What’s in store for Kenya’s economy in 2016?

Central Bank of Kenya

Central Bank of Kenya

After navigating through a rough and mixed 2015, the 40 million ordinary Kenyans and analysts are pondering heavily on what 2016 holds for the resilient economy of the East African economic powerhouse.

This comes against the background of a turbulent 2015 that saw Inflation rates hit the highest rate in over 36 months, Kenya Shilling depreciation emanating from a general US Dollar appreciation across the world and limited US Dollar flows into Kenya, and uncertainty over interest rates spiraling against increased demand for the Kenya Shilling by the Private Sector and Government alike.

Economic conditions in Kenya are set to improve on the whole over 2016, with real GDP growth quickening slightly in 2016 to 5.9% from an estimated 5.6% in 2015, according to forecasts. The latest data from the Kenyan National Bureau of Statistics (KNBS) indicate that economic growth in the country remained resilient through a turbulent 2015 characterized by significant currency instability and an aggressive bout of monetary tightening. Provisional data show that real GDP expanded by 5.8% y-o-y in Q3, which amounts to a steady acceleration through the first nine months of year following prints of 4.9% and 5.5% in Q1 and Q2 respectively. While growth has been resilient, it has not been unaffected by the events of 2015. Although a less significant pace of currency depreciation in 2016 and a normalization of interest rates point to improving conditions, headwinds will linger through H116. Kenya Shilling is currently trading at 102 KES/USD, and analysts’ predictions are that the KES is expected to lose at least 6-8% by end of 2016.

Kenya is not immune to global headwinds, but its diversified economy means that it is less exposed than many emerging markets to the downturn in commodity prices and the slowdown in China. Indeed, as a major net importer of fuel Kenyan businesses and consumer are benefitting from lower oil prices (already prices are at the lowest seen and analysts’ consensus is that the Brent to average <USD50 per barrel in 2016). These benefits should become more strongly felt over the coming quarters amid greater currency stability, and will indeed cushion Kenya against a worsening current account deficit – the real fundamental cause of the Kenya Shilling weakening against the US Dollar.

GDP data suggests that key economic growth engines appear to be firing, particularly construction, financial services and wholesale & retail trade. These account for roughly 5%, 7% and 9% of GDP, and expanded by 14.0%, 10.1% and 6.5% in Q3 respectively. The agriculture sector also continued to expand strongly, increasing by 7.1% following 6.8% growth in Q2. That said, the outlook for the sector over the near term remains uncertain owing to unpredictable weather conditions in the region and softening demand in key export markets.

Concerns remain over the cost of capital, however, as the lagged effects of monetary tightening in 2015 are being transmitted to businesses and consumers. Having increased the key rate by 300 basis points (bps) over the course of 2015 it is likely that the Central Bank of Kenya (CBK) has reached the end of its hiking cycle and there will be a move towards interest rate normalization in 2016. It is unlikely that monetary conditions shall be loosened until Q316, and credit conditions may remain relatively tight over the near term. The question of ‘how fast and how far’ the interest normalization will change will to a large extent be governed by currency considerations. With the US dollar finally topping out in 2016 after a two year bull-run analysts predict supportive conditions for Sub Saharan currencies over the coming quarters. That said, global risks have not disappeared entirely and a fresh bout of FX volatility cannot be ruled out.

While the sell-off in Emerging Markets currencies that some analysts predicted in the lead up to the Fed hike on December 16 did not materialize, expectation for further Fed hikes over the course of 2016 (Fed target rate may rise to 1.00% by end-2016 from 0.5% currently) creates possibilities for renewed external pressures. As things stand, a cutting of interest rates through the first several months of 2016 would come as a surprise, and could potentially be construed as complacent by the market. This could ultimately spook investors and trigger a sell-off in shilling denominated assets. Since taking over the reins at the CBK in June 2015, governor Dr Patrick Njoroge has been seen to take a more hawkish and pro-active approach to interest rate-setting than that of his predecessor, something that has generally been welcomed by the market. This being the case, a cautious and hawkish bias is likely to be maintained through early 2016.

Fiscal Pressures owing to Wastage and Corruption

Election-related spending pressures, deep-seated corruption and a lack of political are set to undermine fiscal consolidation efforts in Kenya over the next financial year and only a modest narrowing of the country’s gaping budget deficit in 2016.
The President enacted a raft of new measures aimed at limiting waste and reining in public spending. While the Treasury’s increased commitment to fiscal restraint is likely to be welcomed, the measures announced thus far fall well short of what is required to shore up Kenya’s battered public finances or convince investors that the country has turned a corner. The latest data from the Ministry of Finance show that Kenya ran a fiscal deficit worth some 8.7% of GDP in FY2014/15 (July to June) and while this deficit is predicted to narrow modestly to 7.7% in FY2015/16, analysts remain skeptical over the likelihood of meaningful budget consolidation taking place over the next two-to-three years. By extension, Kenya’s fragile fiscal dynamics will remain a key pressure point for the economy and a source of sensitivity for investors.

Kenya’s rank of 145 out of 174 countries on Transparency International’s Corruption Perceptions Index is, embarrassingly for a country of Kenya’s international reputation, below that of its poorer neighbors Uganda, Tanzania and Rwanda. While recent statements by the Treasury hint at a move towards greater fiscal austerity, the measures appear vague and are unlikely to be viewed as a serious step towards improving fiscal oversight and stability. Such steps would require a significant and consistent effort on the part of key political figures – a level of political will that has and will likely continue to prove beyond the current government. Moreover, with elections in 2017, additional spending pressures are likely to be felt through the second half of 2016 as electoral campaign machines gear up.

The devolution of spending to 47 recently created county-level governments will further complicate and likely weaken the budgeting process over the coming years. The decentralization of power and spending will make it increasingly difficult for the finance ministry to rein in spending, while local governments – with even less developed financial administrative systems than central government ministries- will face strong popular pressures to increase expenditure.