December 2017 | Edition No. 16 GDP Fiscal Revenue GDP GDP Consolidation Revenue Tax Exemptions Fiscal GDP Drought Consolidation Investment Tax Exemptions Private Sector Drought Investment Investment Debt Credit Private Sector Investment Interest Rate Cap Slowdown Credit Debt Interest Rate Cap Slowdown POISED TO BOUNCE BACK? Reviving Private Sector Credit Growth and Boosting Revenue Mobilization to Support Fiscal Consolidation POISED TO BOUNCE BACK? Reviving Private Sector Credit Growth and Boosting Revenue Mobilization to Support Fiscal Consolidation © 2017. World Bank Group This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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TABLE OF CONTENTS ABBREVIATIONS.................................................................................................................................................................................................................................................. i FOREWORD............................................................................................................................................................................................................................................................. ii ACKNOWLEDGEMENTS................................................................................................................................................................................................................................. iii EXECUTIVE SUMMARY................................................................................................................................................................................................................................... v PART 1: THE STATE OF KENYA’S ECONOMY 1. Recent Economic Developments ....................................................................................................................................................................... 2 1.1 The global economy is firming up ......................................................................................................................................................................................... 2 1.2 Similar to developments in the sub region, economic activity in Kenya moderated in 2017.......................................................... 2 1.3 Performance of the agriculture and non-agriculture sectors diverged in the first half of 2017....................................................... 3 1.4 Private sector spending moderated, whereas public sector spending held-up ...................................................................................... 6 1.5 Though relatively stable, the macroeconomic environment faced challenges in 2017 ...................................................................... 8 1.6 The current account widened in 2017, but remains close to recent lows ................................................................................................... 10 1.7 Fiscal consolidation is yet to commence ........................................................................................................................................................................... 11 2. Kenya’s Growth Prospects Are Favorable Over the Medium Term........................................................................................................... 13 2.1 As headwinds ease and reforms pick-up, growth will recover over the medium term ....................................................................... 13 2.2 Robust domestic demand will continue to be the main driver of medium term growth ................................................................. 14 3. Kenya’s Growth Prospects are Subject to Significant Domestic and External Downside risks ..................................................... 16 3.1 Domestic risks...................................................................................................................................................................................................................................... 16 3.2 External risks ........................................................................................................................................................................................................................................ 16 4. Accelerating Growth Will Require Structural and Sectoral Reforms ...................................................................................................... 17 4.1 Further structural reforms are needed to achieve the Vision 2030 growth target .................................................................................. 17 4.2 Consolidate the fiscal stance to safeguard macroeconomic stability ............................................................................................................. 17 4.3 Improve the efficiency of public investment and reforms in state-owned enterprise sector ......................................................... 18 4.4 Crowd in the private sector to undertake infrastructural projects..................................................................................................................... 18 4.5 Macro and micro economic policy interventions can improve credit access ............................................................................................ 19 PART 2: SPECIAL FOCUS I 5. Slowdown in Private Sector Credit Growth in Kenya: A Confluence of Multiple Shocks?.............................................................. 26 5.1 Introduction ......................................................................................................................................................................................................................................... 26 5.2. Kenya’s slowdown in credit growth can be attributed to exogenous events beginning in 2015 ................................................. 27 5.3 Interest rate caps made an already tough lending environment even more difficult .......................................................................... 28 5.4 Interest rate caps has had unintended negative consequences in Kenya ................................................................................................... 29 5.5 The interest rate cap is undermining confidence in the banking system .................................................................................................... 30 5.6 The recovery of credit growth faces further headwinds .......................................................................................................................................... 32 5.7 Policy recommendations ............................................................................................................................................................................................................. 32 PART 3: SPECIAL FOCUS II 6. Enhancing Revenue Mobilization to Support Fiscal Consolidation........................................................................................................ 36 6.1 Growth in revenues have not kept pace with robust GDP growth .................................................................................................................. 36 6.2 Improving Corporate Income Tax (CIT) collection in Kenya .................................................................................................................................. 37 6.3 CIT findings and policy options................................................................................................................................................................................................ 38 6.4 Improving Value Added Tax collection in Kenya ........................................................................................................................................................... 40 6.5 Options for enhancing VAT collections ............................................................................................................................................................................... 41 6.6 Conclusion ............................................................................................................................................................................................................................................ 43 REFERENCES ............................................................................................................................................................................................................................................................ 45 STATISTICAL TABLES ......................................................................................................................................................................................................................................................... 47 LIST OF FIGURES Figure 1: Global growth strengthens in 2017 ................................................................................................................................................................................ 2 Figure 2: After years of weakness, economic activity in Sub-Saharan Africa begins to pick-up .................................................................... 2 Figure 3: Though weaker, growth across EAC economies is still above the regional average ........................................................................ 3 Figure 4: Economic activity in Kenya remained robust in 2016 .......................................................................................................................................... 3 Figure 5: However, Kenya’s growth slowed down in the first half of 2017.................................................................................................................... 3 Figure 6: In 2017, performance of agriculture and non-agriculture sectors in Kenya diverged ..................................................................... 3 Figure 7: The effects of the drought on key agriculture products commenced in 2016 ................................................................................... 4 Figure 9: Services sector contribution remains robust (contribution by sector to GDP growth) .................................................................. 4 Figure 8: The impact of the drought on agricultural output worsened in 2017 ...................................................................................................... 4 Figure 10: Performance within services was heterogeneous (contribution to GDP growth by services subsector) ........................... 4 Figure 11: The stock of gross non-performing loans continued to rise across sectors in Kenya ...................................................................... 5 Figure 12: Non-performing loans have been on the rise across EAC economies in recent years ................................................................... 5 Figure 13: Within the industrial sector, output from manufacturing subsector continues to remain lethargic ..................................... 6 Figure 14: Business sentiment has been on a steep decline in recent months (Purchasing Managers’ Index) ...................................... 6 Figure 15: The deceleration in private sector credit growth has continued unabated into 2017.................................................................... 7 Figure 16: However, credit to public sector has remained strong........................................................................................................................................ 7 Figure 17: The weakness in private sector credit growth is prevalent across other East African economies ........................................... 8 Figure 18: In Kenya, the weakness of credit to private sector is agriculture and industry broad-based ..................................................... 8 Figure 19: In Kenya, the weakness of credit to private sector is services and private households broad-based ................................... 8 Figure 20: Reflecting weakness in private investment, imports of key private sector driven capital goods has decelerated ....... 8 Figure 21: Despite a H1 2017 spike in headline inflation, it has since started decelerating towards the target range ...................... 9 Figure 22: Food inflation continues to be the main driver of headline inflation in Kenya ................................................................................... 9 Figure 23: Inflation peaked in most EAC economies on account of the drought...................................................................................................... 9 Figure 24: Exchange rate has been relatively stable ..................................................................................................................................................................... 9 Figure 25: The Central Bank Rate has remained unchanged in 2017................................................................................................................................. 10 Figure 26: There has been a rebound in the Nairobi Securities Exchange .................................................................................................................... 10 Figure 27: The increase in imports led to widening current account deficit................................................................................................................. 10 Figure 28: Capital inflows have helped to finance the current account deficit and accumulate reserves ................................................ 10 Figure 29: Net portfolio flows (BOP) and NSE index...................................................................................................................................................................... 11 Figure 30: Capital flows to government and non-financial corporates have increased in recent months ................................................ 11 Figure 31: Fiscal deficit increased in FY16/17 .................................................................................................................................................................................... 11 Figure 32: Kenya’s fiscal deficit remains well above other EAC countries ....................................................................................................................... 11 Figure 33: Development spending continues to be a major driver of the increase in government expenditure................................. 12 Figure 34: Revenue collection continues to underperform .................................................................................................................................................... 12 Figure 35: VAT and income tax are the largest sources of tax revenue ............................................................................................................................. 13 Figure 36: Public debt is on the rise......................................................................................................................................................................................................... 13 Figure 37: GDP growth, potential output and the output gap .............................................................................................................................................. 14 Figure 38: Compared to other regions the Government wage bill in Kenya is elevated ...................................................................................... 18 Figure 39: Higher government security yields are associated with lower GDP growth ......................................................................................... 19 Figure 40: Higher government security yields are associated with lower private investment .......................................................................... 19 Figure 41: Credit growth to private sector .......................................................................................................................................................................................... 26 Figure 42: EAC: ratio of non-performing loans to gross loans ................................................................................................................................................ 26 Figure 43: EAC: annual credit growth ..................................................................................................................................................................................................... 26 Figure 45: Interest rates before and after the cap .......................................................................................................................................................................... 28 Figure 44: Growth in private sector credit .......................................................................................................................................................................................... 28 Figure 46: Lending to the public sector ............................................................................................................................................................................................... 28 Figure 47: Private credit growth and NPLs/Gross loans (2014-2017) ................................................................................................................................. 28 Figure 48: Changes in domestic credit ................................................................................................................................................................................................. 30 Figure 49: Government treasury bill rates ............................................................................................................................................................................................ 30 Figure 50: Quarterly returns on assets .................................................................................................................................................................................................... 30 Figure 51: Quarterly capital to assets ...................................................................................................................................................................................................... 30 Figure 52: Quarterly growth in deposits .............................................................................................................................................................................................. 31 Figure 53: Quarterly growth in deposit account holders ........................................................................................................................................................... 31 Figure 54: Interbank market segmentation ........................................................................................................................................................................................ 31 Figure 55: Stock market activity .................................................................................................................................................................................................................. 31 Figure 56: Kenya’s GDP growth, 2009-2016 ......................................................................................................................................................................................... 36 Figure 57: Revenue performance .............................................................................................................................................................................................................. 36 Figure 58: Main sectors as percentage of total GDP and CIT revenue, 2015 .................................................................................................................. 37 Figure 59: VAT performance .......................................................................................................................................................................................................................... 41 LIST OF TABLES Table 1: List of ongoing major projects ........................................................................................................................................................................................... 7 Table 2: Medium term growth outlook (percent, unless otherwise stated) .............................................................................................................. 15 Table 3: The cost of tax exemptions from sample, by sectors*........................................................................................................................................... 38 Table 4: CIT collections by tax station, from sample ................................................................................................................................................................. 