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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 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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