A staff team from the International Monetary Fund (IMF), visited Kenya from 19 February to 3 March 2020, to conduct the Article IV consultation discussions with the authorities and undertake negotiations on a new precautionary three-year Stand-By Arrangement/Stand-By Credit Facility (Kenya’s previous IMF programme, also a combined SBA/SCF, ended in 2018). Although it is not confirmed if the new facility will be availed to Kenya, the team seemed positive in their outlook on the country.
The facility would be a great boost to the country given that the Central Bank of Kenya recently sent a circular to banks notifying the sector that they will be buying US dollars (up to US$100mn each month from May to June 2020) from the market in order to boost foreign exchange reserves. These reserves were at US$9.1 billion (5.4 months of imports) at end-2019.
In normal instances, the Central Bank does not make such announcements publicly. We see this as an indication that the Central Bank sees some likely vulnerability for the shilling, hence it is opting to shore up reserves in the absence of a Stand-By facility.
Loan rate cap pre-condition met, focus now on fiscal discipline
Since the loan rate cap was repealed – a prior pre-condition to accessing the IMF facility – the key concern has become Kenya's fiscal deficit. The IMF has acknowledged the government's target to reduce its fiscal deficit to 4% of GDP by the 2022/23 fiscal year. This would be a major decline from a high of 7.7% in the 2018/2019 fiscal year.
The agreed plan is for the government to reduce wasteful spending while targeting to increase revenues. So far, on the ground, the Kenya Revenue Authority has been keen on targeting unpaid taxes and has been collecting higher taxes on imports. To continue raising revenue, there is reason to believe the government will again propose further tax increases in the upcoming June 2020 budget. We believe the likely target areas remain ‘sin taxes’, which would impact East Africa Breweries Limited (EABL) and British American Tobacco (BAT). EABL has already been impacted by tax increases over the past two years. The top platforms for mobile payments and transfers – often called 'mobile money' – could also prove to be an easy target as this avenue has proven to be fairly inelastic to cost.
Going forward, the IMF team expects greater focus from the government on refining its revenue and expenditure policies in order to reduce debt vulnerabilities while preserving high priority, growth-enhancing public investment and social spending. The table below shows the current standing of the country in key fiscal ratios. Evidently, the government will need to accelerate efforts to realise a narrower fiscal deficit.
|Net lending/borrowing as % of revenue||-46.8%||-39.5%||-42.7%||-41.6%||-34.1%|
|Net lending/borrowing as % of total expenditure||-27.7%||-24.7%||-26.8%||-25.2%||-21.3%|
|Net lending/borrowing as % of GDP at current prices||-9.1%||-7.5%||-8.1%||-7.6%||-7.2%|
|Revenue as % of GDP at current prices||19.5%||19.0%||18.9%||18.3%||21.2%|
|Total govt expenditure as % of GDP at current prices||33.4%||30.4%||30.1%||30.2%||34.1%|
Other key highlights from the meeting included:
- Real GDP growth was an estimated 5.6% in 2019, driven by the continued resilience of the service sector. This helped to offset a slowdown in agriculture due to delayed rains in the first half of the year and excessive rains later in the year.
- Headline inflation averaged 5.2% in 2019 and stood at 6.4% in February 2020, mainly driven by food prices. The IMF team noted that food inflation has remained elevated (averaging 8.4% between April 2019 and February 2020), but the IMF expects this to decline with normalising weather. In our view, it is likely that food inflation will tick-up further with locusts now reaching food-producing regions in the country as well as expected excessive rains in 2Q 20.
- The external current account deficit narrowed further to 4.6% of GDP, from 5.0% in 2018, mainly due to lower imports of capital goods and petroleum products, which more than offset a decline in goods exports (e.g., in tea and coffee).
- Remittances remained strong. External buffers are healthy, with foreign exchange reserves increasing to US$9.1 billion (5.4 months of imports) at end-2019.
- The banking sector remains well-capitalised and liquid. The system’s Tier 1 and CAR capital to risk-weighted assets stood at 16.8% and 18.8%, respectively, as of December 2019.
- Lending to the private sector started to gain momentum in 2019, reaching 7.3% yoy in January 2020. Credit is expected to rise further following the removal of interest rate controls in November 2019.
- The ratio of non-performing loans has declined from its peak of 12.9% in April 2019 to 12.0% in December 2019, and should continue to fall with the recent repayment of pending bills, recovery efforts by banks, and higher credit growth.