39 Table 5: Revenue foregone from exemptions, 2015 ................................................................................................................................................................. 41 Table 6: VAT details by turnover, 2015 (Ksh Millions) ................................................................................................................................................................ 42 LIST OF BOXES Box B.1: Climate proofing agriculture in Kenya ............................................................................................................................................................................ 22 Box B.2: Improving the efficiency of public investments ...................................................................................................................................................... 23 Box B.3: Crowding in Private Investment: What can Kenya learn from Colombia? ................................................................................................ 24 Box B.4: Potential sectors to further streamline VAT tax exemptions ........................................................................................................................ ���� 44 ABBREVIATIONS AfDB African Development Bank LAPSSET Lamu Port Southern Sudan and Ethiopia Corridor ASALs Arid and Semi-Arid Lands LTO Large Taxpayers Office BoP Balance of payments M&E Monitoring and Evaluation CAADP Comprehensive Africa Agriculture Development MENA Middle East and North Africa Program MFMod Macro and Fiscal Model CBK Central Bank of Kenya MTO Medium Taxpayers Office CBR Central Bank Rate NEER Nominal Effective Exchange Rate CIT Corporate Income Tax NPL Non-Performing Loans CMA Capital Markets Authority NSE Nairobi Security Exchange DFID Department for International development NT National Treasury DTMASS Drought Tolerant Maize for Africa Seed Scaling OAG Office of the Auditor General EAC East African Community PFM Public Financial Management EAP East Asia and Pacific PIM Public Investment Management ECA Eastern Europe and Central Asia PIT Personal Income Tax EMDE Emerging Markets and Developing Economies PMI Purchasing Managers' Index EPZ Export Processing Zone PPP Public Private Partnership ETR Effective Tax Rate Q1,2,3,4 Quarter One, Two, Three, Four ETR-TI Effective Tax Rate on Taxable Income q-o-q Quarter on quarter FDN La Financiera de Desarrollo Nacional RAPs Resettlement Action Plans FOMC Federal Resource Open Market Committee REER Real Effective Exchange Rate FSD-K Financial Sector Deepening Kenya SA South Asia FY Fiscal year SACCOs Savings and Credit Cooperative Organization GDP Gross Domestic Product SASRA SACCO Society Regulatory Authority H1, H2 First, Second Half SGR Standard Gauge Railway ICT Information Communication Technology SME Small and Medium Enterprises IFC International Finance Corporation SRC Salaries and Remuneration Committee IFMIS Integrated Financial Management Information SSA Sub-Saharan Africa System T-Bill Treasury Bill IMF International Monetary Fund TFP Total Factor Productivity IFRS International Financial Reporting Standard USA United States of America IOD Indian Ocean Dipole VAT Value Added Tax KNBS Kenya National Bureau of Statistic WBG World Bank Group KRA Kenya Revenue Authority Y-o-Y Year on Year LAC Latin America and Carribean YTD Year to Date i December 2017 | Edition No. 16 FOREWORD T his is a critical time for Kenya, as the incoming administrations at national and devolved levels face the high expectations of ordinary Kenyans to deliver on ambitious economic development agendas and hasten the attainment of Vision 2030. Against this backdrop, it is my pleasure to present the sixteenth edition of the World Bank’s Kenya Economic Update—a report which seeks to contribute to the policy discourse on pertinent economic issues. The report has three key messages. The Kenyan economy faced multiple headwinds in 2017. A drought in the earlier half of the year, the ongoing slowdown in private sector credit growth, and a prolonged election cycle weakened private sector demand, notwithstanding an expansionary fiscal stance. Nonetheless, reflecting the relatively diverse economic structure, these headwinds were partially mitigated by the recovery in tourism, better rains in the second half of the year, still low global oil prices, and a relatively stable macroeconomic environment. Consequently, GDP growth is projected to dip to 4.9 percent in 2017—its lowest in the past five years, but still higher than the Sub-Saharan African average. With headwinds subsiding, economic growth is projected to rebound over the medium term, reaching about 5.8 percent in 2019. However, this rebound is predicated on policy reforms needed to address downside risks that have the potential to derail medium term prospects. Two macroeconomic risks are pertinent. First, there is a need to consolidate the fiscal stance in order not to jeopardize Kenya’s hard-earned macroeconomic stability—a critical ingredient to Kenya’s recent robust growth performance. Second, is the need to jumpstart the recovery of credit growth to the private sector; particularly to micro, small and medium size businesses and households. Further, efforts to mitigate weather-related risks by climate proofing agriculture could be supportive of a robust and inclusive medium term growth agenda. We are pleased to present a rich menu of policy options tabled in this edition of the Kenya Economic Update, identifying opportunities for the consolidation of the fiscal stance, both from an expenditure and revenue mobilization perspective. This is complimented with specific suggestions of macroeconomic and microeconomic reform measures that could help address the slowdown in credit growth and the broader issue of access to credit. Finally, policy options to climate proof the agriculture sector, to mitigate the worse effects of adverse weather conditions are discussed. The World Bank remains committed to working with key Kenyan stakeholders to identify potential policy and structural issues that will enhance inclusive economic growth, keep Kenya on the path to upper middle income status, and attain Vision 2030. The semi-annual Kenya Economic Update offers a forum for such discussions. We hope that you will join us in debating topical policy issues that can contribute to fostering growth shared prosperity and poverty reduction in Kenya. Diarietou Gaye Country Director for Kenya World Bank December 2017 | Edition No. 16 ii ACKNOWLEDGEMENTS T his sixteen edition of the Kenya Economic Update was prepared by a team led by Allen Dennis. The core team included Sarah Sanya (author of Private Credit Slowdown chapter), Christine Awiti (author Revenue Mobilization chapter), Mehnaz Safavian, Caroline Cerruti, Ladisy Chengula, Leif Jensen, Moses Kajubi, Celina Mutie, and Angélique Umutesi. The team acknowledges contributions from Anne Khatimba, Vera Rosauer, Charles Muiru, Sarah Farhat, and Robert Waiharo. The report benefitted from excellent comments from Kevin Carey, Jose Luis Diaz Sanchez, Tania Begazo, Jan Mikkelson, Joseline Ogai, Joseph Sirengo, and James Maina. The team also received overall guidance from Abebe Adugna (Practice Manager, Macroeconomic and Fiscal Management), Trichur Balakrishnan (Country Program Coordinator for Kenya, Uganda, Rwanda, Uganda and Eritrea), Johan Mistiaen (Program Leader for Kenya, Uganda, Rwanda and Eritrea), and Diarietou Gaye (Country Director for Kenya, Uganda, Rwanda, Uganda and Eritrea). Partnership with key Kenyan policy makers was instrumental in the production of this report. The preliminary findings in this report were shared with the National Treasury, the Central Bank of Kenya, and Kenya Revenue Authority. Furthermore, in preparation for this report, the team solicited views from a broad range of private sector participants. iii December 2017 | Edition No. 16 EXECUTIVE SUMMARY 1. Buffeted by multiple headwinds, economic activity development projects thereby reducing the burden on decelerated in 2017. After posting a solid 5.8 percent the public purse, and improving the efficiency of public growth in 2016, GDP growth slumped to 4.8 percent in investment spending. Second, private sector credit growth the first half of 2017, with the third quarter showing signs can be crowded in through fiscal consolidation as well of continued weakness. The slowdown in Kenya’s growth as through the establishment of an electronic collateral momentum has been triggered by three main headwinds. registry and improvements to the credit scoring system. First, poor rains led to a contraction in agricultural output Third, a durable and robust growth can be supported by and curtailed hydropower generation in the first half of climate proofing agriculture through increased adoption the year. Relatedly, this led to the build-up of inflationary of drought tolerant seeds, investing in water management pressures and dampened household consumption. systems and improving agronomical practices. Second, private sector credit growth continued its trend decline, thereby further dampening aggregate demand. 5. The second part of the Kenya Economic Update Third, private sector activity weakened over the first three focuses on two topical issues. These are the slowdown in quarters of 2017 on account of the election induced wait- credit growth to the private sector and domestic revenue and-see attitude. However, tail winds from the rebound in mobilization. tourism, strong public investment, and still low oil prices partially mitigated the headwinds. Special Focus I: Slowdown in Private Sector Credit Growth 2. Near term growth is projected to weaken, however with the easing of headwinds, economic activity is 6. Credit growth has slowed significantly in Kenya projected to rebound in the medium term. Given ongoing since 2015 reflecting a series of shocks. Private sector headwinds, GDP growth in 2017 is expected to decelerate credit growth fell from its peak of about 25 percent in mid- to 4.9 percent—its weakest growth in five years. However, 2014 to 1.6 percent in August 2017—its lowest level in over predicated on the easing of headwinds and policy reforms, a decade. The slowdown in credit is not attributable to one growth is expected to recover to 5.5 and 5.9 percent in single event. It reflects the impact of the liquidity shock in 2018 and 2019 respectively. 2015/16, the impact of the resolution of three non-systemic banks on confidence within the banking system, and the 3. Nonetheless there remain significant downside liquidity implication of a segmented interbank market. risks that could scuttle the projected rebound in With the advent of a less supportive demand environment economic activity. First, delays to fiscal consolidation risks in 2017, regional slowdown in credit growth and supply jeopardizing Kenya’s hard earned macroeconomic stability constraints—most importantly, the rise in non-performing with adverse implications on medium term growth and the loans—the outlook for strong credit growth remains dim. inclusivity of that growth. Second, the weakness in credit growth risks curtailing a robust recovery. Third, lingering 7. The enactment of the interest rate caps in political uncertainty can further undermine business September 2016 made an already tough lending confidence, and stunt a robust recovery. environment more difficult. Although the interest rate cap was meant to reduce the cost of credit, thereby making 4. Implementing key macroeconomic and sectoral credit accessible to a wider range of borrowers, after a reforms can avert downside risks and contribute to year of implementation the decline in credit growth to a robust medium term outlook. First, safeguarding the private sector has continued with several unintended macroeconomic stability—a foundation for robust negative consequences. First, banks have shifted lending to growth—will require fiscal consolidation. Fiscal corporate clients and government at the expense of small consolidation can be supported through enhancing and medium sized enterprises and personal household domestic revenue mobilization and reining in of recurrent loans. Second, the proportion of new borrowers has fallen expenditures, crowding in the private sector to carry out by more than half, likely impacting entrepreneurship and December 2017 | Edition No. 16 iv Executive Summary new job creation. Third, the operating environment for role in the widening deficit. The Special focus section banks has become more challenging for them to perform on Domestic Revenue Mobilization reviews two taxes— their financial intermediation role. Fourth, the interest rate Corporate Income tax (CIT) and Value Added Tax (VAT), cap has undermined monetary policy implementation and gives policy options that could enhance revenue with adverse implications for Central Bank’s independence collection for the two taxes. Three key messages emerge and ability to steer the economy. from the analysis. 8. The removal of the interest rate cap is critical to 11. First, there remains substantive scope to boost tax preserving medium term growth prospects. Removing revenues by rationalizing exemptions. The analysis finds the interest rate cap can help jump start domestic credit that exemptions represent a significant source of forgone to the private sector, support the flow of funds to longer tax revenues. While tax exemptions may have been set term private investments, and allow the Central Bank for specific reasons, over time the initial objective might to effectively implement monetary policy, a key role in have lapsed. Forgone revenues from corporate income fostering growth. tax alone account for 1.8 percentage points of GDP with the bulk of tax exemptions concentrated in a few sub- 9. Though important, the reversal of the interest rate sectors. Similarly, on VAT, the indiscriminate application cap, will not be sufficient to improve access to credit. As of exemptions account for revenue leakages of up to 3.1 discussed, the weakness in credit growth started well before percent of GDP arising from various exemptions (over 70 the enactment of the rate caps. In this regard, there is a need percent of actual revenue). to carry out a deeper set of macro and microeconomic reforms to improve credit access and financial inclusion. 12. Second, there is need to enhance revenue On the macroeconomic side, a reduction in fiscal deficit collections in the sectors where the losses in revenue are and better management of public debt is key to lowering the greatest. The financial, manufacturing, health and social benchmark interest rates and ultimately bank lending work activities, account for 88 percent of total exemptions. rates. On the microeconomic front, the universal adoption Any rationalization of the CIT exemptions regime therefore, of credit scoring and sharing would help counteract should have a focus on these sectors, to the extent that the perennially high interest rates for borrowers and improve specific tax exemptions being enjoyed in these sub sectors bank lending policies. Furthermore, accelerating the are no longer a priority within the national development implementation of the movable collateral registry can agenda. On the VAT front, taking into account international help fast track the resolution of non-performing loans. In best practice, the report finds that Kenya applies a relatively addition, reforms that strengthen consumer protection liberal VAT exemptions regime on domestic supplies. This and increase financial literacy is essential to address suggests that there is scope to improve VAT collection predatory lending. by streamlining exemptions on domestic supplies. Other areas for streamlining VAT exemptions with the potential to Special Focus II: Domestic Revenue Mobilization augment revenues include zero-rated supplies and VAT on exempt imports. 10. Improvements to domestic revenue mobilization can be supportive of the medium term fiscal 13. Third, the tax base could be widened and consolidation plans. Despite the robustness of GDP compliance improved. Measures such as cleaning up of growth in recent years, revenues have underperformed the tax register to ensure it includes an accurate number of targets by an annual average of about 3.7 percentage taxpayers as well as accurate master data could be adopted. points of GDP since FY11/12. While a rapid rise in the The KRA’s adoption of an electronic system is a step in the expenditures has significantly contributed to the deficit, right direction and should contribute to ensuring a wider the underperformance of revenues has also played a tax base coverage. v December 2017 | Edition No. 16 Photo: © Kenya Airports Authority November 2017 | Edition No. 16 vi RECENT ECONOMIC TRENDS AND OUTLOOK The moderation in growth was mainly driven by weakness Economic growth has slowed down in 2017 in the agriculture sector 8 8 5.8 5.8 5.9 Year-on-year GDP growth (%) 6 5.6 5.7 6 Year-on-year growth (%) 5.1 4.8 4 4 2 2 0 0 H1 H2 H1 H2 H1 H2 H1 H1 H2 H1 H2 H1 H2 H1 2014 2015 2016 2017 2014 2015 2016 2017 Agriculture Non-Agriculture Source: Kenya National Bureau of Statistics Source: World Bank computation based on data from Kenya National Bureau of Statistics Robust activity in the services sector was strong …. helped Business sentiment has weakened, with the PMI output mitigate some of the weakness from the agriculture sector and new orders indicators deep in contractionary territory. 8 55 PMI (3 month moving average) 6 50 Year-on-year (%) 4 3.3 45 3.1 2.8 3.4 4.4 3.4 2 1.2 3.9 1.4 1.1 40 1.5 0.8 1.1 1.1 1.6 1.4 0.9 0.9 0.8 0.4 0 0.0 35 H1 H2 H1 H2 H1 H2 H1 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 2014 2015 2016 2017 Agriculture Industry Services GDP growth Source: World Bank computation based on data from Kenya National Bureau of Statistics Source: CFC Stanbic and World Bank After spiking in H1 2017, inflation has since fallen to within The recent drought and rise in oil prices contributed to the the target corridor. Core inflation remains subdued surge in inflation during the first half of the year 14 120 12 100 10 80 Upper bound 8 Percent Percent 60 6 4 40 Lower bound 2 20 0 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 0 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Overall in ation Upper bound Lower bound Core in ation Food In ation Energy In ation Core In ation Source: Kenya National Bureau of Statistics Source: World Bank computation based on data from Kenya National Bureau of Statistics vii December 2017 | Edition No. 16 RECENT ECONOMIC TRENDS AND OUTLOOK …however an increase in imports led to a widening Exchange rate has remained relatively stable of the current account deficit 140 15 10 120 5 Jan 2003=100 100 Percent of GDP 0 -5.2 -5 -6.7 -6.4 80 -8.3 -9.2 -8.8 -10.4 -10 60 -15 40 -20 2011 2012 2013 2014 2015 2016 2017 July Jan-15 Jun -15 Nov-15 Apr -16 Sep-16 Feb -17 Jul -17 NEER REER Services Balance of trade Income Net errors and omissions Current account Source: Central Bank of Kenya Source: Central Bank of Kenya …Medium Term Fiscal Framework points to Fiscal consolidation is yet to commence delays in fiscal consolidation 2012/13 2013/14 2014/15 2015/16 2016/17* 2016/17* 2017/18** 2018/19 2019/20 2020/21 0 0 -2 -2 Percent of GDP -4 -4 -4.9 -5.1 -6 - 5.7 -6 - 6.1 -6.1 -5.9 -8 -7.3 -8 - 8.1 - 9.0 -9.0 -10 -10 Source: The National Treasury Source: The National Treasury Note: * indicates preliminary results Note: * indicates preliminary results, ** budget The deceleration in private sector credit growth Near term growth has moderated, however medium term has continued into 2017 growth will rebound as headwinds ease 20 8 5.9 5.7 5.8 5.9 15 6 Year-on-year growth (%) 5.4 5.5 4.9 GDP growth (%) 4.6 10 4 5 2 0 0 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 2012 2013 2014 2015 2016 2017e 2018f 2019f Source: Central Bank of Kenya Source: World Bank Note: “e” denotes an estimate and “f” denotes forecast December 2017 | Edition No. 16 viii Part 1: The State of Kenya’s Economy Photo: © Kenya National Highway Authority The State of Kenya’s Economy 1. Recent Economic Developments 1.1 The global economy is firming up agricultural output and GDP growth in Zambia and Malawi. Supported by domestic demand (including a robust public 1.1.1. Global growth strengthened in the first half of investment drive), GDP growth has remained stable in non- 2017. The Euro Area recorded a two-year, high growth in resource intensive economies. the first half driven by a dissipating policy uncertainty, a pickup in industrial activity, and an upturn in credit growth following years of accommodative monetary policy. 