Last week I touched on a very poignant topic, the devastation the economy is going through due to the rising fuel prices and the weakening shilling. In the post, the discussion was simply that Kenya is going through those situations where all that can go wrong does go wrong. So what really has lead to this situation, high and unmanageable inflation and worse still an unmanageable economy? My answer is simple, our Balance of Payments.

A country's balance of payments is a record of all its transactions with the world, by world I mean all the countries it transacts with. It is divided into two sections, the current or trade account that records its exports and imports, and the capital account that records any capital (money) that flows in and out of the country. With the trade account, there is a surplus when the exports exceed the imports and with the capital account, there is a surplus when the money flowing into the country exceeds the money that is flowing out. From an accounting perspective, the balance of payments should balance i.e. the trade account should offset the capital account. 

Ideally, a country should export more than it imports and use the surplus to invest and build the country. If the country's exports exceed its income, then it saves, these savings if re-invested will generate even greater returns and lead to a compounding economy. The history of the world is rich with prime examples of what a country can achieve if it has trade surpluses. From the British empire to America from the 1950's to the late 1970's, to Japan from the 1980's to date and now China. These nations grew and some are still growing by creating things of value that they could sell to their trading partners so as to generate wealth, they then used whatever surpluses they got to invest in their own nation through building schools, roads, hospitals and in general social and physical infrastructure that enabled more growth.

Alternatively, a country that imports more than it exports has a trade deficit, like a family, one can only spend more than they earn if they take on debt, and thus countries that run trade deficits are often indebted nations. Since loans are flowing into the country, the nation records a capital inflow and thus runs a capital account surplus. 

In Kenya's case, we have been running ever growing deficits especially since the country's economy was liberalised in the early 90's. This has been further exacerbated during the Kibaki regime, when deficits have grown out of hand. In 1994, exports financed about 74% of the imports, as of 2009, this figure had dropped to just under 44%. Competitively, we are getting weaker and weaker and as a nation, we are getting relatively poorer and poorer. 

This situation leads to three dangerous outcomes; a weakening shilling, increased vulnerability to the global economy and more perversely increased indebtedness. 

Given that we import more than we export, we demand more foreign currency than foreigners demand the shilling. When we have a weak shilling, then the price of important commodities like oil and wheat rise leading to soaring inflation. Due to political turmoil in the middle east and wheat shortages in Russia, the prices of both commodities have risen dramatically, however a weakening shilling has greatly exacerbated this situation. The trends in the trade deficit show that the shilling will only get weaker in the future leading to even more vulnerability in terms of our import prices and thus our inflation.

As a nation, since we are taking on more debt to finance our expenditures, we are a debtor nation. This leads to a situation where our colonialism comes about through finance rather than through military conquest. As the trade deficit gets bigger and bigger, our sovereignty  gets weaker and weaker. More and more creditors can lay claim to our assets and thus dictate any direction that we take as a country. This is the crucial aspect about us running such trade deficits, the dwindling sovereignty. I laugh when the anti-ICC politicians talk of our "Sovereign Nation". 

In the next post, I will talk about the effects of the capital account and the solutions to our trade deficit.