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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 to grow at 6% in 2019 amidst Q3 growth expansion

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Q3 to maintain growth pedal

For the third quarter of 2019, Kenya’s real economic growth is likely to bounce back to 5.8 percent, above the trend of 5.3 percent. Analysts from Genghis Capital suggests the economic growth of Kenya for Q3 to be driven by the service sectors. “We doubt the going concern of the counties in the near-term. What was a tail risk situation at the start of Q2, 2019 has morphed into a base case; the unresolved Division of Revenue Bill, 2019,” said Genghis in their latest outlook. The bullish tone on the private sector at the tail end of last quarter will likely spill into Q3 2019.

A slow start of the budget cycle will offset this high degree of exuberance. The inflation rate in July touched a 3-month high of 6.3 percent from 5.7 percent in June highlighting increased pressure on the consumer spending ability.

The hike in inflation has been attributed in great part to the acceleration in the pricing of key agricultural commodities including maize and sifted grain flour and the implementation of new taxes under tax amendments by the National Treasury.

While the overall food and non-alcoholic beverages index has retreated by a single percentage point since the last review, with a slide to the pricing of commodities such as milk, potatoes and sukuma wiki, biting maize grain shortages has countered hopes for further relief to the costing of food.

“The decline in price of these commodities outweighed the observed increase in the cost of other commodities like maize grain, maize flour-loose, carrots and onions which increased by 0.52, 1.33, 6.81 and 1.19 per cent, respectively, over the same period,” noted the Kenya National Bureau of Statistics (KNBS) in its end month (July) inflation publication.

New taxes targeted at the ‘sin’ alcohol and cigarette industries which were made operational on July 1, 2019 to include a Ksh18 and Ksh24 hike of excise duty charged on wine and whisky respectively and a raise of a Ksh.61 tax on a packet of cigarettes have seen the index jump by 0.8 percent during the month.

At the same time, the impact of fluctuating petroleum prices has seen the cost of housing, electricity and transport rise in spite of a hold in the increase of diesel and kerosene prices by the Energy and Petroleum Regulatory Authority (EPRA) in mid-July.

While the impending harvest season will further support recourse in the rise of food prices; taxes, fuel costs and a depreciating shilling are, when combined, expected to anchor further shocks to the consumer disposable income represented in the Consumer Price Index (CPI).

The Kenya Revenue Authority (KRA) is expected to implement new excise taxes on non-alcoholic beverages and cosmetics beginning September 1, 2019 to effectively eat into the level of disposable income available to consumers.

Meanwhile, the pricing of petroleum commodities in the international market is set to remain unpredictable in the near-term irrespective of its recent cool down as tensions in the oil-rich Persian Gulf persists.

The recent devaluation of the Kenyan shilling against the US dollar will however make for the gravest concern on inflation, given the dollar’s impact on major purchases of imports and pricing of essential services including the electricity billing’s fuel-cost charge.

The shilling has been on a free-fall in the past couple of months, hitting both the two and five-year low in a matter attributed mainly to increased foreign currency demand by investors and heightened liquidity in the financial markets.

The over-supply of money in the economy has brought forth real risks of more money chasing fewer goods in a build-up which when held in the long-run poses the risk of hyper-inflation.

The shilling touched a low Ksh.104.20 valuation against the dollar at the close of trading on 23rd July before recovering marginally on the following day.

While inflation is once again on the rise, the rate holds within the government targeted range of 2.5 to 7.5 percent aligned to the ongoing medium term III plan, with the range being most recently retained for the eighth consecutive year by the National Treasury.

On the maize debate that is ongoing, analysts say they do not foresee maize supply shock to either give headline or food inflation a lift in Q3 2019. The CBK Monetary Policy Committee (MPC) reaction function signals a stable CBR at 9.0 percent in Q3 2019. Investors say they expect the local currency to be at 102.5 – 103.5 levels in Q3 2019.

At the macro level, the reduced big-ticket needs in FY2019/20, increased remittances (5.2 percent y/y to USD 1.45 billion in 1H19) and lower ADNOC Murban crude price will support the local currency.

The maturity of the 2-year bond (FXD1/2017/2Yr) in the current depressed yield environment will likely nudge its refinancing (a 2-year primary bond paper) in the month of August.

“We believe the issuance of longer tenor bonds will remain the baseline scenario although net domestic borrowing target in FY2019/20 (KES 289.2Bn) is higher than FY2018/19 (KES 255.4Bn).”

