Kenya exhibits sustained economic growth and benefits for investors

Even amidst a broader downturn in many African markets, Kenya has consistently been one of sub-Saharan Africa’s most reliable performers. It was the sub-Saharan Africa’s fifth-largest economy in 2015 behind Nigeria, South Africa, Angola and Sudan, ranked 11th in inward foreign direct investment and is one of the few countries in Africa that is not primarily dependent on extractive revenues. This performance is not necessarily surprising given the country’s comparative advantages.

The East African market has one of the highest financial inclusion rates in the developing world, and a strong and diversified private sector. Kenya has some of the largest and most developed transportation and logistics infrastructure in Africa, serving as a trans-shipment centre for imports to 150m people in the neighbouring landlocked neighbours of Ethiopia, South Sudan, Uganda and Rwanda. Kenya is also seen as a safe haven for assets in the region, with significant inflows from countries such as Somalia and South Sudan a contributing factor to the country’s overall balance sheet.

However, the nation is not without its challenges, and it remains a country of extremes with a largely undeveloped arid north, which brings down per capita GDP to $1376, placing it lower than 15 other continental markets. Job creation, particularly for the country’s large youth population, is low, sustaining a large informal economy. Kenya benefits from a strong agricultural sector, but this leaves it exposed to climate volatility, and disparities in rural development.

Recent History

Kenya’s economic growth averaged 5.7% in the 1960s and 7.2% in the 1970s, but has slowed in recent decades. The rate was 4.2% in the 1980s and 2.2% in the 1990s. The 2000s brought the only period with five years of uninterrupted growth, including a peak rate of 7.1% in 2007. However, the post-election violence that same year led to a significant shake-up of the country’s economic structure. Not only did it have an impact on cyclical industries like tourism and agriculture, but it also led to a number of major reforms.

Chief among these was the implementation of a new constitution in 2010, which created a presidential system to replace the extant parliamentary one, along with an emphasis on devolving power to local governments in key areas such as education and health. This was accomplished by creating 47 counties, which receive national revenues and are able to generate revenues of their own. The transition has not always been smooth, but is expected to yield long-term gains in governance.

A number of other efforts in recent years have helped solidify Kenya’s profile as a potential frontier market investment destination. In 2013 Kenya rebased its GDP, which boosted the country to lower middle-income status, and in 2014 it sold its first eurobond, raising $2.8bn in the process. Much of the proceeds are going towards infrastructure projects and debt repayment.

Key Indicators

Overall, GDP growth from 2000 to 2014 averaged 4.3%, dragged down in part by the post-election instability and inconsistent rainfall. The population grew at a rate of 2.7% in that period, suggesting a low-growth environment in which the country is not realising its full economic potential, according to analysis from the Brookings Institution, a US-based think tank. The growth rate lagged the average for sub-Saharan Africa in that 15-year period, which was 4.9%. The country’s current performance is a significant step up, as a result. The country’s Vision 2030 economic blueprint targets 10% GDP growth on an annual basis, and while that pace may not be on the cards in 2017, the outlook is bullish. The World Bank predicted 5.9% growth for 2016 in its October 2016 Economic Update, and predicted growth of 6% for 2017. This compares favourably against an average of 3.5% growth for sub-Saharan Africa, and well above several other major investment destinations in Africa, including Nigeria, Ghana and South Africa.

In the longer term, boosting growth beyond the average of recent years will be a function of becom-continuation of the innovation narrative in the telecoms and technology sectors, while sidestepping climate, security challenges and public overspend.

On the immediate horizon, as Kenya entered the 2017 basic economic indicators were largely positive, however, there are some causes for concerns. Inflation hit a five-year high in March 2017, rising to 10.3%, which was above the target range of 2.5% to 7.5% set by the Central Bank of Kenya (CBK). Inflation has been driven almost entirely an ongoing drought, which has impacted prices, but is expected to recover in the spring of 2017. The current-account deficit had dropped from over 10% in 2014 to 5.2% of GDP, as of September 2016. It was expected to be at 8% in 2016, fuelled in part by importing material to build the Standard-Gauge Railway (SGR) project; and is forecast to fall to 6.7% in 2017.

