Effects Of Crude Oil Prices On Gross Domestic Product Growth And Selected Macroeconomic Variables In Kenya

ABSTRACT

Crude oil is one of the main drivers of economic growth and a key ingredient to

sustainable development. It is therefore vital that crude oil products be efficiently and

competitively priced in order to accelerate economic growth. Realization of a 10

percent economic growth in Kenya by the year 2030 requires a massive development

in the energy sector. Kenya suffers from a shortage of internal energy resources,

including oil and as a result, Kenya continues to be in the category of net oil importing

developing countries; this subjects the economy to vulnerability to external shocks,

notably oil price fluctuations, exposing the country to risks associated with oil prices

such as a reduction in aggregate demand, increase in consumption price deflator and

reduction in real income. This study empirically explored the effects of crude oil on

GDP growth and selected macroeconomic variables in Kenya. This was achieved by

investigating how crude oil prices affect GDP growth, inflation rate and real exchange

rate. Literature has presented these three variables as the main indicators of economic

health and key variables affected by crude oil prices. Demand for oil in Kenya has

been progressively increasing since the 1970s and this is expected to increase even

further from the current consumption of 4.2 million Metric tons per year to 12 million

Metric tons by the year 2030. The forecasted rise in demand has been attributed to the

achievement and sustainability of the desired 10 percent economic growth, as

envisioned in the national vision 2030 blueprint. The study used time series data

sourced from BP, WDI and CBK covering the period 1970 to 2016. This period was

chosen so as to capture different oil shocks that have been shown through empirical

and theoretical literature to have had an effect on the economy. The study estimated

three Autoregressive Distributed lag (ARDL) models to analyse the effect of crude oil

on the selected variables in the study. The findings of the study revealed that, crude

oil prices have a positive long-run effect on GDP growth. This can be attributed to the

fact that Kenya imports oil and re-exports it to Uganda, Rwanda and South Sudan.

The findings also established that Crude Oil Prices have a positive effect on inflation

in the long run, while in the short run its lag of one has the effect on inflation rate,

meaning that the Crude oil prices for the previous one year affects the current year’s

inflation. The relationship between crude oil prices and Real Exchange Rate was

negative in the long run. CUSUM and CUSUMQ tests were also conducted and the

three models were stable. The study recommends that the government should revive

the oil refinery in Changamwe in order to improve the oil value chain and therefore

gain from exporting petroleum products as opposed to crude oil. The Energy

Regulatory Commission should also moderate oil prices in a way that considers social

equity in order to mitigate its effect on inflation.