1.1.3. Although still above the regional average, Supported by continued improvements in its labor market, growth across East African economies slowed down in the US economy also remains on track to strengthen in 2017. The prolonged effect of drought experienced in 2017, notwithstanding the marginal growth slowdown 2016 continued in 2017, dampening agricultural output in the second quarter. At 6.9 percent growth for the first and GDP growth in Uganda, Tanzania and Rwanda. In half of the year, China’s economic performance was robust, addition, there was a cyclical downturn in the credit driven by private consumption and a pick-up in exports growth across countries in the region, which has further (Figure 1). dampened recent growth (Figure 3). Though GDP grew at a robust 7.0 percent in Tanzania in 2016, growth is expected 1.1.2. After recording the lowest growth in two to decline to 6.5 percent in 2017. In Uganda growth fell by decades in 2016, economic activity in Sub-Saharan 1.3 percentage points to 3.4 percent in FY 16/17, while in African economies is rebounding. Among large Rwanda the recent drop in growth has been sharper (from commodity-exporting Sub-Saharan African economies 8.9 percent in 2015 to 5.9 percent in 2016) on account such as Nigeria and Angola, the pick-up in economic activity of a tighter fiscal stance. Further, insecurity and political has been supported by recovering global commodity tensions continued to constrain economic activity in prices and policy adjustments (Figure 2). Dented by Burundi, Somalia, and South Sudan. weak domestic demand and low business confidence, South Africa entered a technical recession in Q1 2017. 1.2 Similar to developments in the sub region, economic activity in Kenya However, it is beginning to recover, supported by the lift moderated in 2017 in the agriculture sector. Excluding the larger economies, economic activity is also recovering in the rest of the 1.2.1. Buffeted by both cyclical and structural factors, region. The recovery in global prices of metals and minerals economic activity in Kenya has moderated in 2017. has been supportive of growth in these economies, as After posting a solid 5.8 percent growth in 2016 (Figure well as in other metal and mineral exporting countries 4), GDP growth slumped to 4.8 percent (y-o-y) in the first (Namibia, Sierra Leone, Ghana). Further, in Southern Africa, half of 2017 (Figure 5). The slowdown in Kenya’s growth above average rains after two years of drought are lifting momentum has been triggered by both cyclical and Figure 1: Global growth strengthens in 2017 Figure 2: After years of weakness, economic activity in Sub- Saharan Africa begins to pick-up 10 8 8 6 6.7 4.2 GDP growth (%) 6 GDP growth (%) 4 2.7 4 2 0.8 2.1 0.8 2 1.7 0 1.5 2013 2014 2015 2016 2017e 0 -2 2013 2014 2015 2016 2017e -2 -4 USA United Kingdom China Japan Euro Area Angola South Africa Nigeria SSA (excl. Nigeria) Source: World Bank (Mfmod) Source: World Bank (Mfmod) Note: “e” denotes an estimate Note: “e” denotes an estimate 2 December 2017 | Edition No. 16 The State of Kenya’s Economy Figure 3: Though weaker, growth across EAC economies is still Figure 4: Economic activity in Kenya remained robust in 2016 above the regional average 8 10 8 6.1 5.9 6 5.7 5.8 GDP growth (%) 5.4 GDP growth (%) 6.5 6 4.6 5.2 4.9 4 4 3.5 2.5 2 2 0 2013 2014 2015 2016 2017e 0 Kenya Uganda Tanzania Rwanda Sub-Saharan African 2011 2012 2013 2014 2015 2016 Source: World Bank (Mfmod) Sources: Kenya National Bureau of Statistics Note: “e” denotes an estimate Figure 5: However, Kenya’s growth slowed down in the first half Figure 6: In 2017, performance of agriculture and non- of 2017 agriculture sectors in Kenya diverged 8 8 5.8 5.9 6 Year-on-year growth (%) 5.8 Year-on-year GDP growth (%) 6 5.6 5.7 5.1 4.8 4 4 2 2 0 0 H1 H2 H1 H2 H1 H2 H1 H1 H2 H1 H2 H1 H2 H1 2014 2015 2016 2017 2014 2015 2016 2017 Agriculture Non-Agriculture Sources: Kenya National Bureau of Statistics and World Bank Sources: Kenya National Bureau of Statistics and World Bank structural headwinds. First, poor rains during the short 1.3 Performance of the agriculture and non- (October to November 2016) and long rains (March to agriculture sectors diverged in the first half May 2017) led to a contraction in agricultural output and of 2017 dampened power generation, particularly hydropower. 1.3.1. From the supply side, the growth deceleration Relatedly, this led to the build-up of inflationary pressures was mainly driven by developments in the agriculture in the first half of 2017, which dampened household sector. While the economy grew by 4.8 percent (y-o-y) in H1 consumption. Second, reflecting the trend decline in 2017, lower than 5.8 percent in H1 2016, a decomposition growth of credit to the private sector since 2015, private of growth suggests that most of the growth slowdown was sector credit growth further weakened in 2017, from the driven by the contraction in the agriculture sector as activity already record low levels at the end of 2016. This has in the non-agriculture sector remained healthy, growing contributed to the downturn in Kenya’s business cycle. at 6.4 percent (y-o-y) in H1 2017 (Figure 6). Poor rains and Further, beyond the tightening of lending conditions by army worm infestation led to a contraction in agriculture the banks, private investment also weakened over the output. With the agriculture sector being predominantly first three quarters of 2017 on account of the election rain-dependent, the sector has been severely impacted by induced wait-and-see attitude adopted by the private the drought. Agriculture output grew by 0.1 percent in the sector. However, on the brighter side, tail winds from the first half of 2017, and with the sector contributing almost rebound in tourism, strong public investment, and still low a quarter of GDP, the sector’s poor contribution in H1 2017 oil prices have partially mitigated some of the headwinds pulled back GDP growth by 1.0 percentage points. The poor facing the economy. performance of the agriculture sector in the first half of the year has been impacted by the poor short rains in Q4 2016 December 2017 | Edition No. 16 3 The State of Kenya’s Economy and the late onset of the long rains in Q2 2017. Further, acceleration of 14.8 percent in H1 2017—the fastest half- the Fall Army Worm pest infestation in major food growing year growth since 2013. This has been supported by the regions has destroyed thousands of acres of planted maize, improved security situation, leading to the removal of thereby further dampening output. This has negatively travel alerts from major tourist originating countries, the impacted livestock and food production, beginning with ongoing recovery of the global economy and the rise in the last quarter of 2016 (Figure 7 and Figure 8). Likewise, domestic tourism. Kenya’s main export crop, tea, contracted by 19.4 (YTD) percent in H1 2017. The contraction in output of major 1.3.3. Other rapidly expanding services subsectors food crops contributed to the subsequent spike in food include transport and storage, and ICT subsectors. prices observed in the first half of the year. The transport subsector expanded by a solid 9.0 percent (y-o-y) growth in H1 2017 thanks to the provision of 1.3.2. The dampening effect on growth emanating transport logistics services related to the boom in from the agriculture sector was mitigated by the robust tourism, an expanding construction sector, ongoing performance of the services sector, particularly tourism public investments, and relatively low oil prices (even if related services. Services sustained its growth momentum prices are marginally higher than in 2016). Reflecting still from 2016, growing at 7.0 percent (y-o-y) in the first half of strong demand (both households and firms) for telecom 2017, higher than 5.9 percent in 2016, thus contributing services, efforts by banks to lower costs by deploying new some 3.9 percentage points to Kenya’s growth (Figure 9). technologies and the ongoing ramping up of mobile Except for the financial sector, most service subsectors banking operations, growth in the information and recorded a solid performance (Figure 10). Accommodation communication services maintained double-digit growth and restaurants was the fastest growing sector with an (10.4 percent y-o-y) in the first half of 2017. Figure 7: The effects of the drought on key agriculture products Figure 8: The impact of the drought on agricultural output commenced in 2016 worsened in 2017 300 80 250 60 40 200 Index 2010= 100 Year -to date growth 20 150 0 100 Aug-15 Nov-15 Feb -16 May-16 Aug-16 Nov -16 Feb -17 May-17 Aug -17 -20 50 -40 0 2010 2011 2012 2013 2014 2015 2016 -60 Maize Beans Potatoes Sorghum Millet Cane Tea Co ee Sources: Kenya National Bureau of Statistics and World Bank Sources: Kenya National Bureau of Statistics and World Bank Figure 9: Services sector contribution remains robust Figure 10: Performance within services was heterogeneous (contribution by sector to GDP growth) (contribution to GDP growth by services subsector) 8 2 6 1 Year-on-year (%) Year-on-year (%) 4 2.8 3.3 3.1 3.4 4.4 0 3.4 2 1.2 3.9 1.1 H1 H2 H1 H2 H1 H2 H1 1.4 1.5 0.8 2014 2015 2016 2017 1.1 1.1 1.6 1.4 0.9 0.9 0.8 0.4 -1 0 0.0 Manufacturing Constrution Mining & quarrying H1 H2 H1 H2 H1 H2 H1 Electricity & water Industry 2014 2015 2016 2017 Sources: Kenya National Bureau of Statistics Agriculture Industry and World Bank GDP growth Services Sources: Kenya National Bureau of Statistics and World Bank 4 December 2017 | Edition No. 16 The State of Kenya’s Economy 1.3.4. Financial services expanded at the lowest Q3, reaching 10.6 percent in October. All sectors except pace in six years, reflecting the tough environment personal household and tourism, restaurant & hotels facing banks. Kenya’s financial sector has traditionally contributed to the spike in non-performing loans in recent been one of the most robust subsectors of the economy, months (Figure 11 and Figure 12). expanding at an average pace of 7.7 percent between 2010 and 2016. The challenges facing the subsector 1.3.6. Public sector construction has remained include lingering confidence effects from the earlier bank buoyant, in contrast to private sector construction. liquidation and receiverships, the rise in non-performing Reflecting ongoing major public and public private loans, the introduction of the interest rate caps in late partnership infrastructural projects in energy, rail (including 2016, the election-induced wait-and-see attitude adopted the completion of the SGR), road, and ports, the construction by the private sector, and insolvency challenges of certain subsector that accounts for some 27 percent of industrial systemically important corporates. Consequently, the output expanded at 7.9 percent (y-o-y) in H1 2017, albeit sector posted a five-year low growth of 4.8 percent (y-o-y) lower than 8.8 percent in H1 2016 (Figure13). Nonetheless, in H1 2017 (compared to 8.2 percent during the same reflecting election-related jitters and the tightening of period in 2016). The subsector’s contribution to GDP lending conditions, private sector construction activity growth was some 0.3 percentage points lower in the H1 dipped as reflected in the contraction in residential and 2017 compared with its five-year average of 0.5 percent. non-residential building permit approvals by 21.0 percent Reflecting an adaptation by banks to boost non interest in the first seven months of 2017 in Nairobi. incomes, the banking industry recorded increases in profitability between Q4 2016 and Q2 2017 with return on 1.3.7. Manufacturing growth remains sluggish. The equity increasing to 22.3 percent (q-o-q) from 19.2 percent. manufacturing sector remains an important pillar of the government’s employment creation strategy. However, 1.3.5. Notwithstanding the ongoing challenges, the sector’s growth has been sluggish in recent years. The Kenya’s banking sector remains on a solid footing. Capital sluggishness continued in H1 2017 with manufacturing adequacy and liquidity ratios remain above the statutory output expanding by only 2.6 percent. Given the requirements. The ratio of capital to deposits reached 18.2 importance of the manufacturing sector for job creation, percent in Q2 2017, which is above the 8 percent minimum this weak performance is at a level too low to make a threshold; while the liquidity ratio moved from 43.8 in dent to unemployment or absorb the yearly increase in Q1 2017 to 44.7 in Q2 2017, which is above the statutory the labor market. Though Q3 2017 data has not yet been requirement of 20 percent. Nonetheless the quality of published by Kenya National Bureau of Statistics (KNBS), assets has continued to deteriorate, with the ratio of business sentiment indicators suggest that manufacturing non-performing loans (NPLs) to total loans averaging 8.2 output fell significantly in that quarter, with the Purchasing percent in H1 2017, up from 6.5 percent during the same Manager Index (PMI) output and new orders indicators period last year. The deterioration in NPLs continued into showing deep contraction (Figure 14: PMI). In part, this Figure 11: The stock of gross non-performing loans continued Figure 12: Non-performing loans have been on the rise across to rise across sectors in Kenya EAC economies in recent years 80 12 67.5 65.7 60 10 Ksh. Billions 40.5 38.0 40 31.7 30.0 NPL to gross loans 29.2 29.8 23.4 23.8 17.2 8 20 16.4 8.7 9.3 6.1 4.9 6.2 4.2 3.22.9 1.5 1.2 0 6 Trade Manufacturing Mining & Quarying Financial Services Real Estate Energy and water Agriculture Building & Construction Transport & Communication Tourism, restaurant & Hotels Personal/Household 4 2 Mar-15 Jun-15 Sep -15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar Uganda Rwanda Tanzania Kenya Jun -17 Mar -17 Source: Central Bank of Kenya Source: Central Bank of Kenya, Bank of Tanzania, Bank of Uganda and National Bank of Rwanda December 2017 | Edition No. 16 5 The State of Kenya’s Economy Figure 13: Within the industrial sector, output from Figure 14: Business sentiment has been on a steep decline in manufacturing subsector continues to remain lethargic recent months (Purchasing Managers’ Index) 2 55 PMI (3 month moving average) Year-on-year (%) 1 50 45 0 H1 H2 H1 H2 H1 H2 H1 2014 2015 2016 2017 40 -1 Manufacturing Constrution Mining & quarrying 35 Electricity & water Industry Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Sources: Kenya National Bureau of Statistics and World Bank Sources: CFC Stanbic and World Bank reflects the slowdown in economic activity due to the likely moderated in the first half of the year because of general and repeat presidential elections, as well as the spike in inflation, poor agricultural performance, and slowdown in credit uptake in this sector. the recent tightening of lending conditions by the banks, which saw a contraction in credit growth to the household 1.3.8. Beyond election jitters, there are structural sector. Furthermore, the labor market, particularly in the factors affecting manufacturing output. Output in the private sector, has been less dynamic in 2017 as reflected manufacturing sector has also been curtailed by tightening in reported lay-offs in key sectors including the banking credit conditions, insufficient raw materials for certain agro- sector.1 The softness in the labor market is also reflected processing industries due to the drought (sugar, and maize in the weakening of revenues from personal income taxes meal) and spillover effects from the challenges facing and the drop in the employment PMI sub indicator to Nakumatt—one of the largest retailers in Kenya—since below 50 (contraction territory) for the first time in three many local manufacturing firms are suppliers. Further, years. However, the negative impact of these factors on the competitiveness of Kenya’s manufactured exports in household consumption was likely cushioned by the the regional market is being undermined by the influx increase in public sector wages resulting from the many of cheaper goods (mostly from Asia), intra-regional trade wage agitations in 2017 and robust remittance inflows (6.4 frictions, several non-tariff barriers and the upgrading of percent increase for first eight months of 2017). the manufacturing capabilities in neighboring countries (Uganda, Tanzania), thereby reducing their reliance on 1.4.2. Notwithstanding the lull in private spending, manufactured exports from Kenya. public investment continues to stimulate economic activity. Over the past five years, public investment has been 1.4 Private sector spending moderated, an important driver of Kenya’s GDP growth, contributing whereas public sector spending held-up an average of some 0.7 percentage points between 2011 1.4.1. On the demand side, household consumption, and 2016. Addressing Kenya’s infrastructural deficit lies the largest component of aggregate demand moderated at the core of the government’s development strategy. in 2017. Kenya’s dynamic growth performance in recent Consequently, the government of Kenya continues to years has been largely driven by the strong growth in private invest heavily in improving roads, rails, ports network and consumption (76.3 percent of GDP in the last five years), the power sector (see Table 1). In FY16/17 development which has averaged some 5.8 percent between 2011-2016. expenditures expanded by a solid 34.3 percent in nominal Hence, the sustenance of a robust growth performance terms, with the completion of phase one of the standard hinges on a continued healthy growth in private gauge railway between Mombasa and Nairobi being the consumption. Though the aggregate demand breakdown main flagship infrastructure project. of quarterly GDP data is not available, private consumption 1 Kenya Bankers Association (KBA) - http://www.kba.co.ke/news59.php 6 December 2017 | Edition No. 16 The State of Kenya’s Economy Table 1: List of ongoing major projects Project Name Type Distance Project Value (US$ Millions) Standard Gauge Railway Phase 2A Railway 120 Km 1,500 Lamu Port Southern Sudan and Ethiopia Corridor (LAPSSET) Port, Roads, Rail, Pipeline .. Nairobi Mombasa Expressway Road 473 Km 2300 Northern Corridor Transport Improvement Project Roads Public Private Partnerships (PPP) Capacity Project Value MW (US$ Millions) Thika Power Thermal 87 146 Triumph Thermal 82 156.5 Gulf Power Thermal 80 108 Orpower Geothermal 150 558 Lake Turkana Wind 300 847 Longonot Geothermal 140 760 Kinangop Wind 61 150 Rabai Heavy Fuel Oil 90 155 Kipevu Heavy Fuel Oil 74 85 Mumias Bagasse Co-gen 32 50 Source: Public Private Partnership (PPP) Unit, National Treasury; Kenya Railways. 1.4.3. Unlike the resilience in public investment imports (Figure 20: import growth by product). Thirdly, the flows, private investment is subdued. Although high Stanbic PMI indicator, an important barometer of business frequency private investment data is not published, there sentiment, shows business sentiment to have contracted are several indicators that point to a weakness in private for five successive months since April—the first time in the investment. First, notwithstanding the drop in lending indicator’s history. rates, overall credit growth to the private sector reached its lowest recorded level in 2017 (Figure 15, Figure 16 and 1.4.4. Both cyclical and structural factors are Figure 17). Apart from the ICT sector, the weakness in depressing private investment. Part of the weakness credit growth to the productive sector has been broad- in investment sentiment may reflect a downturn in the based, including: agriculture (-7.6 percent), manufacturing business cycle related to the political cycle. However, the (-3.3 percent), mining (-7.6 percent) and construction downturn in the business cycle has also been influenced by (-1.5 percent) (Figure 18 and Figure 19). Secondly, this the weakness in credit growth, which started since Q4 2015 weakness in private investment activity is reflected in and was further complicated by the enactment of the caps subdued imports of machinery and capital equipment on interest rates. Further, on account of higher inflation, Figure 15: The deceleration in private sector credit growth has Figure 16: However, credit to public sector has remained strong continued unabated into 2017 20 80 60 Year-on-year growth (%) 15 Year-on-year growth (%) 40 10 20 5 0 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 0 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 -20 Source: Central Bank of Kenya Source: Central Bank of Kenya December 2017 | Edition No. 16 7 The State of Kenya’s Economy Figure 17: The weakness in private sector credit growth is Figure 18: In Kenya, the weakness of credit to private sector is prevalent across other East African economies agriculture and industry broad-based 35 60 30 40 Year-on-year growth (%) 25 Year-on-year growth (%) 20 20 0 15 10 -20 5 -40 0 -60 Jun-15 Oct-15 Feb-16 Jun-16 Oct -16 Feb-17 Jun-17 -5 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Uganda Rwanda Tanzania Kenya Agriculture Manufacturing Building & construction Mining & quarrying Source: Central Bank of Kenya, Bank of Tanzania, Bank of Uganda and National Bank Source: Central Bank of Kenya of Rwanda Figure 19: In Kenya, the weakness of credit to private sector is Figure 20: Reflecting weakness in private investment, imports services and private households broad-based of key private sector driven capital goods has decelerated 60 100 80 Year-to-date growth (%) 60 Year-on-year growth (%) 40 40 20 0 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 20 -20 -40 -60 0 -80 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Industrial supplies (non-food) Machinery & other capital equipment Trade Transport & communication Real estate Private households Transport equipment Source: Central Bank of Kenya Source: Kenya National Bureau of Statistics and World Bank private consumption demand has been weak, in particular Rwanda, South Sudan and Burundi. Imports of goods for durable goods, thereby depressing investment. If the and services grew by 12.8 percent, driven by increased factors that are depressing private investments are not oil imports (as international oil prices rose), a ramp up in sufficiently addressed, this could reduce the productivity public investments, and higher food imports due to the of public investments and reduce the long-term growth drought-induced shortages in domestic staples. potential of the Kenyan economy. 