Oct 30, 2016

In our report last week focusing on Kenya’s economic growth, we noted Kenya’s economy is positioned for impressive growth and stands out in East Africa due to its economic diversity and vibrancy as it is the regional hub for innovation, technology, financial services and real estate development.

This week, the World Bank released the Doing Business 2017 report. As highlighted in our Cytonn weekly report #32 (2015), the report is significant since it offers governments and policy makers a benchmarking tool useful in policy formulation to improve economy’s business regulatory environment as it highlights potential challenges and provides insight into good practices worldwide. Additionally, it is used by international investors as a guide to which countries have more favorable operating environments.

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.

In 2015/2016, 137 economies implemented a total of 283 reforms across different areas with starting a business being the most common reform area followed by paying taxes. Kenya was among 10 economies highlighted this year for making the biggest improvements in their business regulations recording an improvement of 16 places to rank position 92 out of 190, which is a build-up from last year’s improvement of 28 places to position 108 from 136 in 2015. In this report, we highlight five key areas where Kenya has made significant improvement and actions that need to be taken to further improve Kenya’s overall rank going forward.

The five areas where Kenya has made significant improvements include;

1. Starting a business: With 7 procedures and 22 days to set up, Kenya’s ranking greatly improved from position 150 in 2016 to 116 in 2017. Positive reforms during the period were (i) removal of the stamp duty fees required for the nominal capital, memorandum of association and articles of association and, (ii) elimination of requirements to sign the declaration of compliance before a commissioner of oath. However, despite the above, the introduction of a flat fee of Kshs 10,000 for company incorporation has made starting businesses more expensive.
2. Getting electricity: There has been a reduction in the number of days and interactions needed to obtain an electricity connection to 97 days and 3 interactions, leading to Kenya’s improved rank from position 127 to 106. This was enabled by the introduction of a geographic information system, allowing the price quotes to be provided to customers without conducting a site visit.
3. Registering property: Kenya’s rank has slightly improved from position 122 to 121 on the back of increased transparency at the land registry. It takes an average of 21 days to register property in the country using data from 11 towns. In Mombasa, it takes an average of 41 days while in Isiolo it averages 73 days.
4. Protecting minority investors: Kenya’s ranking improved from position 112 to 87 owing to strengthened minority investor protections through (i) introducing greater requirements for disclosure of related-party transactions by the board of directors, (ii) making it easier to sue directors in cases of prejudicial related-party transactions, and (iii) allowing the rescission of related-party transactions that are shown to harm the company.
5. Resolving insolvency: Kenya was ranked position 92, an improvement of 48 positions from position 140 in the 2016 report, supported by increased ease of resolving insolvency which was made possible by (i) introducing a re-organization procedure, (ii) facilitating continuation of the debtor’s business during insolvency proceedings, and (iii) introducing regulations for insolvency practitioners. Kenya adopted a new Insolvency Act in line with the insolvency framework of the United Kingdom. The new law introduced a form of reorganization that allows insolvent companies to continue to operate while negotiating a settlement with creditors

Despite the general improvement in rank, Kenya also declined in a few business life cycle stages, that offer room for improvement and provide basis for formulation of positive reforms going forward. These areas include:

1. Getting credit: Kenya’s rank declined to 32 from 29 in 2016. This is due to the low credit bureau coverage, which currently stands at 25.8% of the adult population and low access to credit information which is a critical element for private sector-led growth. Availability of information to lenders translates into increased access to finance and cheaper loans.
2. Paying taxes:The metric assesses cost of complying with tax obligations up to the filing of tax returns, payment of taxes due and post filing processes such as claiming a VAT refund, undergoing a tax audit or appealing a tax assessment. Kenya was ranked 125 from 122 in 2016 on this metric. To file taxes in Kenya, it takes an average 145 hours per year and 25 number of payments. We expect the recent adoption of technology in preparation, filing and payment of taxes by the KRA to lead to an improvement in this metric. On post filing processes, Kenya restricts the right to receive an immediate cash refund to specific types of taxpayers such as exporters, embassies and NGOs.

