a bathtub) which translates to $0.45 per liter. Unless your government has subsidy program you would then pay higher than the $0.45, why? Well, you will have to add at least some shipping costs, which are $13 per barrel and then depending on the transportation from the port if its trucks that is an additional $20 per barrel or if it is a pipeline $5. Therefore, for illustration purposes if you use trucks in your country which is the most preferred means in Africa your total cost per barrel before any taxes would be $105 per barrel translating to $0.66 per liter.  

You might be wondering but we pay higher than this yes because, the oil marketing companies must make a profit hence they add a profit margin, governments make money as they add various taxes like road levy, value added tax etc hence the price that lands at the pump might be upwards of $1 per liter. 

Let us use an illustration to show why this price affects you, if the price of Brent crude goes up from $ 72 per barrel or $0.45 per liter to $82 per barrel $0.51 per liter this is the probable ripple effect, 

If it costs $13 per barrel to ship it to your country it will now cost $14.82, once it lands at the port, assuming using a truck where it would have cost $20 per barrel now it will cost $22.8 meaning at the pump before taxes it will now cost $0.75 instead of $0.66. The impact of this would be an increase in the following, 

Price of transportation. Whether you use public, or private your commuting costs would go up. If it is an absolute necessity for you to use transportation, then your disposable income will reduce with the amount of increase you have allocated to the transport budget. 

Cost of electricity. If your country relies on generators fueled by petrol or diesel then the cost of your monthly electricity bill will go up. This, as stated on the above about transportation, will also eat into your disposable income. 

Cost of goods. If cost of electricity goes up and cost of transportation locally goes up, then the price of manufactured goods and farm produce will increase in the supermarkets as the suppliers will pass that cost to consumers. This will further eat into your disposable income. 

If the aggregate disposable income reduces in the economy, then economic growth will also reduce. Hence Oil prices have an impact on your everyday life. In part 2 of this blog will look at what affects the price of Oil 

Economic Growth but No Jobs – Africa Achilles heel

Historically there has been a lot of news on economic growth across the globe but more so on the Africa. On average the GDP of countries in Africa grew at 4% per annum from the year 2010. This has led to a forage of investment from developing countries all wanting a piece of the African success pie. However, the previous decade’s (2000-2009) growth was slightly higher at an average 5%, hence Africa has been on a steady growth pattern for the last 20 years in GDP terms. For example, Kenya had an average growth rate of 4.5% between 2001-2009 and 5.5% between 2010-2020, Mozambique 8% and 5.5%, Nigeria 7.97% and 3.97%. Rwanda 8.23% and 7.14%, and these rates are exceptional compared to the sub 3% in OECD countries.

However, If one looks at the 2020 human development index statistics,  not a single African country ranks in the top 60 countries in the world. The ranking of the human development index is categorized by the United nations as very high HD, high HD, medium HD and low HD. It is sad to note that only one African country is in the high HD category, 13 in medium and the remaining 30 in low HD. Why is this economic growth not translating into improvement in the standards of living? What is the purpose of economic growth if it does not reduce poverty?

Today we look at the interaction between two of the past blogs, what is GDP and employment. When economic growth does not translate into jobs then we end up with the above scenario of stellar growth but no change in standard of living. When we looked at the GDP formula below:

GDP = C + G + I + NX

C = consumption or all private consumer spending within a country’s economy, including, durable goods (items with a lifespan greater than three years), non-durable goods (food & clothing), and services.

G = total government expenditures, including salaries of government employees, road construction/repair, public schools, and military expenditure.

I = sum of a country’s investments spent on capital equipment, inventories, and housing.

NX = net exports or a country’s total exports less total imports.

There are many components that drive the GDP figures we hear. However, from research you would then notice that most GDP growth is driven mainly by the G component. See selected chart below:

Is there then a link between how much a government spends and jobs creation? I would like to say it is where the government spends that is key to translate economic growth to jobs created and higher incomes for the populus.

