The KENYA INSTITUTE for PUBLIC POLICY RESEARCH and ANALYSIS No. 13/2017-2018 Supporting Sustainable Development through Research and Capacity Building The Impact of Drought on Key Macroeconomic Variables Naomi M. Mathenge, Policy Analyst, KIPPRA Adverse weather conditions have that have effects on economic systems, become more prevalent all over the including political instability, high international world, and with devastating impacts commodity prices, and global downturns, on economies. In Kenya, adverse weather among others. This complicates the task of conditions are manifested in the frequent disentangling economic losses caused by occurrence of droughts and floods, and while droughts and floods from losses brought droughts are widespread throughout the about by these other events. However, it is country, floods tend to be localized. possible to identify patterns in the disruption Data obtained from Climate Hazards Group of production flows, decline in revenues, and InfraRed Precipitation with Stations (CHIRPS) higher operational costs that typify disaster shows that there has been an increase in the periods and which are felt across all sectors. frequency of occurrence of drought months in In 2004, for example, extreme drought was Kenya, ranging from mild to extreme drought. reported between May and July, which For example, in the 1980s, there were two coincided with the cultivation season. As a extreme drought months, three extreme result, the agricultural sector grew by 1.6% drought months in the 1990s and four extreme during the year compared to 6.9% in 2005 and drought months in the 2000s. Between 2010 6.4% in 2010, which were considered normal and 2015, the country experienced five production years. This decline in production extreme drought months. Additionally, data caused a food deficit that necessitated from the Kenya Meteorological Department importation of 241,800 tonnes of maize (KMD) identifies 2017 as a severe drought valued at Ksh 4.6 billion to cover the deficit year. Floods though do not exhibit a pattern from production. Again in 2011, imports of but have become more frequent. The same unmilled maize increased by 56.5% from 2010 data sources (CHIRPS and KMD) identify to supplement local production. Likewise, the 1997/98, 2000, 2003, 2006, 2010, 2016 and average monthly hydro electricity generation 2018 as flood years. declined in 2009 and 2011, both extreme The economic effects of droughts and drought years. Similarly, the prolonged floods are manifested in the disruption of drought in the period 2016-2017 saw a production flows resulting in production decline in the growth of the agricultural sector losses, income losses, loss of employment, from 5.1% in 2016 to 1.6% in 2017. Like in the and increased operational costs. These previous drought years, there was a deficit effects are compounded by lack of and/or in maize production which necessitated an inadequate infrastructure development such increase in imports of unmilled maize from as storage facilities that can absorb surpluses 148,600 tonnes to 1.3 million tonnes at a cost during bumper harvests. However, droughts of Ksh 40 billion. These direct adverse effects and floods do not occur in isolation, and at from drought are passed on to other sectors, times they occur in presence of other events for example manufacturing and transport, that KIPPRA Policy Brief No. 13/2017-2018 1 incur higher operational costs for their own in February 2017, the government declared production. drought a national disaster and Ksh 11 billion was set aside to cater for drought-related During the drought of 2011, 0.2% of GDP interventions, including providing food rations was lost, amounting to approximately Ksh 6.2 and cash transfers to the affected households. billion, while the drought of 2017 caused a An additional Ksh 3.8 billion was set aside in one per cent pullback on GDP, amounting to February 2018 to address drought-related approximately Ksh 71.6 billion (World Bank, effects in drought hit parts of the country, out 2011). A field survey carried out in 2011 by of which Ksh 2.5 billion was earmarked for a joint assessment team drawn from the food and cash transfer programmes. In the Kenyan government line ministry staff, the 2017/18 budget summary (Government of World Bank, European Union, United Nations Kenya 2017), the government set aside Ksh and other partners on post-disaster needs 46.6 billion for environment management and assessment for Kenya showed that during the protection, flood control and water harvesting. 2008–2011 drought, the losses and damages More recently, the government supported the incurred amounted to US$ 12.1 billion, with Red Cross with Ksh 1 billion for their flood livestock sector absorbing 72% of the losses. relief kitty. Similarly, Ksh 194 million was set What exacerbates the adverse effects is the aside by Nairobi County to address the recent lack of preparedness and late response floods that rocked the city during March, April occasioned by poor road networks especially and May 2018 long rain season. While these in the arid and semi-arid regions which are funds are not necessarily budgeted for, the most vulnerable. fiscal responsibility principles provide for The Government of Kenya has initiated deviations from financial objectives of public programmes to directly respond to drought- revenues “only in a temporary basis and only related issues. For example, in response to where such deviation is caused by a major the prolonged drought of 2008 - 2011, Ending natural disaster, other significant unforeseen Drought Emergencies (EDE) strategy was event….” (Public Finance Management Act, put in place that commits the government to 2012). end drought suffering by 2022. This strategy The prolonged drought of 2008-2011 slowed is incorporated into Kenya Vision 2030. growth of tax revenues especially from VAT Likewise, the National Drought Management and Excise duty. Notable during this period Authority (NDMA) was established in 2011 were the tax exemptions given to importers. to coordinate drought management and it For example, between February 2007 and manages the National Drought Contingency February 2008, importers of raw/mill sugar Fund whose funds are pooled from both could import up to 89,000 metric tonnes duty the government and donors for response free from COMESA Free Trade Area countries purposes. This will ensure a more timely and to curb the rising prices caused by the drought efficient response. (Kenya Gazette, Vol CXIX-No.47). Likewise, The macroeconomic imbalances that result, duty on imported maize was suspended in though temporary in