1.5 Though relatively stable, the macroeconomic environment faced 1.4.5. The contribution of net exports turned negative challenges in 2017 in 2017. Although the contribution of net exports to GDP growth was positive in 2016, net exports is serving as a drag 1.5.1. Inflation spiked in H1 2017. Headline inflation to GDP growth thus far in 2017, owing to a contraction during the first half of the year surged to a peak of in exports and a moderate pick-up in imports. Despite the 11.7 percent in May, some 420 basis points above the strengthening of the global economy and the recovery in maximum target level (Figure 21). This was mainly due to tourism, the value of exports of goods and services in US cost-push factors rather than a reflection of underlying dollars contracted by 1.7 percent in the first seven months demand pressures. First, insufficient rains during the of 2017. This has been driven by the drought-induced short rains in 2016 and delays in importation to make contraction in tea exports (3.6 percent in 2017) and a sharp up for the domestic shortfall led to a sharp rise in food drop in exports to Tanzania (due to simmering bilateral prices. Secondly, a moderate increase in energy inflation, trade disputes). Kenya’s export growth has also been weak reflecting the pick-up in global oil prices and a moderate on account of subdued economic activity in Uganda, depreciation of the shilling, drove up inflation (Figure 22). 8 December 2017 | Edition No. 16 The State of Kenya’s Economy Figure 21: Despite a H1 2017 spike in headline inflation, it has Figure 22: Food inflation continues to be the main driver of since started decelerating towards the target range headline inflation in Kenya 14 120 12 100 10 80 Upper bound 8 Percent Percent 60 6 4 40 Lower bound 2 20 0 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 0 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Overall in ation Upper bound Lower bound Core in ation Food In ation Energy In ation Core In ation Sources: Kenya National Bureau of Statistics Sources: Kenya National Bureau of Statistics and World Bank The above two factors were also responsible for the pick- 1.5.3. Consistent with subdued private demand, core up in inflation in countries in the EAC region during the inflation remains subdued. Notwithstanding the rise in first half of 2017 (Figure 23). headline inflation, core inflation, which excludes food and energy prices, continued to decelerate through the first half 1.5.2. Inflation decelerated towards the target band in of 2017. It averaged 3.4 percent over the first three quarters H2 2017. Since June 2017, inflationary pressures started to of the year compared with a still subdued 4.9 percent for ease as the weather situation improved and earlier measures the same period in 2016. The low level of core inflation is taken by the government to address the emerging food consistent with an economy where demand pressures are shortages took effect. Among these measures include benign, as has been observed in the subdued demand allowing duty free imports of major food items (maize, from households and weaknesses in private investment. wheat, sugar, and milk) and introducing a temporary subsidy on maize. As a result, headline inflation had fallen 1.5.4. Following the passage of the Banking to 5.7 percent in October compared to the high of 11.7 Amendment Act (2016), monetary policy has been percent in H1 2017. Further, the stability of the shilling has compromised. With the policy rate directly linked to the also served as a nominal anchor to inflationary pressures level of interest rate cap, monetary policy creates perverse (Figure 24), contributing to the relative stability of the incentives for using the policy rate to spur or restrain macroeconomic environment, and thereby counteracting economic activity. For instance, under the new regime, some of the headwinds on economic activity. a lowering of the policy rate—an action often taken by Figure 23: Inflation peaked in most EAC economies on account Figure 24: Exchange rate has been relatively stable of the drought 14 140 12 120 10 Jan 2003=100 100 Percent 8 80 6 60 4 2 40 Jan -16 Apr-16 Jul-16 Oct -16 Jan -17 Apr-17 Jul-17 Jan-15 Jun -15 Nov-15 Apr -16 Sep-16 Feb -17 Jul -17 Rwanda Uganda Kenya Tanzania NEER REER Sources: Kenya National Bureau of Statistics, National Institute of Statistics Rwanda, Sources: Central Bank of Kenya Uganda Bureau of Statistics and Tanzania National Bureau of Statistics December 2017 | Edition No. 16 9 The State of Kenya’s Economy Central Banks globally if they want to stimulate economic 1.6 The current account widened in 2017, but activity—could lead to the opposite effect since the remains close to recent lows lowering of the cap further narrows the spread between 1.6.1. Kenya’s current account marginally widened. In yields on risk free government securities and the maximum July 2017, the current account deficit stood at 6.4 percent allowed lending rates. Thus far in 2017, the policy rate has of GDP compared to 5.2 percent in 2016—a five-year been kept stable at 10 percent (Figure 25). low (Figure 27). Kenya’s trade balance worsened in 2017 despite resilience in services. Trade deficit increased to 13.2 1.5.5. The stock market has staged a moderate percent of GDP in July 2017, from 10.1 percent of GDP in recovery in 2017. The stock exchange index (20 share) 2016, as uptake in merchandise imports was unmatched increased from 3,186.6 in December 2016 to 4,027.1 in by exports. Despite improvements in the global August 2017 (Figure 26). The improvement in the first half commodity prices and recovery in global trade, Kenya’s of 2017 reflected attractive valuations, and a decline in weak merchandise exports (9.4 percent of GDP in 2017) yields on government securities. While the recovery in the reflected the challenges in the real economy, and the stock market continued in the lead-up to general election, effect of the drought. Merchandise imports on the other it took a big hit upon the announcement of the annulment hand, were driven by machinery and transport equipment of the results of the presidential results in September, with for ongoing public projects, oil imports following slight the stock market losing a record Ksh 92 billion in a single recovery of international oil prices, and food imports day. In general, the market was bearish in September to to plug shortages from the drought. The resulting October, reflecting political uncertainty. merchandise imports increased to 25.1 percent of GDP Figure 25: The Central Bank Rate has remained unchanged Figure 26: There has been a rebound in the Nairobi Securities in 2017 Exchange 14 5,000 12 10 NSE 20 Share Index 4,000 Percent 8 6 3,000 4 2 0 2,000 Oct -14 Apr -15 Oct -15 Apr-16 Oct -16 Apr -17 Oct -17 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Source: Central Bank of Kenya Source: Financial Times Figure 27: The increase in imports led to widening current Figure 28: Capital inflows have helped to finance the current account deficit account deficit and accumulate reserves 15 16 10 12 5 8 Percent of GDP Percent of GDP 0 -5.2 4 -5 -6.7 -6.4 -9.2 -8.3 -8.8 -10.4 -10 0 -15 -4 2011 2012 2013 2014 2015 2016 2017-July -20 2011 2012 2013 2014 2015 2016 2017 July Direct investment Portfolio investment Services Balance of trade Income Net errors and omissions Current account General government Non nancial corporations and NPISHs Other investments Net errors and omissions Source: Central Bank of Kenya Source: Central Bank of Kenya 10 December 2017 | Edition No. 16 The State of Kenya’s Economy in 2017, compared to 22.2 percent of GDP in 2016. The portfolio flows have reversed (outflows) since December weakness in the trade balance was somewhat mitigated by 2015 (Figure 29). A breakdown in other investments a surplus on the primary and secondary income account, reveals some important differences amongst sub- including tourist receipts, and diaspora remittances. components: the general government and nonfinancial corporates have increased their borrowing from abroad 1.6.2. Increased inflows to the financial account (inflows) while banks have continued to see a decline in were sufficient to finance the current account deficit external financing since Q2 2015 (Figure 30), consistent and accumulate reserves. With respect to financing of with developments elsewhere in the global economy. This the current account, inflows to the financial account has less supportive external financing conditions for banks improved to about 7.7 percent in Q2 2017 compared to suggests an increasing reliance on domestic savings to about 5.9 percent of GDP in 2016 and 6.2 percent in 2015 fund loan growth—a likely compounding factor to the (Figure 28). Stronger capital inflows reflect ongoing foreign decline in credit to the private sector. investor confidence in the Kenyan economy, thereby supporting the CBK’s effort to accumulate reserves, which 1.7 Fiscal consolidation is yet to commence as of end-August 2017 stood at 5.3 months of imports 1.7.1. Driven by a combination of higher expenditure coverage. In terms of the breakdown of capital flows, the and weak revenue performance, the fiscal deficit widened balance on the financial account has been driven almost in FY16/17. For FY16/17, total expenditure increased by entirely by other investments inflows, which tend to be 19.3 percent, which is above the nominal expansion in shorter term and more volatile. In contrast, net foreign GDP growth of 14.9 percent (Figure 31 and Figure 32). direct investments inflows have been subdued, and As a result, the share of total government expenditure Figure 29: Net portfolio flows (BOP) and NSE index Figure 30: Capital flows to government and non-financial corporates have increased in recent months 6,000 1,000 6,000 1,200 1,000 5,000 5,000 0 800 NSE 20 Share Index 4,000 Millions of USD 4,000 600 Millions of USD Miilions of USD -1,000 3,000 400 3,000 2,000 200 -2,000 2,000 0 1,000 -3,000 -200 1,000 0 -400 0 -4,000 -1,000 -600 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Jan-15 Apr-15 Oct-15 Jan-16 Apr-16 Oct-16 Jan-17 Apr-17 Oct-17 NSE Index (Jan 1966=100), End-month Net portfolio ows, BOP (-ve, in ows) General government Non nancial corporations, households, and NPISHs Sources: Central Bank of Kenya and World Bank Source: Central Bank of Kenya Figure 31: Fiscal deficit increased in FY16/17 Figure 32: Kenya’s fiscal deficit remains well above other EAC countries 2012/13 2013/14 2014/15 2015/16 2016/17* 2009 2010 2011 2012 2013 2014 2015 2016 0 0 -2 -2 Percent of GDP -4 -4 -6 -6 - 5.7 - 6.1 -8 -8 -7.3 - 8.1 -10 - 9.0 Uganda Tanzania Rwanda Kenya -10 Source: National Treasury Source: World Bank (MFmod) Note: * indicates preliminary results Note: Fiscal balances are in calendar years December 2017 | Edition No. 16 11 The State of Kenya’s Economy in GDP rose to 27.4 percent in FY16/17 compared to also remains a drain on the public purse through, grants, 27.2 percent in the previous year and 23.7 percent five loans, guarantees and contingent liabilities (see policy years earlier. This represents a continuation of the rising section for further details). trend of the importance of government spending in the Kenyan economy both as an important driver of growth 1.7.3. Increased capital expenditures in recent years, (contributing 1.8 percentage points of GDP growth in while improving competitiveness, have contributed 2016), but also as a source of fiscal risk. While development towards a narrowing of the fiscal space. Consistent with spending has been one of the main drivers of spending the goal of increasing competitiveness of the Kenyan in recent years, transitional factors such as elections and economy to foster industrialization and create jobs in order drought response related-expenses, and structural factors to be able to absorb the teeming new entrants to the labor such as interest payments and wage agitations has made market, Kenya has in recent years accelerated the pace it challenging to rein in spending. The 19.3 percent of infrastructural development. In FY16/17, development expansion in expenditure was, however, unmatched by the spending increased by 34.3 percent in nominal terms 13.3 percent revenue growth. Consequently, the resulting (rising from 7.0 percent of GDP in FY15/16 to 7.9 percent in fiscal deficit widened from 7.3 percent of GDP in FY15/16 FY16/17). The sharp increase was directed towards various to 9.0 percent in FY16/17. infrastructure projects including rail, roads, ports, energy, and water supply. Similarly, infrastructural spending has 1.7.2. Recurrent expenditures absorb most of been increasing at the county level. However, despite the the tax revenues, leaving limited fiscal space for sharp increase in development spending, inefficiencies development spending. As a share of total revenue, in public investment (project appraisal, selection, recurrent expenditures remain elevated. In FY16/17, implementation, procurement, evaluation, and land national level recurrent spending alone accounted for 90.2 acquisition issues) are limiting the requisite productivity percent of ordinary revenues (taxes and levies) and 15.3 gains from the development spending, and contributing percent of GDP (Figure 33). For FY16/17, transfers to the to fiscal pressures. counties (which covers both county-level recurrent and development spending) accounted for an additional 21.8 1.7.4. Nonetheless, revenues are failing to keep apace percent of ordinary revenues. Hence, even before funding with the expansion in expenditures and the buoyancy for any national level development project is considered, of economic growth. Although it grew by 13.3 percent in ordinary revenues are exhausted mostly by national nominal terms in FY16/17, tax revenues expanded by less recurrent spending as well as from county transfers. A high than nominal GDP 14.9 percent, hence the tax-to-GDP ratio public sector wage bill (which according to the Salaries and fell to 16.9 percent of GDP—its lowest level in a decade. Remuneration Commission accounts for 49.2 percent of Despite a stable VAT, excise duty, and import duty of 4.4, tax revenues), rising interest payments from the increase in 2.1, and 1.2 percent of GDP respectively, the drop in tax- debt stock, and pension liabilities are major components of to GDP ratio was occasioned by subdued growth in both the recurrent spending. In addition, the parastatals sector personal income and corporate income taxes, consistent Figure 33: Development spending continues to be a major Figure 34: Revenue collection continues to underperform driver of the increase in government expenditure 30 30 25 3.9 3.7 4.1 25 3.8 3.0 3.5 5.5 5.1 3.3 5.8 20 2.7 20 1.2 Percent of GDP 1.5 1.4 Percent of GDP 5.1 4.4 4.7 5.5 15 15 7.4 6.7 10 7.6 6.6 10 18.7 19.2 19.2 19.0 18.7 18.2 5 7.9 8.8 7.0 6.3 5 0 2013/14 2014/15 2015/16 2016/17* 0 Development and Net Lending Other recurrent Wages and salaries 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17* Interest payments County allocation Actual Revenue Shortfall Target Source: National Treasury Source: National Treasury Note: * indicates preliminary results Note: * indicates preliminary results 12 December 2017 | Edition No. 16 The State of Kenya’s Economy with the subdued in private sector demand, as discussed (gross) as percentage of GDP increased by 3.3 percentage elsewhere (Figure 34 and Figure 35). For instance, over the points, to 57.2 percent of GDP in June 2017 from 53.8 past year, the financial sector, which is one of the largest percent of GDP during the same period in 2016 (Figure 36). contributors to corporate tax, experienced a slowdown The overall surge was attributed to increase of both external following the interest rate cap—this has in turn reduced and domestic debt, as government borrowed to finance their profits margins and tax obligations. Further, beyond the fiscal deficit. External debt reached 29.8 percent of GDP the election-induced slowdown in economic activity, a in June 2017, while domestic debt stood at 27.4 percent of number of companies in the manufacturing and financial GDP, representing 3.0 and 0.4 percentage points higher than sector have laid off employees. However, not all the their level in June 2016 respectively. On the composition weaknesses in tax growth can be explained by weaknesses of external debt, the stock of debt on concessional basis in economic activity, as this trend has recurred over the past continued to decline. The share of multilateral debt to five years, notwithstanding the buoyant economy, thereby total external debt declined by 7.0 percentage points to suggesting the need to address administrative and policy 38.0 percent in June 2017 compared to the same period in measures to plug tax loopholes (see special focus section). 2016 in favor of bilateral and commercial banks (which rose by 2.8 and 4.1 percentage points to 32.7 percent and 28.6 1.7.5. The expansionary fiscal stance and percent in June 2017 respectively). The most recent IMF/ underperformance in revenue generation has led to a World Bank debt sustainability analysis assesses Kenya in a continued rise in the stock of debt. Kenya’s public debt low risk of debt distress. Figure 35: VAT and income tax are the largest sources of tax Figure 36: Public debt is on the rise revenue 20 70 1.3 1.3 1.2 1.2 60 57.2 16 2.0 55.5 2.0 2.1 2.2 1.3 1.3 50 47.8 48.8 1.3 1.1 43.1 40.6 42.1 Percent of GDP 12 39.7 40.7 37.7 Percent of GDP 4.6 4.5 4.4 40 4.4 8 30 20 4 8.9 8.7 8.6 8.1 10 0 0 2013/14 2014/15 2015/16 2016/17* 2007/08 2010/11 2013/14 2016/17* Income tax Value Added tax Other revenue Excise duty Import duty (net) Domestic External Total public debt (Gross) Source: National Treasury Source: National Treasury Note: * indicates preliminary results Note: * indicates preliminary results 2. Kenya’s Growth Prospects Are Favorable Over the Medium Term 2.1 As headwinds ease and reforms pick-up, neutral or positive. This bodes well for favorable rainfall growth will recover over the medium term patterns over the short-to-medium term. The Kenya 2.1.1. Transient headwinds are expected to ease Meteorological Service forecasts enhanced rainfall for over the medium term. First, we expect the election- the October-December short rains. Thirdly, given the induced precautionary stance taken by the private sector ongoing public discourse on the ineffectiveness of the to relent in the post-election period, and with that the Banking Amendment Act to deliver on the promise of pent-up investment demand to come on-stream, boosting improved credit access, particularly to the SME sector, economic activity. Secondly, unlike the poor rains over the our baseline assumes that over the medium-term past year, which were influenced by La Nina conditions and measures will be taken to address the broader issue of a negative Indian Ocean Dipole (IOD) effect2, international the slowdown in credit growth and access to credit (see climate models suggest that currently conditions remain chapter on credit slowdown). 