Between the year 2010 and 2012, the degree of trade openness in Kenya averaged 70.1% hence underlining the importance of international trade to the country. In 2012, Kenya‟s trade deficit stood at 20.8% of GDP, contributing a negative 4 percent drag to GDP growth and further threatening macroeconomic stability. This is despite the development of numerous trade policies to boost the country‟s trade balance. Empirically, there have been attempts to investigate the determinants of Kenya‟s trade balance, but all have used aggregated export, import, trade balance and real effective exchange rate data. These efforts suffer from aggregation bias which conceals important bilateral movements such as bilateral real exchange rate movements and entity-specific effects like cultural and institutional effects. It is on this backdrop that this study aimed to analyze the determinants of Kenya‟s bilateral trade balance using the recently developed Extended Trade Balance Model which captures the effects of key factors influencing trade balance as suggested by elasticity, absorption, and monetary approaches to balance of trade determination and the Gravity Model. The specific objectives include: examination of the long-run effect of exchange rate on Kenya‟s bilateral trade balance through the Marshall-Lerner condition, investigation of the effect of trade liberalization on Kenya‟s bilateral trade balance, and examination of the influence of import-weighted distance on Kenya‟s bilateral trade balance. A sample of 10 of Kenya‟s key trading partners based on data availability and representing about 60% of Kenya‟s total trade was considered for the period 1970-2013. This study used secondary data drawn from the Kenya National Bureau of Statistics (KNBS), International Monetary Fund (IMF) and the World Bank (WB). Im-Pesaran-Shin (IPS) test for stationarity and Pedroni cointegration test were applied on the data after which dynamic panel data regression techniques were used in the analysis. The results of the study showed that the Marshall-Lerner condition was only met for the trade between Kenya and China, UAE, India and South Africa. The study established that the onset of trade liberalization policies had significant negative impact on Kenya‟s bilateral trade with China, Germany, India, South Africa, UAE and the United Kingdom. Transportation costs were also found to negatively influence bilateral trade balance with all the countries. This study recommended that while considering currency devaluation, the country should do so in bilateral terms. The government should also develop policies to encourage local manufacturers to produce import substitutes and offer subsidies and incentives to the export sector. To reduce transportation costs, the government should import huge volumes from relatively close sources.

1.1 Background to the Study 
International trade involves the exchange of goods, services and capital between two or more countries. It involves exports, which are goods and services sold to the foreign country, and imports, which are goods and services bought from foreign countries. International capital flows represent the financial side of international trade. For most countries, and especially developing countries, exports and imports represents a significant share of their gross domestic products (GDPs) (OECD, 2012). 

A key component in international trade is the balance of trade or trade balance, which refers to the difference in monetary terms between exports and imports by a country over a given period of time. It takes the form of a trade deficit if the monetary value of imports exceeds that of exports or trade surplus if exports exceed imports in monetary value or equivalent when the values of exports and imports are equal. A persistent trade deficit signifies a weakening economy, and reflects increased and excessive foreign dependence. Trade deficits are funded through capital account borrowings which consequently lead to rise in the external debt burden position of a country. These deficits therefore indicate that a country is sacrificing its future growth because the country would be presently purchasing more than it would be producing, thus trading investment in future growth for present consumption (Osoro, 2013). 

With a trade-to-GDP ratio of 70 percent for the period between 2010 and 2012, Kenya heavily relies on external trade. But since early 1970s, the value of Kenya‟s imports has persistently exceeded that of exports. For instance, the period between the year 2010 and 2012 saw Kenya‟s trade balance deficit average at 19.8 percent of the GDP (KNBS, 2013). These trade balance deficits have been blamed for the low economic growth rates in Kenya. According to the World Bank (2013), the trade balance deficits are a drag on economic growth, having reduced overall growth by 4.1 percent in 2012. This economic slump was mainly attributed to high oil prices and low exports. The World Bank (2013) further argued that if Kenya was to have a balanced trade balance position, the country would already be growing at an overall growth rate of 8%. 

Figure 1.1 shows the trend of Kenya‟s exports, imports and trade balance since 1960. In the post-independence era, Kenya recorded back-to-back trade balance surpluses from 1963-1969 save for 1967 when a trade balance deficit of Ksh. 80 million occurred. From 1970-1975, Kenya‟s exports were outstripped by imports and 1974 recorded a relatively huge trade deficit of Ksh. 1.5 billion which was attributed to the oil crisis of the same year. The coffee boom of 1976 and 1977 contributed to two years of trade balance surpluses after which trade deficits resumed and kept on growing each year. This deficit increased significantly between the year 2005 and 2012, reaching 20.8 percent of the country‟s GDP in 2012. This ever-rising trade balance deficit has attracted the attention of economists, policy makers and even the World Bank, with the latter warning Kenya of walking on a tight rope with her ballooning trade deficit as the country was risking a balance of payments (BOP) crisis (World Bank, 2012).

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Item Type: Kenyan Topic  |  Size: 77 pages  |  Chapters: 1-5
Format: MS Word  |  Delivery: Within 30Mins.


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