Evident from the key areas highlighted above, there exists room for Kenya to improve its business climate to attract more entrepreneurs and investors to start businesses and foreign direct investment. This can be achieved by;

1. Make it easier to start a business- Countries around the world have streamlined processes involved in starting a company by; (i) setting up a one stop shop for all services required in starting a company, (ii) automating the processes involved, and (iii) eliminating minimum capital requirements. Currently, to start a business in Nairobi, an entrepreneur must involve 6 agencies, namely the Nairobi Huduma Center, Kenya Revenue Authority, Nairobi City Council, National Social Security Fund, National Hospital Insurance Fund, and a company seal maker. For a standard company, this will cost Kshs 27,800, equivalent to 21.1% of income per capita, which is quite high compared to comparable efficient countries like Botswana and Mauritius, at 0.8% and 1.8%, respectively, which highlights the high initial cost to start a business can be reduced
2. Improve on dealing with construction permits- The advanced economies around the world are adopting smart construction regulation which ensures that standards are met while making compliance easy and accessible to all. Governments have worked on consolidating permit requirements for simple, straight forward and inexpensive compliance that leaves everyone better off. In Kenya, for example dealing with construction permits for building a standard warehouse requires 17 procedures, takes 160.0 days and costs 6.3% of the warehouse value. There needs to be an improvement in Kenya’s building quality control index, notably in laws governing liability for structural flaws in a building and mandatory insurance policies to cover problems once the building is in use. Where complying with building regulations is excessively costly in time and money, many builders opt out. However, Kenya in the recent past has made dealing with construction permits costlier and difficult by increasing building permit fees and requiring additional approval before issuance of building permits, and increasing costs for both water and sewerage connections
3. Improve sharing of credit information- This is to facilitate lending decisions especially towards the private sector. Kenya should adopt additional sources of customer data which generates incentives to improve borrower discipline especially following the enactment of Banking Act Amendment 2015 that effectively placed an interest rate cap on loans by commercial banks
4. Enhancing minority investors protection – Kenya should enhance investor protection mainly towards (i) the extent of shareholder rights, (ii) the scope of governance index, and (iii) the extent of disclosure. Actions that should be taken include (i) regulations around shareholder involvement each time a company issues new shares, and pre-emption rights to the same, (ii) shareholder involvement for the election and dismissal of the external auditor, (iii) corporate governance that requires the board of directors include independent and non-executive board members, and (iv) disclosure of information about board members’ other directorships as well as basic information about their primary employment   
5. Make it easier to pay taxes- Kenya made paying taxes faster for companies by enhancing electronic filing systems. However, the country also increased the administrative burden of paying taxes by requiring quarterly filing of taxes and costlier by increasing employer’s social security contribution rate. The tax paying process can be made easier by (i) consolidating payments and filings of taxes, (ii) establishing taxpayer service centres, and (iii) allowing for more deductions, exemptions or lower tax rates.
6. Improve efficiency of contract enforcement- To enhance their judicial systems, lower-income economies often work on reducing backlogs by introducing periodic reviews to clear inactive cases from the docket and by making the procedures faster. In Kenya, contract enforcement averagely takes 465.0 days and costs 41.8% of the value of the claim. Kenya can improve on this through (i) reducing the current case backlog by clearing inactive cases from the docket, (ii) automation of court and judicial procedures, (iii) complaints being filed electronically through a dedicated platform within the competent court, (iv) court fees being paid electronically within the competent court enforcing contracts, and (v) reducing the number of days taken to deliver case verdicts. Kenya has so far introduced a case management system that will help increase the efficiency and cost-effectiveness of commercial dispute resolution.
7. Heighten the fight against corruption- Despite the Doing Business report not touching on incidences of corruption, Kenya needs to heighten its fight against the vice to ensure that resources don’t get misused, leading to lower contribution to economic growth. Comprehensive measures to handling corruption include (i) proper vetting of public officials by the Ethics and Anti-Corruption Commission, (ii) educating people on the effect corruption has on development, and (iii) independence of the judiciary in handling cases. Recently, we have seen corruption cases fade away without explanations and questions unanswered.

Kenya’s Ease of Doing Business ranking over the last decade is now improving after significant deterioration as shown below;

As seen from the graph above, Kenya has greatly improved its ranking from last year, however the country still has a lot to do to reclaim its peak 2006 rank of 68. To improve in the ranking requires partnership between the government and the private sector to create a conducive business environment. Implementing effective business regulations will encourage entrepreneurial activities and ensure that all participants have fair and equal opportunities to participate in a competitive market. This will in turn attract more business investment into the county and spur economic growth, which ultimately creates jobs and improves the standard of living for Kenyans.

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only, and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.