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 of 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, an 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 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, the 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.