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Kenya’s Economy and its budget cut Implication

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Recent data signals that the economy remains on course for a solid third quarter following the second quarter’s likely stronger performance. Business conditions improved in August as reflected by the latest PMI reading, which climbed further above the critical threshold separating expansion from contraction in private-sector activity. Economic growth has been buoyed by rising confidence following the end of a protracted election cycle, along with buoyant exports and rising remittances.

On 30 August, Kenya’s parliament voted to maintain the long-standing interest rate cap on commercial bank lending rates. Since coming into effect in September 2016, the cap has significantly curbed private credit growth. Parliament’s decision rejected a bid by the Treasury to scrap or modify the policy, as well as defying calls from the IMF to do so, thus failing to qualifying for a new standby arrangement.

The Treasury confirmed that it would allow the existing USD 1.5 billion IMF standby credit facility to expire. Removal of the balance of payments’ support is seen increasing the economy’s vulnerability to external shocks. 

Leading Economic Indicator

The Leading Economic Indicators highlights trends in Consumer Price Indices (CPI) and inflation, interest rates, exchange rates, international trade, agriculture, energy, manufacturing, building and construction, tourism and transport.
Consumer Price Index (CPI) decreased from 193.31 points in June 2018 to 191.59 points in July 2018. The overall rate of inflation rose slightly from 4.28 per cent to 4.35 per cent during the same period. In July 2018, the Kenyan Shilling appreciated against the major trading currencies except for the Sterling Pound and the Ugandan Shilling.

The average yield rate for the 91-day Treasury bills, which is a benchmark for the general trend of interest rates decreased slightly from 7.87 per cent in June 2018 to 7.69 per cent in July 2018, while the inter-bank rate rose from 5.03 per cent in June 2018 to 5.06 per cent in July 2018.

The Nairobi Securities Exchange (NSE) 20 share index increased from 3,286 points in June 2018 to 3,320 points in July 2018, while the total number of shares traded dropped from 453 million shares to 323 million shares during the same period. The total value of NSE shares traded decreased from KSh 13.69 billion in June 2018 to KSh 9.74 billion in July 2018.
Broad money supply (M3), a key indicator for monetary policy formulation, increased from KSh 3,242.94 billion in June 2018 to KSh 3,258.99 billion in July 2018.

Gross Foreign Exchange Reserves increased from KSh 1,221.83 billion in June 2018 to KSh 1,235.33 billion in July 2018. Net Foreign Exchange Reserves decreased from KSh 760.51 billion in June 2018 to KSh 759.29 billion in July 2018.

Budget Cuts and big losers

The National Assembly recently approved budget cuts worth Sh37.6 billion from the Executive, Parliament and the counties to bridge the current deficit. With a shortfall of more than Sh500 billion, the Government expects to further bridge the deficit through external borrowing to finance its Sh3 trillion budget.

The MPs adopted the report of the Budget and Appropriations Committee chaired by Kikuyu MP Kimani Ichung’wa, which also retained the National Government Constituencies Development Fund (NG-CDF) at Sh 33.3 billion and the Affirmative Action Fund at Sh2.1 billion.

Earlier, the legislators had planned to reject sections of the Supplementary Appropriation Bill based on proposals by the National Treasury to take away Sh6 billion from NG-CDF and Sh2 billion from the Affirmative Action Fund. The MPs also lost Sh3.8 billion from the Equalization Fund while the Parliamentary Service Commission (PSC) budget was reduced by Sh600 million.

Lawmakers’ interests

To ensure that the lawmakers’ interests were catered for after a charged meeting of the Jubilee Party Parliamentary Group (PG) at State House and the Opposition Orange Democratic Movement (ODM) party’s PG meeting at Orange House, Treasury assured Parliament that it would only lose funds for operations and maintenance.

“The Government lost the standby credit when the International Monetary Fund (IMF) stood down its credit, although the Government is still in talks with them,” said Mr. Ichung’wa when he moved the motion to adopt the report. “Our foreign reserve depends on diaspora remittance, which requires a solid insurance policy. With a deficit of Sh562 billion, we now bank on domestic and foreign borrowing as well as local revenue,” he said. The MP said the budget cuts were arrived at after intense negotiations with Treasury, PSC and the Judicial Service Commission that went into the night.

“We had to reduce expenses by 7.5 per cent to meet the fiscal deficit. We must exercise fiscal discipline in the principle of give and take. Then development partners will have confidence in the Government,” he said. The biggest losers in the new austerity measures are the Last Mile Connectivity electricity programme (Sh1.5 billion), the laptops for schools project (Sh5.5 billion), roads (Sh8.7 billion), Equalisation Fund (Sh3.8 billion) Ministry of Education infrastructure project (Sh600 million) and Konza City (Sh400 million).

