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Kenya’s economy poised to bounce back and grow at 5.5% in 2018

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This is a critical time for Kenya, as the incoming administrations at national and devolved levels face the high expectations of ordinary Kenyans to deliver on ambitious economic development agendas and hasten the attainment of Vision 2030. The Kenyan economy faced multiple headwinds in 2017.

A drought in the earlier half of the year, the ongoing slowdown in private sector credit growth, and a prolonged election cycle weakened private sector demand, notwithstanding an expansionary fiscal stance. Nonetheless, reflecting the relatively diverse economic structure, these headwinds were partially mitigated by the recovery in tourism, better rains in the second half of the year, still low global oil prices, and a relatively stable macroeconomic environment.

Consequently, overall GDP growth is projected to dip to 4.9 percent in 2017— its lowest in the past five years, but still higher than the Sub-Saharan African average. With headwinds subsiding, economic growth is projected to rebound over the medium term, reaching about 5.8 percent in 2019.

However, this rebound is predicated on policy reforms needed to address downside risks that have the potential to derail medium term prospects.

Two macroeconomic risks are pertinent. First, there is a need to consolidate the fiscal stance in order not to jeopardize Kenya’s hard-earned macroeconomic stability—a critical ingredient to Kenya’s recent robust growth performance.

Second, is the need to jumpstart the recovery of credit growth to the private sector; particularly to micro, small and medium size businesses and households. Further, efforts to mitigate weather-related risks by climate proofing agriculture could be supportive of a robust and inclusive medium term growth agenda.

The Kenyan Economy in 360°

Buffeted by multiple headwinds, economic activity decelerated in 2017. After posting a solid 5.8 percent growth in 2016, GDP growth slumped to 4.8 percent in the first half of 2017, with the third quarter showing signs of continued weakness. The slowdown in Kenya’s growth momentum has been triggered by three main headwinds.

  • First, poor rains led to a contraction in agricultural output and curtailed hydropower generation in the first half of the year. Relatedly, this led to the build-up of inflationary pressures and dampened household consumption.
  • Second, private sector credit growth continued its trend decline, thereby further dampening aggregate demand.
  • Third, private sector activity weakened over the first three quarters of 2017 on account of the election induced wait-and-see attitude.

However, tail winds from the rebound in tourism, strong public investment, and still low oil prices partially mitigated the headwinds. Near term growth is projected to weaken, however with the easing of headwinds, economic activity is projected to rebound in the medium term.

Given ongoing headwinds, GDP growth in 2017 is expected to decelerate to 4.9 percent—its weakest growth in five years.

However, predicated on the easing of headwinds and policy reforms, growth is expected to recover to 5.5 and 5.9 percent in 2018 and 2019 respectively. Nonetheless there remain significant downside risks that could scuttle the projected rebound in economic activity.

  • First, delays to fiscal consolidation risks jeopardizing Kenya’s hard earned macroeconomic stability with adverse implications on medium term growth and the inclusivity of that growth.
  • Second, the weakness in credit growth risks curtailing a robust recovery.
  • Third, lingering political uncertainty can further undermine business confidence, and stunt a robust recovery.

Implementing key macroeconomic and sectoral reforms can avert downside risks and contribute to a robust medium term outlook.

  • First, safeguarding macroeconomic stability—a foundation for robust growth— will require fiscal consolidation. Fiscal consolidation can be supported through enhancing domestic revenue mobilization and reining in of recurrent expenditures, crowding in the private sector to carry out development projects thereby reducing the burden on the public purse, and improving the efficiency of public investment spending.
  • Second, private sector credit growth can be crowded in through fiscal consolidation as well as through the establishment of an electronic collateral registry and improvements to the credit scoring system.
  • Third, a durable and robust growth can be supported by climate proofing agriculture through increased adoption of drought tolerant seeds, investing in water management systems and improving agronomical practices.

Slowdown in Private Sector Credit Growth

Credit growth has slowed significantly in Kenya since 2015 reflecting a series of shocks. Private sector credit growth fell from its peak of about 25 percent in mid-2014 to 1.6 percent in August 2017—its lowest level in over a decade.

The slowdown in credit is not attributable to one single event. It reflects the impact of the liquidity shock in 2015/16, the impact of the resolution of three non-systemic banks on confidence within the banking system, and the liquidity implication of a segmented interbank market.

With the advent of a less supportive demand environment in 2017, regional slowdown in credit growth and supply constraints—most importantly, the rise in non-performing loans—the outlook for strong credit growth remains dim.

The enactment of the interest rate caps in September 2016 made an already tough lending environment more difficult. Although the interest rate cap was meant to reduce the cost of credit, thereby making credit accessible to a wider range of borrowers, after a year of implementation the decline in credit growth to the private sector has continued with several unintended negative consequences.

  • First, banks have shifted lending to corporate clients and government at the expense of small and medium sized enterprises and personal household loans.
  • Second, the proportion of new borrowers has fallen by more than half, likely impacting entrepreneurship and new job creation.
  • Third, the operating environment for banks has become more challenging for them to perform their financial intermediation role.
  • Fourth, the interest rate cap has undermined monetary policy implementation with adverse implications for Central Bank’s independence and ability to steer the economy.

