Nov 22, 2015

This week, we saw the Kenya National Treasury announce that they had revised their 2015 GDP growth forecast to 5.8%, from 6.9% at the beginning of the year. For our Focus of the Week, we highlight the events that are shaping the economy and the investment landscape in Kenya and the region. As such, this week we wish to cover Kenya’s economic growth path: the expectations with which we started the year, the journey so far, and finalizing with our outlook.

Kenya presents to investors, developers, and entrepreneurial individuals a host of opportunities. Of the different Sub Sahara African regions, East Africa stands out due to the diversity and vibrancy of its economy; and in East Africa, Kenya stands out as the hub for innovation, technology, financial services and real estate development.

At the beginning of 2015, the economic expectations in Kenya for growth were bullish, and pointed towards a stable macroeconomic environment, supportive of growth, through a (i) low and stable interest rate environment, (ii) improved tourism numbers, (iii) foreign exchange inflows from tea and horticulture, (iv) growth in private sector credit, and (v) a stable inflation rate. However, the Kenya Shilling was expected to remain under considerable pressure as a result of increased capital expenditure to finance large-scale infrastructural projects.

During the first and second quarter the GDP grew by 4.9% and 5.5%, respectively, underpinned by growth in the construction, financial, hospitality (hotels and restaurants) and agricultural sectors. However, this growth has been below expectations for the year. A number of factors have been at play to influence Kenya’s operating environment, which have affected macroeconomic stability, and hence had a negative effect on affect the overall growth in Kenya in 2015:

1. Interest Rates Environment: At the beginning of the year, interest rates were expected to be low and stable, with the CBR at 8.5%. Expectations were for rates to remain at those levels. In June, Treasury announced the largest Budget in Kenya’s history, with a wide budget deficit of Kshs 567 bn to be financed through borrowings in the domestic and foreign markets. As a result of this expansionary fiscal policy, and increased pressure to finance the budget, the government began borrowing aggressively, resulting into an increase in interest rates, with the 91-day T-bill peaking at 22.5% in the month of October, and now falling back to 9.4% in this week’s auction. The high and volatile rate environment has resulted into an increase in the cost of borrowing, led to crowding out of the private sector, and eventually poor corporate earnings. This has led to a reduction in consumption and investment expenditure in the economy, reducing total output and leading to lower growth rates;
2. Exchange Rate: The Kenya Shilling was expected to come under pressure at the start of the year, as a result of (i) a high current account deficit, (ii) increased importation of capital equipment to finance infrastructure development, and (iii) a strong dollar in the global markets as United States recovers and hence expectations for a rate hike. However, (i) a slowdown in tourism, (ii) increased dollar obligations to fund the budget, and (iii) a mismatch of local fiscal and monetary policies have continued to exert more pressure to the shilling, which has lost 12.7% YTD, and led to the CBK increasing the CBR to 11.5% to support the currency. The effect has been to reduce earnings for firms reliant on imported inputs, and increasing the obligation on the Government to finance their dollar debt, which has resulted to lower than expected growth. This is despite our exports being more competitive in foreign markets, which has been outweighed by Kenya being a net importer;
3. Inflation: Although the other macroeconomic factors have deteriorated, inflation has remained stable, albeit rising, but within a single digit, as was expected at the start of the year. This has helped to increase consumption expenditure within Kenya, as wages are not eroded by price increases. The ability of the Kenyan economy to support consumption will continue to generate additional growth.

As a result of the above three mentioned factors, and given that the interest rates have corrected towards the tail end of the year, we expect Kenya’s GDP growth for 2015 to be between 4.7% and 4.9%. Despite this estimated lower than expected growth, Kenya’s economic future remains robust and positive, and the country is set to have one of the highest GDP growth rates in Sub-Saharan Africa, and maintain a growth rate of 6.2% for the next 15 years to 2030, according to World Bank’s African Pulse October 2015 Report. Growth will continue to be driven by:

1. Infrastructural spending: Spending on infrastructural development has long-term benefits to any economy. In Kenya, the ongoing investments in the LAPSSET corridor, Standard Gauge Railway among many others, will set the country up as the hub for trade in the region;
2. Development of Technology: Kenya has positioned itself as the hub of technology and innovation in the region, evidenced by the entry of firms such as Google into the market. This investment in technology will be key factor in improving efficiency, productivity, and enabling economic growth;
3. Devolved System of Governance: This is expected to improve economic activities in different counties, with the onus on a county level to drive growth and development.
4. Young and growing population: Africa, and most notably countries in East Africa like Kenya, benefit from a demographic profile that is attractive for investment. This includes a young population, rapid urbanization, and an expanding middle class driven by employment on both the formal and informal sectors. The impact of this is (i) increased demand for basic services, including food, water and shelter, (ii) increased number of people joining the workforce, increasing the disposable income levels in the economy while and contributing to the growth and development of consumer markets, and (iii) increased appetite for investments by a younger, more educated population;
5. Growth of the middle class: The Sub-Saharan region’s middle class has grown from approximately 26% of the population three decades ago, to about 34% currently. Kenya’s middle class will represent 49% of the population by the end of 2015. The growth of this middle class, their demand for goods and services, and hence an increase in their spending power translates into a significant opportunity driven by consumption expenditure.

A harmonization of the above factors will help Kenya achieve a long-term stable growth. Whereas there are inherent external risks, such as the strengthening of the dollar and internal risks such as the approaching election in 2017, structural improvements point to a much stable economic environment. --------------------------
Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.