The Ministry of Energy will lose Sh2.6 billion, the Petroleum ministry Sh1.5 billion, PSC Sh1.2 billion, the National Assembly Sh1 billion, Teachers Service Commission Sh67 million and Sports ministry Sh29 million. Other losers were the Department of Planning (Sh286 million), Health ministry (Sh22 million) and Independent Policing Oversight Authority (Sh20 million). The Department for Immigration will lose Sh91 million, Devolution ministry Sh2.6 million, Department of Arid and Semi-Arid Lands Sh47 million, Defense ministry Sh42 million and Foreign Affairs ministry Sh179 million.

Others were the Department of Vocational and Technical Training (Sh1.3 billion), Basic Education (Sh1 billion), University Education (Sh1 billion) and National Treasury (Sh6.5 billion). Among the austerity measures adopted were reduction of capital expenditure by Sh28.5 billion. The Presidency’s budget for recurrent expenditure and development was reduced by Sh323 million while the Interior ministry lost Sh377 million.

“We have proposed 16 per cent budget cuts across the board. MPs’ house allowance, personal emolument, salaries and wages were not touched. We want real austerity measures cutting across all departments of Government,” said Ichung’wa. He said some items in domestic and foreign travel budgets had been cut while training and seminars for all ministries were reduced. Leader of Majority Aden Duale (Garissa Township) seconded the austerity proposals.

“Let us engage from the point of facts and figures. Leaders should show goodwill. In law, the House balances the budget,” said Mr Duale. Leader of Minority John Mbadi (South Suba) admitted that the country was facing tough financial choices. “We must maintain financial integrity as a country. We projected the revenue at Sh1.9 trillion. The debt repayment stands at Sh870 billion,” he said, adding that there was no money left in the country’s budget for development.

“Salaries stand at 650 billion; add that to debt repayment, and it goes to Sh1.5 trillion as Sh314 billion goes to counties. That makes it Sh1.8 trillion, leaving us with less than Sh100 million to spend on development,” he said.

Opposed measures

A number of MPs, including Robert Mbui (Kathiani), Omboko Milemba (Emuhuya), Ali Wario (Garsen), Alpha Miruka (Bomachoge Chache), Gideon Mulyungi (Mwingi central), Geoffrey Osotsi (nominated) and Owen Baya (Kilifi North) opposed the austerity measures.
They took issue with the reduction of budgets for education, roads and energy.

Mr Baya censured Cabinet secretaries, whom he accused of lacking innovation to help Government raise revenue instead of relying on budget cuts and tax increments. “They can offload assets and scale down their budgets.

There are better austerity measures to ensure we cut costs,” he said. Mr. Osotsi argued that some budgets could be harmonized to seal the deficit. “The budget for technical and vocational education was initially Sh2.3 billion, now it is Sh7.4 billion. Why the huge variation?” Mr. Mbui said Parliament had a chance to correct the mistake of an ambitious budget with a lot of duplication.

Implications on the economy

The proposed eight per cent VAT increase and proposed supplementary budget cuts will impact public service users and households, and Parliament should reject them.

Counties are already distressed because the national government has fallen behind on its remittances to the devolved units. The proposal to reduce the allocation to county governments will further hurt services. Cutting the Equalization fund will hurt development in marginalized areas, particularly access to water, which is a main focus of the fund. A failure to address access to water in turn increases the disease burden, undermining health.

The proposal to slash budgets on road repairs is irresponsible and equally counterproductive. Bad roads push up the cost of operating vehicles to all drivers, negatively affecting households, businesses and the economy. Poor roads also contribute to road accidents and deaths.

It is unfortunate that the President’s flagship projects — Last Mile and digital learner platform — are facing the axe. In particular, electrification is a key development indicator with knock-on effects for economic growth. Similarly, the plan to slash capacity building at a time when the country needs to develop its human resource capacity is ill-advised.

This will be the third supplementary budget of the year, a clear indication that the government is broke and the economy is in distress. It is also of concern that funds are being removed from development to debt servicing.

The tax measures come against the backdrop of stringent conditions set by IMF that would negatively affect the economy further. So, what should be done?

First, the President should declare the debt situation a national crisis and institute sustainable recovery measures that will target government waste, size and corruption and not hurt Mwananchi.

These include releasing idle funds held by ministries and state corporations and redistributing equitably to debt repayment and basic service delivery at county level.

The President should also redeploy CDF funds towards debt servicing whilst making sure ongoing projects are not affected.

However, the fund should be restructured to conform to the Constitution as per the High Court’s ruling in Petition 71 of 2013.

Further, the government should implement the parastatals restructuring report to eliminate duplication and overlap. This should be accompanied by rationalization of staffing and structures of the presidency and national government administration to reduce the wage bill.

Other measures should include reduced overpricing and waste; intensifying the fight against corruption, civil service effectiveness and fiscal compliance.

 

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Kenya

Kenya’s Economy to Experience Moderate Slowdown In 2019

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Kenya’s economy entered the year on a less promising note, with weaker domestic demand causing a notable slowdown in private sector activity. That said, a buoyant tourism sector and solid remittance inflows, which have helped narrow the current account deficit, likely cushioned the impact of the decline. Unfortunately, the country aimed to raise up to KES 50 billion (USD 500 million) through auctioning a tax-free 25-year amortized infrastructure bond on 20 March, with proceeds expected to fund the “Big Four Agenda” development projects and the bond was to some extent undersubscribed and resulted to a total of KES 16.3billion bonds accepted by the Central Bank of Kenya (CBK) as against the KES 50billion bonds anticipated.

