Stimulating Economic Growth for Prosperity

The year 2017 was quite an eventful one for the economy, characterized by intense political activity which culminated in two elections between August and October. As a result of the prolonged uncertainty, businesses failed to thrive and there was a marked decline in private sector activity; worsened by the declining availability of credit to the private sector. In addition, the country endured the effects of a prolonged drought which led to food and water scarcity. The focus for 2018 should therefore be to set the country back on a positive growth trajectory targeted at creating jobs, reducing poverty and generally improving the quality of life for all Kenyans.

The theme for the ninth edition of the Budget Options is, “stimulating economic growth for prosperity”. This entails policy directions and strategic initiatives for the government to consider that will best address the prevailing challenges in the economy and transform livelihoods in line with the government’s economic transformation agenda. The ‘Big Four’ Plan is one direction that if implemented in an environment that is conducive for fostering economic growth, will lead to a reduction in poverty and general improvement in various aspects of wellbeing such as food, shelter and health.

This Budget Options reviews the state of the economy, analysing the country’s productive capacity and how this can be scaled up as well as the dynamics of fiscal policy and how this can be streamlined in order to limit borrowing while ensuring value for money. The document also reviews the place of the interest rate capping law in the economy including the perceived benefits and challenges and addresses the imbalances in the external sector. In addition, the Budget Options proposes measures to enhance equity and efficiency in allocation of resources as well as options for achieving higher revenue growth.

The purpose of the Budget Options is to engage, enhance and enrich discourse on the economy and development matters; proposing viable options in policy making to inform the next medium-term budget.

---

Restoring Balance in the External Sector

Though the current account deficit appears to have improved in 2015 and 2016 following nine years of sustained expansion, it is likely to worsen in 2017. The improvement in the current account balance in 2016 was because of decline in merchandise imports as well as increased net inflows. From 2015 to 2016, net inflows increased by 32.7 percent occasioned by improved foreign earnings from tourism supported by conference tourism as well as increase in remittance inflows. By the end of 2016, remittance inflows stood at USD 160.9 million (CBK). Going forward, the likely deterioration of the current account deficit is due to lackluster performance of the export sector even as imports increase.

Exports grew at a slow pace over the past decade before experiencing stagnation and eventually a gradual decline whereas imports have steadily declined over the past three years. In the last decade, the trade balance of the country averaged 13 percent with the country’s exports having grown on average by 9 percent while imports grew at an average rate of 11 percent before experiencing a slowdown. Domestic exports declined from Kshs. 581 billion in 2015 to Kshs. 578.1 billion in 2016. This is attributed to a decrease in re-exports of Kenya’s petroleum products as well as manufactured goods that may have been occasioned by increased cheap imports of manufactured goods from china within East Africa.

On the other hand, imports have declined over the past three years, from Kshs. 1.6 trillion in 2014 to Kshs. 1.43 trillion in 2016. The decline was attributed to lower global oil prices as well as reduced transport equipment acquisitions. Despite the decline however, it is worth noting that there has been a steady rise in nonfood industrial supplies as well as food items relative to total expenditure on imports. The increase in importation of food items can be attributed to the prevailing drought conditions for the better part of 2016 and 2017.

Going forward, the import bill may face upward pressure due to global rise of crude oil as well as likely increased importation of machinery and equipment as key infrastructure projects continue to be implemented.

A review of the recent trend of exports shows a decline in both value and volume terms. Kenya seems to be losing grip on its East African export market as available data indicates a decline in Kenya’s exports to the region. Exports to Uganda decreased by Kshs. 6 billion in 2016 compared to 2015 whereas exports to Rwanda decreased to Kshs. 17.5 billion in 2016 from Kshs. 18 billion in the previous year. In volume terms, it is noted that there is a steady decline in the volume of the main export products, namely, coffee, tea and horticulture in the course of 2017. Though this is attributed to unfavorable weather conditions, it is noted that the decline in volume of Kenyan exports to Europe by 3 percent in 2016 is partly due to the European Union placing Kenya’s exports on their watch list due to quality concerns. This is a concern as it compromises the image of the country as a key exporter and may generate a lack of confidence in Kenyan products going forward.

It is also indicated that weak global demand and fall in prices led to temporary closure of local firms and a decline in exportation of Soda Ash and Fluorspar. It is important therefore, for the country to expand its export base and diversify goods as well as value addition in order to be protected from such vulnerabilities.

On the other hand, there has been an increase of exports to Asia with export earnings having increased by 7.4 percent to earn the country Kshs. 140.5 billion in 2016. Similarly, there has been an upward trend in volume of exports to North America namely USA and Canada. Export earnings to USA have risen by on average of 14 percent while exports to Canada have risen by 46 percent in the last five years as shown in the figure below. This could be partly explained by the expansion of Export Processing Zones (EPZ) being supported by Africa Growth Opportunity Act (AGOA).

On the other hand, though the capital account is at a surplus, it has been on a declining trend and this may adversely affect the country’s balance of payment position.The decline in the capital account is occasioned by a decrease in Foreign Direct Investments (FDIs) as well as increased foreign interest payments. Net financial inflows increased to Kshs.420 billion from Kshs. 384 million in 2015 because of short term capital inflows occasioned by ongoing foreign financing for government infrastructure projects. The financing of the country’s capital account primarily through loans is not reliable as this is money that has to be repaid. A sustainable improvement in the current account balance will typically require higher national savings which will ultimately lead to higher investment levels and therefore boost growth levels in the country.

Policy Options

1. Revamp the manufacturing industry: In order for Kenyan goods to compete successfully in the international arena, there is need to bring down the cost of production by lowering the electricity tariffs as well as increase value addition to the products produced especially agricultural products. As indicated in the Budget Watch 2017, the focus should be on increasing exports in value as well as volume terms through diversification of the export base as well as value addition to export products; improved competitiveness

2. Support Private Credit growth: The government should formulate policies that are geared towards supporting private sector credit. With increase in access to credit, companies may be more innovative hence invest in the latest technology which are energy efficient as well as increase efficiency in the production of goods and services.

3. Institutional and governance reforms to attract Foreign Direct Investment: this entails measures to reduce cost of doing business in the country such as energy and transportation costs as well as easing licensing processes to make it easy for businesses to set up in Kenya. Some reforms such as easing construction costs and reliability of electricity supply, enhanced tax compliance systems. Further reforms can be done still on energy reforms and improving process of registering a business and obtaining licenses.

4. Linking infrastructure development with exports: Any strategy of upscaling infrastructure development must be geared towards supporting export of goods and services.