Kenya’s economic outlook to dip in 2017 – World Bank report
Kenya’s GDP growth is projected to decelerate to 5.5%, a 0.5 percentage point mark down from the 2016 forecast, according to the World Bank’s latest Kenya Economic Update (KEU) released in Nairobi today.
“Consistent with its robust performance in recent years, once again economic growth in Kenya was solid in 2016, coming in at an estimated 5.9% – a five-year high. This has been supported by a stable macroeconomic environment, low oil prices, earlier favorable harvest, rebound in tourism, strong remittance inflows, and an ambitious public investment drive,” said Diarietou Gaye, World Bank Country Director for Kenya. “Nonetheless, Kenya is currently facing headwinds that are likely to dampen GDP growth in 2017.”
Firstly, the ongoing drought which has led to crop failure, dying herds of livestock, and increased food insecurity. Further, with hydropower being the cheapest source of energy in Kenya, poor rains increase energy costs, their effects spilling over to other sectors. The rise of in food and energy prices drove inflation to a five-year high of 10.3% in March.
Secondly, Kenya faces a marked slowdown in credit growth to the private sector. At 4.3%, this remains well below the ten-year average of 19% and is weighing on private investment and household consumption. Thirdly, as a net oil importer, the rise in global oil prices compared to the lows of 2016 has a dampening effect on economic activity. However, in the medium term, economic growth is projected to rebound to 5.8% in 2018 and 6.1% in 2019, consistent with Kenya’s underlying growth potential.
But while the medium- to long-term outlook appears favorable, Kenya’s economy remains vulnerable to downside risks. These include potential for fiscal slippages, a more prolonged drought in 2017, and external risks from a weaker than expected growth amongst Kenya’s trading partners, as well as uncertainties related to US interest rate hikes and the resultant stronger dollar.
“Going forward, prudent macroeconomic policies will help safeguard Kenya’s robust economic performance, in particular fiscal consolidation consistent with the Medium Term Fiscal Framework,” said Allen Dennis, Senior Economist and Lead Author of the KEU. “Fiscal consolidation needs to be implemented in such a way so as not to compromise the development spending needed to unlock the country’s productive capacity. This will require adjustments on recurrent spending and improvements on domestic resource mobilization.”
The report recommends a number of structural reforms that could accelerate growth potential. Credit access can be supported by reducing public sector borrowing, and the transactions cost for accessing credit through better credit reporting, the creation of a central electronic collateral registry, and a framework to promote property as collateral with the automation of land registries and the implementation of the National Payments System Act.
Agricultural productivity can also be improved by increasing the competitiveness of agricultural input and output markets. New engines for economic growth need to be supported, such as unlocking the affordable housing market, which is the focus of the Kenya Economic Update.
But the special focus of the 15th edition of the KEU advocates a concerted campaign to develop the housing finance market that will present new avenues of income through the construction sector and other related industries, as stipulated in the Constitution of Kenya 2010 and the National Development Plan, Vision 2030 Strategy.
These blueprints have targeted the provision of 200,000 housing units annually for all income levels. However, the production of housing units is currently at less than 50,000 units annually, well below the target number, culminating in a housing deficit of over 2 million units, with nearly 61% of urban households living in slums. This deficit continues to rise due to fundamental constraints on both the demand and supply side and is exacerbated by an urbanization rate of 4.4%, equivalent to 0.5 million new city dwellers every year.
According to Mehnaz Safavian, Lead Financial Sector Specialist and co-author of the report, “Kenya can make housing more affordable to many more Kenyans, and in turn create new channels to boost overall economic growth both at the national and county levels.”
Numerous benefits can be attributed to improving access to housing finance, including economic growth, job creation, and deepening of the financial sector. There are various global examples supporting the “housing multiplier effect” as every dollar spent directly on a housing unit results in various indirect benefits to the country.
