Kenya Economic Update: Policy options to advance the Big 4
Policy reforms to re-ignite the private sector can help accelerate Kenya’s pace of recovery, foster inclusive growth and advance the Big 4
Kenya’s GDP growth is projected to recover to 5.5% in 2018 up from an estimated 4.8% in 2017. Over the medium term, economic activity is expected to gain momentum, steadily rising to 6.1% by 2020, according to the World Bank’s 17th Kenya Economic Update (KEU) launched in Nairobi on 11 April 2018.
The positive outlook is underpinned by recovering agricultural output (thanks to favorable rains); the easing of political uncertainty which is lifting business sentiment; and a broad-based strengthening of the global economy. However, partially mitigating these favorable factors is the drag to growth coming from still weak private sector credit growth, the expected downsizing of the fiscal stimulus from previous years and higher oil prices.
“Policy initiatives to spur credit growth to the private sector and ongoing efforts to reduce the deficit are critical to safeguard macroeconomic stability and support the recovery of the Kenyan economy,” said Diarietou Gaye, World Bank Country Director for Kenya.
The Government has announced an ambitious development agenda for the next 5 years anchored on “the Big 4”: deliver affordable housing, roll-out universal health coverage, increase the share of manufacturing in the economy and improve food security. For the Big 4 to be realized, support from both the public and especially the private sector will be required.
“Policy reforms can play an important catalytic role in incentivizing private sector resources to advance the Big 4,” said Allen Dennis, World Bank Senior Economist and Lead Author of the KEU.
The second special section of the Update also reports on the macroeconomic drivers of and trends in poverty reduction in Kenya assessed against international benchmarks. “Currently one out three Kenyans live below the international poverty line of $1.90 per day (in 2011 PPP): the poverty rate declined from 43.6 percent in 2005/06 to 35.6 percent in 2015/16,” said Utz Pape, World Bank Economist and author of the KEU special section on Poverty. “Poverty in Kenya declined substantially over the past decade, especially among households engaged in agriculture, but these remain vulnerable to climate and price shocks”.
Poverty incidence in Kenya declined significantly, but unlikely to be eradicated by 2030
Current monetary and non-monetary poverty indicators in Kenya are better compared to most Sub-Saharan African (SSA) countries, but continue to lag other lower middle-income countries. Overall, given Kenya’s income levels and poverty rate, human development indicators are relatively high, illustrating that Kenya performs better on non-monetary dimensions of poverty, the latest Kenya Economic Update says.
The Update also points out that the agricultural sector was a key driver of poverty reduction in the past decade. However, this also implies progress in poverty reduction remains vulnerability to agro-climatic shocks such as droughts that can force households back into poverty. To avoid recurrent seasonal spells of poverty experienced by agricultural households, the report recommends that the country build resilience, including climate-proofing its agriculture.
Assessing poverty reduction in Kenya
Kenya has registered growth domestic product (GDP) growth rates above 5% for most of the past decade. However, the KEU notes that the transmission of that growth into increased consumption at household level remains low, or GDP growth would have translated into even higher poverty reduction.
“At the current pace of poverty reduction, about one percentage point per year, Kenya cannot eradicate poverty by 2030,” says Utz Pape. “Accelerating the pace of poverty reduction in Kenya will require higher and more inclusive growth rates coupled with a sharper focus on poverty reduction policies.”
The KEU also notes that the profile of poverty in Kenya has a significant spatial dimension that is omitted in the international comparison. For example, Most of Kenya’s poor live in rural areas predominantly in the northeastern parts of the country. This spatial dimension persists, and possibly exacerbated inequality across regions in Kenya. Scaling up and geographic targeting of anti-poverty and social protection programs are important instruments to target the neediest households and reduce regional disparities, according to the economic update.
Kenyans enjoy improved access to sanitation while access to improved water remains low, according to the update. For example, while almost 72% of Kenyan households have access to improved water sources – above the 68% average in the SSA – this is below the current access levels observed in peer countries such as Ghana, Rwanda and Uganda. However, Kenya performs better in access to improved sanitation when compared to countries with similar international poverty headcount rates.
According to the report, Kenya’s literacy rate is amongst the highest in SSA, and it has increased further by 11% since 2005, reflecting the massive progress made in Kenya’s educational system over the past decade. In 2015, 84% of the population above 14 years could read and write compared to Ghana at 71%.
