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 for 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 the 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 that 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 the 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 the 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 the 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.