Q2-2016 Outlook | Kenya – Banks’ fears & political troubles to weigh

By Rafiq Raji, PhD

Click to download full report (includes monthly inflation forecasts, etc)

We revise our 2016 growth forecast to 5.7 percent (previously 6.0 percent). There is still a lot to cheer about the Kenyan economy. Better rains should boost the agricultural sector (27 percent of GDP). Negative El Nino effects have largely subsided, albeit risks remain. And we expect tourism would pick up as travel advisories have been lifted by key source markets – in this regard, recent opposition parties’ CORD coalition – who fear the so-called Independent Electoral and Boundaries Commission (IEBC) would be biased and thus want it scrapped ahead of August 2017 elections – clashes with the police during recent protests potentially dampens this prospect. CORD leader, Raila Odinga lost the 2013 presidential elections to incumbent president, Uhuru Kenyatta. The political cycle has started in earnest – way too early in our view. President Uhuru Kenyatta and his Jubilee coalition partners have been campaigning since the beginning of the year – subtly at first but now more overt. Opposition parties have taken the hint clearly, judging from their own recently ramped-up efforts. Also, troubles in the banking sector (3 bank failures as at April) raises the prospect that likely higher loan delinquencies – bad loans rose to 8 percent in March (5.7 percent in March 2015) – may make banks slower to lend, as they implement stronger risk management measures. There are questions about the Central Bank of Kenya’s capacity to provide robust supervision of banks; it lacks capable information technology staff for instance. Add to that the likely need for authorities to rely more than planned on the local debt markets as external financing conditions tighten further – especially on renewed expectations of a US Fed rate hike in June and general market caution with respect to the debt of African sovereigns. Security challenges from still existing terrorist threats are compounded by renewed worries about potential election violence – writ large in already intermittent clashes between members of opposition parties and the security services. These concerns would also likely impact portfolio flows, a major source of support for the Kenyan economy. Still, authorities’ infrastructure spending (in power, rail, etc.) remains on course – China is providing significant support in this regard, offering a US$5.4 billion loan in late March for the extension of the Mombasa-Nairobi-Naivasha standard gauge railway (geothermal power infrastructure in Naivasha is expected to support a planned industrial cluster) to Malaba on the Ugandan border, with the benefits expected to manifest over the medium term. The Mombasa-Nairobi SGR is 70 percent complete and should be operational in June 2017, authorities say. We thus retain the view that a 10 percent medium-term growth expectation is realisable: as completed transport and energy infrastructure and improved regional integration releases ample growth reserves.

Kenya Macro Forecasts 2016 2017 2018
Real GDP, % change 5.7 6.0 6.1
Inflation, % change 6.0 5.2 5.0
Current Account Balance (% GDP) -8.3 -7.0 -6.5
Fiscal Balance (% GDP)* -8.1 -6.6 -5.2
USD:KES** 102.5 104.0 101.0
Source: Macroafricaintel Research, *fiscal year begins July 1, **year-end

Budget overruns in the 2016/17 fiscal year are likely in light of early start to political cycle. Treasury secretary Henry Rotich is scheduled to deliver a KES2.26 trillion (30.6 percent of GDP) budget for the 2016/17 fiscal year – a 23 percent increase in spending on the KES1.84 trillion 2015/16 FY budget – in June. This would be the first budget since responsibility for preparing the document was transferred to the Presidency. Although spending cuts are planned, we are skeptical they would be met in an election year. Still, authorities were able to reign in spending to some extent in the concluding fiscal year and look set to achieve the deficit target of about 8 percent. This is despite revenue collection falling below expectations. So, there is reason to expect some improvements in the fiscal outlook. Authorities have set a budget deficit of 9.3 percent of GDP for the 2016/17 fiscal year, expecting it would likely be 6.9 percent on slower spending. The completion of the Mombasa-Nairobi Standard Guage Railway (SGR I) is expected to provide relief for the fiscus to the tune of at least 1.8 percent of GDP, according to the IMF. Authorities expect that planned measures to increase revenue and cut costs should enable an additional 1.2 percent of GDP in savings. Furthermore, authorities aim to bring the fiscal deficit down to 5.3 percent of GDP in FY 2018/19 and less than 4 percent for subsequent fiscal years.

Inflation expectations have subsided, allowing for monetary policy easing. The Central Bank of Kenya (CBK) was vindicated in its view that El Nino price pressures were temporary and would subside as heavy rains eased. With headline inflation now below the upper bound of the CBK’s inflation target of 7.5 percent – April inflation was 5.3 percent year-on-year, conditions have become ideal for the easing of monetary policy. We expect headline inflation to be below 6 percent throughout Q2, albeit it should average at 6 percent for the year. Our July inflation forecast takes into consideration an expected inflation-adjusted excise tax increase of about 6 percent on some consumer goods in that month. We also expect Shilling stability for most of the quarter. Still, we differ at the moment from CBK governor Patrick Njoroge’s view – which we have come to respect – in mid-May that the current account deficit would shrink faster than expected to about 6.2 percent from the Bank’s estimate of 6.5 percent in 2015. Improvements in tea and horticulture exports and higher remittances from Kenyans in the diaspora are attributed. Our view of the likely current account deficit in 2016 remains in line with earlier expectations of about 8 percent of GDP, 8.3 percent specifically. This is in light of likely volatility in portfolio and capital flows (in part due to electoral violence fears and worries about banks’ strength) and renewed US Fed rate hike expectations. As this is our worse case scenario, we envisage a likely downward revision in Q3 when there should be more clarity. In any case, the CBK has an adequate buffer (via the US$1.5 billion IMF standby facilities it secured in March) should there be shocks. Following from our expectation of slower inflation, we see the CBK cutting rates at its first meeting in Q2 (23 May) by 150 basis points to 10 percent from 11.5 percent hitherto. We also envisage further rates cuts later in the year, as much as 200 basis points probably. Our end-2016 policy rate forecast is 8.0 percent.

Kenya Q2 2016 Q3 2016 Q4 2016 Q1 2017
Policy Rate, % 10.0 9.0 8.0 7.5
Source: Macroafricaintel Research

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