The report says that today, more than half of Kenyan adults above 24 years (almost 58%) have completed primary education, a notable increase from an estimated 44% in 2005. However, the report also highlights that while just over 14% of adults aged 25 and older have completed secondary school, up from 3% in 2005, this falls below other countries with comparable poverty rates. That notwithstanding, net school enrollment ratios have improved in the last decade with a primary school enrollment ratio of about 87%, but secondary school completion presents a significant barrier.
Kenya has also made significant gains in reducing child stunting and has one of the lowest stunting rates in international comparison, according to the KEU. As of 2015, nearly one out of five (about 19%) of children under five years old were stunted in Kenya, compared to one in three in 2005. Kenya has the lowest stunting rate in Eastern Africa, but the rate is still higher compared to other SSA countries, such as Ghana.
“The forthcoming World Bank Kenya Poverty and Gender Assessment (KPGA) will provide a more detailed analysis combined with policy recommendation for poverty reduction,” said Pierella Paci, World Bank practice manager for poverty and equity covering East and Central Africa.
Using the Kenya Integrated Household Budget Survey (KIHBS 2015/16) data, the KPGA will provide a more detailed analysis of poverty characteristics and trends in Kenya, incorporating both a sectoral and a spatial lens. The KPGA will also zoom into the gender aspects of poverty, contrast poverty profiles in urban and rural areas, and examine poverty through education, health and social protection lenses. The objective of the KPGA is to foster an evidence-based debate about policy options to accelerate poverty reduction in Kenya.
The State of Kenya’s Economy
Recent Economic Developments
A broad-based global economic recovery is underway
For the first time since the global financial crisis, a broad-based pick-up in the global economy is underway. Global GDP growth is estimated to have reached 3.0 percent in 2017, up from 2.4 percent in 2016. The recovery is broad based, coming from a synchronous recovery in both high income and emerging market economies. Notwithstanding downside risks, the recovery in the global economy is being supported by still benign financing conditions, generally accommodative monetary policy stance, a rebound in trade and investments, improved confidence with the global manufacturing Purchasing Managers’ Index reaching a 7-year high in Q1 2018 and an upturn in commodity prices on the back of positive momentum in global trade.
Supported by the uptick in commodity prices, a modest recovery is also underway in sub-Saharan Africa (SSA). At (2.4) percent in 2017, growth in the region rebounded from a 22-year low of 1.3 percent in 2016. While growth in non-resource rich countries remained stable on account of infrastructure investments, growth in resource rich economies such as Angola and Nigeria, was lifted by the beginning of a steady recovery in oil, metal and mineral prices. In Nigeria, a recovery in the oil sector was a key factor for the positive growth, as reduced attacks on oil pipeline paved way for increased production. Growth in the region is projected to accelerate to (3.2) percent in 2018 supported by strengthening commodity prices, the expected increase in demand as inflation declines, robust public investment growth in some economies, and improved rainfall that will see the rainfed agriculture sector flourish in addition to improved electricity supply.
Real GDP growth in the East African Community (EAC) region decelerated, albeit still stronger than the SSA average. In 2017, the EAC economies endured the adverse effects of drought and lower credit to private sector to grow at an average of 5.3 percent. Kenya lagged her regional peers by 0.5 percentage points to grow at 4.8 percent on account of poor rains, slow growth in credit to private sector and a prolonged election cycle. Tanzania, Rwanda and Uganda are estimated to have grown by 6.4 percent, 6.1 percent and 4.0 percent respectively in 2017. In Tanzania and Uganda growth was driven by a bumper harvest in the latter half of the year following favorable weather conditions while in Rwanda, improved weather and a rebound in exports explained accelerated growth from 6.0 percent recorded in 2016. In the wider EAC regions, Ethiopia maintained a strong growth at (10.3) percent in 2017 mainly driven by the public sector’s investment in infrastructure.
Following multiple headwinds that dampened output in 2017, an incipient recovery of the Kenyan economy has started
Drought conditions dampened agriculture output in 2017, however with improved rains in Q42017, the sector is recovering. With only 2.0 percent of Kenya’s cultivable land under irrigation, agricultural output is highly rain dependent. Reflecting poor weather conditions in the first half of the year, the contribution of the agricultural sector to GDP growth in 2017 dropped from a historical average of about 1.2 percentage points to just 0.2 percentage points for the first three quarters of 2017. Growth in the sector declined to 0.8 percent (first three quarters) from 5.0 percent for the same period in 2016. This was the lowest agricultural sector growth since 2009, an indication of the severity of the drought. The weakness in the sector’s performance reflected in the contraction in output of key agricultural exports such as tea and coffee, and staple food such as maize, kale, and potatoes. However, better rains in the second half of 2017 improved the sector’s fortunes, with solid recoveries recorded in Q4 2017 for tea, cane, and coffee output.
