Jun 21, 2015

Kenya’s 2015/2016 budget presented last week outlined a planned expenditure of Kshs 2.2 trillion, representing a 20% increase from the 2014/2015 budget. The increase in expenditure is going to be financed through both normal revenue collections increases (Kshs 1.3 bn) and also increased borrowing both in the local (Kshs 229.7 bn) and international markets (Kshs 340.5 bn).

To attain the economic growth rate of 7%, the budget allocation was guided by the following key sub objectives:

1. Improving the business environment through (a) enhancement of security, (b) improving the ease of doing business, (c) maintenance of a stable macro economic environment, and (d) deepening of the financial sector;
2. Better infrastructure development. We continue to see a lot of allocation towards development expenditure and streamlining of procurement procedures, which has increased absorption of the allocated funds;
3. Continued investment in agriculture and industrialization to continue increasing employment in the sector and take up better farming activities;
4. Increased investment in the social sector like education, health and training to support the youth and women and enhance economic inclusivity.

On the back of stable macroeconomic variables both in the local and international markets, the Treasury is projecting a 7% growth rate this year. However, in our view, given the high reliance on rain fed agriculture in our country, and agriculture being the backbone of the economy, together with lower tourism arrival figures, we think the projections are overly ambitious and may not be achievable.

The investment in development expenditure is expected to go a long way in enhancing economic growth rate; however in the past the budget utilization has remained low, though there have been improvements over the years. The continued confusion between the national and county governments roles in development remain a key challenge but there is more clarity now and that will go a long way in improving accountability by both arms of government.

With the increased borrowing to finance the budget we see a number of key challenges:

• The government may crowd out the private sector as it has continued to borrow more from the domestic market making it difficult for companies to borrow as interest rates remain high;
• Increased international borrowing may lead to the country being opened to any significant shocks in the international market;
• With increased borrowings by the government, which has led to uncertainty in interest rates, the development of the government’s secondary bond market has remained sluggish compared to other market;
• Increased currency volatility since, despite the normal market forces for dollars, the government will be in the market to finance debt repayment.

The country is however on the right track towards the achievement of the vision 2030 despite the roadblocks that it is currently facing. The inflation rates have remained low and stable, and despite the recent weakness of the currency, the volatility is low. The Monetary Policy Committee has been alert in reviewing the performance of the economy and taking the necessary actions but more vigilance to this end will go a long way in increasing investor confidence in the economy. The currency may remain under pressure due to the expected increase in the current account deficit since the country is at an investment phase and so importation of machinery and capital goods are high, but in the past we have seen increased capital flow offset the negative current account.

Lastly, the government revenue collections targets are high but we have seen KRA become more aggressive in revenue collection. Despite the efforts, consistent growth might be difficult given that the targets have continued to increase but in the past they have constantly missed targets. This has resulted in continued increases in domestic borrowing. The country’s debt levels remain sustainable at about 43.7% of GDP but we need to be careful not to get to the 50% level, which would be a concern for an emerging markets country like Kenya. Government’s discipline in following the budget provisions to the latter will also be important to increase investor confidence and also assist in easily predicting the economic performance by the public.

In conclusion, in as much as the economic growth forecast of 7% may not be achievable, we are of the view that the macroeconomic fundamentals are attractive and offer a solid foundation for investments, especially given the relatively low Debt / GDP levels and stable levels of single – digit inflation. However, there are some areas of concern to monitor:

1. Government’s level of borrowing in the domestic market has been increasing, and at Kshs 229.7 bn, is the highest on record for the 2015 / 2016 fiscal year. Government has to be wary to not crowd out the private sector which is key to driving growth, improving efficiency and creating jobs;
2. Kenya Shilling’s depreciation is worrying and government should take steps to ensure its stability. With Kenya currently importing majority of capital equipment, the shilling shall only stabilise and stop depreciation in the long-term, once we transform to a manufacturing economy and import less machinery and capital equipment.