The uncertainty arising from disruptions in the flow of goods through the Strait of Hormuz has finally reached Kenya in the form of ‘tail risks.’ Although we all quietly expected it, the announcement of a sharp rise in fuel prices mid this month has still come as a shock.
Economists describe the current situation as a ‘tail risk’ because most models did not anticipate that the blockage of such a narrow waterway would occur, or, if it did, that it would have such far-reaching consequences for global supply chains and financial markets.
Before this war began, few people were familiar with terms like ‘Strait’ or ‘Hormuz.’ Today, phrases such as ‘blocking of the Strait of Hormuz’ have become part of everyday conversation.
Just this week, I overheard someone jokingly threaten to block another person’s ‘Strait of Hormuz.’ I did not follow up to understand what they meant, but the reference itself reflects how quickly global events have entered local discourse.
Beyond the terminology, what we will feel most are the economic consequences arising from the current situation. While the transmission of this shock was initially delayed by the Energy and Petroleum Regulatory Authority (Epra) statutory pricing regime, fuel costs have now caught up with global market prices.
For other cost-areas outside Epra, the effects of this tail risk now have no ‘delayer’.
Transport costs are expected to quickly rise, increasing the cost of moving goods across the country. Manufacturers and farmers, facing higher transport and production expenses, will pass these costs on to consumers.
Ultimately, the costs of goods in supermarket shelves will shortly increase. The result is broad-based, persistent, and systemic cost-push inflation.
In the real economy, consider large corporates with sufficient capital buffers in sectors such as transport, logistics, agriculture, and manufacturing, but which heavily dependent on fuel.
Even if they initially resist raising prices, increased operating costs will quickly erode profitability and capital, potentially pushing them out of business. The rational response, regardless of firm size, is to adjust prices accordingly.
Unlike demand-push inflation, which can be managed through interest rate adjustments, cost-push inflation creates a difficult trade-off between controlling inflation and supporting economic growth.
Raising interest rates may help stabilise prices but risks slowing growth by making borrowing more expensive. Conversely, keeping rates low may support growth but risks weakening the currency and amplifying imported inflation.
On the exchange rate front, higher oil prices have increased Kenya’s import bill, widening the current account deficit. This continues to put downward pressure on the Kenyan shilling. A weaker currency, in turn, makes imports more expensive, reinforcing inflationary pressures.
Rising fuel and food prices are also eroding household disposable income, forcing consumers to prioritise essential spending. As incomes shrink, less money is available for loan repayments. Micro, small, and medium enterprises, particularly those in non-essential sectors, are likely to be among the hardest hit due to declining sales.
As prices rise across the board, demand will likely decline. Reduced demand leads to lower output, delayed investments, and eventually layoffs. Job losses then hitback and reduce household income, further increasing credit risk across the economy.
As incomes fall, borrowers’ credit profiles deteriorate, increasing their probability of default. Under risk-based pricing frameworks, this leads to higher interest rates, which in turn raise loan repayment burdens and further strain household and business finances.
Lenders, facing elevated credit risk, will need to increase provisions, limiting their capacity to extend additional credit to the market.
This is how a geopolitical conflict thousands of kilometres away ultimately imports risks which eventually affects everyone.
Are there other tail risks ahead? No one knows. What is clear, however, is that the impact of Strait of Hormuz disruption on inflation, and the resulting pressure on the broader financial system requires urgent attention.