Economic headwinds in 2017 adversely impacted manufacturing activity, however, with their easing, the green shoots of a modest recovery are underway, albeit uneven. The industrial sector which accounts for some 19 percent of GDP, contributed only 0.8 percentage points to GDP growth in 2017 compared to a historical average of 1.2 percentage points on account of the headwinds faced by the economy. Growth in the manufacturing sector, an important pillar in the government’s job creation agenda, but whose performance in recent years has been lack-lustre, decelerated to 2.4 percent in 2017 from 3.8 percent in 2016. Activity in the sub sector was impacted by a prolonged electioneering period which dampened business sentiment and trade with neighboring countries; poor agricultural harvests which weakened agribusiness activity; and challenges in credit access which limited working capital and the ability of firms to expand. The weak performance was broad-based as contractions were recorded in sugar, beverages, cement and galvanized sheet. However, reflecting an uneven recovery, as some headwinds started to ease in Q4 2017, there has been a pick-up in some sectors (e.g. cement, sugar and sheet metal), while output remained in contractionary territory for others (e.g. soft drinks). Nonetheless, a healthy rebound in the Purchasing Managers Index for Q1 2018 suggests that the incipient recovery that began in Q4 2017, is continuing into 2018.
Performance in other industrial sub sectors was mixed in 2017. While the manufacturing sector is the largest industrial sub-sector (50 percent), construction and electricity generation are also significant, accounting for some 25 percent and 13 percent of industrial activity respectively. Despite weakness elsewhere in the economy, growth in the construction sector was at a robust 6.9 percent (albeit lower than the 8.4 percent registered in 2016). Given weakness in private investment, much of the robust growth in the construction sector can be attributed to the higher execution of government development spending in 2017. In contrast to the robust performance in the construction sector, growth in electricity generation decelerated to 5.4 percent in 2017 from 7.9 percent in 2016. This was mainly on account of the lower generation of electricity from hydropower sources, given poor rains. With fiscal consolidation commencing in 2018 the construction sector is likely to moderate (unless private investment picks up strongly); however, electricity generation is picking up with improved rains.
The service sector has remained resilient, albeit with differences across sub-sectors. The services sector, which accounts for 58.5 percent of GDP was the main engine of economic growth in 2017 – single handedly accounting for some 80 percent of the 4.8 percent growth. However, the robust performance in the sector was uneven. Reflecting the ongoing rebound in tourism, the accommodation and transport sectors recorded robust growth. Solid growth was also recorded in the ICT sub sector (thanks to the exponential growth in mobile money and data services) and the real Estate sub sector (spurred by the dynamism in commercial real estate market and steady growth in residential real estate market). Reflecting the dynamism in the real estate sector, the largest mall in East and Central Africa was completed and works on the tallest building in Africa began in 2017 – all of which are situated in and around Nairobi, the Nation’s capital. However, reflecting ongoing challenges in the banking sector, including from the interest rate caps, growth in financial services, which has historically been one of the key drivers of GDP growth, decelerated to 4.0 percent – its lowest in over five years.
Rising oil prices and underperformance of exports are contributing to the widening of current account deficit
Kenya’s current account deficit widened in 2017. Following a pickup in international commodity prices and economic recovery among Kenya’s major trading partners (e.g. the EU, USA etc.), the value of Kenya’s agricultural exports improved in 2017. Tea, coffee, and horticulture grew by 11.5 percent, 11.3 percent, and 1.1 percent respectively in 2017, compared to 4.2 percent, -1.6 percent and 5.7 percent respectively in 2016. However, the expansion in agricultural exports was unable to mitigate the contraction from manufactured exports. Indeed, manufactured export volumes and re-exports from neighboring countries contracted on account of disruption to trade logistics arising from the prolonged election cycle. On the imports side, a moderate recovery of international oil prices, public infrastructural projects, and an increase in food imports to supplement for poor harvests led to a rise in the import bill. Total imports increased by 18.1 percent in 2017 (November), compared to a contraction of 12.4 percent growth in 2016. The widening of the current account deficit was curbed by the rebound in tourism receipts and increased diaspora remittances. Remittances grew by 12.9 percent in 2017, travel receipts increased by 17.1 percent in 2017 compared to 8.1 percent in 2016.