Kenya’s currency, the shilling, is considered a strength, and was stable after the first three quarters with about a 1% drop against the US dollar on the year. The 12% decline against the dollar in 2015 was less than the drop of other regional currencies, and institutional confidence in the central bank is high, given that having both budget and trade deficits are often a challenge to monetary policy in developing countries. “Despite global currency fluctuations, the Kenyan shilling has remained very strong, even with the strengthening of the US dollar,” Julius Muia, director-general of Kenya Vision 2030 Delivery Secretariat, told OBG.

The CBK boosted the benchmark lending rate from 8.5% to 11.5% in 2015, then dropped it down to 10%, where it remained as of March 2017. It used foreign exchange reserves to defend the currency in 2015, driving the total below $9bn temporarily before building the total back up to about $9.8bn in the summer of 2016. It has also injected liquidity into the system through reverse repossession offerings.

Sector By Sector

Although Kenya stands out in Africa for its low reliance on petroleum and mineral exports, its economy is still based on natural resources to a large extent: some 42% of GDP and 70% of overall employment comes from activities such as agriculture, forestry and fishing, as well as some indirect uses of natural resources such as tourism. Agriculture is the mainstay, accounting for almost 30% of GDP in 2015, while industry contributed 19.5% and services 50.5%. Agriculture grew at a rate of 5.6% in 2015, providing about a fifth of overall GDP growth. However, the sector experienced a slowdown in 2016 with growth falling to 3.9%, due largely to a prolonged drought. While Kenya’s agricultural sector is strong, shifts in consumer behaviour are driving change. “Agricultural testing is becoming more and more important as export markets have high standards for produce,” Albert Stockell, managing director of SGS Kenya, told OBG. Kenya is the world’s largest exporter of black tea, with other major export crops including coffee and legumes.

Sectoral Shift

While the broader split between agriculture, industry and services has been changing relatively slowly, there have been sharper shifts in growth and GDP contribution among their constituent subsectors. Tourism, for example, has struggled as a result of not only continued slow growth in Europe – the country’s largest source market – but also concerns over security. The sector’s contraction averaged 15.1% from 2010 to 2014. “There is still a need for a comprehensive security policy that includes both regional and domestic security priorities,” Jules Delahaije, CEO and chairman of SGA Security Kenya, Uganda and Tanzania, told OBG. However, 2016 marked a return to form for the sector, as visitor number were up by 16.7% over the previous year. The IMF even attributed real GDP growth to stronger than expected tourism numbers. According to Christopher Hockey, command and control centre manager at the Nairobi-based security consultancy, Warrior Insight, concerns remain. “The economy has clearly been effected by travel warnings issued by foreign governments,’’ Hockey told OBG.

As is the case in many emerging markets, Kenya would like to boost manufacturing to support job creation and export revenues — currently it provides 290,000 direct jobs — but the sector’s contribution to GDP has been relatively constant, at about 10% of the total. Constraints include the high cost of manufacturing inputs, either via imports or transporting them within the domestic market, as well as an expensive and unreliable power supply. Kenya’s electricity sector has ample capacity, contrary to the majority of the continent’s economies, but relatively high tariffs and supply disruptions limit the benefits of that supply.

The extractive energy and mining sectors have been seeing more aggressive growth, based on a handful of key discoveries. The first major foreign investment in mining opened in 2014, with Base Titanium’s project to extract titanium from sands on the country’s southern shores, and gold production, on the back of Acacia Mining’s evaluation of prospects in the south of Kenya In hydrocarbons, Tullow Oil and Gas found a commercial-scale deposit in the country’s northern region situated in the Lokichar basin, and estimated a base reserve amount of 750m barrels. Production is likely to begin in 2022, although the government would prefer an earlier start. Kenya has prospective oil and gas basins beyond Lokichar as well, and other companies are exploring in other regions of the country. Natural gas has been discovered offshore, but in smaller quantities.