Kenya has the right fundamentals in place to achieve results on a significant scale. Collaborative efforts between government and the private sector are required, and a supportive policy and regulatory environment strengthened so that tools like the ones below can be leveraged:
Narrow the affordability gap in the housing market and improved financing for both developers and users. The inaccessibility of affordable housing finance is highlighted by the fact that there are fewer than 25,000 mortgages outstanding. Mortgage debt in 2015 represented 3.15% of GDP, substantially lower than in developed countries. Banks have limited access to long-term funding and few institutions have accessed capital markets to fund mortgages. Kenya ought to explore the role of SACCOs to help bridge the gap in the housing finance market.
Explore financing solutions can play a catalytic role in stimulating the supply and demand of affordable housing, and create momentum for other underlying reforms. Such solutions have been used in other emerging markets, including the creation of Mortgage Refinance Companies (MRCs), the provision of Housing Finance Guarantees, and developing Public-Private Partnerships (PPPs) for Affordable Housing.
Innovative financing instruments must be accompanied by policy reform to be effective. Such reforms include the standardization of mortgage contracts, the establishment of appropriate mortgage foreclosure regulations, a clear legal and regulatory framework for mortgage-backed securities and covered bonds, and the creation of an environment conducive to mobilizing long-term domestic capital. Underpinning these is the inclusion of cooperatives and SACCOs.
The Government of Kenya could rely on the private sector to provide financing for affordable housing, with government actively supporting the sector by creating the right environment for lenders and developers. Such support can come in the form of working with the private sector to attract financing through financing instruments, improving access to land, providing basic infrastructure, and improving the efficiency of accelerating mortgage registration and title transfers.
Outside of housing, Kenya’s economic performance is expected to strengthen once the rains return to normal, the global economy picks up, the tourism sector rebounds, and some of the underlying causes of slow credit growth are resolved, as well as the completion of major infrastructure projects.
Is Kenya loosing competitiveness in the East African market?
Kenya’s merchandise trade performance has been dismal in recent years, in particular its exports to the East African Community. Kenya’s merchandise exports contracted by an estimated 23.3 percent in 2016. In part, this reflects weakness in global trade. In the aftermath of the global financial crisis, global trade has been subdued on account of weak demand and structural factors (Matoo et al, 2015). Nonetheless, the contraction in Kenya’s exports is not only due to weakness among its highincome trading partners. Worryingly, Kenya’s exports to the EAC saw a significant decline in 2016, a region where growth has remained relatively resilient. Of further concern is that longer term trends show that Kenya’s exports to the EAC have been on a decline for the past several years: export growth in value terms was some 29.5 percent in 2007 but has since contracted to a low of -8.9 percent in 2013. The decline in Kenya’s exports to the region in recent years has occurred despite overall growth in EAC intraregional trade, reflecting the stronger growth performance of its regional trading partners. This begs the question whether Kenya is becoming increasingly less competitive in the EAC region?
Decomposition of Kenya’s export performance show that both agricultural and manufactured products contributed to the decline. The loss in Kenya’s exports to the region is particularly reflected in its trade with the region’s two other large economies. While Ugandan and Tanzanian imports grew at 12.4 and 16.0 percent respectively over the 2000-2015 period, their imports from Kenya only increased by 4.3 percent and 6.3 percent. Agricultural products whose exports to the EAC has weakened the most over the past 10 years include: cereals (HS10), Products of milling industry; malt and starches (HS11), lac; gums, resins & other vegetable (HS13), animal or vegetable oils (HS15), sugar and sugar confectionery (HS17). For instance, in Uganda, Kenya’s largest EAC market, the growth rate of (HS11) and (HS13) imports from Kenya declined by 25.3 percent and 11.6 percent respectively over the (2000 to 2015). Similarly, manufactured goods whose exports to the EAC has weakened the most over the past 15 years include: Chemical products (HS38), Plastics (HS39), Photographic or cinematographic (HS37), Raw hides and skins (HS41), Paper and paper boards (HS48), Glass and glassware (HS70) Iron & steel products (HS72) Electrical machinery & equipment (HS85), Motor vehicles (HS87) and Musical instruments; parts and ace (HS92). Further, in Tanzania, Kenya’s second largest EAC market, the manufacturing imports growth from Kenya has declined by 6.2 percent over the compounded annual growth of fifteen years compared to 16.8 percent of its manufacturing imports to the World over the same period. The products that contributed to this growth include: (HS 37), (HS41) and (HS92). However, it needs to be mentioned that Kenya has also gained market share in a few select dynamic export markets including European Union, Asia and America. Nonetheless, the losses far outweigh these gains, thus leading to the overall declining trend. Given the importance of manufactured exports in supporting the diversification of Kenya’s economy, the loss of market share in these products has implications for diversification of the Kenyan economy.
