We are currently in a period of high inflation and based on historical norms, whenever inflation peaks, the investment markets slow down. When markets go down, the economy follows suit by getting into the trough. There is no single cause of inflation. It is a case of several negative things happening in succession.
Since mid-2021, Kenya and many other countries have experienced record-high inflation rates, a situation that has led economists to speculate and prophesy a looming recession. 2023 is one year that has economists and financial experts split.
On one hand, we have the realists saying a global recession is nigh, and on the other, we have the optimists saying the recession has been on the way for long enough, it might not be coming, after all. But what does this mean for us, laymen, whose only understanding of the economy is centred on the price of bread and milk?
What does a recessed economy or prolonged inflation mean for the property industry? Will developers still make good profits? is it a good year to invest in property? And what about personal finance? Michael Obaga, a Senior Advisor at Standard Investment Bank breaks down the economic jargon.
In simple language, what does inflation mean?
It is the rise in the cost of goods and services. If bread was Sh5 in the 90s, right now it is Sh60 because of inflation. However, in a growing economy, prices are supposed to increase over time. Inflation is an important economic indicator because it measures the rate at which the cost of goods and services increases over a given period of time. We are able to establish whether the growth is healthy or not.
In Kenya, we have a standard rate of 2.5 per cent at which the cost of things should grow. The current inflation rate is higher than the acceptable margin (2.5 to 7.5). It has oscillated between 9.75 and 9.45, which is a worrying trend. It means the cost of goods is volatile and there is a lot of money circulating in the economy while chasing fewer goods. However, decreasing the prices of goods and services is not necessarily a good thing. In Japan, for instance, the cost of things has gone down and they have relatively low inflation, but this is not a good thing.
What causes inflation?
It can be caused by a number of factors. The first one would be cost-push inflation which means there is an increased cost of manufacturing and production. Subsequently, the cost is passed on to the end consumers. There is also demand-pull inflation which results from high employment rates, meaning everyone has money and there is too much of it in circulation scrambling for few goods in markets. Hence demand outstrips supply causing prices to rise.
The US and Canada are good examples where high employment rates have caused inflation. The third cause is monetary inflation where there’s a lot of money in supply as a result of easy access to credit and borrowing at low-interest rates.
As you can imagine, if people could access loans at an interest rate as low as two per cent, there would be a lot of money in people’s pockets. Lastly, there is imported inflation which is basically caused by an increase in imported goods. This leads to two things – a decline in the external value of the country’s currency and less manufacturing. When the currency has a lower value, goods cost more and with less manufacturing, there are fewer goods in the market.
How did Kenya end up in inflation?
There is no single cause of our inflation problem. It is a case of several negative things happening in succession. First, the effects of the Covid-19 pandemic are long term and the economy is still bearing the brunt of 2020 lockdowns and curfews. Remember, when we went into lockdowns and quarantines in 2020, there was less production of goods because people who work in factories were sent home too, in a bid to curb the spread of Covid-19.
This meant fewer goods and more money in the economy. We are still trying to recover production and it might take more than 10 years to recover, especially as a third-world country, though developed countries will recover much faster.
Then there is also the breakdown in global supply chains that affected the importation of raw materials which were supposed to be used in the manufacture of goods in different sectors. The breakdown was caused by travel restrictions that led to cost-push inflation. And just as we were taking a breather from these restrictions, geo-political tension in Eastern Europe, especially the Ukrainian War, worsened the already constrained supply chains that were on recovery, globally affecting key industries such as oil, gas and even cereals.
The inflation situation in the US has forced the Federal Reserve System (FED), the central banking system in the US, to increase interest rates and suppress demand in a bid to reduce the amount of money in circulation. This is a popular method of dealing with inflation called Quantitative Tightening. The result is high demand for the dollar as importers, speculators and Market Makers moved to hoard the greenback, thus making it difficult for those who rely on dollars to import raw materials or other products to transact.
Lastly, our Current Account Deficit (more imports than exports) has made the Kenyan economy uncompetitive and it has reduced the demand for the Kenyan shilling. Besides, our Exchange Rate Policy has made the currency too misaligned with market forces leading to potential devaluations. We’re importing so many things including election materials, second-hand clothes, plastics and some construction materials. All the importers are looking for the dollar to import and there is a low demand for the shilling. Low demand for the shilling means there is more of it circulating in the economy, leading to inflation.