2 The Indian Ocean Dipole (IOD) is the difference in sea surface temperature between two areas. The IOD affects the climate of countries that surround the Indian Ocean Basin, and is a significant contributor to rainfall variability in these regions. http://www.bom.gov.au/climate/enso/history/ln-2010-12/IOD-what.shtml December 2017 | Edition No. 16 13 The State of Kenya’s Economy 2.1.2. Near term growth will be weak. Growth in GDP and has been one of the principal drivers of growth the second half of 2017 is likely to be supported by in Kenya, contributing some 76.3 percent of GDP growth improvements in agriculture output, thanks to the over the past five years. However, the drought-related improving weather conditions. Nonetheless, headwinds spike in consumer prices in the first half of 2017 dampened from the weakness in credit growth and more importantly consumer spending, particularly for low-income the prolongation of political uncertainty will continue to households. With the deceleration in inflation in H2 2017 significantly weigh down on aggregate demand (both and expected improvements in agricultural harvests over household purchases and business investment), thereby the medium term, we expect consumer prices to be limiting the lift to the economy from the agriculture sector. lower and to stay within the government’s target range Against this backdrop, and a first half-year growth of 4.8 of 2.5 percent to 7.5 percent over the forecast horizon, percent, GDP growth in 2017 is projected to decelerate to thereby supporting a pick-up in consumption. Consumer 4.9 percent (from 5.8 percent in 2016)—its weakest level spending will also be supported by remittance inflows, in five years and a 0.6 percentage point markdown from with remittances projected to reach US$2.0 billion by 2019 earlier forecasts. from an estimated US$1.7 billion in 2017. Furthermore, consumption spending will continue to benefit from the 2.1.3. The easing of the headwinds over the medium ongoing rise of the middle-class, which has grown to at term should pave way for a rebound in growth. Predicated least 44.9 percent of the population (AfDB, 2011). on the easing of headwinds (dissipation of political uncertainty, improved rains), policy reforms to address the 2.2.2. Public investment will remain robust over the slowdown in credit growth, and the existing slack in the medium term. Infrastructure development continues economy as reflected in the negative output gap (Figure to remain an important pillar of the government’s 37), we project medium term growth to recover to 5.5 development agenda, as articulated in the medium-term and 5.9 percent in 2018 and 2019 respectively. Domestic plan III and Vision 2030. Major planned public investments demand will be the main driver of growth over the medium include the second phase of Standard Gauge Railway (SGR) term, with some support from the strengthening of the project and dualling of the Nairobi-Mombasa highway. global economy (section 2.2). Nonetheless, risks are tilted These investments are expected to support growth in to the downside (section 3). the short-term, and over the medium-term ease supply- side constraints, and boost the competitiveness and 2.2 Robust domestic demand will continue to productivity growth of the Kenyan economy. be the main driver of medium term growth 2.2.1. Private consumption expenditures are expected 2.2.3. The robust public investment pipeline will be to rebound on dissipating inflationary pressures. Private complemented by increased private investment flows. consumption remains the largest component of Kenya’s First, the election related wait-and-see attitude taken by investors should ease, in the post-election period. Hence, Figure 37: GDP growth, potential output and the output gap pent-up investment demand is expected to come on- 8 stream. Secondly, under the baseline assumption, private investment will most likely be supported by the expected 6 ease credit conditions. Furthermore, there remains a strong pipeline of PPP projects (see Table 1) particularly in Percent 4 the energy sector and major public investment projects. 2 Last but not least, with a robustly growing economy and a rising middle-income, Kenya continues to remain 0 an attractive investment destination for domestic and 2015 2016 2017 2018 2019 regional market-seeking investors (both foreign and -2 domestic), particularly in real estate, consumer goods, Output Gap Potential GDP GDP health and education subsectors. Source: World Bank (MFmod) 14 December 2017 | Edition No. 16 The State of Kenya’s Economy 2.2.4. Medium term fiscal framework points to a of fiscal consolidation outlined in the medium-term plan. tighter fiscal stance. The government’s medium term The dropping off of one-off expenditure items (elections fiscal consolidation suggests that recurrent spending and drought related expenses) should be supportive of as a share of GDP is expected to decline by about one fiscal consolidation in FY18/19. However, deeper fiscal percentage points annually over the next three to four reforms will be required to achieve the medium term years. Specific areas of slowdown in growth include wages targets. In this regard, our baseline anticipates some fiscal and salaries, interest payments, pensions, and operations consolidation over the forecast horizon, however, without & maintenance. While the slower pace of government the needed fiscal adjustment on both the expenditure and spending, if implemented, will serve as a drag on GDP revenue front (see policy discussion section), the pace of growth in the near-term, over the medium to longer term, fiscal consolidation over the medium term is likely to be it will be a net positive for Kenyan economy through weaker than projected. sustained macroeconomic stability, sending of positive signals to the market of fiscal prudence, improving Kenya’s 2.2.6. The contribution of net exports will be credit worthiness and thereby lowering future borrowing moderate. Historically, the contribution of net exports costs and crowding in private investment. has been negative. However, in both 2015 and 2016, its contribution has been positive, thanks to lower oil prices 2.2.5. Achieving the medium term fiscal consolidation as well as a moderation of capital imports in 2016. Over plans will require fiscal discipline. Plans to reduce the the medium term, with oil prices projected to rise, this will fiscal deficit below 5 percent over the medium term are dent the contribution from net exports. This is expected commendable. However, given challenges faced, including to be mitigated somewhat by an expanding global from a strong labor lobby, rising debt payment charges, an economy which will be supportive of Kenya’s merchandise ambitious infrastructure agenda (see Table 2), inefficiencies (horticulture and tea) and services (mainly tourism) exports. in public investment, vulnerability to exogenous shocks Hence the net exports contribution to GDP is expected and the need to respond (security, political, weather, etc.) to steadily decline to a neutral or a moderate negative and historical underperformance of revenues compared to contribution over the forecast horizon. targets, fiscal discipline will be required to achieve the pace Table 2: Medium term growth outlook (percent, unless otherwise stated) Project Name 2014 2015 2016 2017 e 2018 f 2019 f Real GDP Growth 5.4 5.7 5.8 4.9 5.5 5.9 Private Consumption 4.3 5.1 4.8 4.6 4.9 5.1 Government Consumption 1.7 13.0 7.0 1.7 0.3 0.5 Gross Fixed Capital Investment 14.2 6.7 -9.3 3.9 12.7 14.6 Exports, Goods and Services 5.8 6.2 0.6 3.9 4.0 4.2 Imports, Goods and Services 10.4 1.2 -4.7 1.3 5.1 6.3 Agriculture 4.3 5.5 4.0 2.9 3.9 4.3 Industry 6.1 7.3 5.8 4.5 5.6 5.8 Services 6.3 6.1 6.5 6.0 6.2 6.6 Inflation (Consumer Price Index) 6.9 6.6 6.3 8.0 6.8 6.5 Current Account Balance (percent of GDP) -10.4 -6.7 -5.2 -6.5 -7.0 -8.2 Fiscal Balance (percent of GDP)* -8.1 -7.3 -9.0 -6.1 -5.9 -4.9 Source: World Bank and the National Treasury Note: “e” denotes an estimate, “f” denotes forecast * Fiscal Balance is sourced from National Treasury and presented as Fiscal Years December 2017 | Edition No. 16 15 The State of Kenya’s Economy 3. Kenya’s Growth Prospects are Subject to Significant Domestic and External Downside risks 3.1 Domestic risks foundational necessity recognized in the Medium- 3.1.1. Lingering political uncertainty. Our baseline Term Plan. Given pressures from recurrent expenditures, assumes political uncertainty will dissipate over the vulnerability to exogenous shocks (e.g. weather and medium term, and with that, the wait and see attitude security-related) an ambitious public investment agenda adopted by both businesses and consumers will wane. This (see Table 1), and a track record of underperformance of should lead to a pick-up in aggregate demand over the revenues vis-a-vis targets (subsection 1.7), fiscal pressures medium term and support the projected robust rebound in could exacerbate if the planned fiscal consolidation is economic activity. However, if political uncertainty lingers not adhered to. This could have adverse implications for beyond the near term, its dampening effect will persist government borrowing cost, crowding out of the private into 2018 and 2019, thereby leading to a weaker than sector, exchange rate stability, inflation, and financial sector projected growth performance. The extent of the impact stability, thereby potentially reversing some of Kenya’s will depend on the severity of the political disquiet. Indeed, recent hard-earned gains (macro-stability, robust growth, the three-decade record weak growth of 0.2 percent in poverty reduction). Unfortunately, for a variety of reasons 2008 is a reminder of the potential calamitous impact (decline in commodity prices, growth decline, weak political perturbations could have on economic activity. revenues, fiscal indiscipline etc.), this fate has in recent However, given significant improvements in institutions years befallen several Sub-Saharan African countries (e.g. and major reforms carried out in recent years (including Angola, Burundi, Ghana, Cameroon, Chad, Gabon, Guinea, a new constitution in 2010, the devolution process, etc.) Malawi, Nigeria, Nigeria and Zambia), thereby forcing them the governance framework to address political differences into fiscal adjustment. Recent World Bank studies point to are in a relatively stronger position, hence the baseline a further rise in fiscal sustainability gaps in the sub region. assumption of dissipation in political uncertainty over the By adhering to its medium term fiscal consolidation plan, medium term. this downside risk can be averted for Kenya.3 Indeed, recent studies confirm that fiscal stabilization enhances medium-term growth (Choi et al., 2017) and governments 3.1.2. The projected rebound in economic activity that delivered on fiscal consolidation plans are rewarded could be scuttled if the ongoing weakness in private by financial markets and not penalized by voters (Gupta et sector credit growth is not reversed. For Kenya’s robust al., 2017).4 growth to be sustained over the medium term, it is imperative for private investment to rebound, particularly 3.1.4. Inadequate or unpredictable rains present within an environment of projected medium term fiscal significant downside risks. Our forecast assumes consolidation. The robust medium term growth projections normal rains over the medium term. This may, however, are predicated on the assumption that policy makers will act to alleviate the weakness in credit growth to the not materialize. The poor rains of the past year have private sector. If this does not occur, it presents a significant accounted for at least a 1.1 percentage point decline in downside risk to growth prospects since weak credit GDP growth for the first half of the year. Hence, if normal growth will dampen effective demand by households, stunt or near normal rains does not materialize, they pose a business expansion plans, and lower the growth potential significant risk to agricultural output, with downside risks of the Kenyan economy over the long-run. to medium term growth. 3.1.3. Delays in fiscal consolidation can jeopardize 3.2 External risks Kenya’s hard-earned macroeconomic stability and 3.2.1. Spillovers from global markets represent a risk undo some of the gains of recent years. Fiscal slippages to Kenya’s medium term prospects. We observe three represent a risk to medium term growth projections potential sources of external risks. First, destabilizing capital through its impact on macroeconomic stability—a outflows from emerging and frontier markets triggered by 3 http://pubdocs.worldbank.org/en/752761493655512338/Global-Economic-Prospects-June-2017-Topical-Issue-Debt-dynamics.pdf ; and “World Bank Group. 2017. Africa’s Pulse, No. 16, October 2017. World Bank, Washington, DC. © World Bank. https://openknowledge.worldbank.org/handle/10986/28483 License: CC BY 3.0 IGO.” http://www.imf.org/en/Publications/WP/Issues/2017/02/23/Governments-and-Promised-Fiscal-Consolidations-Do-They-Mean-What-They-Say-44690) 4 16 December 2017 | Edition No. 16 The State of Kenya’s Economy the tightening of global financing conditions could be which should in turn be supportive of Kenya’s growth detrimental to Kenya. Median projections by the United prospects. Nonetheless, escalating tensions in global trade, States Federal Reserve Open Market Committee (FOMC) adversarial geopolitical developments, and an increase members point to one more interest rate hike by year end, in policy uncertainty among high-income countries and another three next year, bringing policy rates to 2.1 (including from ongoing Brexit negotiations) could mark percent by end-2018. If rising U.S. yields are supported by down global growth. If this were to occur, support to prospects of strengthening U.S. growth, then for frontier growth from the global economy through trade, tourism, markets such as Kenya, borrowing conditions could remain investment and remittances would be weaker than benign and positive trade spillovers could lift growth. assumed in the baseline, thereby presenting a downside However, if rising U.S. yields are not accompanied by risk to Kenya’s growth prospects. stronger U.S. growth prospects, borrowing cost for frontier and emerging markets such as Kenya could rise and capital 3.2.3. Sharper than expected recovery in oil prices. flows could slow sharply. The loss of Ksh 92 billion at the Last but not least, the projected moderate increase in NSE in one day (due mostly to withdrawals from foreign global oil prices that underpins the forecast may not hold. portfolio investors), after the recent annulment of the Indeed, if the increase is much stronger than expected, net- Presidential elections is a stark reminder of the potential for oil importing countries such as Kenya (that have continued destabilizing capital outflows in Kenya. However, this risk is to benefit from the windfall of low oil prices) could see assessed low given healthy reserve levels of US dollar 7.9 their growth prospects curtailed as domestic demand billion (equivalent to 5.3 months of import cover). is dampened on account of higher energy inflation. This, however, remains a tail risk event given that higher oil 3.2.2. Weaker global growth. Secondly, the baseline prices are likely to induce a supply response, especially assumes a further strengthening of the global economy, from US shale oil producers. 4. Accelerating Growth Will Require Structural and Sectoral Reforms 4.1 Further structural reforms are needed to percent of GDP, the fiscal deficit in FY16/17 would have achieve the Vision 2030 growth target been lower by 1.2 percentage points. The special focus 4.1.1 Under Vision 2030, the target GDP growth is chapter provides extensive policy recommendations on 10 percent. This pace of growth will be consistent with policy and administrative measures to enhance domestic making significant inroads into reducing unemployment revenue mobilization. and alleviating poverty. Based on recent developments discussed, this section focuses on a subset of structural 4.2.2. Rationalize public sector wages and salaries. (section 4.2) and sectoral reforms (Box 1) that will Over the past ten years, average public sector wages be pertinent to safeguarding Kenya’s robust growth have increased by 10.2 percent compared to an increase performance and could contribute towards accelerating of 11.4 percent for the private sector. Further, reflecting inclusive growth and job creation. new institutions at the national and county levels required under the 2010 constitution, the public sector 4.2 Consolidate the fiscal stance to safeguard work force has increased. A recent Capacity Assessment macroeconomic stability and Rationalization of Public Service (CARP) audit report 4.2.1. Strengthening revenue mobilization can has recommended rationalization of staff levels to a support fiscal consolidation. While Kenya’s GDP growth more optimal size. Further, according to the Salaries and has remained robust in recent years, tax revenues have not Remunerations Commission, the public sector wage kept a pace with economic activity. A World Bank study bill accounted for some 49.2 percent of total ordinary finds a tax gap of about 5 percent of GDP mostly arising revenues and 9.3 percent of GDP—much higher than in from exemptions. Measures to plug this gap will enhance comparable countries and regions (Figure 38). The large domestic revenue mobilization and support the fiscal public sector wage bill makes it more difficult to rein in the consolidation process. Indeed, had revenues from taxes fiscal deficit, thereby increasing the risk of macroeconomic and levies been sustained at the FY13/14 levels of 18.1 stability. Ongoing, efforts by the Salaries and Remuneration December 2017 | Edition No. 16 17 The State of Kenya’s Economy Figure 38: Compared to other regions the Government wage bill in Kenya is elevated 50 40 Middle income average 30 20 Middle income average 10 0 ECA SA EAP SSA MENA LAC Kenya ECA SA EAP SSA MENA LAC Kenya ECA SA EAP SSA MENA LAC Kenya Wage Bill % GDP Wage Bill % Expenditure Wage Bill % Revenue Note: 1/ Kenya’s data is for 2016/17, while regional averages corresponds to 2000-2013 2/ ECA - Eastern Europe and Central Asia; SA - South Asia; EAP - East Asia & Pacific; SSA - Sub-Saharan Africa; MENA - Middle East& North Africa; LAC - Latin America & Caribbean Source: World Bank (2015) and Salaries and Remuneration Commission (2017) Commission (SRC) to tame the wage bill through to parastatals was Ksh 572 billion, comparable in size to rationalization and streamlining of public service payroll, the development budget. Outstanding parastatals loans hiring freezes and carrying out job evaluation for State and also pose a risk to financial sector stability. For instance, other public officers are commendable. in 2017, Kenya Airways had to restructure Ksh24 billion in loans from the banking sector, with several banks taking a 4.3 Improve the efficiency of public significant haircut. Steps to implement a revised legal and investment and reforms in state-owned regulatory framework governing the parastatal sector have enterprise sector stalled in Parliament. The Government Owned Entities Bill, 4.3.1. Despite increased spending on infrastructure 2015, if passed, will support a framework for the merging to boost productivity, efficiency of public investment and dissolution of government owned enterprises, and has been declining. The contribution of net investment transformation into leaner and efficient GOE’s that help to GDP growth declined to 0.7 percentage points in crowd in private investment. Efforts to reinvigorate 2013-16 compared to 1.9 percentage points in 2008-12. such reforms will help protect the public purse, reduce Furthermore, growth in Kenya’s total factor productivity contingent fiscal liabilities, and leverage government (TFP), though rising, is at about 1.3 percent, well short of resources for market and private solutions that can productivity growth in other Sub-Saharan economies such accelerate Kenya’s growth in the medium term. as Rwanda, Ethiopia and Ghana (Kenya Economic Update Edition 14). Causes of low efficiency of investment can be 4.4 Crowd in the private sector to undertake attributed to weakness in the system of public investment infrastructural projects management (PIM), particularly project appraisal, selection 4.4.1. Recalibrate the financing of critical and management. Furthermore, the process of land infrastructural projects, by crowding in private acquisition poses a unique challenge (see Box 3 for detailed investment and reducing the burden on public finances. catalogue of policy recommendations). Infrastructure needs in Kenya are vast, and the resources required to provide them through the public space are 4.3.2. Re-invigorate reforms in government-owned insufficient. Addressing Kenya’s infrastructure deficit will enterprises to reduce the drain on the public purse. require sustained expenditures of almost US$ 4 billion per There are over 200 Government Owned Entities (GOE) year in the medium-term, which is about 6.1-7 percent (State Corporation Advisory Committee, 2013) in Kenya. For of Kenya’s GDP. Given a narrowing fiscal space, the public FY15/16, grants to SOE’s accounted for some 10 percent sector cannot sustainably meet these needs, yet addressing of government recurrent spending, with a 100 of them the infrastructure gap remains critical to improving the making losses to the tune of Ksh 15 billion while receiving competitiveness of the Kenyan economy. Fortunately, Ksh39 billion in grants. Loans and guarantees to parastatals Kenya’s capital markets are the most developed in East constitute a potential source of fiscal risk. As of June 2016, Africa with assets under management of institutional the outstanding balance of national government loans investors representing 18 percent of GDP. Her capital 18 December 2017 | Edition No. 16 The State of Kenya’s Economy markets also enjoy significant interest and participation rates should help bring down the cost of credit to the of foreign investors in the domestic capital market as well private sector. In general, lower T-bill rates are associated as in the independent power production sector through with better economic performance including GDP growth PPPs. Hence, there exists significant potential to scale-up and private investment (Figure 39 & Figure 40). For instance, the participation of the private sector in the provision of in 2010, a year in which the Kenyan economy attained an infrastructural needs, including in social sectors such as enviable growth rate of 8.4 percent, its highest in three housing, education and the provision of health care. decades, the 364 and 184-day T-bill rates registered an average of 4.5 and 3.8 percent. Hence, at an average 4.4.2. The private sector could be incentivized to coupon rate of 10.9 and 10.3 percent for the 364 and 184- participate in the provision of infrastructural development day T-Bills in 2017 respectively, there remains significant through (see Colombia Case study—Box 3): scope for a reduction. Lower fiscal deficits should help • Pension industry reforms to create greater flexibility in reduce government borrowing requirements, thereby their investment process, limit the ability of members putting downward pressure on yields of government to withdraw and reduce trustee rotation. securities, as was the case in 2010, when the fiscal deficit • Tax reform to incentivize institutional investors and and 364-day T-bill rate were at multi-year lows of 3.4 and banks to invest in infrastructure assets (e.g. by providing 4.5 percent respectively. similar tax incentives as currently exist on infrastructure bonds). 