Aug 20, 2017

In our report before the Kenyan 2017 General Elections, Post-Election Business Environment, & Cytonn Monthly – July 2017, we highlighted our expectation of the immediate business environment post-elections. Our conclusion was that we expect the post-election business environment to remain largely peaceful and non-violent. This expectation was driven by the changes and reforms we had seen in our electoral process in the years leading to this past election, the circumstances and indicators leading to the election. Specifically;

1. Integrity and independence of the electoral body was better than before. For example, in this election, biometric voter identification worked, while at the last election this functionality failed,
2. Integrity and independence of the judiciary,
3. Election preparedness was generally better than before and the voting process went fairly smooth,
4. International presence and monitoring,
5. Market sentiment leading to election was positive.

However, we already have a dispute regarding the second step of the election, which is the tallying and results announcement, which has resulted into a petition in the Supreme Court. That the dispute ended up in the Supreme Court is a vindication of our institutional reforms. The NASA coalition, which is contesting the results, had heavily relied in the courts prior to the election; it would have been difficult and contradictory for the coalition to refuse to go to court to litigate the results they dispute.

Irrespective of the outcome of the petition, there are challenges that the incoming administration will need to address. In this focus note, we highlight the key economic areas that we expect the incoming administration to focus on.

Under the administration of the previous government, Kenya experienced some key economic developments and some changes in economic policies highlighted below:

1. Introduction of Interest Rate Cap: In August 2016, the President signed into law The Banking (Amendment) Act 2015, which stipulates a deposit and loan pricing framework, with (i) a cap on lending rates at 4.0% above the Central Bank Rate (CBR), and (ii) a floor on the deposit rates at 70% of the CBR. We have written severally on this matter in the following articles,
   1. Interest Rates Cap is Kenya’s Brexit – Popular but Unwise,
   2. Impact of the Interest Rate Cap,
   3. State of Interest Rate Caps, and
   4. Update on Effect of Interest Rate Cap on Credit Growth & Cost
2. Rebasing of Kenya’s GDP: In October 2014, Kenya rebased its GDP, meaning that the base year previously used for compiling the total volume and value of goods and services produced changed from 2001 to 2009. The revised GDP for 2013 rose from Kshs 3.8 tn to Kshs 4.8 tn, a 25.3% increase and subsequently moving the country from low-income status to lower middle-income status
3. Infrastructure Development: In the past 4.5 years, the government has invested in the development of infrastructure around the country. These developments have contributed positively to the economy through job creation and growth of the economy in various sectors. Some of the major infrastructure developments that the government has undertaken include the USD 3.2 bn Standard Gauge Railway(SGR), the continued investment in the USD 23.0 bn Lamu Port, South Sudan, Ethiopia Transport (LAPSSET) corridor project, the upgrade of the Mombasa port, the upgrade of Jomo Kenyatta International Airport and USD 84.4 mn upgrade at Moi International Airport.
4. Opened capital markets to international investors through the issue of the country’s first Eurobond: Kenya successfully raised USD 2.7 bn in 2014 through the issue of a USD 2.0 bn Eurobond in June and an additional USD 0.7 bn through a tap sale in December.

Looking at how Kenya’s economy has evolved over the years, we find that the economy is in a position for sustained growth, with projections from IMF averaging at 6.3% GDP growth over the next 5-years. For this to happen, even as the incoming administration seeks to deliver on their manifesto, we are of the view that the government should address the following six key economic issues, in order to boost economic growth and improve the business environment in the country:

