"The current Desert Locust situation remains extremely alarming and represents an unprecedented threat to food security and livelihoods in the Horn of Africa." This is how the Food and Agriculture Organisation (FAO) of the UN described the locust risk on 28 January 2020. Two factors have contributed to the worst locust infestation in the region for 25 years: heavy rainfall and, particularly, a lack of counter-measures in war-torn Yemen.
Our understanding of the FAO assessment is that the most sensitive areas of Kenya for agricultural crop production (central and west regions) are unlikely to be hit by devastating locust swarms but that counter-measures need to be enhanced. It may take until April to see the full extent and coverage of the damage (given the reproductive cycle). The infestation is already present in northern Kenya.
Every year, there is a risk from natural disaster (drought or flooding) for Kenya. Given the first-in-a-generation scale of the locust infestation, this has to be acknowledged as an investment risk factor.
A number of factors exacerbate the sensitivity of the investment case to this elevated natural disaster risk.
- Key economic sector
- Agriculture contributes c35% to Kenya GDP (according to World Bank data), 65% of export revenues (FAO), and 40% of the labour force (FAO).
- Real GDP growth is forecast by the IMF to accelerate from 5.6% in 2019 to 6.0% in 2020.
- Inflation driver
- Food accounts for 36% of the Kenya consumer price index.
- CPI was 5.82% yoy in December 2019 (in the middle of the target range of 2.5% to 7.5%) but the food component was 10%.
- Interest rate easing cycle
- The central bank cut policy rate to 8.25% (from 8.5%) on 27 January 2020 (against a backdrop of consensus expectations of no change, according to Reuters, and following no change over the past seven monetary policy committee meetings).
- It also signaled further easing was on the way. Obviously, a negative inflation shock will imperil this.
- FX rate risk
- Kenya FX rate risk is already high in our view and vulnerable to a negative shock on growth, inflation and the current account. The real effective exchange rate currently calculated by Breugel or JPM implies c40% over-valuation. The last comment from the IMF in October 2018 (page 41 of the 2018 Article IV report) mentioned an estimate of over-valuation of c18% (central bank governor Njoroge disputed this and claimed the FX rate was in line with a correctly calculated REER).
- A current account deficit for 2020 of 4.6% is forecast by the IMF, broadly similar to 2019.
- FX reserve cover of imports is still comfortable but now below 6 months (compared to 6.5 in mid-2019).
- There is no IMF stand-by arrangement in place, unlike 2016-2018 (although an IMF mission is planned to discuss this in early 2020).
- Political leadership divided
- The ruling Jubilee coalition is openly divided between those who support Vice President Ruto's 2022 presidential and those who oppose him (and favour an alliance with parts of the formal opposition led by Odinga).
- The policy response, in terms of adequate counter-measures to a potential emergency, may be compromised by this split.
- Outperforming large-cap stocks
- Equities, measured by the Nairobi All Share index, have rallied 16% in total US$ return terms over the past 12 months, slightly ahead of the 13% of MSCI FM index and well ahead of the 9% of MSCI EM. But Kenya's largest stocks, represented by MSCI Kenya (ie Safaricom, Equity Bank and East African Breweries) have far out-performed (up 31%); in part, reflecting the migration of foreigners to stocks with greater liquidity.
- Although there are a range of stocks that screen well on trailing valuation metrics, we would prefer to seek value in non-CIB Egypt or, for geographically broader portfolios, in Asia (particularly in Indonesia and Pakistan).