BY GILBERT NG’ANG’A
When terrorists hit the upmarket Dusit D2 Hotel in Nairobi mid-January killing at least 20 people, the incident tinkered with Kenya’s political risk profile that could set up the economy for a difficult start.
For the past three years, investors had relegated security concerns to the backburner, a departure from the earlier era when terror attacks had dented Kenya’s image abroad, scaring off tourists and hurting economic prospects.
But the risk of terrorism could emerge as one of the biggest worries for investors in Kenya this year, at a time when the outlook was seen as largely positive. The level of political risk has also been amplified by fallouts within the ruling Jubilee Party over President Uhuru Kenyatta’s succession ahead of the 2022 elections.
So which way for Kenya’s economy?
The Nairobi Business Monthly ploughed through outlook reports and spoke to multiple economists, entrepreneurs and economic managers to understand the state of the economy and the projected trajectory in the next 10 months.
“We are likely to see a stronger year for the economy and businesses. Private sector credit is expected to continue growing largely in the manufacturing, business services and building and construction. In the financial sector, new opportunities from technology will drive expansion, boosting the industry’s catalytic role in driving the big four agenda—Healthcare, Housing, manufacturing and food security—as well as providing solutions towards youth unemployment,” said Joshua Oigara, KCB Group CEO and MD. “The volatility in the global financial markets and change in investor sentiment could lead to further instability in emerging market economies,” he added.
Economists reckon that economic growth would be in the region of 5.7% – 5.9% in 2019, supported by the recovery of the agricultural sector, growth in the tourism, real estate and manufacturing sectors with a focus on the “Big 4 Agenda”.
Last year, the Kenyan economy recorded an average growth of 6% for the first three quarter, government data shows, compared to an average of 4.7% in a similar period in 2017. The growth was mainly supported by a significant recovery in agriculture due to improved weather conditions, increased output in the manufacturing, and wholesale and retail trade sectors, and continued growth of the tourism sector.
They also expect muted inflationary pressures and the inflation rate to average 5.4% over 2019, which is within the government target range of 2.5% – 7.5%. Month-on-month overall inflation remained within the target range in 2018 on lower food prices and muted demand driven inflationary pressures, said the Central Bank of Kenya (CBK) in its latest assessment on the economy. Overall inflation stood at 5.7% in December 2018 from 5.6% in November 2018, owing to a decline in food prices.
Government data shows that Kenya’s rate of inflation compares favorably with the rest of sub-Saharan African countries and especially its peers such as Nigeria and Ghana whose inflation rates were 11.2% and 9.5%, respectively in November 2018. The Kenya Shilling is expected to be largely stable, ranging between Sh101.0 and Sh104.0 against the USD throughout the year, supported by the CBK) in the short term through its sufficient reserves of Sh800 billion, increasing diaspora remittances, and an improving current account position.
Kenya’s foreign exchange market has remained balanced supported by a narrowing in the current account to 5.3% in the 12 months to September 2018 compared to 6.5% in September 2017. The narrowing of the current account deficit is largely due to increased exports of tea and horticulture, increased diaspora remittances, strong receipts from tourism, and lower imports of food and SGR-related equipment relative to 2017. It is expected to narrow further to 5.2% of GDP from 6.3% in 2017.
The financial sector is expected to face turbulence in light of tighter regulations and disruptions caused by financial technology. A major development to watch will be the planned move by Gatundu MP Moses Kuria to introduce a motion in the National Assembly to amend the Banking Act to review the cap on lending rates. Ordinarily, this proposed law should help increase lending to SMEs to grow the economy.
“We expect interest rates to remain relatively stable as the CBK continues to reject expensive bids amidst improved liquidity in the market” said Cytonn Investments in a research note, adding that they “see 2019 registering improved foreign inflows from the negative position in 2018, mainly supported by long term investors who enter the market looking to take advantage of the current low/cheap valuations in select sections of the market.”
Private sector credit growth improved in 2018, averaging 3.4% in the 10-months to October, compared to 2.3% in a similar period in 2017, but remained below the 5-year average of 12.4%. The low credit growth has persisted since the enactment of the Banking (Amendment) Act, 2015, with banks finding it difficult to adequately price risk, prompting banks to reassess their risk assessment framework, preferring to lend to the government at the expense of the private sector, as returns are higher on a risk-adjusted basis.
With the rate cap still in place coupled with the implementation of IFRS 9, which requires banks to be more prudent in terms of provisioning for bad loans, economists at Cytonn expect private sector credit growth to remain well below the government target of 18.3%.