1. Review of Interest Rate Cap: The interest rate cap was introduced to increase affordability of loans to the larger economy and at the same time ensure savers get returns for the money in the bank. However, the caps are yet to achieve this desired effect and have had a negative impact on the economy as they have (i) locked out SME’s and retail borrowers from accessing credit, (ii) led to widespread restructuring and lay-offs in the banking sector, (iii) strained the smaller banks, who have to mobilize expensive funds and can only lend out within the stipulated margins, and (iv) continued to weigh down on private sector credit growth which stood at 2.1% as at May 2017, the lowest in 8-years, from a high of 17.0% in 2016. It is clear from the above that the effects of interest rate capping, are more disastrous than productive with the cons far out-weighing the pros. In our view, the policy makers should scrap off the interest rate caps, and instead, (i) put in place enabling regulation for the development of innovative and competing alternative sources of funding in order to bring down the 95% funding dominance by banks as compared to more developed markets where bank funding makes up only 40% of total funding. We need to spur innovation and growth of alternative and capital markets funding, and (ii) provide fundamental and strong consumer protections for Kenyan public and push for more information sharing by the banks. While we are of the view that rate caps ought to be scrapped or at least radically reviewed, the review ought to be coupled with legislation that will make funding markets more competitive.
2. Government Debt: Over the past 6-years, we have seen the National Budget continue to grow with the total expenditures growing at an average of 14.7% to Kshs 2.2 tn in 2016/17 from Kshs 977.0 bn in 2010/11, while revenue growth (KRA Tax collections) has increased by 12.7% to Kshs 1.4 tn in 2016/17 from Kshs 670.0 bn in 2010/11, meaning that the difference has been funded through borrowing. This has led to an increase in the debt level from 40.7% debt to GDP in 2011 to the current level of 54.4%, which is 440 basis points above IMF’s threshold for developing countries.

Below is a table showing the sectoral contribution to 2016 GDP:

Sector	Percentage Contribution to 2016 GDP
Agriculture	23.9%
Manufacturing	11.3%
Real Estate	9.2%
Wholesale and retail trade	8.3%
Education	7.6%
Transport and Storage	7.6%
Financial & Insurance	6.8%
Construction	5.9%
Public Administration	4.2%
Information and Communication	4.2%
Electricity & Water Supply	2.7%
Professional, administration and support	2.5%
Health	2.0%
Other services	1.4%
Accommodation and Restaurant	1.2%
Mining and quarrying	1.2%

Source: Central Bank of Kenya
The increase in debt levels is mainly driven by (i) slow growth in revenue collection compared to the budget growth. Revenue collection has grown by an average of 12.7% compared to the 14.7% growth in the budget, and (ii) significant investment in infrastructure projects such as the SGR, which are mainly financed through external debt. In our view, the government should strive to manage the country’s debt levels going forward by (i) enhanced tax revenue collection growth, which can be achieved by developing avenues that will allow for taxation of the informal sector and enforcing efficient tax collection methods such as requiring the use of iTax for tax remittance, (ii) involve private sector in development through more Public-Private Partnerships (PPPs) so that private funding reduces the need for public borrowing and also private funding enhances the self sustainability of a project, and (iii) reduce recurrent expenditure that currently accounts for 58.8% of the 2017/2018 budget, compared to 54.3% in 2016/2017 and 50.8% in 2015/2016.

3. Ease of Doing Business: Ease of Doing Business is an aggregate ranking method for countries, based on indicators that measure and benchmark regulations applying to domestic SME businesses throughout their life cycle. The ranking is done by the World Bank, and tracks changes in the following 10 life cycle stages of a business: (i) starting a business, (ii) dealing with construction permits, (iii) getting electricity, (iv) registering property, (v) getting credit, (vi) protecting minority investors, (vii) paying taxes, (viii) trading across borders, (ix) enforcing contracts and (x) resolving insolvency. The results for each economy are then compared with those of 189 other economies and over time. According to World Bank Report, The Doing Business 2017 released in October 2016 Kenya was highlighted for making the biggest improvements in their business regulations leading to an improvement of 16 places to rank position 92 out of 190, which is a build-up from the improvement of 28 places to position 108 in 2015 from 136 in 2014.

Of the factors highlighted in the report that Kenya requires to improve on, the government has put effort in, (i) easing the tax remittance process through the online iTax platform, and (ii) improving the accessibility of credit information through the launch of a Cost of Credit website that is meant to provide the public with information on fees and charges relating to loan facilities offered by commercial banks and microfinance institutions. However, as highlighted in our write up, Ease of Doing Business in Kenya, we maintain our view that there exists room for Kenya to improve its business climate to attract more entrepreneurs and investors to start businesses and foreign direct investment by (i) making it easier for entrepreneurs to start a business by reducing the cost and processes involved, (ii) easing the process of obtaining construction permits, (iii) heighten the fight against corruption and (iv) enhancing minority investors protection.

