Structural Issues in kenya's economy

Private Sector Development

In 2010, the World Bank Doing Business report ranked Kenya 98^th out of 183 economies in the "Ease of doing business", three places below its 2009 ranking. Poor infrastructure, political risk, finding the right quality of staff, and access to adequate credit and financing were among the major constraints faced by small and medium enterprises (SMEs) in 2010. The government’s Economic Stimulus Programme played an important part in boosting infrastructure projects and creating credit for SMEs. The government streamlined the financial sector by regulating microfinance institutions. The 2010/11 budget included a Business Regulation Bill to prevent the regulatory authorities from setting arbitrary charges and fees. It is meant to address the main constraints faced by businesses and promote growth in the private sector.

The Kenyan banking sector performed well in 2010. Total assets of the banking sector rose by 22.6% between June 2009 and June 2010. Growth in asset base was due to growth in deposits, retained profits and capital injections. From June 2009 to June 2010, non-performing loans decreased by 7.9%, total deposits increased by 27.8%, capital and reserves of the banking sector grew by 25.6%. In the meantime, total capital to risk weighted assets ratio only decreased marginally from 19.8% to 19.6%. The banking sector pre-tax profits increased by 41.9% over the same period.

The good performance of the Kenyan economy and the gradual recovery of the global economy in 2010 contributed to the rebound in trading activities at the Nairobi Stock Exchange (NSE). The NSE 20 share index rose by 55% between September 2009 and October 2010. Market capitalisation increased by 58.3% over the same period. Bond turnover for the year up to November 2010 stood at KES 460 billion compared with the annual turnover of KES 110 billion in 2009, representing a 316% increase.

2010 was dubbed the year of Rights Issue. Up to October 2010, KES 16 billion had been raised through rights issues at the NSE as listed firms raised additional capital. This represented 56% of the total amount raised since 1988, which stands at KES 28 billion. During the year, TPS Serena, Kenya Commercial Bank Group, Standard Chartered Bank and KPLC raised capital through rights issues. TPS Serena raised KES 1.60 billion out of the planned KES 1.18 billion while KCB raised KES 12.50 billion out of the targeted KES 15.00 billion. Standard Chartered Bank raised KES 2.50 billion – more than the target of KES 1.88 billion. The funds were raised to complete the buyout of a planned custodial business from rival Barclays Bank. The bank used the excess proceeds to support its balance sheet.

Other Recent Developments

The 2010/11 budget emphasises agricultural and rural development, in recognition of agriculture’s major contribution to GDP (23%), as well as employment and exports. The strategy’s main objectives are to secure livelihoods in rural areas and ensure food security and employment. The government plans to promote agriculture through improving agro-business, value-addition and market access; increasing access to credit and to affordable inputs; and promoting research and training. Key infrastructure facilities were also given major attention in the 2010/11 budget. The government will continue to scale up investments in transport networks, both roads and ports. and energy supply. The development budget for constructing the road network was allocated KES 78.6 billion. KES 34.1 billion were dedicated to diversifying energy sources mainly through the expansion of the national transmission system and the development of geothermal energy.

The Information and Communication Technologies (ICT) sector is vibrant and has actively contributed to economic growth in recent years. Telkom Kenya is the main fixed line telephone service provider in Kenya. Because of intense competition, the company has diversified to other services including enhanced voice and data services. In 2010, Telkom Kenya had a client base of about 460 000 on both fixed line and CDMA wireless. During the year up to June 2010, the number of fixed lines was 234 522, representing a 5.4% decline compared with the similar period in 2009. In the same period, the number of fixed wireless subscriptions declined by 46.2%. The decline in fixed network subscriptions is an indication of the increased availability of more convenient and affordable mobile phones.

As at the end of June 2010, the penetration of mobile phone services was reported at 51.2 per 100 inhabitants, still below the world average of 67.0 per 100 inhabitants. Mobile phone money transfer service is a Kenyan innovation that has performed outstandingly well over time. Safaricom and Airtel have been the major providers of this service through M-pesa and Zap respectively. Orange Kenya started its money transfer service – Orange Money – in 2010. The mobile phone money service subscribers increased to 7.7 million by December 2009 from 5.5 million by December the previous year. It is estimated that the service had attracted over 13.5 million subscribers by November 2010.