The ICT sector is also experiencing double-digit growth rates, having expanded at an average of 13.5% from 2010 to 2014, and is expected to grow by 20% in 2017. Kenya’s reputation as a tech hub for sub-Saharan Africa — it is known colloquially as Silicon Savannah — was supported in part by the success of the M-Pesa mobile money programme. The success of Kenyans in adapting to mobile finance has led to something of a start-up culture in Nairobi, with technology entrepreneurs clustering in laboratories and incubators to develop software and apps.

However, some legal concerns are arising. “Due to the growing overlap between ICT and financial services via initiatives like mobile money, there will be a growing need for additional regulations to clarify the legal framework in these sectors,” John Ohaga, managing partner at TripleOKLaw Advocates, told OBG.

Regional Bloc

Kenya is a member of the EAC, along with Tanzania, Uganda, Rwanda and Burundi. The bloc is perhaps the most integrated on the continent in terms of trade activity, with trade volumes among member states making up roughly one-third of the region’s overall volumes, compared to 10% in West Africa’s ECOWAS bloc, for example. Coordination among EAC members has been challenging in recent years. Potential pipeline and transport corridors have been subject to competition between Tanzania and Kenya, for example, the two most populous countries with sole access to maritime shipping routes. Ongoing discussions over an EAC-EU economic partnership agreement (EPA) have also highlighted the disparity in development and economic clout among members. An EPA would give the EAC duty- and quota-free access to EU markets, and Kenya and Rwanda have already signed the agreement. At the end of 2016 Tanzania, Burundi and Uganda had not, however. Kenya has the most to lose if the group does not sign, because it is the only country in the group not classified as a least-developed country. Least-developed countries already enjoy that level of access to the EU, so the main impact of signing the EPA would be providing this status to Kenya as well.

Fiscal Stance

The budget for the FY 2016/17 stands out for its shift from years of expansionary fiscal policy to consolidation. The KSh2.1rtn ($20.5bn) spending package proposes a deficit of KSh555.4bn ($5.4bn), which is 6% smaller than the revised budget for the 2015/16 period. The deficit is projected to drop from 9.2% of GDP to 7.7% as a result.

Kenya underscored its commitment in 2016 to reducing the fiscal deficit by 3% of GDP over the following two fiscal years. It also requested an extension to an IMF contingency loan of $1.5bn that allows the state to draw on emergency funds if need be. It has not needed to use this backup plan, but the decision to request an extension is a sign of commitment to fiscal consolidation. The push to consolidate is motivated in part by two key figures. After 10 years of expansionary policy, in part financed by borrowing, concerns at this point focus on indicators such as the ratio of interest payments to revenue, at 13.5%, and a debt-to-GDP figure of 52.8%.

Cutting Costs

Budget figures show that overall Kenya is working to reduce spending on all types of recurring expenses, and to increase spending on developmental projects that improve economic prospects. According to IMF figures, in 2013-14 recurrent expenditures amounted to 19.4% of GDP, and this figure is projected to fall to 17.6% by the 2019-20 budgeting cycle. Kenya proposed spending 5% of GDP on wages in 2016-17, down from 5.2% in the two previous years, and 5.6% in 2013-2014. The IMF projects the figure to fall to 4.8% by 2018-2019. Development and net lending, however, are seen rising from 6.3% of GDP to 7.4% by 2019-20. While that figure is an overall increase, it is actually expected to decline from a level of 8.9% of GDP or higher from 2014-17, when spending on the first phase of construction of the SGR peaks. Unless major new infrastructure projects are announced using foreign financing, the reliance on foreign loans is also expected to drop by 2018-19, from the current range of about 4% to 5% of GDP to less than 2%. As for how the money retained by the national government for spending is allocated, two sectors stand out: energy and infrastructure. These sectors’ allocation decreased from 27% of the budget to 25% in 2016/17, whereas governance spending rose from 10% to 12%.

Revenue Sharing

In any Kenyan budget, transfers from the national government to counties must be worth at least 15% of overall state resources, according to the 2010 constitution. Allocations to county governments were 19.9% of total revenue in FY 2013/14 and 24.2% in FY 2014/15, according to the Kenya Institute for Public Policy Research and Analysis, but the issue is nonetheless a matter of contention between the two levels of government. In the FY 2016/17 budget the rate of increase in the absolute amount of the transfer was 7.9%, less than in previous fiscal years and less than the 15% recommended by the Commission on Revenue Allocation, which was created in the 2010 constitution to ensure an equitable sharing of revenue between governments. The Treasury did not supply an explanation for the use of a lower growth rate.