Investors should expect interbank rates to average 4.0 percent at the end of Q3 2019 from the current sub 2.0% levels. In the event a modification of the interest rate cap comes to pass at the tail end of Q3 2019, “we expect a normalization at the long end of the yield curve beginning Q4 2019.”

CBK Maintains Lending Rate

The Central Bank of Kenya (CBK) on 24th July maintained the benchmark lending rate at 9 percent due to the relatively stable inflation rate.

Patrick Njoroge, CBK governor, who chaired the Monetary Policy Committee (MPC) meeting in Nairobi said that the inflation expectations remained well anchored within the target range, and that the economy was operating close to its potential.

“The MPC will continue to closely monitor developments in the global and domestic economy, including any perverse response to its previous decisions, and stands ready to take additional measures as necessary,” Njoroge said in a statement issued in Nairobi.

The monetary policy organ met to review the outcome of its previous policy decisions as well as the recent economic developments against a backdrop of domestic macroeconomic stability, increased optimism on the economic growth prospects, and increased global uncertainties.

Njoroge said there is need to be vigilant on the possible effects of the recent increases in fuel prices, the ongoing demonetization, and the increased uncertainties in the external environment.

The committee noted the gradual demonetization through the withdrawal of the older 1,000 shilling notes (10 U.S. dollars) and the close monitoring by CBK will ensure that the process is not disruptive to the economy.

The governor noted that month-on-month overall inflation remained relatively stable and within the target range in May and June 2019.

“The inflation rate stood at 5.7 percent in June compared to 5.5 percent in May. However, food inflation rose to 6.6 percent in June from 6.0 percent in May, reflecting increases in the prices of non-vegetable food crops particularly maize, due to uncertain supply,” Njoroge said.

According to the MPC, non-food-non-fuel inflation remained below 5 percent, indicative of muted demand pressures and spillover effects of the recent rise in fuel prices.

“Overall inflation is expected to remain within the target range in the near term largely due to expectations of lower food prices following improved weather conditions, and lower electricity prices with the reduced reliance on expensive power sources,” Njoroge observed.

The governor added that the economy remained strong in the first quarter of 2019, despite the effects of the delayed long rains on agricultural production.

The MPC noted that the leading indicators of economic activity point to stronger growth in the second quarter of 2019.

“Consequently, growth in 2019 is expected to remain strong, supported by agricultural production, strong growth of micro, small medium enterprises and the service sector, foreign direct investment, and a stable macroeconomic environment,” he added.

The apex bank said that the real GDP growth stood at 5.6 percent, reflecting a stronger than expected performance of agriculture and a resilient services sector, particularly information and communication, accommodation and restaurants, and transport and storage.

Njoroge added that the alignment of the 2019/20 financial year government budget to the Big 4 priority sectors is expected to boost economic activity in manufacturing, agriculture, construction and real estate, and health sectors.

Growth on right gear

Kenya’s gross domestic product (GDP) is likely to expand by at least 6 per cent this year, the country’s finance minister said, sticking to rosy government forecasts despite delayed rains that could hit agriculture, a mainstay of the economy.

The Kenyan economy grew 6.3 per cent in 2018, the statistics office said, helped by adequate rainfall, which spurred farming, which contributes about a third of output. Growth had slumped to 4.9 per cent the previous year in 2017.

“The Kenyan economy remains resilient. It is expected to perform better in 2019, growing by at least over 6 per cent,” the minister, Henry Rotich, said at an event to disclose last year’s economic performance.

The World Bank trimmed its forecast for Kenyan growth in 2019 to 5.7 per cent this month from an earlier forecast of 5.8 per cent because the main rainy season was delayed. Food shortages and water scarcity could worsen if the rainy season – from March to May — fails entirely, the country’s meteorological department said just days after the World Bank’s move.

“Uncertain rainfall may act as an inadvertent drag on growth,” said Razia Khan, the head of research for Africa at Standard Chartered in London.

The government, however, which expects the economy to grow by at least 6.3 per cent in 2019, according to President Uhuru Kenyatta in a speech earlier in the month of July, stuck to its optimism.

“Though the onset of the long rains have delayed, it is still early to predict on its impact on agricultural production,” Rotich said.

Last year’s recovery in growth was driven by agriculture, excluding fisheries and forestry, which expanded by 6.6 per cent, up from 1.8 per cent in 2017, said Zachary Mwangi, director general of the Kenya National Bureau of Statistics.

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