The removal of the interest rate cap is critical to preserving medium term growth prospects. Removing the interest rate cap can help jump start domestic credit to the private sector, support the flow of funds to longer term private investments, and allow the Central Bank to effectively implement monetary policy, a key role in fostering growth.

Though important, the reversal of the interest rate cap, will not be sufficient to improve access to credit. As considered, the weakness in credit growth started well before the enactment of the rate caps. In this regard, there is a need to carry out a deeper set of macro and microeconomic reforms to improve credit access and financial inclusion.

On the macroeconomic side, a reduction in fiscal deficit and better management of public debt is key to lowering benchmark interest rates and ultimately bank lending rates.

On the microeconomic front, the universal adoption of credit scoring and sharing would help counteract perennially high interest rates for borrowers and improve bank lending policies. Furthermore, accelerating the implementation of the movable collateral registry can help fast track the resolution of non-performing loans.

In addition, reforms that strengthen consumer protection and increase financial literacy is essential to address predatory lending.

Domestic Revenue Mobilization

Improvements to domestic revenue mobilization can be supportive of the medium term fiscal consolidation plans.bDespite the robustness of GDP growth in recent years, revenues have underperformed targets by an Kenya annual average of about 3.7 percentage points of GDP since FY11/12.

While a rapid rise in the expenditures has significantly contributed to the deficit, the underperformance of revenues has also played a role in the widening deficit.

The Special focus section on Domestic Revenue Mobilization reviews two taxes— Corporate Income tax (CIT) and Value Added Tax (VAT), and gives policy options that could enhance revenue collection for the two taxes. Three key notes emerged from the analysis.

  • First, there remains substantive scope to boost tax revenues by rationalizing exemptions. The analysis finds that exemptions represent a significant source of forgone tax revenues. While tax exemptions may have been set for specific reasons, over time the initial objective might have lapsed. Forgone revenues from corporate income tax alone account for 1.8 percentage points of GDP with the bulk of tax exemptions concentrated in a few subsectors. Similarly, on VAT, the indiscriminate application of exemptions account for revenue leakages of up to 3.1 percent of GDP arising from various exemptions (over 70 percent of actual revenue).
  • Second, there is need to enhance revenue collections in the sectors where the losses in revenue are the greatest. The financial, manufacturing, health and social work activities, account for 88 percent of total exemptions. Any rationalization of the CIT exemptions regime therefore, should have a focus on these sectors, to the extent that the specific tax exemptions being enjoyed in these sub sectors are no longer a priority within the national development agenda. On the VAT front, taking into account international best practice, the report finds that Kenya applies a relatively liberal VAT exemptions regime on domestic supplies. This suggests that there is scope to improve VAT collection by streamlining exemptions on domestic supplies. Other areas for streamlining VAT exemptions with the potential to augment revenues include zero-rated supplies and VAT on exempt imports.
  • Third, the tax base could be widened and compliance improved. Measures such as cleaning up of the tax register to ensure it includes an accurate number of taxpayers as well as accurate master data could be adopted. The KRA’s adoption of an electronic system is a step in the right direction and should contribute to ensuring a wider tax base coverage.

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Kenya

Kenya’s economy on sound footing in 2019: Thanks to the political stability

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After a year that began on the wrong footing due to divisions over the hotly contested and controversial 2017 presidential polls, 2019 could bring with it better economic growth prospects.

Among the key issues that could shape economic conversations and the lives of Kenyans this year are whether a law on interest rate caps will be repealed, the national census, a new currency, and the political climate.

This positive outlook could, however, be affected by the high-octane politics that is gaining momentum – specifically a referendum and 2022 succession politics that could hamper the country’s economic growth.

But with the World Bank having projected Kenya’s economy to hit 6.01 per cent this year from 5.475 per cent recorded in 2018, the Government is upbeat about the oncoming economic prospects.

“Our growth outlook at around six per cent remains stable and so are other macroeconomic indicators like inflation, interest rates, and the currency exchange rates,” Treasury Cabinet Secretary Henry Rotich averred.

“We will continue to monitor the global developments especially trade wars, Brexit, commodity prices and US monetary policy and take appropriate actions to mitigate any negative consequences to our growth,” he said.

Since Uhuru Kenyatta became president, the highest rate at which Kenya’s economy has grown in a year was 5.9 per cent in 2016 and 2013, when Mwai Kibaki retired.

 

Remittance inflows

This year’s growth could be supported by strong remittance inflows and rising household income from agriculture and lower food prices.

“Manufacturing is still recovering and its activities remain sluggish. The sector growth rose from 0.5 per cent in 2017 to 2.7 per cent in 2018, but still remains weak compared with a three-year average of 3.6 per cent over 2013 to 2016,” said the World Bank recently.