The financial account balance improved in 2017. With respect to the financing of the current account, the financial account balance improved to about 7.5 percent of GDP in November 2017 compared to about 5.9 percent of GDP in 2016. In terms of the breakdown of capital flows, the balance on the financial account has been driven almost entirely by the “other investments” category related to foreign borrowing by the government while banks have continued to see a decline in external financing – a likely compounding factor to the decline in credit to the private sector. In contrast, net foreign direct investments inflows have been subdued. At about 5.9 months of imports, international reserves provide a comfortable buffer against external shocks.
Recovery in private demand is expected to drive the rebound in growth, even as the stimulus from fiscal policy wanes
A modest recovery in private consumption is expected to occur over the medium term. The baseline assumes normal weather conditions. With that, food price inflation is expected to remain benign, thereby lending support to the recovery in private consumption, unlike in 2017 when household consumption was hit hard by the drought. With the ongoing broad-based recovery in the global economy, remittances to the economy is projected to be robust, thereby lending support to household consumption. Further, given that unsecured lending to households has been one of the hardest hit borrower segments in the aftermath of the interest rate cap regime, the anticipated repeal or significant modification to the cap is likely to bolster private consumption as more households gain credit. However, on the downside, with global oil prices expected to continue their steady rebound (about 10 percent increase in 2018 over 2017 prices) and with the pass-through of these prices dampening household real incomes, this will serve as a drag on private consumption, thereby mitigating the lift from some of the upside factors.
With fiscal consolidation underway, the earlier stimulus from the fiscal stance is expected to wane over the medium term. Government expenditures have expanded at a compound average growth rate of 12.1 percent between FY13/14 and FY16/17, and with that the contribution of government spending (including recurrent and development) to GDP growth has averaged about 1.8 percentage points. In other words, over the past five years about a third of growth has come from the public sector. With fiscal consolidation underway, the pace of expansion of government spending is projected to slow down to 5.8 percent. On the one hand, this will reduce the stimulus to the economy coming from the public sector, nonetheless, a necessary step to safeguard macroeconomic stability. On the other hand, to the extent that the slowdown in government spending is likely to translate into lower
Private investment growth is expected to recover, but could remain sub-par without a supportive policy environment. With the easing of political uncertainties in the aftermath of the Presidential elections, pent-up investment is coming onstream as the wait-andsee attitude adopted by the private sector in 2017 gives way to a rebound in business sentiment (as reflected in the recent increase in PMIs). Further, the strengthening of the global economy is providing a further fillip to private sector activity as external demand for Kenyan goods and services (e.g. tourism) is expected to increase. However, the extent to which the private sector in Kenya will be able to take advantage of improving conditions could be curtailed by the extent to which it is starved of credit. Our baseline assumes that with a repeal or significant modification of the cap in 2018, credit conditions will improve by 2019, thereby lending support to a recovery in the private sector. Relatedly, this will help bring down yields on government securities, thereby incentivizing banks to lend to the broader private sector rather than current skewed lending to the public sector or blue-chip Kenyan companies. However, as noted in the risk section, if the favorable policy environment, factored in our baseline does not materialize, the expected recovery in private sector activity will be significantly curtailed.
The contribution of net exports will be moderate. Historically, the contribution of net exports to GDP growth has been negative, subtracting about 1.1 percentage points from GDP growth. Lower oil prices in recent years has however reduced the extent of the drag from net exports. However, since oil prices are expected to continue their steady ascent in 2018 and beyond, we expect the drag from net export over the forecast horizon to rise. This is expected to be mitigated somewhat by the lift from Kenya’s merchandise (horticulture and tea) and services (mainly tourism) exports as the projected broadbased recovery in the global economy takes root. Further, with fiscal consolidation underway and with it a projected slowdown in development spending, this should moderate the pace of import expansion and reduce the extent of the drag from the net exports contribution to growth.
The World Bank remains committed to working with key Kenyan stakeholders to identify policy and structural issues that will enhance inclusive growth, keep Kenya on the path to upper middle-income status, and attain its Big 4 policy objectives. The Kenya Economic Update (KEU) offers a forum for such policy discussions. This 17th edition of the KEU was prepared by a team led by Allen Dennis and Christine Awiti.