nature, arise either 2009, 2011 and 2017. Similarly, maize flour directly from the natural disasters and/or and bread were zero rated in 2017 to curb from government’s efforts to mitigate the rising prices. It is not surprising therefore that economy against the negative effects of despite the increase in imports to cater for the drought. The main imbalances occur in production deficits, growth in import duty fell the fiscal and the external sectors. Directly, during this period. This has a direct implication natural disasters reduce government revenue on the fiscal balance. Reports show that following decreases in tax revenue collections extreme droughts and floods are estimated to due to production losses and destruction reduce long-term growth by 2.4% of GDP, an of productive fixtures. Expenditures also estimated fiscal liability of Ksh 16 billion. increase, especially expenditures related to On the external sector, the current account building resilience and mitigation measures of the balance of payments, in which the necessitated by the disasters. For example, 2 KIPPRA Policy Brief No. 13/2017-2018 Maize and wheat imports coupled with delayed importation. For example, food and electricity prices are bound to rise due to food shortages and reduced hydro power generation. The figure below shows that food and non-alcoholic beverages inflation (which contributes 36% to overall inflation) rises sharply during the drought periods, contributing to increases in overall inflation. Maize, which contributes over 10% to crop production in Kenya plays a major role in the increase in food prices. For example, the high food inflation in 2017 economic transactions of the economy with was attributed mainly to the increase in the the rest of the world are recorded, is expected prices of maize flour, sugar and beef. This to be negatively affected. At the minimum, necessitated government intervention, which adverse weather conditions necessitate an it did by subsiding the cost of maize flour to increase in imports, specifically food imports cushion consumers from the price rise. to cater for the shortfall in production, where crop failure occurs. Likewise, we expect With reduced and unreliable hydropower, a decrease in the export of merchandise there is bound to be an increase in industrial because of reduced production capacity. costs due to power outages, forcing firms to Such effects exert pressure on the exchange seek alternative sources of power. The figure rate, leading to a depreciation of the Kenya below shows that generation of hydropower shilling against major currencies, especially declined significantly in 2009 and 2017, all of if exports of other major items decline. The which are drought years. It also shows that figure below shows the sharp increases in generation of geo-thermal power has been maize imports during drought periods (2009, increasing over time and has now overtaken 2017) relative to other periods. Year 2011, hydropower generation. The combined effects also a drought year, saw a slight increase of increasing food prices and high industrial in imports relative to 2010 when the country cost have inflationary pressure on domestic experienced favourable weather. It is thus prices. evident that droughts disrupt the normal flow With the projected climate change, droughts of imports, which will feed into imbalances in are likely to become more frequent. The the current account. consequences of not being prepared for the The effect on prices and inflation are felt due disasters from a macroeconomic perspective to supply constraints brought about by crop means that the country will continue to failure that results in reduced production, experience economic costs with the likely Overall and food and non-alcoholic beverages (NAB) inflation KIPPRA Policy Brief No. 13/2017-2018 3 Total annual electricity generation by source design and mix of these infrastructure needs (GwH) to consider climate change vulnerabilities. In addition, there is need to integrate research and development into drought management and response. This will entail research on fast growing and drought resistant crops which have higher productivity under depressed rainfall. Agricultural production can also be enhanced through adoption of irrigation technologies to reduce over-reliance on rain- fed agriculture. This will be key in ensuring food security in the country. exposure to macroeconomic imbalances To reduce the cost of power, diversifying the that can hamper the country’s development sources of energy becomes paramount. For agenda. There is, therefore, need for the example, the vast renewable energy resources country to increase its efforts in managing such as geo-thermal, solar and wind should and responding to the disasters. Adequately be scaled up to increase their overall share in considering the climate change effects in the country’s energy mix. the macroeconomic framework is critical in sustaining macroeconomic stability. It is thus evident that addressing disaster- related issues will be key in realizing the “Big Infrastructure, including transport, storage Four” development agenda, especially food and ICT is key in mitigating the effects of security, and manufacturing. drought especially in ensuring supply is stabilized, consequently reducing inflationary pressure. For example, the current poor Further Readings state of infrastructure especially in drought prone areas hampers effective preparedness, http://chg.geog.ucsb.edu/data/chirps/ response and recovery efforts. To reduce the effects of drought, it is necessary for the Government of Kenya (2017), The budget national and county governments to improve summary for the fiscal year 2017/2018 and infrastructure development by upgrading the supporting information the existing infrastructure and expanding to The Public Finance Management Act, 2012 areas with low coverage to allow for timely distribution of food from surplus and scarce World Bank (2011), Kenya Economic Update, areas, and enhance access to the market. The December 2011, Edition No. 5 About KIPPRA Policy Briefs For More Information Contact: Kenya Institute for Public Policy Research and Analysis KIPPRA acknowledges generous support from the Bishops Road, Bishops Garden Towers Government of Kenya, the African Capacity Building Foundation P.O. Box 56445-00200, Nairobi (ACBF), and the Think Tank Initiative of IDRC, who have Tel: 2719933/4 continued to support the Institute’s activities over the years. Cell: 0736712724, 0724256078 Email:admin@kippra.or.ke Website: http://www.kippra.org Twitter: @kipprakenya 4 KIPPRA Policy Brief No. 13/2017-2018