Country Report Kenya
Peaceful elections in 2013 restored confidence in Kenya’s political stability to some extent and bode well for economic development, while the large twin deficits remain a matter of concern.
Strengths (+) and weaknesses (-)
(+) Regionally important and relatively well diversified economy
All three sectors of the Kenyan economy are well diversified, providing a strong base for weathering problems in any one industry. Furthermore, Kenya’s central role in regional transport, telecommunications and financial services should keep supporting economic activity.
(-) Ethnically heterogeneous society prone to violent outbreaks
The vast ethnic diversity within Kenya and the rivalry amongst the various tribes on issues such as land division and political preferences, make up for an environment prone to violent conflicts.
(-) High reliance on external flows as a result of structural twin deficits
Kenya’s reliance on fuel imports results in structural current account deficits, while excessive spending leads to persistent fiscal deficits. This renders Kenya highly reliant on external financing.
(-) Economy vulnerable to weather conditions
Droughts have a significant impact on the Kenyan economy. Output is affected in agriculture, agro-processing industries and through reduced energy supply from hydroelectric plants. This also impacts inflation, through higher prices for food and fuel.
1. Kenyatta victory leads to mixed results
Following the post- election violence in 2007, the polls held on March 4th 2013 represented an important milestone for Kenya. The peaceful outcome indicates that the country’s institutions, overhauled by the constitution adopted in 2010, are better able to provide for political stability. However, incumbent president, Uhuru Kenyatta, and his main ally, William Ruto, face charges at the International Criminal Court for involvement in the 2007 events. The trials will start later this year and might re-ignite ethnic conflicts. More importantly, the trials could deter the relationship with donors and affect the concessional borrowing on which Kenya relies to finance its substantial twin deficit. The closer ties and increased financial support from China provides some mitigation, as does the good relationship with the IMF whose appraisal in April 2013 was very favorable, releasing an additional loan tranche of USD 108.5m.
The uncertainty around the elections has had serious detrimental effects on economic activity. Illustrative is the 15.8% yoy contraction of the tourist sector in 1Q2013 due to an 18.4% yoy drop in tourist arrivals. So is the slowdown in the financial sector to 1.1% yoy growth in the 1Q2013, compared to 10.5% yoy growth in 4Q2012 and 3.1% yoy in 1Q2012, despite a fall in interest rates, while a survey of the Central Bank of Kenya indicated political risk affected both credit demand and supply. The reduction in political uncertainty is expected to boost investor confidence, both local and foreign, and the economy is expected to benefit from the peace dividend. Economic growth is expected to pick up and come in at 5.6% in 2013, compared to 4.6% in 2012. There were already signs of foreign investment gaining momentum after the elections.
2. Twin deficit widens and increases the already high reliance on external funding
In 2012, Kenya’s current account deficit widened to 10.6% of GDP, from 9.7% in 2011, contributing to a 38% increase in the financing requirement to USD 6.4bn. This increase was also induced by the higher borrowing in 2011, when capital inflows fell short of covering the current account deficit. Furthermore, the increase in the fiscal deficit to a historical high 6.9% of GDP, almost half of which was financed from external debt, also put upward pressure on the financing requirement. The higher financing requirement renders Kenya increasingly reliant on external funding, while the increase in short term capital inflows makes it increasingly vulnerable to market sentiment. Therefore, recent volatility in emerging markets due to jitters about the Federal Reserve tapering the QE program in recent months is a worrying development; especially because countries with large twin deficits like Kenya are particularly susceptible to a reversal of flows. The fairly comfortable level of FX reserves, that amount USD 5.7bn, the equivalent of 4 months import cover, provides some mitigation. As do the low level of external debt (27% of GDP) and the fact that most of it is public concessional debt (at least 82% of foreign debt). The twin deficit is expected to contract in 2013, though there are downside risks to fiscal consolidation.
3. FDI expected to pick up on the back of the nascent regional oil industry
The prospects for the development of a Kenyan oil industry improved in February 2013 when Tullow Oil confirmed finding “the first potentially commercial flow rates” in the Lokichar Basin. While commercial viability of the plays requires further drilling, interest in the fields has increased remarkably since the announcement. 45 of the 46 blocks delineated and offered by the Kenyan government have been licensed so far. Furthermore, Kenya looks poised to play a central role in the transportation of regional output. The memorandum of understanding signed by Kenya, Uganda and Rwanda this summer for the construction of two pipelines linking Kenyan ports Lamu and Mombasa to South Sudan and, respectively, Rwanda sets the first step in this direction. Consequently, FDI inflows that amounted to less than 1% of GDP in recent years are expected to pick up.
4. The al- Shabab insurgency threat persists
Kenya’s participation in a military operation against Islamist rebel groups in Somalia in 2011 has resulted in a number of terrorist attacks and kidnappings by al-Shabab militants on Kenyan territory ever since. Most incidents have been concentrated around the border with Somalia and have therefore not had an economic impact or altered stability. However, some incidents took place in Mombasa and Nairobi, and the risk of a large terrorist attack remains. On top of that, this risk is exacerbated by the large numbers of Somalis on Kenyan territory and the tensions caused by the disputed presence in Somalia. Namely, Kenya has been accused by the UN and the Somali government of undermining UN rules and the UN backed government by restarting charcoal exports and cooperating closely with the Ras Kamboni militia.
Kenya has a relatively well diversified and sophisticated economy, that plays an important role in the East African Community, a customs union also comprising Burundi, Rwanda, Tanzania and Uganda. Agriculture makes up for 29% of GDP, but represents an important foreign currency earner as tea, horticulture and coffee are the main merchandise exports. Industry accounts for 17% of GDP. Services are the largest sector, at 54% of GDP, and comprises vibrant financial and telecommunications industries: mobile phone coverage is estimated at 75.8 people per 100 and internet usage at 42, while telebanking is widespread among mobile phone users. Furthermore, Nairobi is regarded the financial center of East Africa. Tourism and transportation also bring a substantial contribution to the services sector, Kenya being an important vacation destination and a regional hub for logistics. The lion’s share of Kenyan exports go to Africa (42.6% over 2007-2011) and to Europe (30.8% over 2007-2011). The dynamic private sector in Kenya is in stark contrast to the country’s high level of corruption and the difficult business environment, as indicated by indices in the table above. Decompositions hereof reveal that Kenya scores particularly bad on the tax regime. Poverty also remains persistent in Kenya, as 43% of the population lives below the poverty line, while social development is low (ranked 145/187 on the Human Development Index).
The Kenyan political landscape is highly divided along ethnical lines and the changing nature of coalitions makes it very volatile. Kenya gained independence in 1963 and became a one party state under the Kenya African National Union (KANU). In 1991 it switched to a multi-party system. The fragile democratic credentials built up by the first (peaceful) shift of power in 2002 was damaged by the post-electoral violence in 2007. In response, a new constitution was adopted in 2010 to strengthen the democratic institutions. Consequently, Kenya now has a presidential system characterized by a clear division of powers between the executive, the legislative and the judiciary.