4.5.2. The regulatory environment for banks could be • Regulatory reform to ensure that infrastructure assets relaxed to allow them competitively price risks associated are within the permissible investment categories of with different borrowers. With risk-free 364-day treasury institutional investors. bills and five-year government bonds at about 10.9 and • Prompt payment of contractors of ongoing 12.5 percent respectively, on a risk adjusted basis a cap of infrastructure projects. 14 percent, effectively prices out several borrowers and • Reduction in the higher end of the yield curve to make disincentivizes banks to offer longer maturity loans. This other asset classes (including longer term infrastructure is because apart from the “risk free” and relative “costless” projects) relatively attractive to incentivize banks and nature of lending to government, extending new credit to institutional investors in alternative investments. private entities often involves cost associated with legal fees, insurance, government levies, stamp duty, valuation 4.5 Macro and micro economic policy fees, security registration and other third party costs. interventions can improve credit access Further, different borrowers present different risk profiles 4.5.1. A reduction in government borrowing on the hence attracting different risk premiums. Thus, taking domestic market can contribute to lowering borrowing these factors into account, on a risk-adjusted basis, under costs. Given that Kenyan banks price loans off equivalent the current regime where margins have been compressed, government securities, a reduction in benchmark T-bill the operating environment supports the extension of Figure 39: Higher government security yields are associated Figure 40: Higher government security yields are associated with lower GDP growth with lower private investment 10 20 2010 Private investment growth (%) 8 10 GDP growth (%) 2010 0 6 4 6 8 10 12 14 16 2016 -10 4 -20 2016 2 4 6 8 10 12 14 16 -30 364 T-Bill rate (%) 364 T-Bill rate (%) Sources: Kenya National Bureau of Statistics, Central Bank of Kenya and World Bank Sources: Kenya National Bureau of Statistics, Central Bank of Kenya and World Bank Note: Each dot represents a year. The sample period is 2010-2016. Note: Each dot represents a year. The sample period is 2010-2016. December 2017 | Edition No. 16 19 The State of Kenya’s Economy Microeconomic frictions to accessing credit need to be addressed Photo: © Sarah Farhat credit to only a limited number of borrowers—the lowest website allowing potential borrowers to compare cost of risk borrowers. Accommodating credit worthy borrowers credit across banks5 are commendable. Nonetheless more with a higher risk profile, including personal unsecured could be done, specifically relating to the establishment loans and loans to SMEs—the back bone of the Kenyan of a publicly available electronic collateral registry, digital economy- thereby calls for a more flexible pricing regime lands registry, and improvements to the information that allows banks to competitively determine loan content provided to the credit reference bureaus to help prices. Further, there needs to be improvements in the lenders better identify credit worthy borrowers. In Ghana, institutional environment to prohibit predatory lending, reforms under the Borrowers and Lenders Act (2012) through stronger consumer protections. and the establishment of the collateral registry has led to over 77,500 loans registered, and an extension of over 4.5.3. Microeconomic frictions to accessing credit US$12 billion in financing to in excess of 8,000 SMEs and need to be addressed. Recent efforts to reduce the 30,000 Micro loans (see Special Focus I for further policy transactional cost in accessing credit including the recommendations). Moveable Property and Securities Right Act and a new 5 (http://www.costofcredit.co.ke/) 20 December 2017 | Edition No. 16 BOXES The State of Kenya’s Economy Box B.1: Climate proofing agriculture in Kenya 1. Kenya is highly vulnerable to the impacts of climate change. Extreme weather events, largely droughts and to a lesser extent floods, have been the principal source of volatility in the performance of agriculture in Kenya. The Center for Global Development ranks Kenya 13th out of 233 countries for direct risks arising from extreme weather. The frequency and intensity of severe weather events has recently increased, and this trend will be further amplified in the future as temperatures rise due to climate change. In Kenya, about 83 percent of land area is in the Arid and Semi-Arid Lands (80 percent of the population lives in the remaining 17 percent of land), and two-thirds of the country receives less than 500 mm of rainfall per year. 2. Yet, agriculture in Kenya remains predominantly rain-fed. The agriculture sector accounts for the livelihood of 60 percent of the workforce, generates two-thirds of (65 percent) of merchandise exports, and roughly 60 percent of foreign exchange. While rainfall patterns will inevitably continue to influence agricultural sector output for a foreseeable future, some measures need to be taken to reduce the extreme vulnerability of Kenya’s agriculture sector to the vagaries of the weather. Investing in climate-smart agriculture (increased productivity, enhanced resilience, and reduced greenhouse gases) can help to mitigate some of the worse effects of increasing temperatures and droughts, such as occurred in recent years. Policies 3. Increase the adoption of drought tolerant varieties. Advances in biotechnology has led to the development of seeds that can grow bigger and longer roots allowing them to capture more water from the soil, and thereby making them more drought tolerant. According to the Drought Tolerant Maize for Africa Seed Scaling project (DTMASS)6, the adoption of such varieties has led to yield increases of some 20-30 percent compared to non-drought tolerant varieties in 13 African countries over a five-year period. While Kenyan farmers have adopted drought tolerant maize varieties, they are yet to do so at a scale that would make a dent in mitigating severe downturns in agricultural output. Beyond the adoption of drought tolerant seeds, there may be the need to switch to dryland crops, such as millet, sorghum, and cassava. For instance, maize, which is the most widely grown food crop in Kenya is very sensitive to water stress; and even when rains are adequate it is sensitive to the timing of rains. Further, a significant share of the maize is also grown in marginal lands, thus making it every susceptible to droughts. Switching to dryland crops would increase food crops production by building resilience to climate change and variability, and thereby boost food security. Hence, the need to provide adequate extension services and incentives to switch from maize to dryland crops. However, with the current bias towards maize production, through various production and marketing subsidies, farmers may not be sufficiently incentivized. 4. Invest in better water management systems. Virtually all (98 percent) agriculture in Kenya is rain-fed and extremely vulnerable to increasing temperatures and droughts. Studies in Kenya find that by 2030, under business- as-usual scenario, climate change will reduce yields of staples (maize by 12 percent, rice by 23 percent, wheat by 13 percent) as well as prospects for cropland to sustain maize and wheat production. Depending on the region and type of production system, water scarcity due to climate change will result in less productive pasture, lower dairy yields, and higher risks that crop and livestock diseases will spread. Reducing this risk will require investments in irrigation infrastructure to build resilience to drought shocks. Droughts cannot be stopped. However, they can be managed. A historical review of Kenya’s drought history shows some degree of predictability that droughts occur every three- four years, interspersed with years of abundant rain (even floods). Yet the requisite infrastructure to harvest rainwaters for the inevitable drought years remains highly inadequate. Notwithstanding ongoing efforts, to help mitigate the worse effects of drought (and flood years) will require a radical overhaul of the investment to the agriculture sector, including into efficient surface irrigation, precision irrigation (drip technology), and sustainably harvesting ground aquifers. While spending on infrastructure has significantly increased in recent years, expenditure on specific agriculture infrastructure remains weak. Spending on agriculture in Kenya, like many countries in Sub-Saharan Africa, is significantly below the African Union Comprehensive Africa Agriculture Development Program (CAADP) target of 10 percent of national budgets. 5. Make relevant and timely information available to farmers to improve agronomical practices. To help farmers address the challenges of climate change and variability, and to enhance their resilience amid those challenges, it is imperative that Kenya develops and use agro-weather forecasting, monitoring and dissemination tools, as well as market information systems (input/output prices and quantities). Adopting these measures will http://www.cimmyt.org/project-profile/drought-tolerant-maize-for-africa-seed-scaling-dtmass/ 6 22 December 2017 | Edition No. 16 The State of Kenya’s Economy improve the capacity of smallholder farmers to adopt climate-smart agriculture technologies, innovations, and management practices. In other words, developing “big data” for climate smart agriculture will help farmers and pastoralists make informed decisions on what, when, where and how to produce and market their commodities. Recent advances in information technology can be deployed to further climate proof agriculture production, including the adoption of sensors, and satellite imagery to gather important information including on soil moisture, soil type, and weather forecasts; and can therefore, provide a more predictable basis for undertaking the best agronomical practices. For instance, information on soil analysis can guide farmers on knowing the crops and fertilizers suitable for specific soils types. Further, the provision of information on advanced weather patterns by locality can also help farmers make an informed decision on the right planting time, thereby avoiding the failed harvests that several farmers have faced due to untimely planting. Box B.2: Improving the efficiency of public investments A recent World Bank study points out that Kenya can enhance the efficiency of its public investments by undertaking reforms in two broad areas: improving public investment management and the process of land management. Policies on Public Investment Management Quick-win, high-priority actions include: • Establishing minimum criteria for project preparation, appraisal and inclusion of a project in the budget; • Gradually strengthening the role of National Treasury as an independent reviewer of project proposals before selection for funding; while enhancing the capacity to undertake this role; • Improving transparency and accountability for management of the portfolio of public investment projects. A more comprehensive and longer term reform action plan and effort could include: • Strategic guidance: ensure that investment proposals are more stringently reviewed for alignment with the strategies of the Vision 2030 and related Medium Term Plans. • Project design and appraisal: draft project appraisal guidelines with minimum standards for technical design, costing and economic analysis. • Project selection and budgeting: strengthen the role and capacity of the National Treasury to review and challenge proposals by line Ministries as part of the annual budget cycle. • Project implementation: strengthen core public financial management systems: procurement, contract management, cash management, and improving IFMIS functionality and compliance. • Procurement: ensuring competition in public procurement and strengthening the antitrust enforcement to prevent bid rigging and reduce the cost of delivering public infrastructure. • Audit and Monitoring and Evaluation: continuation of reforms at the Office of the Auditor General (OAG), and supplement the existing indicator-based approach to M&E at national level with a focus on project and program evaluation. • Transparency and disclosure: the National Treasury could initiate a cleaning up of the data in e-Promis and use the database to improve information and transparency. Policies on Land management: Mitigating the delays related to land acquisition requires legislative and administration reform which include protecting the public land currently available and strengthening the legislation that governs compulsory land acquisition and involuntary resettlement. Some quick wins in the regard include: • Providing payment assurance (such as via an escrow account at the National Treasury) for financing land acquisition and resettlement to ensure immediate availability of funds for compensation when needed. • Preparing and periodically updating comprehensive public land inventory. Strengthen administrative systems to safeguard public land by registering and titling all public land parcels in the name of the county or the appropriate national authority. • Developing a policy on involuntary resettlement, with supporting legislation, which reflects the principles of international good practice. Source: World Bank. (2016). Kenya Economic Update, Edition 14. December 2017 | Edition No. 16 23 The State of Kenya’s Economy Box B.3: Crowding in Private Investment: What can Kenya learn from Colombia? The Colombian 4G Toll Road Program Infrastructure Debt Fund In 2014, the Government of Colombia launched a USD 20 billion PPP Toll Road Program (7 percent of GDP), one of the largest in the world, covering 40 road transactions. Through WBG engagement: 1. Close to 50 percent of the projects have been awarded (equivalent to USD10 billion of investment mobilization) of which 10 projects have reached financial close. 2. Out of two of the 10 projects awarded, a dominant share of the debt was provided by pension funds through the creation of infrastructure debt funds and project bonds. The WBG supported this endeavor with a comprehensive approach, including: 1. Policy and regulatory reforms, to allow pension funds to invest in infrastructure assets. 2. Strengthening of the PPP framework to enable a pipeline of bankable projects. 3. Investing USD 50 million seed IFC investment in a local infrastructure debt fund that helped mobilize over USD 400 million from pension funds; USD 70 million IFC equity investment in the local infrastructure development bank (FDN). 4. Technical support to strengthen their ability to address market gaps by supporting in the design of financial guarantees. The newly created infrastructure debt fund, provided many advantages: 1. Allowed local pension funds to participate in the bank syndicate with the same terms and conditions. 2. Benefited from the participation of banks and engagement of a fund manager to ensure proper due-diligence, monitoring and management of the project(s) and fund. 3. Matching of investment tenures: whilst banks provided medium term funding (10-12 years), the provision of longer tenured financing (19 years) was well suited for pension-funds long-term investment horizon. 4. The structure benefited from a 15 percent partial credit guarantee from the local infrastructure development bank (FDN). A key factor contributing to the success of WBG’s efforts in Colombia was the early engagement of the Government alongside the institutional investors. This enabled the introduction of amendments to the structure of the PPP road projects. Such changes included, notably: 1. Increase in the share of availability payments in USD from 15 percent to 30 percent. 2. Increase in the frequency of top-up payments related to traffic shortfall. 3. Allocation of specific construction risk to the Government, pertaining to more geologically challenging sections of the road. To date, two more debt funds have been created with private funding, illustrating that this modality is not only successful to crowd in long-term local currency infrastructure finance, but can be easily replicated for future projects, and possibly other markets. PART 2: SPECIAL FOCUS I Photo: © World Bank November 2017 | Edition No. 16 25 Special Focus 5. The Slowdown in Private Sector Credit Growth in Kenya: A Confluence of Multiple Shocks? 5.1 Introduction Uganda, Rwanda, and Tanzania (Figure 42 and 43). The 5.1.1. Credit growth has slowed significantly in Kenya. synchronization of the credit slowdown in part reflects Private sector credit growth fell from its peak of about 25 trade and financial interlinkages between these countries, percent in mid-2014 to 2 percent in October 2017—its decline in economic growth, and the deterioration in the lowest level in over a decade. Limited credit availability, can quality of bank assets and rise in non-performing loans. hinder robust economic recovery, as has been observed Nonetheless, there remains significant idiosyncratic factors in several economies in Europe and elsewhere after the driving the increase in NPL’s in each of these economies, global financial crisis. This box seeks to investigate the including for instance the deterioration of business driving forces behind the recent broad-based slowdown in sentiments in Tanzania and a bank failure in Uganda. credit growth in Kenya (Figure 41). Furthermore, the CBK’s stepped up oversight of banks since 2015 underscored the need for higher loan loss Figure 41: Credit growth to private sector provisioning for several banks in Kenya. 50 40 5.1.3. This chapter focuses on a chronological sequence of events that contributed to the decline 30 Percent in private sector credit growth, and makes policy 20 recommendations for reversing this trend. In Kenya, credit 10 slowdown reflects several factors including exogenous factors such as the external financing shock in 2015, and 0 endogenous events, most notably the interest rate caps -10 Manufacturing Trade T&C Real Households Consumer Business introduced in 2016 and the elevated risk free rate of return estate durables services due to high levels of government borrowing in the domestic Average 2016-17 credit growth Average 2014-15 credit growth Source: Central Bank of Kenya and World Bank market7. It is useful to clarify at the outset that the slowdown Note: T&C - Transport & Communication in credit cannot be attributed to one single event. 5.1.2. Kenya’s slowdown in credit growth is partly a sub-regional phenomenon linked to the rise in 5.1.4. From a theoretical perspective, both demand non-performing loans and adverse macro-financial and supply factors are significant in explaining credit shocks. The credit slowdown has also been observed in cycles.8 Private sector credit to GDP varies widely across Figure 42: EAC: ratio of non-performing loans to gross loans Figure 43: EAC: annual credit growth 12 35 30 10 25 Year-on-year growth (%) 8 20 Percent 15 6 10 4 5 0 2 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Feb-17 Jun-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 -5 Uganda Rwanda Tanzania Kenya Uganda Rwanda Tanzania Kenya Source: Central Bank of Kenya, Bank of Tanzania, Bank of Uganda and National Bank Source: Central Bank of Kenya, Bank of Tanzania, Bank of Uganda and National Bank of Rwanda of Rwanda 7 The slowdown in credit growth may also reflect a correction of the strong credit growth between 2010-13 when external financing conditions very favorable. 8 Akhtar (1994) in the study of the 1989-92 credit slowdown in the U.S highlights the challenge with separating shifts in the supply schedule from developments on the demand side. As the extent of lenders’ response depends not only on the degree of perceived economic weakness and its effects on borrowers’ credit quality but also on the state of their own balance sheets. 