Risk drivers and outlook

Kenya’s ST political risk classification has been stable since 2010 as liquidity remains sufficient, with foreign exchange reserves moving in line with increasing imports, covering slightly over three months of imports. Commercial risk remains high due to high corruption levels, although higher economic activity is promising and monetary uncertainty and exchange rate risks have abated.

Kenya’s economy could outperform Sub-Saharan African growth in the years ahead, supported by political stabilization after the relatively peaceful elections, its location as a hub for regional trade and services, improved monetary stability and recent oil discoveries. These oil discoveries also improve the country’s outlook in terms of energy dependency. However, in order to convert its vast development potential into real economic improvement, Kenya will need to deal with diverse challenges which continue to affect the medium/long term (MLT) political risk. Ethnic and tribal divisions remain a significant source of friction.

Political stability and international relations may be challenged by pending ICC trials against the new president and his vice-president. Moreover, infrastructural bottlenecks and corruption will need to be tackled, and oil exploration carefully managed. Meanwhile, poverty and regional inequality remain significant, as well as the country’s vulnerability to terrorist attacks.

Facts & figures

Pros

  • Regional trade and services hub
  • Peaceful elections can restore investor confidence
  • Oil discovery may boost economy and reduce energy dependency
  • Debt levels remain sustainable

Cons

  • Widespread poverty and regional inequality
  • Stability is vulnerable to ethnic and tribal divisions
  • Structural current account deficits
  • Corruption

Main export products

  • Private transfers (23% of current account receipts), Tea (14.7%), Tourism (6.7%), Manufactured goods (5.3%), Horticulture (4.6%)

Income group

  • Low-income

Per capita Income (USD)

  • 820

Population

  • 41.6 M

Description of electoral system

  • presidential: 5-year term; next election: 2018
  • legislative: 5-year term; next election: 2018

Prime Minister

  • Function abolished under the new constitution

Head of State and Government

  • President Uhuru Kenyatta

Country risk assessment

Relief after peaceful elections

In March, Kenya held general elections, the first since December 2007, when grave violence broke out after the results of the presidential ballot were disputed, resulting in more than a thousand deaths and the displacement of hundreds of thousands of people. While low-level political violence was reported in some parts of the country, there was no repetition of the 2007-08 events. Hence, the relatively peaceful latest election was a significant relief for Kenyans. A new president, National Assembly, senate, county assemblies and governors were chosen in the ballot, which was also the first general election under the new 2010 constitution. The leader of the Jubilee Coalition, Uhuru Kenyatta, who is the son of the country’s first president and one of the richest men in the country, was elected president. Surprisingly, he secured his victory from the first round, winning slightly more than 50% of the votes, against 43% for the outgoing Prime Minister Raila Odinga. While the latter initially challenged the results, he eventually accepted the ruling of the Supreme Court. The new president and his administration will further implement the  devolution of power to 47 counties that had been provided for in the 2010 constitution. This position gives them significant influence in how Kenya’s devolved institutions and country administrations are set up and will eventually operate. President Kenyatta has close links with the country’s business community and held the positions of Minister of Trade and Finance in the former unity government. Therefore, radical changes in the business environment as a result of Kenya’s new leadership are not immediately expected.

Political tensions can still flare

Despite electoral stability, the risk of political tensions has not yet fully vanished as both President  Kenyatta and his running mate and current Vice-President Ruto are still facing trial at the International Criminal Court (ICC) in The Hague. Both are accused of orchestrating the violence after the 2007  elections, in which they were opponents and supported rival presidential candidates. While it looks like  they were able to turn the ICC threat into an electoral benefit for their political alliance, the pending trial is likely to complicate matters in the coming months. While VP Ruto’s trial was recently delayed to an unspecified date, the trial of President Kenyatta is planned to start in the first half of July, but the proceedings could take a long time. Both deny the charges, and Kenyatta has pledged to cooperate with international bodies. However, diplomatic relations with the EU and US are troubled by the upcoming trials.