According to the CBK, an assessment of the impact of interest rate caps showed that the caps had weakened the effectiveness of monetary policy transmission, with further evidence of perverse outcomes. In particular, the transmission of changes in the CBR to growth and inflation takes longer compared to the period before caps, said the banking sector regulator.
The economy has a few risks hovering around it, which could dampen the optimism in growth. First, domestically, the economy will continue to be exposed to risks arising from adverse weather conditions until the mitigating measures of food security under “The Big Four” Plan are put in place, said Treasury Cabinet Secretary Henry Rotich.
Secondly, additional risks could emanate from public expenditure pressures especially recurrent expenditures. The National Treasury says that the planned implementation of a policy to pay the police house and commuter allowance, capitation to universities, negotiated high payments to maize farmers and subsidized fertilizers are likely to constrain expenditure targets. Further, revenue performance, which performed extremely below target in the FY 2017/18 may not increase as quickly to cover the anticipated expenditure increments.
Thirdly, there are a number of external risks especially escalating trade tensions among major advanced economies regarding imposition of tariffs on selected imports by the United States from its main trading partners particularly China, and the likely retaliatory measures. The prolonged uncertainty regarding Brexit negotiations and financial market volatility resulting from uncoordinated and abrupt monetary policy normalization are projected to be a major threat as are noneconomic factors such as political uncertainties and geopolitics in the Middle East and some countries in the sub-Saharan Africa region.
“Although global growth has continued to strengthen in 2018, the risks have increased particularly with regard to trade tensions, pace of normalization of monetary policy in the advanced economies and divergence in the monetary policy stances between the developed and emerging market economies. This could lead to further turbulence in emerging markets,” said Dr Patrick Njoroge, the CBK governor.
Activity at the Nairobi Securities Exchange (NSE) will be interesting to watch. Last year, the equities market was on a downward trend, with the NASI, NSE 25 and NSE 20 declining by 18%, 17.1% and 23.7%, respectively. Since the peak in February 2015, NASI and NSE 20 closed the year down 20.9% and 48.4%, respectively. Equity turnover during the year rose by 2.3% to Sh170 billion from Sh168 billion the previous year. Foreign investors remained net sellers with a net outflow of Sh2.8 billion compared to Sh1.1 billion in 2017.
“The foreign investor outflows during the year was largely due to negative investor sentiment, as international investors exited the broader emerging markets due to the rising US interest rates, improved corporate performance in the US, and the strengthening US Dollar” said Cytonn.
The year also saw eight companies issue profit warnings to investors, compared to 12 companies that were in the red in 2017. Of these, four of the companies that issued profit warnings in 2018 also issued in 2017, suggesting their poor run in performance is due to specific company business models as opposed to the operating environment. The companies cited the relatively tougher operating environment, which affected the top-line revenue, leading to rising inefficiencies, and consequently declining net income.
The level of government debt that is seen by many as unsustainable is this year is expected to dominate the political economy. In the fixed income segment, the government is currently 35.9% behind its domestic borrowing target, having borrowed Sh107.2 billion domestically, against the pro-rated target of Sh167.2 billion, going by the revised government domestic borrowing target of Sh299.8 billion as per the Budget Review and Outlook Paper (BROP) 2019.
“We do not expect this to lead to upward pressure on interest rates, with the increased demand on government securities, driven by improved liquidity, provided the government does not accumulate too much short term debt during the year, which would worsen the government’s debt maturity profile,” said researchers at Cytonn.
According to Bloomberg, yields on the 5-year and the 10-year Eurobond issued in 2014 increased by 2.2% points and 3.2% points to close at 5.6% and 8.2% at the end of 2018, from 3.4% and 5.0% at the end of 2017, respectively. Economists expect that the trend in rising yields will continue mainly due to higher country risk perception by investors, partly attributed to the International Monetary Fund (IMF) raising the risk of Kenya’s debt distress from low to moderate in October.
This coupled with the aggressive tightening monetary policy regime adopted by the US Federal Open Market Committee (FOMC), and with the prospects of additional hikes in 2019, is expected to push a further rise in yields as most foreign investors continue pulling out their capital in the wake of rising US treasury yields. Furthermore, the government has a foreign borrowing target of Sh272.0 billion, and needs to retire three commercial loans maturing in the first half of 2019 totaling to Sh200 billion, including the repayment of about Sh78.3 billion of the debut Eurobond in June, government projections show. As such, investors will require higher yields to match the risk profile.
“The outlook, therefore points to a continued coordination of monetary and fiscal policies for overall macroeconomic stability which will support robust growth, lower fiscal deficits, contain inflation within the target range and a gradual improvement in the current account balance” said Treasury in the 2019 Budget Policy Statement issued on January 10.