The Internet market continued to expand in 2010. From January to June 2010, there were an estimated 7.8 million Internet users in the country, up from 3.6 million users in the same period of the previous year. The increase in the number of Internet users was mainly attributed to increased access of Internet services through mobile phones. In the first half of 2010, there were 3.1 million Internet subscriptions in the country compared with 1.8 million subscriptions reported over a similar period in 2009, representing a 69.8% increase. The increase in the number of Internet subscriptions continued to be dominated by mobile data. Internet subscriptions through GPRS/EDGE and 3G accounted for 99% of total subscriptions. Orange Kenya was granted a 3G licence by Communications Commission of Kenya in 2010.  The number of subscribers therefore increased because of innovations in Internet access by operators from the standard personal computer to mobile handset and portable broadband Internet modems. The effect of the Seacom cable on Internet prices is lagging as investors recoup their investment before bringing down prices.

Macroeconomic Policy

Fiscal Policy

In 2010, the government continued to implement its economic stimulus programme, funding public projects in agriculture, services, infrastructure, health and education as well as various community-based initiatives through the Constituency Development Fund and Group funds (Youth and Women fund). To mitigate the impact of multiple shocks, the government eased its macroeconomic policies. The deficit of the primary balance increased from 3% of GDP for the fiscal year 2008/09 to 3.2% in 2009/10. It is expected to deteriorate further down to a deficit of 4.1% of GDP for fiscal year 2010/11. The overall deficit also grew from 5.4% of GDP in 2008/09 to 5.8% in 2009/10 and is forecast to increase to 6.8% in 2010/11.

Total revenue collection and grants increased to 24.9% of GDP in the fiscal year 2009/10, from 23.3% of GDP in 2008/09. Government total expenditure and net lending followed the same path, increasing from 28.7% of GDP in 2008/09 to 30.8% of GDP in 2009/10. Total government expenditure for the fiscal year 2009/10 increased by 21.7% amounting to KES 725.2 billion, against a target of KES 791.4 billion. The shortfall was attributed to lower absorption in both recurrent and development expenditures by the ministries. On the one hand, recurrent expenditure amounted to KES 510.5 billion, against a target of KES 536.3 billion, therefore representing a 95% execution rate. The lower-than-targeted recurrent expenditures mainly emanated from the operations and maintenance expenditures. On the other hand, development expenditures were executed at 84% compared with the target.

Cumulative external financing at the end of the 2009/10 fiscal year represented a net borrowing of KES 22.4 billion compared with KES 11.7 billion in 2008/09. Total disbursements including appropriations in aid amounted to KES 39.8 billion against a target of KES 66.5 billion. Public debt increased from KES 1 075.7 billion by the end of September 2009 to KES 1 294.4 billion by the end of September 2010.

From January to September 2010, domestic debt increased by 28% compared with a similar period in 2009. The stock of Treasury bills increased by 5.8% while Treasury bonds increased by 24.5%. External public debt increased from KES 525.5 billion in December 2009 to KES 589.7 billion in September 2010. The Fitch Rating for 2010 remained B+ for long-term foreign debt, B for short-term foreign debt and BB- for domestic long-term foreign debt.

Cumulative debt service payments to external agencies as of the end of September 2010 amounted to KES 8.6 billion: 81.2% in principal and 18.8% in interest. For the first quarter of the fiscal year 2010/11, government expenditure on interest and other charges on domestic debt increased to KES 16.2 billion from KES 14.1 billion in the first quarter of the fiscal year 2009/10. For the current fiscal year 2010/11, budget estimates are that government domestic borrowing will amount to 3.8% of GDP while external borrowing shall account for 3.0% of GDP. Gross domestic debt-to-GDP ratio is projected to increase from 24.2% in June 2010 to 27.1% in June 2011.

For the fiscal year 2010/11, the government plans to contain the increase in expenditures through improved public financial management while maintaining strong revenue collection. In addition, the composition of expenditures will be shifted from recurrent to capital expenditures. For 2010/11, total government revenues and grant should represent 24.5% of GDP. Overall expenditures are projected at 31.3% of GDP. The overall recurrent expenditures are targeted at 21.3% of GDP, an increase from 20.9% of GDP recorded in fiscal year 2009/10. Current expenditures are projected at 21.9% of GDP, compared to 20.3% of GDP in 2009/10. Additional expenditures are targeted at supporting infrastructure by reducing the cost of doing business and encouraging private sector investment.

The overall fiscal deficit (after grants) is expected to worsen from the equivalent of 5.8% of GDP in 2009/10 to 6.8% of GDP in 2010/11. The government plans to cover it by net external financing of 3% of GDP and domestic borrowing of 3.8% of GDP, including domestic infrastructure bonds on 1.1% of GDP. Over the medium term, the government expects to take the fiscal deficit down to about 5% of the GDP and to bring the debt-to-GDP ratio towards 45%. The debt management strategy will aim to diversify sources of financing by emphasising long term maturities and concessional loans.