Among the key drivers of growth this year will be an improved business environment as well as the easing of the political climate, underpinned by strong agricultural output and a good performance by the service sector.

Further, the Bretton Woods institution projects that with interest rates capping and banks leaning towards government securities, credit is unlikely to grow, especially for small enterprises.

This view has also been shared by the Central Bank of Kenya (CBK) which has consistently said that the ceiling on interest rates charged by banks was denying entrepreneurs access to credit which is stifling economic growth.

However, according to a survey released last week by research firm Trends and Insights for Africa (Tifa), four out of 10 Kenyans, or 44 per cent would like to set up a business next year while 32 per cent will be scouting for jobs.

The drafters of Vision 2030 had insisted that for Kenya to be a medium income economy, its GDP was supposed to grow by more than seven per cent annually for two decades.

If the political environment remains stable, Kenya’s economy will for the first time in a decade hit a six per cent growth rate in 2019. Industry leaders are however afraid that all this could be wiped out by the unpredictable operating environment.

“2019 promises to be a strong year for the sector, specifically if the predictable and stable business environment can be guaranteed in policy formulation and implementation,” Kenya Association of Manufacturers Chief Executive Phyliss Wakiaga revealed.

On the bright side, previous economic growth numbers show that Kenya’s economy has in the last two decades grown its fastest in the second year after a presidential election.

The growth, however, starts to decline in the third year as another election approaches.

In 2004, just a year after Mwai Kibaki had been elected as president Kenya’s economy grew by seven per cent. In 2010 it rebounded to 8.4 after the peace deal between Kibaki and his political nemesis Raila Odinga in the 2007 elections that led to the grand coalition government.

Then in 2015, year after Uhuru had been elected for his first term it hit 5.9 per cent. Thanks to the handshake between Uhuru and Raila, Kenya’s business climate has stabilized, though still struggling in some sectors such as mining which remains on the growth path.

In all real GDP grew an estimated 5.9% in 2018, from 4.9% in 2017, supported by good weather, eased political uncertainties, improved business confidence, and strong private consumption. On the supply side, services accounted for 52.5% of the growth, agriculture for 23.7%, and industry for 23.8%. On the demand side, private consumption was the key driver of growth. The public debt–to-GDP ratio increased considerably over the past five years to 57% at the end of June 2018. Half of public debt is external. The share of loans from non-concessional sources has increased, partly because Kenya issued a $2 billion Eurobond in February 2018. An October 2018 International Monetary Fund debt sustainability analysis elevated the country’s risk of debt stress to moderate.

A tighter fiscal stance reduced the fiscal deficit to an estimated 6.7% of GDP in 2018, with the share of government spending in GDP falling to 23.9% from 28.0% in 2017. To stimulate growth, the Central Bank of Kenya reduced the interest rate to 9% in July 2018 from 9.5% in May. Nonetheless, a law capping interest rates discourages savings, reduces credit access to the private sector (especially small and medium enterprises), and impedes banking sector competition, particularly by reducing smaller banks’ profitability. The exchange rate was more stable in 2018 than in 2017. The current account deficit narrowed to an estimated 5.8% of GDP in 2018 from 6.7% in 2017, thanks to an improved trade balance as a result of increased Kenyan manufacturing exports. Kenya’s gross official reserves reached $8.5 billion (5.6 months of imports) in September 2018— a 7% increase from a year before.

Tailwinds and headwinds

Real GDP is projected to grow by 6.01% in 2019. Domestically, improved business confidence and continued macroeconomic stability will contribute to growth. Externally, tourism and the strengthening global economy will contribute.

The government plans to continue fiscal consolidation to restrain the rising deficit and stabilize public debt by enhancing revenue, rationalizing expenditures through zero base budgeting, and reducing the cost of debt by diversifying funding sources. Inflation is projected to be 5.5% in 2019 due to prudent monetary policy. Kenya also benefits from renewed political momentum (including the 2010 constitution and devolution), a strategic geographic location with sea access, opportunities for private investors, and the discovery of oil, gas, and coal along with continued exploration for other minerals.

Among downside risks are possible difficulties in making fiscal consolidation friendly to growth and in finding affordable finance for the budget deficit caused by tightening global markets. Boosting domestic resource mobilization and enhancing government spending efficiency are critical to restrain public borrowing.

Kenya continues to face the challenges of inadequate infrastructure, high income inequality, and high poverty exacerbated by high unemployment, which varies across locations and groups (such as young people). Kenya is exposed to risks related to external shocks, climate change, and security. The population in extreme poverty (living on less than $1.90 a day) declined from 46% in 2006 to 36% in 2016. But the trajectory is inadequate to eradicate extreme poverty by 2030.

Kenya’s Big Four (B4) economic plan, introduced in 2017, focuses on manufacturing, affordable housing, universal health coverage, and food and nutrition security. It envisages enhancing structural transformation, addressing deep-seated social and economic challenges, and accelerating economic growth to at least 7% a year. By implementing the B4 strategy, Kenya hopes to reduce poverty rapidly and create decent jobs.

 

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