Why are there fears of a possible recession and what does a recessed economy look like?
We are currently in a period of high inflation and based on historical norms, whenever inflation peaks, the investment markets slow down. When markets go down, the economy follows suit by getting into the trough.
In addition, as mentioned above, Quantitative Tightening is a popular method that many Central Banks around the world used in 2022 to control inflation. It involves increasing interest rates, making it difficult to access credit.
The Central Bank of Kenya raised the key lending rate to 8.75 per cent in November 2022 though earlier in May the rate had also been raised to 7.50 per cent. This was just weeks after the US revised its rates. When banks revised their interest rates to adjust to CBK’s new rates, the cost of credit goes up. This is supposed to reduce the amount of money in circulation and subsequently reduce the inflation rates to normal.
However, if the inflation is dealt with successfully, there is the possibility of a recession, as limited access to credit means businesses or sectors that depend on credit struggle to stay afloat. This leads to the common markers of a recession that include job loss or high unemployment rates, collapsing businesses and negative economic growth. If an economy experiences more than two-quarters of negative GDP, then we can say it has been in recession. The most relatable example of a global recession is the 2008 cash crunch, though in 2020 we had a brief recession.
What are the chances of Kenya’s economy going into recession?
In reference to the above economic indicators, the likelihood of a recession is low. However, Kenya being an open economy, it is prone to be affected by global economic downturns. Whatever happens to the dollar happens to the shilling. However, what makes it difficult to predict a recession is that a country like the US which has the highest fears of a recession has successfully gone through two-quarters of negative GDP, but employment is still high and companies are still posting profits. I would say the possibility of a recession is at 60 per cent.
How long does a recession last and what are the early signs of one?
Recessions have no timelines as proven by history. The 2020 pandemic recession only lasted a couple of months though previous global recessions have lasted for more than a year. Besides, it is often challenging to tell when an economy is going through a period of recession. However, economists and bankers often use several indicators as identified above, to establish whether we are in one.
For instance, two-quarters of negative real GDP, high levels of unemployment just like we had in 2020, reduced incomes which kill spending, and reduced corporate earnings or profits which circle back to mass layoffs and reduced spending.
If in case we do not experience a recession, should we expect a breather on the cost of goods and services this year?
The high cost of goods and services might still go on for several years. Even when CBK comes up with measures to ease the situation, like increasing interest rates or fixing foreign exchange policy, the positive impact will be felt years later.
What does all this mean to real estate businesses and how can developers and other property entrepreneurs maximise profits despite the situation?
If the cost of credit goes up, the pool of potential buyers reduces as fewer people qualify for or afford credit. In addition, financing projects on credit might not be an option for many and the cost of construction materials might remain high. However, real estate is subjective since it’s dependent on location.
Properties in good locations will always attract high demand. If you’re going to develop, make sure it’s in a good location. In addition, the deficit in Kenya is in affordable housing, it’s important for developers to target the right demographics –mostly middle and low-income earners.
Developers should also maximise on economies of scale by developing multiple units per project. It’s also a good time to embrace modern construction and project management such as precast technology, 3-D printing and BIM-360.
What about financing? Are there other options (other than credit) developers can explore if they want to finance projects?
Developers can make use of joint-venture agreements with landowners, but ensure the legal agreements are comprehensive enough to cover risks for both parties. Given that the cost of land is too high, sometimes developers can’t afford to buy land, develop and still earn reasonable profits, hence the need to reconsider this model. We should also consider tightening regulations on models like rent-to-own and off-plan sales models as this would ease the burden of construction costs and buying real estate.
REITs (Real Estate Investment Trusts) are also proving to be a great way to inject much-needed liquidity during the development phase. With REITs, instead of developing and selling, you can lease a REIT (just like listing an IPO at NSE) and use the money to finance a project. An investment is equivalent to a certain amount and investors get returns after an agreed-upon period of time.
From a business standpoint, real estate businesses can source advice from financial advisors on taxes, expenses, investments and expansions. Get a third eye if you already have one because they will give you objective advice.
Start-ups need to be empowered to scale and be listed on the NSE as it is a good way to raise more capital for projects and expansion. It helps manage the company without emotions. Basically, you are giving your company more life by detaching emotions and the company goes professional as you yield to pressure from stakeholders and adhere to the NSE rules.