Table 4: Public finances (percentage of GDP)

	2002	2007	2008	2009	2010	2011	2012
Total revenue and grants	19.8	22.5	23.4	23.3	24.9	24.5	23.7
Tax revenue	17.7	19.6	20.4	20.7	21.3	21.1	20.8
Oil revenue	0	0	0	0	0	0	0
Grants	0.7	0.9	1.3	0.8	1.3	1.2	0.8
Other revenues	1.5	2	1.7	1.8	2.4	2.2	2.1
Total expenditure and net lending (a)	22	23.4	28.6	28.7	30.8	31.3	30.7
Current expenditure	19.3	18.7	21.8	21.2	20.3	21.9	21.2
Excluding interest	16.3	16.2	19.3	18.8	17.7	19.1	18.8
Wages and salaries	7.6	7.4	7.5	7.1	7	7	6.7
Goods and services	4.4	5.8	8.2	7.9	7.2	8.3	8.3
Interest	3	2.5	2.5	2.4	2.6	2.7	2.4
Capital expenditure	2.6	4.7	6.7	7.4	10.3	9.4	9.4
Primary balance	0.8	1.6	-2.7	-3	-3.2	-4.1	-4.7
Overall balance	-2.2	-0.8	-5.2	-5.4	-5.8	-6.8	-7.1

a. Only major items are reported.
Source: Data from Kenya Central Bureau of Statistics (KNBS) and Ministry of Finance; estimates (e) and projections (p) based on authors' calculations.
Fiscal year July (n-1)/June (n).

Figures for 2010 are estimates; for 2011 and later are projections.

http://dx.doi.org/10.1787/888932409462

Monetary Policy

The Central Bank of Kenya (CBK) implemented flexible monetary policy in 2010. It aimed to keep inflation low by setting an inflation target of 5%, ensuring stable long-term interest rates and competitive exchange rates. It supported the economic activity by facilitating the private sector access to credit. The CBK has cut the Central Bank Rate (CBR) four times, amounting to a total reduction of 100 basis points in 2010, from 7% in January to 6% in July 2010. In addition, the CBK reduced the Cash Reserve Ratio from 6 to 5% in the first half of 2010.

By implementing these measures, the government expects to revive lending and stimulate the economy through increased consumer consumption. This monetary stimulus has been successful and resulted in increased access to credit for the private sector as well as recovered consumption growth. The credit allocated to the private sector grew dramatically, registering a 17% increase in the first half of 2010. The major part of this growing credit was captured by credit to households, which grew by 30% over the same period.

The CBK introduced agency banking in 2010 to deepen access to financing for a majority of Kenyan small entrepreneurs and to reduce the high cost of financial services. Under the Guideline on Agent Banking enacted in May 2010, banks are allowed to conduct banking business through third party agents such as petrol stations, shops, telecom companies, chemists and sole proprietors. However, services delivered by these entities exclude customer appraisal and loan approval. Information asymmetry between borrowers and banks is another factor contributing to the high premiums charged by banks. To reduce information asymmetries and promote cheaper credit, the CBK has created a credit information-sharing mechanism. The first Credit Reference Bureau was licensed in February 2010.

As a result of strong and prudent macroeconomic management combined with a favourable conjuncture (slowing international oil prices and better food supplies), inflation dramatically decreased to 3.1% in October 2010 from a high of 19.5% in November 2008. Kenya achieved its lowest inflation performance since 2003, posting a consumer price index inflation rate of 4.1% for 2010. For 2011, the CBK will target a low inflation rate of 5% and stable interest rates. To achieve these objectives, it will need to tackle inflationary pressures arising from the rebounding economic activity as well as accelerated government spending.

Throughout 2010, the Kenyan shilling depreciated against the dollar and appreciated against the euro during the first half of 2010. For 2011, the CBK aims to ensure a competitive exchange rate that should promote private sector development.

External Position

The main exports in the first half of 2010 were tea (23.6%), horticulture (14.5%), manufactured goods (12%), raw materials (4.4%), coffee (3.9%) and oil products (2.2%). Improved commodity prices in the international markets and growing domestic production led to an increase in the value of merchandise exports of 8.4% between August 2009 and August 2010. This increase was mainly attributed to tea exports whose value increased by 37.5%. Over the same period, receipts from other exports also increased. Horticultural exports increased from USD 673 million to USD 709 million. Oil products exports increased by 21.7% from USD 91 million in August 2009 to USD 110 million in August 2010.

