Transmission of International Prices to Domestic Markets in Kenya: The Case of Food and Crude-oil Markets During the 2007-8 Global Crisis

Abstract

This study looks at the transmission of international prices to the Kenyan economy in 2007-2008 with a focus on food and oil prices. The degree of price transmission between spatial markets signifies the level of integration of such markets. The information on magnitudes of the price elasticities of demand for imports, and the extent of price transmissions is very important in the design of policies to deal with external price shocks. The paper uses the imperfect substitute demand model and the Kenya CGE model to estimate the import elasticities that are then employed to simulate domestic price effects of external shocks. The findings show that aggregate import demand elasticities for food and crude oil in Kenya are fairly elastic, with coefficients being slightly greater than unity. This implies that when international prices fall, the demand for imported products rises by more than a proportionate quantity. Thus changes in international prices for oil and food are likely to have substantial effects on the country's trade balance. In addition, the results indicate that in the year 2007-2008, there was less than full transmission of external crude oil price shocks to domestic market prices, and the crisis had low or negligible effects on domestic prices for other goods and services. Similarly, transmissions of world market food prices to the domestic market were negligible. The results suggest very low integration between domestic and world markets, especially for agricultural products. The study recommends re-alignment of Kenya’s food production and supply strategies with international initiatives in order to meet food security requirements and stabilize domestic prices.

Keywords: Price shocks, import elasticities, price transmission, market integration.