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Country Report Kenya

Country Report


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2013 was a crucial year for Kenya, as domestic political stability improved on the back of peaceful elections, which contributed to better economic prospects. Unfortunately, the terrorist security threat increased, which partially offsets these improvements.

Strengths (+) and weaknesses (-)

(+) Regionally important and relatively well diversified economy

The economy is relatively well diversified and that provides a strong base for weathering problems in any one industry. Furthermore, Kenya’s central role in regional transport, telecommunications and financial services should keep is supportive of economic activity.

(-) Ethnically heterogeneous society prone to violent outbreaks

The high degree of ethnic diversity 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 negative 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. 

Key developments

1. Terrorist threat increases and hurts tourism…

In the past year, Kenya has witnessed an increase in terrorist activity by the militant Somali group Al- Shabaab. So far, the economic impact has been limited to the tourism sector, but the economic fallout could be much greater if attacks persist or intensify. In September 2013, Kenya and the world were shocked by the Westgate mall terrorist attack that cost almost 70 lives. The event was followed by a string of smaller attacks. In June-July 2014, terrorist activity intensified and several massacres killed more than 100 people. Attacks have been concentrated in the coastal region, where terrorists have capitalized on existent issues, such as marginalization of the ethnic Somali population and land disputes among tribes. The increase in militant activity is also reported to have increased organized crime targeting expats in the capital, though no major events have taken place there this year. Several Western governments, including the UK and the US, decided to advise against travelling to some regions of Kenya in 2014. As the coastal region is particularly relevant for tourism, the economic damage has so far been limited to this sector. However, the region is also relevant for the nascent oil infrastructure, so persistent terrorist activity could hurt the development of this sector. Moreover, if terrorism intensifies or spreads out to other regions, it will affect investor and consumer confidence and economic damage would increase markedly. 

2. … and threatens the improvement in growth prospects

Kenya’s economic growth perspectives improved on the back of years of sound economic policy under IMF scrutiny, improved domestic stability and new oil finds. However, the increasing security threat is endangering these prospects. Successful completion of several IMF programmes has placed Kenya on a more solid macroeconomic footing. Improved political stability after the peaceful 2013 elections and new oil finds were expected to slowly attract more investments and boost growth prospects. In 2013, economic growth was fairly flat at 4.7% and broad based. The hospitality sector was the exception, as it contracted by 4.5% y-o-y, reflecting an 11% drop in foreign visitors as a result of fears of unrest ahead of the elections, a major fire at Nairobi airport and increased security risks. This trend is set to persist in 2014 and 14Q1 data reinforce these expectations. Indeed, the hospitality sector contracted further by 3% y-o-y. 41Q1 data also point towards weak performance in the agriculture sector, as rainfall was below expectations. As a result of these adverse circumstances, the economy is expected to only gradually gain momentum and grow by around 5% in 2014, supported by major infrastructure projects and strong domestic demand. However, a further increase of the terrorist security threat or capital underspending due to capacity constraints and corruption are significant downside risks to this scenario. 

Figure 1: Economy is slowly gaining momentum
Figure 1: Economy is slowly gaining momentumSource: EIU
Figure 2: Public deficit soared
Figure 2: Public deficit soaredSource: EIU

3. The public deficit soars and the debut Eurobond alters debt structure

An increasing wage bill caused Kenya’s budget deficit to soar in 2013, but the shortfall is forecast to decrease in 2014. Kenya’s debut on international debt markets is a welcome diversification of financing sources, but also translates to a higher risk profile. The budget deficit increased to 8.9% of GDP in 2013, from 6.7% of GDP a year earlier. The main driver of the soaring shortfall was a sharp increase in the wage bill, which is currently estimated to equal almost half of the revenues, if parastatals and the military are included. The devolution of power to 47 counties after elections in 2013, a one-time event, also contributed to the higher wage bill. The government has announced serious measures to contain the wage bill, including a salary freeze and restructuring of the public sector. In 2014, the budget deficit is estimated to fall to 6.3% of GDP on the back of austerity measures as well as some improvements in tax revenue collection. 14H1 data support these expectations, as the shortfall came in at 7.1% of GDP, while implementation of the public sector reforms started in 14H2. The data also indicate that capital spending was 22% below target. Although this may help to reduce the budget deficit, it is in fact a perennial problem in Kenya, as capacity constraints and corruption hinder public investments. As a result, current infrastructural constraints on growth remain in place. In June 2014, Kenya raised USD 2bn on international capital markets - the largest African Eurobond debut so far. Despite the increased security risks in Kenya, the yields were lower than expected, at 5.875% for the 5 year bond and 6.875% for the 10 year bond. They were also lower than the price paid by Zambia in April 2014, the only other African Eurobond issue this year. The bond issue is a welcome diversification of financing sources. It is also comforting that demand for Kenyan debt was high. However, given the considerable size of the bond, equal to 4.5% of GDP, it represents a marked increase of the share of commercial debt in total external debt, which translates to a higher risk profile. Besides, as it pushed external public debt from 23% of GDP to 26% of GDP, it exposes Kenya to higher foreign currency risks. 

Factsheet of Kenya
Factsheet of KenyaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

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. The agricultural sector is an important foreign currency earner and source of employment (61% in 2005), but the services sector is the largest sector. It comprises vibrant financial and telecommunications industries: mobile phone coverage is estimated at 75.8 people per 100 and internet usage at 42. Telebanking is widespread among mobile phone users. Furthermore, Nairobi is regarded the financial centre of East Africa. Tourism and transportation are also important for the economy, as Kenya is an important vacation destination and a regional hub for logistics. Africa and Europe are Kenya’s largest export markets. 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 factsheet. Decompositions hereof reveal that Kenya’s tax regime scores particularly poorly. Poverty also remains persistent in Kenya and social development is low.

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 and Kenya now has a presidential system characterized by a clear division of powers between the executive, the legislative and the judiciary.

Economic indicators of Kenya
Economic indicators of KenyaSource: EIU, IIF
Alexandra Dumitru
RaboResearch RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2326 6856

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