While the outcome of the trial is uncertain, problems could arise if one of the high-profile defendants tries  to elude the ICC. Moreover, domestic stability may still be challenged in case only one of them is condemned. This could weaken the governing alliance between the former rivals, who each have their own ethnic constituency. The fact of the matter is that ethnic divisions continue to play an important electoral and political role in Kenya as voting preferences remain highly influenced by ethnic lines and affiliations.

Other great challenges the new government will face are widespread poverty and regional inequality, insecurity and the continuing high level of corruption, along with major infrastructural bottlenecks and developing the energy sector. Kenya ranks only 139 out of 174 countries in Transparency International’s corruption perceptions index (among its neighbours, only Sudan and Somalia rank lower), with corruption scandals previously hitting the top levels of administration. Kenya’s military intervention in Somalia in 2011 has made the country, which had already been hit by Al-Qaeda linked terrorist attacks before, vulnerable to strikes by Somali militants.

Weak manufacturing base and vulnerability to weather conditions

Kenya is East Africa’s largest economy, slightly larger than neighbouring Ethiopia and functioning as a transport and logistics hub for the region. Kenya’s economy is characterized by a weak manufacturing base (representing only 11% of GDP) and a large agricultural and services sector. With a share of agriculture in total economic output of nearly 30% (and 14% of current account receipts), the Kenyan economy remains very dependent on weather conditions and, more specifically, vulnerable to dry spells that regularly hit the region, like the severe drought that hit East Africa in 2011-12. This year, economic growth is expected to rise to 5.9%, up from about 4.5% over the past two years, when the Kenyan economy not only suffered from poor weather conditions, but also from a plummeting currency, double digit inflation and subsequent aggressive monetary tightening (see below). Stronger growth during the current fiscal year ending June 30th was supported by agricultural production and hydropower generation (with production up by 27% from last year), thanks to better weather conditions. This offsets uncertainty regarding the recent elections and a 10% fall in tourism revenues, which were under pressure from security-related concerns and weak economic performance in Europe. European tourist arrivals, which represent 44% of total arrivals, fell by almost 10% last year.

Services and oil sector brighten up the economic outlook

More than half of economic output comes from the services sector, where most of the country’s longer term economic growth is being realized, mainly in the transport, tourism and telecommunications sectors. Kenya has become a world leader in the “mobile money” sector, a widespread payment and money transfer system through mobile phones, called M-Pesa. Thanks to this mobile money revolution, basic financial services have become more easily available for cell-phone users all over the vast country, energizing economic activity.

Kenya_Graph1EN

Economic growth prospects are positive: economic output is expected to grow by more than 6% annually in the coming years. While average annual economic growth in Kenya underperformed Sub-Saharan African growth by one percentage point during the past decade, the IMF expects the country to perform better than its regional peers in the years ahead. Economic activity is expected to benefit from vanishing political uncertainties related to the 2013 elections and may further be supported in case of successful reduction of infrastructural bottlenecks, further development of (financial, telecom and regional trade hub) services, expanding regional trade and exploration of the oil and coal sector. The discovery of large commercially viable oil reserves in Kenya’s northern Turkana region in 2012 has improved growth and energy dependency prospects. However, oil exploration is still in its early stages and production could – at least – take another six years. Meanwhile, environmental concerns and the development of a legal framework could still influence further developments in the oil sector.