Almost half (46%) of Kenya’s exports for the year up to August 2010 went to African countries. The main destinations for exports were Uganda (12.4%), Tanzania (8.4%), Egypt (4.5%) and Sudan (4.3%). Outside Africa, Kenya mainly exported to United Kingdom (UK) (10.7%), Netherlands (6.9%), United States (US) (4.5%), Pakistan (4.5%), and United Arab Emirates (UAE) (4.4%).

The increased value of imported oil and manufactured goods raised the value of imports by 10.1% during the first half of 2010 compared to the first half of 2009. Oil imports increased by 23.6%; manufactured goods imports increased by 20% and imports of machinery and transport equipment increased by 10.8%. During the third quarter of 2010, Kenya sourced most of its imports from Far East Asia, whose share of imports accounted for 42% of the total import bill as well as from the European Union and Middle East Asia, which shares of imports respectively amounted to 20.4% and 14.7% of the import bill. 

Kenya imports crude oil and refines it for domestic use and for export. In the last five years, the quantity of imported petroleum products has grown from 3.5 million tonnes in 2004 to 4.7 million tonnes in 2009. On the other hand, the export of petroleum products increased from 37 400 tonnes in 2004 to 216 100 tonnes in 2007, fell again to 88 700 tonnes in 2008, but increased to 112 500 tonnes in 2009.

The services current account deficit improved to USD 1 787 million in the year to August 2010 from USD 1 966 million in the year to August 2009. Earnings from tourism and transportation services are the main sources of this improvement. Increased value of Kenya’s imports contributed to worsening its merchandise account deficit from a deficit of USD 5 842 million in the year to August 2009 to a deficit of USD 6 509 million in the year to August 2010. As a result, the current account deficit increased from 5.3% of GDP in 2009 to 7.8% of GDP in 2010.

The main sources of foreign direct investment (FDI) were Australia (KES 16 billion), Israel (KES 4 billion), the UK (KES 738 million) and India (KES 434.3 million). On external grants, commitments amounting to KES 40.4 billion have been received for the fiscal year 2010/11. Remittances flows for 2010 are estimated at USD 642 million, from USD 609 million in 2009. These flows to Kenya are a critical source of foreign currency even if the remittances are mostly used to pay for daily needs.

Table 5: Current account (percentage of GDP)

	2002	2007	2008	2009	2010	2011	2012
Trade balance	-7.6	-15.7	-18.8	-19.5	-20.9	-21.5	-21.1
Exports of goods (f.o.b.)	16.5	15.2	16.8	15.2	16.4	17	16.8
Imports of goods (f.o.b.)	24.1	30.9	35.6	34.7	37.2	38.5	37.9
Services	2.6	4.6	4.6	6.6	5.4	5.5	5.4
Factor income	-1.1	-0.5	-0.2	-0.2	0	-0.1	-0.1
Current transfers	5.2	7.8	7.8	7.8	7.8	7.6	6.7
Current account balance	-0.9	-3.8	-6.6	-5.3	-7.8	-8.5	-9.1

Source: Data from CBK data; estimates (e) and projections (p) based on authors' calculations.

Figures for 2010 are estimates; for 2011 and later are projections.

The macroeconomic performance of the Kenyan economy

The macroeconomic performance of the Kenyan economy improved significantly in 2010 compared with 2009. While the economy grew by 2.6% in 2009, it is estimated that the growth rate of gross domestic product (GDP) nearly doubled to reach 5.0% in 2010. The increase in growth can be attributed to the good rainfall during 2010 and higher prices for Kenyan exports on world markets. The abundance of agricultural output, coupled with increased competition in some key services, helped contain inflation in 2010. However, the Kenyan economy faces two challenges: diversification and the reduction of its dependence on the vagaries of nature.

The outlook for 2011 is promising and a combination of trends could contribute to ensure positive prospects in the short to medium term. The approval of the constitution, continued investment in infrastructure and government policies targeting development in the private sector should all enhance Kenya’s business environment and reinforce a dynamic private sector. Second, deepening regional integration and the launch of the East African Community common market are creating a single trading and investment environment in which Kenyan firms to have access to a larger market. Last, prudent monetary and fiscal policy is expected to reduce inflation and keep interest rates low, creating a credible and stable macroeconomic environment. Given these prospects, the Kenyan economy is forecast to grow by 5.3% in 2011 and 5.5% in 2012.

This positive outlook may however be subject to two main challenges. First, Kenya will need to reduce its high reliance on agricultural outputs to limit its vulnerability to climate hazards by diversifying the economy. Second, Kenya may be vulnerable to another political shock as it faces 2012 elections. Contributing further to the uncertainty weighing on the political environment is the indictment of six high-level Kenyan officials – including the current finance minister and deputy prime minister – by the International Criminal Court for alleged crimes connected to the 2007 post-election violence.