In the developed countries most government spending goes towards social protection, for example family, health, old age, housing. Countries like Finland, Denmark, Spain and the United Kingdom spend upwards of 30% of government spending on social protection, as the adage goes a healthy population is a productive population. In contrast African countries are spending the majority of the government spending on salaries or payrolls at an average rate of 40% with an exception to South Africa which is around 13%, no wonder they are ahead of their peers on the continent. Africa also has a huge debt payment problem which takes an average of close to 40% of government expenditure.

African economic growth is not translating to jobs and higher incomes because government spending is going to areas that don’t create a conducive environment for businesses to thrive or expand and employ more and raise wages. What is your country spending on? Take a look at the budget policy statement of your country to know whether the future is going to be bright.

Some African countries are spending a bit on Education laying the foundation of a skilled workforce as the average demographic age in Africa is below 20. Are these going to be the future stars?

Interest Rates? Central Banks Wrench

We have covered a lot of basic economic ground over the last few months. We have looked at Gross Domestic Product (GDP), Employment, Inflation, Currencies and Credit ratings. This month we will touch on two more fundamental economic items which are key to building  a strong “what does it mean” base and these are interest rates and oil.

In today’s edition we will look at interest rates. In its basic form an interest is an amount that a borrower pays to compensate a lender on the risk of giving the former their money. The interest rate is the amount paid by the borrower expressed as a percentage of the borrowed amount. There are many variants of interest rates you will come across in your interaction with the economy, however the main ones that you should be aware of are:

  • The Central Bank Rate
  • The Interbank Rate and
  • The Libor (London Interbank Offer Rate)

In most countries in the world, you will have a central bank or federal reserve as in the United States of America. The main purpose of this institution is to maintain a certain level of inflation and or employment which they do by controlling interest rates in the economy. A Central Bank controls interest by first setting a target interest rate which is called the central bank rate which becomes the rate which determines other interest rates in the economy. The target interest rate then determines your personal borrowing rate on your loans, mortgage rates and to an extent government bond rates.

When a Central Bank meets through their monetary committee, they will either raise, keep, or reduce the Central Bank rate. The impact of an increased Central Bank rate is that commercial banks will revise their lending rates upwards, making borrowing expensive in the economy. The impact of this is a reduction in economic expansion as borrowing becomes expensive, businesses will reduce new investments, and citizens will not consume, and the housing market will contract. If the Central Bank rate is reduced, the opposite will happen. Banks will lower their lending rates making it cheaper to borrow, businesses will increase their investments, and consumption will rise leading to increased economic expansion. An increase or decrease in the Central Bank (CB) rate has an impact on a country’s exchange rate. Ideally when the CB rate goes up, the currency will strengthen albeit with a lag, and if it is reduced the currency will weaken. Therefore, be on the lookout for central bank rate news as it affects you in the ways stated above.

Below is a schedule of the main central banks, whose actions affect the strength of the US dollar. it therefore is key to know what they are saying as we mentioned in the earlier blog on currency

The interbank rate, is the rate which banks lend to each other overnight, for example Standard Chartered bank lending to Barclays bank. Banks lend from each other to cover short term liquidity needs and to avoid borrowing from the central bank. This rate is key because it helps you understand two elements: how liquid the banks are and the rate a bank will be willing to pay for deposits. The combination of the former and latter will affect the rate at which banks are willing to lend at. Currently interbank rates range between 3% – 5% in Kenya. A high interbank rate signifies that there is not enough liquidity in the banking sector and there will therefore be willing to pay more for your deposit, information on interbank rates helps to determine the best time to invest in fixed deposits and government securities. When there is low interbank liquidity, signified by high interbank rates, interest rates will increase offering good opportunities for high fixed income investment returns.

Finally Libor is the interest rate which global banks borrow from each other in the international interbank market. The rate is administered by the Intercontinental Exchange, which asks several major banks at what rate they would lend to each other short term and come up with an average rate which is called the Libor. The rate acts as a benchmark for short term rates and is then used to price various debt instruments, credit cards, student loans, and government debt. How it works and its impact is similar to the central bank rate. Its main impact is on flow of funds between debt instruments and equity instruments. If  the Libor goes up, money will flow to fixed income securities, as the returns will be higher than equities.

This is what interest rates news means to you. Armed with the above knowledge you can then make the appropriate investment or borrowing decisions.