26 December 2017 | Edition No. 16 Special Focus countries and it correlates strongly with income level as well The CBK increased the policy interest rate (CBR) by 300 as long-term economic growth and poverty reduction9. On bps between May and July 2015, intervened in the foreign the demand side, strong economic growth, stable macro exchange market and restricted banks’ access to the policies, and low debt burden in the private sector support overnight discount window. The resulting liquidity squeeze the expansion of credit and vice versa. On the supply side, curbed the exchange rate depreciation, and together with credit growth is mostly affected by the strength of banks’ the failure of a very small bank, contributed to a significant balance sheet, with capital and NPLs being the main increase in interbank rates (up to 23 percent in September factors that influence the supply of credit, while access 2015) and segmentation of the interbank market. to cheap wholesale funding facilitated by foreign-owned subsidiaries can also play a role.10 Changes in the regulatory 5.2.2.3. The CBK acted to ease bank’s access to liquidity environment—higher provisions and tighter capital and stepped up its oversight of the banking sector. buffers—can further affect the supply of credit.11 Against this backdrop of liquidity concerns particularly for smaller banks, the CBK injected liquidity—purchased 5.2 Kenya’s slowdown in credit growth can be foreign exchange, reopened the discount window, and attributed to exogenous events beginning in 2015 engaged in reverse repo operations to support banks experiencing liquidity pressures. The CBK’s strengthened 5.2.1. The slowdown in credit growth reflects a series oversight of bank’s compliance with prudential guidelines, of shocks that have hit the economy since 2015.12 Private led to a higher loan loss provisioning coverage ratio for sector credit growth in Kenya has been on a consistent several banks.13 By September 2015, private sector credit downward trend since the second half of 2015. However, growth had begun to decline (Figure 44). the triggers for the downturn in the credit cycle can be traced to the first half of 2015, when the economy was hit by 5.2.3. Bank liquidation and receiverships unfavorable external developments and certain domestic shocks coalescing to put pressure on the exchange rate 5.2.3.1. Even as demand conditions stabilized, under and domestic prices. continuing difficult financial conditions, bank balance sheets weakened and credit supply indicators tightened 5.2.2. External financing shock for most of 2016 (Figure 44 and 45). Foreign exchange 5.2.2.1. Like several other emerging and frontier market pressures eased and the economy recovered markets in 2015, the Kenyan economy experienced with real GDP growth of 5.7 and 5.8 percent in 2015 and large capital outflows. Large outflows, including from the 2016 respectively (up from 5.4 percent in 2014). However, banking sector, were due to changing investor sentiment risks appear to have rotated from the real to the financial towards emerging and frontier markets. The situation sector and by April 2016 three non-systemic banks were in Kenya was accentuated by reduced tourism receipts, under receivership for liquidity and capital deficiencies following adverse travel advisories after the Garissa attack reasons. There was “flight-to quality”, as smaller-size banks in April 2015. suffered loss of wholesale deposits, and bank lending to the public sector increased even as private credit growth 5.2.2.2. The external financing shock put pressure on fell precipitously for most of 2016 (Figure 44 and 45). the exchange rate and liquidity in the banking sector. Furthermore, increased segmentation of the interbank The shilling depreciated by 15.2 percent in the first quarter market also intensified the liquidity stress in smaller of 2015 compared to a depreciation of 3.0 percent during banks and their ability to extend credit. the same period in 2014. Along with an increase in food prices, exchange rate depreciation and its pass-through 5.2.3.2. The deceleration of credit growth continued as effects on inflation contributed to a spike in inflation from banks cut back their lending to improve balance sheets 7.0 percent in June 2015 to 8.0 percent in December 2015. hit by a growing number of nonperforming loans (NPLs) 9 Čihák et al. 2012. 10 Holmstrom and Tirole 1997, CESEE monitor, May 2016. 11 Griffith Jones and Ocampo 2009. 12 Credit growth also declined in 2014, stabilized in the first half of 2015, and began a persistent downward trend shortly after. This section focuses on the drivers of credit decline since 2015. 13 Studies have shown that increased emphasis by the regulators on bank capital and asset quality can weigh negatively on the supply of credit—a standard argument for counter cyclical regulations put forward in the literature (Lown and Wenninger 1994 and McCoy 2016). December 2017 | Edition No. 16 27 Special Focus (Figure 46 and 47). While Banks remain well capitalized, Growth in Q1 2017 fell to 4.7 percent—well below the bank asset quality and profitability indicators deteriorated. 2013-16 average of 5.7 percent because of drought, At the same time, non-performing loans increased election related uncertainty and the deceleration of significantly as credit growth fell. In studies of countries in credit growth. Furthermore, inflation spiked in H1 2017 Central, Eastern and Southeastern Europe, it was similarly (up to 11.7 percent in May), reflecting mainly renewed found that sharp increases in NPL’s reduces bank capital spikes in food prices. Taken together, demand for credit is and, hence, their lending capacity. likely to have declined as firm and households cut output and consumption respectively.14 The less supportive 5.2.3.3. These shocks highlight the relative strength demand environment in 2017, and supply constraints— of supply conditions in explaining the decline in credit most importantly, the impaired balance sheet of banks, growth—a situation that is not unique to Kenya. For the outlook for strong credit growth remains difficult and example, empirical research shows interest rate in Jordan clouded by downside risks. to be largely affected by shifts in credit supply as the elasticity of credit demand with respect to the lending 5.3 Interest rate caps made an already tough rate is relatively smaller than the elasticity of credit supply. lending environment even more difficult While supply factors also played a major role in the decline 5.3.1. The new law capping interest rates became of bank credit in Namibia during 1996-2000. effective in September 2016—complicating the recovery of credit supply. The law puts a ceiling on lending rates 5.2.4. More recently, subdued domestic demand in by banks and financial institutions at 4 percentage points 2017 has been both a cause and contributor to the above the Central Bank Rate (CBR), with a floor on term- weakness in credit growth. Real GDP growth, although deposit rates equal to 70 percent of the CBR. This new robust, has weakened markedly in recent months. legislation was in response to the public view that lending Figure 44: Growth in private sector credit Figure 45: Interest rates before and after the cap 30 20 25 16 Year-on-year growth 20 12 Percent 15 8 10 4 5 0 0 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q3 Q4 Q1 Q2 July August 2014 2015 2016 2017 Average lending rate Average deposit rate CBR Source: Central Bank of Kenya Source: Central Bank of Kenya Figure 46: Lending to the public sector Figure 47: Private credit growth and NPLs/Gross loans (2014-2017) 800,000 90,000 10 80,000 700,000 8 Ksh Millions Ksh Millions 70,000 NPLs/Gross loans 600,000 60,000 6 500,000 50,000 400,000 40,000 4 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul-17 0 5 10 15 20 25 30 Net claims on central government by banks Claims on other public sector (rhs) Credit to private sector growth Source: Central Bank of Kenya Source: Central Bank of Kenya and World Bank 14 The lack of bank lending surveys makes it difficult to make definitive statements about the extent of the decline in credit demand. 28 December 2017 | Edition No. 16 Special Focus rates in Kenya were too high, and that banks were engaging consumer lending, but have stopped lending to new and in predatory lending behavior.15 Although the interest unknown customers. All of this has led to a statistically rate cap was meant to reduce the cost of credit, thereby significant decrease in consumer and unsecured loans making credit accessible to a wider range of borrowers, since the cap was introduced. The shift in bank portfolios after a year of implementation weakness in private sector away from smaller and riskier borrowers is particularly credit growth remains. impactful in Kenya, where riskier SME and micro borrowers make up roughly 4/5ths of all borrowers. 5.3.2. Evidence on the effectiveness of interest rate caps around the world is mixed. While more than 5.4.3. The interest cap has also affected Kenya’s 70 countries worldwide have enacted interest rates savers’ access to interest-bearing deposit accounts, caps to some degree, their various forms and modes of as banks are reclassifying interest bearing accounts implementation make definitive conclusions on their net to non-interest bearing accounts. Empirical evidence impact difficult to assess. In theory, interest rate caps can suggests some re-classification of deposit accounts within help reduce the cost of borrowing for consumers and are banks—from interest to non-interest-bearing accounts—is often used by governments to protect unsophisticated happening to avoid higher deposit interest charges. This borrowers from predatory lending. In practice, however, reclassification has contributed to the shorter duration of the impact depends also on how banks adjust credit deposits and bank liabilities, which has helped stabilize supply when faced with interest caps.16 the liquidity coverage ratio of smaller banks albeit at the expense of banks’ willingness and capacity to make longer 5.4 Interest rate caps has had unintended term loans. negative consequences in Kenya 5.4.1. The interest rate cap has negatively affected 5.4.4. Another effect of the interest cap is that banks small borrowers and SMEs’. In response to the caps, have re-allocated credit from the private to the public banks have shifted lending to corporate clients whenever sector (Figure 48). Since the introduction of the caps, credit possible impacting the allocation of credit to smaller to the government has increased significantly even as borrowers. Unable to properly price riskier loans, banks credit to the private sector continues to fall. So far in 2017, have generally adjusted their portfolios to less risky asset growth in credit to the government has averaged about classes and rationing out riskier borrowers including SME’s 15 percent compared to the 2.3 percent to the private and micro borrowers. Our data analysis confirms that sector. With risk-free 364-day treasury bills and five-year commercial banks indeed responded to the interest rate government bonds at about 11 percent and 12.5 percent caps by shifting lending to their corporate clients to the respectively, on a risk adjusted basis a cap of 14 percent extent possible. Specifically, both tier 1 and tier 2 banks effectively prices out several borrowers and encourages exhibited a significant shift towards corporate clients, investment in government securities at the expense of and away from small businesses or individual borrowers lending to the private sector (Figure 49). following the interest rate caps. 5.4.5. The interest rate cap has had a dampening 5.4.2. The proportion of new borrowers has fallen effect on overall economic activity. Compared to earlier by more than half from a peak of 13 percent in March forecasts, GDP growth for Kenya has been downgraded of 2016, to roughly 6 percent after the caps, likely by about 1.1 percentage points from 6.1 to 4.9 percent for impacting entrepreneurship and new job creation.17 2017. While part of that growth downgrade is undoubtedly Smaller banks, who do not have a large corporate client linked to the effects of the drought as well as the political base, are forced to maintain their portfolios in SME and jitters (see chapter one) the continued slowed down in 15 Interest rate spreads in Kenya averaged 10.1 percent between 2001 and 2015, with profits (48 percent) and overheads (40 percent) accounting for a large portion of these margins. 16 At the request of the Central Bank of Kenya, and with strong support from the National Treasury, a World Bank mission visited Nairobi from March 13th-20th, 2017, to assess the impact of the interest rate cap on the real economy. The objective of the mission was to i) engage with counterparts and stakeholders affected by the interest cap to understand their perspectives on how the caps are affecting financial institutions and credit growth to the economy; ii) secure commitments from banks, microfinance institutions, and SACCOs to provide micro-level data to undertake the analysis; and iii) to initiate a research design and analysis initiative to provide a full analysis based on robust data collection and analysis. Meetings were held with key financial sector regulators including the Central Bank of Kenya (CBK), National Treasury (NT), Capital Markets Authority (CMA), and SACCOS Society Regulatory Authority (SASRA). In addition, the mission met with financial institutions, including tier 1, 2, and 3 commercial banks, deposit taking microfinance banks, and SACCOs. Finally, the mission met with development partners including Financial Sector Deepening Kenya (FSD-K) and DFID. Data requests were submitted to commercial banks for an independent empirical analysis. This section is a summary of the insights from mission meetings and analysis of data provided by the CBK. It is part of a more detailed report shared with the authorities on the impact of the interest rate cap so far. 17 Paligorova and Santos (2014) show that supply induced maturity shortening by banks can have implications for financial stability. Forcing borrowers to revisit banks within shorter periods of time exposes them to “own” and “bank” refinancing risks. This potential synchronization of banks’ and borrowers’ rollover risk may be a source of financial instability. December 2017 | Edition No. 16 29 Special Focus Figure 48: Changes in domestic credit Figure 49: Government treasury bill rates 60 Interest rate cap Interest rate cap 12 Year-on-year growth 40 10 Percent 20 8 0 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 6 -20 20-Jun-16 05-Sep-16 21-Nov-16 13-Feb-17 22-May-17 07-Aug-17 364-T Bill 182-T Bill 91-T Bill rate Private Sector Credit Government (Net) Other Public Sector Source: Central Bank of Kenya Source: Central Bank of Kenya credit growth in the aftermath of the rate cap has also non-interest income generating activities to counter lower been a contributing factor. The dampening effects on lending margins and the reorientation of banks’ portfolio growth are likely to be more pronounced in the medium towards government securities. Capital to asset ratios term if the rate cap persists, since the drought and political remain adequate at about 18% since the introduction jitter factors are expected to be transient. Beyond the of the caps; however, persistent declines in profitability growth impact, given the importance of the segment of could have a knock on effect on capitalization and further borrowers that have been worst hit by the cap—the SME’s weaken the outlook for credit recovery (Figure 51). and personal loans—the impact on employment and job creation is likely to be more pronounced, well beyond the 5.5.2. Deposit migration from smaller banks adversely announced lay-offs in the banking sector. impacts the already weak liquidity position of these banks. The evidence shows that the growth in deposits 5.5 The interest rate cap is undermining fell, on a weighted average basis, after the caps were confidence in the banking system introduced and remains subdued. However, this aggregate 5.5.1. Narrower interest margins have translated to trend masks significant volatility in bank funding across declining bank profits which could affect capital. On a different types of banks. On one hand, growth in deposit weighted average basis, return on assets declined following account holders is broadly unchanged across all tiers of the introduction of the caps, particularly in tier 3 banks banks (flat at less than 2 percent). On the other hand, the where return on assets hovering around zero since January caps have exacerbated the migration of deposits from tier 2017 (Figure 50). More recently, profitability indicators have 3 banks to tier 1 and 2 banks, thereby adversely impacting staged a modest recovery as banks adjust their strategies the liquidity position of these banks and their ability to to the decline in net interest income to remain profitable in further mobilize deposits (Figure 52 & Figure 53). the near term. This recovery is in part driven by increases in Figure 50: Quarterly returns on assets Figure 51: Quarterly capital to assets 5 Interest rate cap 35 Interest rate cap 4 25 3 Percent Percent 2 15 1 0 5 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 -1 2012 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017 Tier 1 Tier 2 Tier 3 Weighted Average of all Banks Tier 1 Tier 2 Tier 3 Weighted Average of all Banks Source: Central Bank of Kenya Source: Central Bank of Kenya 30 December 2017 | Edition No. 16 Special Focus Figure 52: Quarterly growth in deposits Figure 53: Quarterly growth in deposit account holders 40 150 Interest rate cap (Aug 24, 2016) Interest rate cap (Aug 24, 2016) 30 100 20 50 10 Percent Percent 0 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 0 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 -10 2012 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017 -50 -20 -30 -100 Tier 1 Tier 2 Tier 3 Weighted Average of all Banks Tier 1 Tier 2 Tier 3 Weighted Average of all Banks Source: Central Bank of Kenya Source: Central Bank of Kenya 5.5.3. In addition, the segmentation in the interbank 5.5.4. Foreign participation in the stock market also market has persisted, with large banks reluctant to continues to be weak following the cap. The stock market provide liquidity to smaller banks (Figure 54). Transaction is often a good indicator of foreign investor sentiments volumes and liquidity have improved since the liquidity towards the economy. The NSE declined in the immediate crisis that lasted well into Q1 2016—reflecting liquidity aftermath of the cap, driven mainly by withdrawal of foreign provisions by the CBK to smaller banks. However, risk participation in the stock market. While the overall index aversion in the interbank market persists due to ongoing has staged an impressive recovery in 2017, this rally masks concerns about the liquidity position and solvency of some negative underlying trends. First, foreign purchases smaller banks. The segmentation in the interbank market have remained subdued (Figure 55). Second, the volumes and its attendant effects on competition between banks of bank stocks traded is more volatile and prices have not also exacerbates the negative effect of the interest rate recovered in some cases. caps on credit supply in smaller banks. There is also an underlying concern about the disproportionate impact 5.5.5. Outside the banking system, interest rate of the caps on smaller banks and the likelihood that caps also undermine monetary policy transmission they would need a major change in strategy to remain and implementation, with implications for CBK’s competitive in this setting. These concerns have been independence and its ability to steer the economy. With reflected in wider gaps between interbank lending rates caps linked to the CBR (policy rate), changes in the policy for large and small banks as well as greater volatility of rates could be counterproductive. For example, if the CBK interbank rates in the post cap period.18 were to loosen its monetary policy stance to stimulate Figure 54: Interbank market segmentation Figure 55: Stock market activity 15 25,000 5,000 10 Interest rate cap Difference between high & low rates 20,000 4,000 5 Ksh million 15,000 3,000 0 2015-01-02 2015-09-07 2016-05-11 2017-01-18 2017-09-21 10,000 2,000 -5 5,000 1,000 -10 -15 0 0 Average di erence before cap (Jan 2, 2015 - Sep 13, 2016) Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Average di erence after cap (Sep 14, 2016- Nov 20, 2017) Foreign purchases (NSE) NSE equity turnover NSE Index (Jan1966=100), end-month, RHS Source: Central Bank of Kenya Source: Central Bank of Kenya 18 The average gap between the CBR and the weighted average interbank rates has widened since the cap was introduced (6.25 in the period January 2016-September 13 (2016) vs. 4.38). the difference between the two periods is statistically significant December 2017 | Edition No. 16 31 Special Focus the economy through a policy rate cut, there would be a economic downturns are often accompanied by higher decline in the interest rate ceiling. This in turn would make unemployment, which affect the ability of debtors to it less profitable for banks to lend, particularly to smaller service their debt, ultimately leading to an increase in NPL’s or higher risk customers, thus potentially offsetting the and deterioration in bank performance.19 impact of the rate cut. The CBR has been changed once since the implementation of the cap. 5.7 Policy recommendations 5.7.1. Removing the interest rate cap can help re- 5.6 The recovery of credit growth faces further boost domestic credit to the private sector and allow headwinds for the Central Bank to effectively implement monetary 5.6.1. The new International Financial Reporting policy, a key role in fostering growth. While the interest standards (IFRS 9) could pose further challenges to the rate cap policy was an attempt to make credit less costly recovery of credit growth in the near term. Specifically, and therefore more accessible to borrowers, this policy the expected-loss impairment framework in IFRS 9 requires objective has not been achieved. Our analysis confirms banks to account for expected credit losses on loans from significant credit rationing to small and medium enterprises the moment of its origination or acquisition and adjust and for unsecured personal loans, while lending to the throughout the life of the loan. Previously, credit losses government and lower risk large corporates has increased. were recognized only once there has been an incurred loss Access to longer term loans have also been curtailed with event. In the context of slow credit growth and elevated potential deleterious consequences for private capital non-performing loans, provisioning will likely increase, investment and long-run economic growth. Since the cap further tightening bank’s ability to allocate credit to the was introduced, total credit growth to the private sector private sector, particularly for higher risk borrowers. has been weak, while the composition of lending has shifted in favor of large corporate clients. Furthermore, 5.6.2. Deteriorating domestic and regional economic pegging the interest rate cap to the Central Bank Rate cycles could further impact bank performance and (CBR) has fundamentally affected the effectiveness of increase NPLs—impacting the recovery of credit monetary policy, and the signaling and relevance of the growth in the near term. The expected weaker domestic CBR. Addressing this issue is even more important at and regional growth prospects are likely to affect bank this current juncture given the slack in the economy. performance, specifically, asset quality, profitability, credit Aggregate demand remains weak as reflected in low supply and in some cases solvency. More generally, business sentiment, weakness in private investment, and Reforms that strengthen consumer protection and increase financial literacy are essential to tackling predatory lending Photo: © Sarah Farhat 19 Grigoli et al. 2016. 