Oil exploration weighs on current account deficit, but could turn it into surplus later

The last time Kenya managed to register a current account surplus (of 1% of GDP) was in 2004. Since then, Kenya’s current account has deteriorated steadily, to a 9.2% of GDP deficit in 2011/12. Traditionally, Kenya’s imports of goods significantly outweigh its exports and as such, the country’s trade balance deficit is amounting to more than 20% of GDP. Much of this structural deficit is due to the fact that Kenya is a huge energy importer. Oil imports represent more than one quarter of goods imports and these imports alone exceed the country’s total current account deficit. Thanks to recent oil discoveries, this could change in the longer term. However, as the oil exploration and production industry needs highly specialized machinery and equipment, imports of such capital goods have increased as well. Currently, these capital imports, which are partly financed through foreign direct investments, represent another quarter of Kenya’ goods imports. Excluding the – currently much needed – capital goods imports (which should pay off in the longer run) would in fact make the current account deficit swing into surplus (at 1.2% of GDP) during the current fiscal year. Meanwhile, private transfers remain very important for the country (with Kenyans working in North America being the main contributors to remittances), representing almost one quarter of current account receipts. Kenya is also traditionally relatively strong in services exports. These represent another quarter of current account receipts, mostly thanks to tourism and transport. During the past years, current account deficits have been financed by strong and increasing FDI and by concessional medium or long-time credits from official creditors. However, non-concessional short-term credits have increased as well. Later this year, Kenya plans to issue its first sovereign bond in the international market, amounting to $ 1 billion.

Success in stabilizing dramatic price and exchange rate evolutions in 2011

Between January and October 2011, as the current account deficit had further deteriorated due to surging oil prices and increased food imports, the exchange rate of the Kenyan shilling had depreciated by 25% against the US dollar and inflation had reached almost 20% one month later. Subsequent (and aggressive) monetary tightening by the Central Bank, which increased its Central Bank Rate (CBR) by 11 percentage points to 18% in four months, decreasing world food prices and improved agricultural output, helped bring down prices during 2012. Meanwhile, monetary policy is being eased gradually – with the CBR currently at 8.5% – as inflation has fallen to about 4% in April (albeit somewhat up from 3.2% in December).

Kenya_Graph2EN

So far, public finances remain under control

While the Kenyan government has registered a budget deficit (including grants) of more than 4% of GDP since 2008, the country has succeeded in keeping its public debt at a tolerable level. During the current fiscal year, its public debt level is projected to fall to 43.7% of GDP, down from 44.5% last year. The IMF projects the ratio to come down further in the coming years. Almost half of public debt is external debt. Revenues as a share of GDP should continue to increase – although slightly, by about 0.5 percentage points by 2015/16 – mainly through higher VAT and income taxes. Public expenditure would decline in terms of GDP as declining recurrent expenditure ratios are expected to more than offset higher development spending.

External financial situation remains manageable as well

Since 2006, Kenya’s external debt has fallen below 30% of GDP. According to the IMF’s latest figures, by the end of this year it will amount to 23% of GDP or about 70% of current account receipts, which remains a reasonable level. However, it is likely that this figure underestimates increases in privately held external debt in recent years, which could bring the total external debt level closer to more than 35% of GDP and more than 100% of current account receipts. It is worth noting that – unlike most of its neighbouring countries – Kenya never benefitted from debt relief under the Heavily Indebted Poor Countries (HIPC) or Multilateral Debt Relieve (MDRI) Initiative. However, between 1994 and 2004, Kenya did receive three Paris Club debt treatments, in which its external debt was rescheduled on concessional terms. Kenya’s current repayment behaviour seems satisfactory and the IMF has confirmed that arrears on external debt by the end of last year were of a technical nature and have been repaid in the meantime. Due to a surge in ST capital inflows in the past years, Kenya’s short term liabilities could, according to some estimates, amount to almost 40% of exports receipts, making the country’s liquidity situation somewhat vulnerable to volatile capital outflows in case of a sudden adverse event. Foreign exchange reserves have increased in line with increasing imports during the past years, supported by capital and financial account surpluses, which have outweighed current account deficits. Despite having fallen somewhat in the beginning of the year, foreign exchange reserves currently cover about 3.3 months of imports, which is slightly above the general benchmark of three months of import cover.

Analyst: The Risk Management Team, l.vancauwenbergh@credendogroup.com