The government’s appetite for spending, however, is at loggerheads with the need for fiscal consolidation. Reining in the country’s escalating public debt burden is a necessary condition to securing a new IMF standby credit facility; discussions with the IMF are currently underway.

 

Highlights of Kenya’s Economic Performance

  • It is expected that headwinds to growth in private consumption, investment and exports will see Kenya’s economy expand at a slower pace in 2019.
  • The ongoing cap on bank lending rates – which will continue to dampen credit growth – and rising inflation will constrain growth in private investment and household consumption.
  • Public investment directed under the ‘Big Four’ agenda will support GDP growth, but is likely to fall short of government expectations.
  • Moreover, export growth is likely to decelerate in 2019 due to reduced production of tea, the country’s main export.
  • It is forecasted real GDP growth of 5.2% will be experienced in 2019 and 5.5% in 2020 respectively, down from an estimated 5.8% in 2018.

 

 

Subdued Credit Growth to Hurt Trade Sector and Households In 2019

It is expected that the harmful banking sector regulations and rising inflation will temper the pace of growth in private investment and private consumption in 2019. Credit growth will continue to be constrained by an interest rate cap introduced in 2016, which limits bank lending rates to 400 basis points above the central bank policy rate. It is forecasted credit growth will remain in single digits in 2019, growing by 7.5% by year-end, compared to a 2010-2015 year-end average of 20.4% (prior to the cap).

This will continue to affect business investment in the wholesale and retail trade sector (the largest recipient of private credit) as well as private consumption, given that household credit represents the second largest share of total private credit. Moreover, these effects will be compounded by an acceleration of inflation to a forecast of 6.0% in 2019 from 4.7% in 2018, given normalizing weather conditions which are likely to boost food prices. It is expected rising inflation will further weigh on private investment and consumption growth in 2019 by increasing firms’ input costs and weakening households’ purchasing power.

 

Meanwhile, public investment as a driver of growth will fall short of the government’s ambitions. It is noted that overall, fixed investment in 2019 will benefit from a healthy infrastructure project pipeline, which includes the Standard Gauge Railway (Phase 2A) and the Lamu Port, scheduled to reach completion in 2019 and 2020 respectively. A forecast on the construction sector is expected to grow at a robust 8.6% in 2019, from 7.5% in 2018, to then tail off from 2020 given project completions.

Public investment will also be directed under President Uhuru Kenyatta’s ‘Big Four’ agenda, which aims to boost healthcare coverage, affordable housing, food security and the manufacturing sector. That said, we believe that implementation of the agenda’s objectives will face structural constraints stemming from administrative inefficiencies and funding shortfalls.

Moreover, several tax measures introduced in the 2018/19 fiscal budget to fund the various programs encountered resistance from lawmakers, including a value-added tax on fuel that was imposed at half the initially proposed rate (8.0% instead of 16.0%). Therefore, it is believed that public spending under the Big Four agenda will have a lesser impact on growth than the authorities expect.

Lower Tea Output to Weigh On Total Export Growth In 2019

Furthermore, weaker tea production is likely to weigh on export revenue growth. In February 2019, the Tea Directorate of the Agricultural and Food Authority estimated a 12.0% y-o-y reduction in tea exports for the full year, owing to lower output in the tea-growing regions of the west. Kenya is one of the world’s main producers of tea, which accounted for 25.6% of total exports in 2018 – the largest share of the country’s export revenue.

Therefore, it is believed that this will drag on total export growth, further contributing to a slowdown in headline growth. Moreover, it is highlighted the possibility that normalizing weather conditions after favorable agricultural yields in 2018 could also weigh on production growth of horticultural goods, the second largest export component (accounting for 19.5% of Kenya’s exports), posing further downside risks.

 

It is believed that risks are tilted firmly to the downside. Kenyatta’s inability to push many economic policies through parliament have in the past hampered implementation of key initiatives, including proposals to remove or modify the interest rate cap on commercial banks. It is believed that, should Kenyatta’s position weaken further, this could slow policy-making and progress on the Big Four agenda. Moreover, weaker-than-expected global economic activity could see the return of risk-off sentiment to financial markets and renewed pressure on emerging market currencies later in the year (although it is stressed that this is not a core view).

Since more than half of Kenya’s government debt (which stands at 61.3% of GDP) is denominated in foreign currency, pressure on the Kenyan shilling would significantly increase debt servicing costs, posing further headwinds to public investment and clouding the country’s short-term growth outlook.

While risks are weighted to the downside, it is to be noted that the removal of the interest rate cap on commercial banks in 2019 would pose an upside risk to our view. Indeed, on March 14 2019 a Kenyan court ruled that the cap is unconstitutional, though judges suspended the implementation of the ruling for 12 months to allow legislators to review the law.

 

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