Revenue

State revenue in the 2016/17 cycle is projected at KSh1.5tn ($14.6bn), up 14.2% from the previous period. About 98% of the total would come from taxes, with the balance from non-tax revenue such as investment income, fees, and grants. Revenue growth in recent years has been led by increases in income taxes paid, which have gone from slightly over 6% of GDP in FY 2006/07 to just over 9% in FY 2015/16. Tax revenue overall has risen from about 15% to almost 17% of GDP.

According to research from Exotix Partners, Kenya’s state revenue per capita in the previous budget cycle was $318, higher than the regional average of $189. For sub-Saharan Africa the figure was $304. The Kenya Revenue Authority (KRA) has been working to improve tax collection, via e-filing and other digitised processes. “The KRA is doing more compliance checks and better audits,’’ Christopher Kirathe, executive director of transaction tax for EY in Nairobi, told OBG. “Audits are more focused because there’s more visibility thanks to the data mined through the online tax platform.’’ One of the attributes of Kenya’s revenue profile is a large amount of revenue from unclear sources: the “other’’ line item in revenue figures typically reaches 6% to 7% of the total. One explanation for this is Kenya’s status as a regional safe haven for financial assets. Somalia lacks a formal banking system and South Sudan is facing civil strife, and those two countries count as sources of revenue flowing into Kenya. The CBK has said that remittances into the country are likely higher than official figures, and perhaps even triple the amount, which was reported at $199m monthly for 2014.

Debt

Kenya’s debt-to-GDP ratio of 52.8% is not high enough to trigger concerns, according to the IMF’s March 2016 debt sustainability analysis, but the debt load is now higher than the average for sub-Saharan Africa and is worth monitoring. The state has been easing its reliance on regular bond sales to domestic investors in favour of accessing global debt markets, such as the sale of its maiden eurobond in 2014. External public debt has risen from a total of $9.1bn in 2012 to $14.3bn as of September 2015. The figure does not include sovereign guarantees, which now total $450m in disclosed contingent liabilities.

Kenya’s development and access to finance means that its debt profile includes more loans at commercial rates than what is owed at the lower concessional rates available from aid agencies and development banks. Commercial creditors went from 7% of the debt load to 19.1% from 2012 to 2015. That includes the $2.8bn raised in the eurobond, for which the interest rate is 6.8%. Cabinet secretary of the National Treasury Henry Rotich said in June 2016 that the country may sell another eurobond and believes it would not have to offer a yield above 10% to attract investors, as some other countries have recently done.

Governance

Kenya ranked 139th out of 167 countries in the 2015 Corruption Perceptions Index published by Transparency International, with a score of 25 – identical to that of 2014. In the 2014 Ibrahim Index of African Governance it ranked 17th out of 52 countries and scored higher than the average for East Africa. “Corruption may or may not be getting worse, but people are seeing more of it because there is more transparency,’’ Kwame Owino, CEO of the Institute of Economic Affairs, a Nairobi-based think tank, told OBG.

In spite of a new financial law passed in 2012, the IMF has found that 75% of the government’s contingent liabilities are not reported and amount to about 12% of GDP. Another 6.2% of GDP in contingent liabilities come from government guarantees to the National Social Security Fund, and should be better monitored, the fund said. “While Kenya has a strong regulatory and legal framework in place, enforcement has room for improvement,” Mary Chege, founding partner at EMSI & Associates, told OBG.

Nonetheless, Kenya performs well according to the standards in the IMF’s Fiscal Transparency Code, the fund reported in March 2016. At the same time.

Outlook

The highlight of 2017 will be the general elections, with hopes for a result that is clear and accepted, and a peaceful transition of power if the incumbent loses. Kenya’s fundamental economic performance continues to be strong, with GDP growth expected to grow by 6%. Key sectors such as tourism continue to rebound, however, important structural reforms are still needed to ensure sustained growth.