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The Budget to Boost Economic Growth

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The macroeconomic environment in Kenya has remained relatively stable in the first half of 2018, supported by (i) continued investment in infrastructure, (ii) a stable interest rate environment, (iii) a relatively stable currency, having gained by 2.1% in H1’2018, and (iv) improved business confidence and strong private consumption as evidenced by an average Stanbic PMI of 55.0 in the first 5 months of 2018 up from 50.2 in the first 5-months of 2017. The outlook on economic growth for 2018, is positive following improved weather conditions set to boost agricultural productivity, water supply and electricity that will in turn favor the manufacturing sector and (ii) recovery in the business environment following easing of political risk caused by the prolonged political impasse over the 2017 presidential elections. Low private sector credit growth, which stood at 2.8% as at April as compared to the 5-year average of 14.0%, remains one of the key concerns for economic growth.

Kenya’s Finance Minister Henry Rotich presented the largest budget on record for the 2018/2019 fiscal year to parliament on 14 June, with the income tax bill tabled alongside it. Both came into effect on 1st July 2018. The government aims to strike a tough balance between realizing an accelerated pace of economic expansion through increased infrastructure investment while also striving for an improved fiscal picture. However, it remains to be seen if the government will be able to meet its ambitious fiscal target, as the budget was devoid of bold tax reforms and the country has suffered from low revenue collection in recent years.

The new budget is 25% bigger than the previous one and amounts to around KES 3 trillion (USD 29 billion). It targets a deficit of 5.7% of GDP for the new financial year, below the estimated 7.2% of GDP for FY 2017/2018. If achieved, this would mark the lowest deficit since 2013. Spending will be tailored to meet the goals set under President Uhuru Kenyatta’s “Big Four” agenda, which will prioritize investment in manufacturing, food security, universal healthcare and affordable housing over a five-year span. In addition, a large chunk of expenditure will go towards servicing the country’s burgeoning debt. On the revenue front, a number of small tax measures were introduced, including a Robin Hood tax of 0.05% that will be instituted on any amount exceeding KES 500,000 transferred through banks or financial institutions. However, the budget was devoid of a large tax reform. While a higher tax bracket of 35% for Kenyans earning above KES 250,000 per month was proposed in the early stages of the draft, this measure was withdrawn from the final bill and awaits further guidance from the cabinet.

Meanwhile, the highlight of the income tax bill was the repeal of the interest rate cap on commercial bank lending rates that has long stymied the availability of credit to the private sector, especially to small- and medium-sized enterprises, and has been a persistent impediment to achieving higher economic growth. The overturn was eagerly awaited by Kenyan banks that have long voiced opposition to the ceiling on the cost of loans, which has hindered their ability to price risk. However, the bill has yet to be approved by parliament, which is likely to see pushback against the law in favor of maintaining access to cheap credit.

Kenya’s economy was derailed last year by a severe drought that crippled agricultural output and a prolonged election cycle, in addition to growth being limited by the interest rate cap. With the political scene returning to stability and weather conditions improving, economic activity has picked up since the start of the year, expanding at a solid pace for six consecutive months. While the measures proposed by the budget should aid the economy onto a higher growth trajectory, the government will be tasked with a tough challenge in meeting the ambitious fiscal consolidation aims given its track record of missed revenue targets.

The latest national accounts data released by Kenya’s National Bureau of Statistics on 29 June published GDP figures for both the final quarter of last year and the first quarter of the current year. The economy expanded 5.7% annually in Q1 2018 and 5.3% in Q4, up from a revised 4.7% in Q3 (previously reported: +4.4% year-on-year). Improved weather conditions and more upbeat business and consumer confidence, thanks to a return to political stability following last year’s prolonged election cycle, powered the upturn in both quarters. Growth in quarter-on-quarter seasonally-adjusted terms shot up to 1.7% in Q4 from a revised 1.1% rise in Q3 (previously reported: +0.9% quarter-on-quarter), before edging up to 1.9% in Q1.

Looking at a breakdown by production, most sectors improved. The agricultural sector made a marked recovery in Q1 on the back of favorable weather conditions, including the onrush of heavy rains in early March, with output expanding 5.2% after losing considerable pace in Q4 when it slowed to a 1.4% expansion (Q3: +3.8% yoy). Manufacturing output rebounded in Q1, growing 2.3% after contracting 0.4% in Q4, which followed a flat reading in Q3. Higher economic growth was also supported by a surge in the real estate sector, which expanded 6.8% in Q1 (Q4: +6.3% yoy; Q3: +6.1% yoy) and a steady pace of expansion in wholesale and retail trade (Q1: +6.3% yoy: Q4: 6.2% yoy).

On the other hand, both the mining and quarrying, and electricity and water supply sectors recorded a slower pace of expansion in Q1. Mining and quarrying output lost momentum for the second consecutive quarter, expanding 4.5% in Q1 (Q4: +5.0% yoy; Q3: +6.4% yoy). Although the electricity and water supply sector grew a robust 5.1% in Q1, largely owing to geothermal power generation, the sector slowed slightly from a 5.8% upturn in Q4 (Q3: +4.5% yoy).

This year, it is expected that the government’s record-high budget for the 2018/2019 financial year would support an accelerated pace of expansion through increased infrastructure spending, but the drive to achieve greater fiscal consolidation at the same time will be tough given the administration’s poor track record in meeting revenue collection targets in recent years. And while the proposal to repeal the cap on commercial bank lending rates—a policy that has long thwarted the availability of credit for high-risk borrowers, has been tabled through the income tax bill—the Treasury will face a tough battle in doing so, owing to stiff opposition from parliament.

Offering their take on the budget, EFG Hermes’ research team stated:

“As in 2017/18, we think potential revenue shortfalls will require the government to submit supplementary budgets through the fiscal year, which could lead to the deficit coming in higher than the 5.7% estimated by the finance minister, which in turn could worsen the country’s growing debt burden. Banks currently own more than 50% of total domestic outstanding debt, given that the government intends to raise almost half of the net additional borrowing from domestic sources, any offshoot in the budget estimate is likely to further crowd out the private sector, especially since banks’ exposure to government securities is already at a seven-year high (due to the introduction of rate caps in 2016).”

Nonetheless, the economy is expected to accelerate this year, thanks to the fading impact of the drought, increased investment and a continued expansion in the agricultural sector. Private consumption should be supported by more favorable credit conditions stemming from the removal of the interest rate cap. Moreover, completion of phase one of the standard gauge railway between Mombasa and Nairobi should help curb import demand and narrow Kenya’s current account deficit. While the return to political stability will lift confidence, substantial fiscal tightening could limit the pace at which the economy will expand. Analysts project GDP growth of 5.5% in 2018.

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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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