4. Diversification of the Economy: The Kenyan economy relies heavily in the Agricultural sector, which contributed up to 25.7% of the GDP in Q1’2017. Owing to the fact that we are still highly dependent on rain-fed agriculture, the economy is highly affected in drought years. As highlighted in our report, Cost of Living, the levels of inflation have been the highest in years during which the country has experienced drought, due to the high dependency on agriculture. As the government puts in measures such as developing irrigation schemes to reduce dependence on rain-fed agriculture and ensure food security in low rainfall seasons, it should also focus on developing a more diversified economy that is less dependent on agriculture.

Below is a chart showing the evolution of the total debt and debt to GDP over the years:

Source: Kenya Bureau of Statistics

In order to do this, the government should seek to support sectors such as (i) manufacturing, through the development of already proposed Export Processing Zones and Special Economic Zones such as the proposed Dongo Kundu SEZ, (ii) transport and storage, through the development of infrastructure such as railroad, upgrade of airports and expansion of roads, (iii) real estate, through improved legislation that will ease approvals for real estate developments and improve access to credit to both developers and homeowners through mortgages in order to improve their contribution to the GDP, and, (iv) tourism, by maintaining the effort to sell Kenya as a good tourism destination. The sector seems to be gaining traction but a lot still needs to be done to ensure that this grows further and seasonality that comes with it is countered by having more diversified tourism offering to cater for both business and leisure.

5. Balance of Payment Position (BOP) and the Currency: The country’s BOP position has remained relatively stable though negative over the years supported by financial flows. However, the trade deficit has continued to fluctuate. In the last quarter we saw the trade deficit more than double due to a slowdown in exports and an increase in imports. As highlighted in our report, Cytonn Weekly #27/2017, the trade deficit increased by 43.1% to Kshs 352.5 bn from January to April 2017, from Kshs 246.3 bn in a similar period in 2016 driven by, (i) increased imports, which grew by 23.6%, due to increases in imports of fuels, machinery & transport and manufactured products by 48.9%, 23.8% and 10.3%, respectively, with the three jointly contributing 62.7% to total imports, and (ii) a marginal increase in exports, which grew by 2.4%, attributed to a 7.1% increase in the value of tea exports, despite a 7.4% decline in the value of horticultural exports, with the two contributing 24.6% and 21.8% of total exports, respectively. Given the importance of maintaining a fundamentally supported currency the government should (i) focus on improving the attractiveness of Kenya as an investment destination especially through the capital markets, by strengthening the regulations and increased investor education, (ii) look for ways to create a diversified export base to stop too much reliance on agriculture based exports. Manufacturing, being one of the sectors that could see an increase in exports but is largely hindered by the cost of power, we are of the view that the government should put effort to provide cheaper power through usage of more renewable energy, and (iii) create incentives for the Kenyan diaspora to invest back home.
6. Job Creation and Entrepreneurship: One of the biggest challenge facing the country today is the huge unemployment rate that is the highest in the East African region at 39.1% in 2016 up from 24.1% in 2015, according to The 2017 Human Development Index. The government should take a deliberate effort to enhance entrepreneurship and provide the more required capital to do this by increasing the allocation to the youth fund and increasing accountability around the same. Investment in technical education will also go a long way in assisting the youth to be more self-dependent.

In conclusion even as the government seeks to carry out its manifesto, it also has its work cut out in regards to meeting the expectations outlined above with the aim of improving the country’s economy. If the government would focus on these economic issues, we are of the view that (i) the economy would experience improved private sector credit growth, which will in turn spur the growth of the economy, (ii) through diversification of the economy, more jobs will be created and the risk the economy is exposed to due to climatic changes will be reduced, and (iii) with improved ease of doing business Kenya will provide an attractive destination for foreign investors increasing the country’s foreign direct investments.