How does Kenya regain its competitiveness in its backyard? Kenya has become less competitive in the EAC due mostly to cheaper products to EAC markets from elsewhere, in particular East Asia (including China). For instance, in both Tanzania and Uganda, the share of East Asia (including China) exports has increased from some 45 percent to 60 percent over the past decade. This has not only driven down market shares of Kenya’s exports but also that of other countries. However, for Kenya, the EAC market remains an important market, and provides a good platform to be able to compete globally. Reversing the decline in Kenya’s competitiveness is of paramount importance and will require both domestic policy actions to improve the competitiveness of Kenyan firms as well as efforts on a regional level to improve market access for Kenyan products and a much freer flow of goods within the EAC.
At the domestic level, this will require policy actions to address the very low levels of labor productivity in Kenya (even compared to the Sub-Saharan African average). Labor costs in Kenya remain high relative to output and regional peers. While Kenya has invested in broadening access to education, the pay-off to educational investment has been low. Many educational assets sit idle because of mismatches, reinforcing the impression that Kenya is not making productive use of its available labor force. Several measures are needed to promote productivity. These include: (i) helping firm access skills, technology and information through, for example, technology extension or technology transfer programs; (ii) ensuring level playing field between informal and formal sector, by streamlining and reducing regulation and ensuring fair enforcement; (iii) decreasing the cost of doing business by addressing critical infrastructure gaps, especially in electricity, developing key financial infrastructure and special programs to help enterprises access financing, and accelerate and facilitate international trade; (iv) supporting firm entry and exit, which is low in Kenya, by facilitating the starting up of a business, and simplifying the insolvency framework; (v) and, streamlining revenue raising schemes that are increasing the cost of doing business unduly in Kenya.
At the regional level, market access could be enhanced by eliminating the myriad non-trade barriers trade costs that impede on intra-regional trade. NTBs affecting intra-EAC trade include non-harmonized technical regulations, sanitary and phytosanitary requirements, customs procedures and documentation, rules of origin, police roadblocks and high costs of cross-border communications and digital transactions for the poorest citizens. A reduction in trade costs is expected to benefit all East African economies. In Kenya, it will favor its capital-intensive sector. Further, a reduction in non-tariff barriers is estimated to increase consumption of 0.16 percent in Kenya and 0.22 percent in Tanzania. Without such action, Kenya will continue to lose out on market share in EAC, and this will be particularly important for not just its exports but the diversification of its economy since, compared to its exports to advanced economies, Kenya’s exports are more diversified and include several non-agricultural or have more manufactured goods.
The KEU was prepared by the World Bank Group in consultation with the Kenya Economic Roundtable. Partnership with key Kenyan policy makers was instrumental in the production of the report. On March 9, 2017, a draft report was presented at the 21st Economic Roundtable. The meeting was attended by senior officials from the Ministry of Finance, The Central Bank of Kenya, Kenya Revenue Authority, Kenya Institute for Public Policy Research and Analysis, Ministry of Land, Housing and Urban Development and The International Monetary Fund.