32 December 2017 | Edition No. 16 Special Focus subdued core inflation. By unhinging the interest cap from 5.7.4. On the microeconomic front, the universal the policy rate, this could allow the lowering of the policy adoption of credit scoring and sharing would help rate to have the intended effect on boosting credit growth, counteract perennially high interest rates for borrowers aggregate demand and overall economic activity. and improve bank lending policies. Credit reporting can have a sizable impact on the ability of banks to differentiate 5.7.2. Removing the interest rate cap must be between risky borrowers, and offer financing that is priced accompanied by a deeper set of structural reforms to per the risk of the borrower. To strengthen credit reporting improve credit access and financial inclusion. Though in Kenya, the CBK is already working with commercial important, the reversal of the interest rate cap, will not banks on increasing the quality of their consumer data be sufficient to improve access to credit. Indeed, as and to include credit reporting data in lending decisions. discussed earlier, the weakness in credit growth started However, overall credit bureau data and products can well before the enactment of the rate caps. In this regard, be significantly improved, and other lenders can be there is the need to carry out a deeper set of macro and supported to also participate in the credit reporting microeconomic reforms to tackle bottle necks to credit system, such as SACCOs and microfinance institutions. This access and improvements in financial inclusion. reform, coupled with a well-functioning credit bureau, will improve pricing transparency among banks, and broadly 5.7.3. On the macroeconomic side, a reduction in lower interest rates. fiscal deficit and better management of public debt is key to lowering benchmark interest rates and ultimately 5.7.5. Accelerating the implementation of the bank lending rates. Elevated fiscal deficit levels in movable collateral registry will help fast track the NPL recent years has increased domestic borrowing by the resolution process. The National Treasury has recently government. For instance, in 2010, a year in which the passed a reform making it possible for borrowers to use Kenyan economy attained an enviable growth rate of 8.4 movable property as collateral which can lower the cost percent, its highest in three decades, the 364 and 184-day of longer term credit. However, the reform to date has T-bill rates registered an average of 4.5 and 3.8 percent, only been partially implemented, with the passage of whereas in 2017 the coupon rates have averaged 10.9 the Movable Property Security Rights Bill. The second and 10.3 percent for the 364 and 184-day respectively. The phase of the reform, setting up a movable property higher domestic borrowing has thereby contributed to registry, currently remains unfinished and is a source of the increase in the “risk free” interest rate and, ultimately, systemic vulnerability. the rate at which banks lend to the private sector. This crowding out has a significant adverse effect on private 5.7.6. Reforms that strengthen consumer protection investments and potential growth. Hence by consolidating and increase financial literacy are essential to tackling on the fiscal stance—rationalizing expenditures (see predatory lending. For example, establishing a consumer chapter 1) and enhancing domestic revenue mobilization protection bureau, could equip borrowers with greater (see special focus chapter)—the government can reduce bargaining power vis-à-vis banks and other lenders; promote its domestic borrowing requirement, and the cost of credit, a more transparent pricing practices; increase financial thereby crowding in the private sector. literacy and allow for more effective dispute mechanisms. December 2017 | Edition No. 16 33 PART 3: SPECIAL FOCUS II Photo: © Kenya Revenue Authority December 2017 | Edition No. 16 35 Special Focus 6. Enhancing Revenue Mobilization to Support Fiscal Consolidation 6.1 Growth in revenues have not kept pace 6.1.3. The weakness in revenue performance with robust GDP growth has exacerbated fiscal pressures. Expenditures have expanded at the pace of 26.5 percent between FY10/11 6.1.1. Economic growth in Kenya has been resilient. and FY15/16—increasing by 3.9 percentage points of Over the last decade, economic growth in Kenya averaged GDP. This expansion has been fueled by an ambitious 5.6 percent, higher than the global economic growth rate infrastructure drive to improve the competitiveness of of 2.3 percent (Figure 56). GDP growth over this period the Kenyan economy, and new institutions emanating was broad-based. The services sector which accounts from the Constitution of Kenya, 2010. However, revenues for the largest component of GDP, grew by 6.2 percent have not kept apace. Consequently, the fiscal deficits have while industry grew at 6.0 percent. The agriculture sector widened from -3.5 percent in FY16/17 to -8.9 percent of expanded by 4.1 percent. On the demand side, public GDP in FY16/17, and with that debt levels have steadily infrastructure spending and consumption, driven by climbed to 57.2 percent of GDP in 2017 from 37 percent increased access to credit, propelled growth. Ceteris in FY10/11. In recognition of the erosion of the fiscal space, paribus, this broad-based growth should be supportive the government’s fiscal framework seeks to embark on a of increased tax revenues from both production and steady fiscal consolidation over the medium term, reducing consumption sources. deficits to about 4.9 percent of GDP by FY19/20. 6.1.2. Despite the robustness of GDP, revenue growth has remained volatile and underperformed targets. 6.1.4. Improvements to domestic revenue As a share of GDP tax revenues increased to a high of mobilization can be supportive of the medium term 16.8 percent in FY13/14, but declined by 0.5 percentage fiscal consolidation plans. Rationalization of spending, in points by FY15/16, before rebounding in FY16/17 (Figure particular recurrent spending, (see chapter one), will remain 57). While Kenya compares favorably to several Sub- core to medium term fiscal consolidation. Nevertheless, Saharan African economies in terms of its taxes collected increased domestic revenue mobilization can allow for as a share of GDP, it lags several middle-income country a softer fiscal adjustment process. If Kenya improves tax peers including South Africa (27.3 percent), Botswana collection from the current average performance, among (25.6 percent), Jamaica (26.8 percent), Mozambique (23.1 its middle-income peers, to the 75th percentile mark, (about percent) Senegal (19.8 percent), and Vietnam (19.1 percent). 20-22 percent of GDP—which is consistent with the target Since FY11/12, revenues have underperformed targets by set in the Budget Policy Statement 2017), it will reach lower an annual average of about 3.7 percentage points of GDP. levels of deficits than currently envisaged. This will signal Kenya’s fiscal prudence credentials to markets and elicit lower borrowing costs domestically and externally. Figure 56: Kenya’s GDP growth, 2009-2016 Figure 57: Revenue performance 10 20 8.4 8 19 GDP growth (%) 6.1 Percent of GDP 5.9 5.7 5.8 6 5.4 18 4.6 4 17 3.3 2 16 0 15 2009 2010 2011 2012 2013 2014 2015 2016 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17* Source: Kenya National Bureau of Statistics Source: The National Treasury Note: * denotes preliminary results 36 December 2017 | Edition No. 16 Special Focus 6.1.5. To improve revenue performance, reforms to which have tended to decrease statutory CIT rates, domestic revenue mobilization are required. Revenue countries in SSA have maintained statutory rates while performance has moderated in recent years. This chapter decreasing effective rates through tax incentives. considers the opportunities available for expanding revenue collection through tax policy and administration 6.2.2. CIT is governed by the Income Tax Act, Cap reforms. The bulk of the analysis in this chapter, is based 470 of the Laws of Kenya. CIT is levied on the income of on two more detailed World Bank tax studies on corporate legal entities such as; Limited Companies, Trusts, and Co- income tax (CIT) and value-added tax (VAT) where further operatives. Resident companies are taxable at a rate of 30 details can be found.20 Kenya faces a number of challenges percent, while non-resident companies at 37.5 percent. in enhancing revenue yield on property taxation, the CIT and The rate applicable to resident legal entities (30 percent) VAT. Yet, these three tax sources offer the best opportunities is aligned to the maximum marginal personal income tax in the tax mix for substantial revenue improvements. rate for individuals. Some companies, such as those on Indeed, CIT and VAT alone, accounted for 49.4 percent of the stock exchange or in EPZs, have received preferential tax revenues in 2015. The revenue performance of personal treatment through lower tax rates. income taxes and Excise in Kenya is much better aligned with the tax potential. The revenue yield as share to GDP on 6.2.3. The CIT response to economic growth Personal Income Tax (PIT) and Excise stood at 4.8 percent remained moderate between 2010 and 2015. During this and 2.0 percent respectively in FY14/15, as seen against the period, growth in job creation and business investment, EAC average of 2.4 percent and 2.1 percent respectively. particularly foreign direct investment, suggest potential The Sub-Saharan Africa (SSA) average for excise in 2015 for significant increase in corporate income tax revenues. was 1.7 percent, indicating revenue collection in Kenya Nonetheless, the response has been relatively muted. around 20 percent higher on Excises taxes than in SSA. Our analysis shows a significant variation between The detailed analysis of CIT and VAT reform opportunities sectoral contributions to GDP and their contributions to provide broader lessons applicable to the overall domestic corporate income tax revenues. Only a few sectors, mostly resource mobilization agenda. those with a higher share of large tax payers, contribute a disproportionately higher share of corporate income 6.1.6. Three key messages emerge from the analysis. tax revenues. On the other hand, certain sectors such as; First, there remains a substantive scope for boosting agriculture, wholesale and retail trade, education and real revenue by rationalizing exemptions. Secondly, there is estate, whose contribution to the total corporate income need to enhance revenue collections in the sectors where tax is disproportionately lower than their share in GDP. This the losses in revenue are the greatest. Thirdly, efforts to suggests that there remains scope for improvement in CIT widen the tax base, and improve compliance through revenues (Figure 58). various administrative measures could significantly boost Figure 58: Main sectors as percentage of total GDP and CIT revenues. Further details are discussed below. revenue, 2015 6.2 Improving Corporate Income Tax (CIT) Mining & quarrying Accomodation & restaurant collection in Kenya Other services Health 6.2.1. Corporate income taxes are widely used Pro e', Admin & support services Electricity & water globally. The corporate income tax (CIT), is one of the main Information & communication Public administration taxes on business profits, a tax policy instrument affecting Construction Financial & Insurance the costs of capital. Empirical evidence shows that higher Transport & storage Education corporate income tax rates reduce business density and Wholesale & retail trade entrepreneurship entry rates and increases the capital Real estate Manufacturing size of new firms. The progressivity of tax rates increases Agriculture 0 10 20 30 40 entrepreneurship entry rates, whereas highly complex tax Sector's CIT revenue as a share of GDP (percent) Sector's contribution to GDP (percent) codes reduce them.21 Unlike in higher income countries, Source: World Bank based on KRA data 20 See Kenya Tax Policy Studies: Value Added Tax and Corporate Income Tax. World Bank Report 2017. https://wol.iza.org/articles/corporate-income-taxes-and-entrepreneurship/long 21 December 2017 | Edition No. 16 37 Special Focus 6.3 CIT findings and policy options for the increase in CIT revenues, after adjusting for reduced Findings rates on account of various socioeconomic factors—an extra revenue loss of 1.9 percent of GDP.23 Compared to 6.3.1. Exemptions represent a significant source of the other middle-income countries such as South Africa and tax gap to CIT revenues. Measures such as the effective tax rate and the magnitude of exempted income in each Mauritius, this magnitude of tax gap remains considerable. sector are widely used approaches in estimating the CIT tax gap.22 Applying this tax gap methodology, the analysis 6.3.2. The bulk of tax exemptions are concentrated shows that holding tax rates constant, CIT revenues in a few sub-sectors. Four subsectors; financial services, could increase by 24 percent or Ksh 33.3 billion if all CIT information and communication technology, health, and exemptions for businesses were eliminated (Table 3). Taking manufacturing, account for about three-quarters of the into consideration the fact that there are legitimate socio- losses in corporate income tax. This reflects the relatively economic reasons for the application of differentiated large size of these subsectors in GDP. Indeed, reflecting tax rates by sector (for instance lower rates in health and higher levels of formalization, the actual contributions of education), the tax gap analysis reveals a still significant the financial and banking sectors to the total corporate Ksh 26.2 billion shortfall in corporate income tax revenues. income tax revenues is disproportionately higher. In other words, there remains about 19 percent potential Table 3: The cost of tax exemptions from sample, by sectors* Taxable Taxable Cost of Cost of Potential income income w/o exemptions exemptions CIT revenue (KSh, millions) exemptions with ETR-TI with uniform increase if all (KSh, millions) (KSh, millions) 30 percent exemptions rate eliminated* (KSh, millions) (Percent) Agriculture, Forestry & Fishing 14,458 16,992 527 760 18 Mining & Quarrying 2,187 3,083 188 269 41 Manufacturing 63,039 73,804 2,459 3,229 17 Electricity, Gas, Steam & Air Conditioning 7,265 7,428 42 49 2 Water Supply; Waste management, Sewerage 533 541 2 2 2 Construction 20,391 21,338 347 284 5 Wholesale, Retail Trade & Vehicle Repair 16,801 16,994 53 58 1 Transportation & Storage 22,880 24,003 395 337 5 Accommodation & Food Services 3,389 3,487 20 29 3 Information & Communication 57,023 61,849 1,487 1,448 8 Financial & Insurance Activities 171,801 218,328 11,897 13,958 27 Real Estate Activities 12,164 14,437 596 682 19 Administrative & Support Services 13,946 15,139 336 358 9 Public Admin, Defence & Social Security 76 121 8 14 60 Education 1,525 9,754 755 2,469 540 Human Health and Social Work Activities 2,845 14,176 1,581 3,399 398 Arts, Entertainment & Recreation 310 350 11 12 13 Other Services 12,164 18,074 1,766 1,773 49 Activities of Extraterritorial Orgs. 115 209 20 28 82 Other Income (not defined, employee & null) 33,689 47,746 3,690 4,217 42 TOTAL 456,600 567,852 26,181 33,376 24 Source: World Bank computation based on data from Kenya Revenue Authority(KRA) Note: *Observed figures for the sample. Furthermore, the table assumes the current effective rates on taxable income are applied (not a uniform 30 percent rate). 22 The Effective Tax Rate is calculated as actual tax levied on a company’s profits. The ETR can be higher or lower than the statutory tax rate. See the Kenya Tax Policy Studies 2017 Reports for a more detailed discussion on the ETR. 23 The estimate of revenues forgone on CIT is unfortunately based only on one year—2014/15 data. Furthermore, as discussed in Section IV, the information and data is incomplete and, consequently, the estimate of revenue forgone is most likely too low. 38 December 2017 | Edition No. 16 Special Focus 6.3.3. Exemptions are higher in several tax stations Policy options compared with the performance of Large Taxpayers 6.3.4. Tax expenditures may prove efficient when Office (LTO). The LTO, Medium Taxpayers Office (MTO), applied targeted and used sparingly. Examples and tax stations in Nairobi and Mombasa collect most of include promotion of export-oriented economic sectors Kenya’s CIT revenue. In 2015, the LTO collected about 80.1 by incentives on the cost side, such as accelerated percent of CIT tax while accounting for only 41.7 percent depreciation, rather than providing enterprises with global of the loss in CIT revenues arising from exemptions. This tax holidays. Similarly, the attraction of highly-skilled contrasts with several other tax stations where the share of workers in the Research and Development activities may foregone revenues due to exemptions is proportionately prove successful when using specific tax exemptions over higher than the share of corporate income taxes collected. a fixed period. The analysis on Kenya, however, shows In Nairobi West for instance, the share of corporate that, even after adjusting for such situations that could income taxes collected amount to 3.3 percent, while the justify the provision of preferential treatments, due to cost of exemptions is at a disproportionately larger share too generous and general application of preferential of 15.5 percent (Table 4). The current data set did not treatments, significant scope to plug in losses from allow for further identification of the reasons behind corporate income taxes remain. This section identifies these variations, and substantive differences in tax three key measures that can help reduce forgone revenues declarations of enterprises across tax stations cannot without compromising development priorities. explain the full variation. Table 4: CIT collections by tax station, from sample Tax station Taxable Taxable CIT Rev. Effective Structure of Cost of Cost of income income w/o 2015 Tax Rate CIT (2015) exemption exemption (KSh, millions) exemption (KSh, millions) on Taxable (Percent) with uniform (Percent) (KSh, millions) Income 30% rate (Percent) (KSh, millions) LTO 367,944 414,334 98,115 27 80.12 13,917 41.70 MTO 25,873 41,486 7,252 28 5.92 4,684 14.00 West Nairobi 16,162 33,407 4,035 25 3.29 5,173 15.50 East Nairobi 14,502 19,534 3,672 25 3.00 1,510 4.50 North Nairobi 10,967 23,798 2,642 24 2.16 3,849 11.50 South Nairobi 6,382 11,478 1,689 26 1.38 1,529 4.60 Machakos 898 1,518 1,628 181 1.33 186 0.60 Mombasa North 3,393 3,818 887 26 0.72 128 0.40 Mombasa South 2,143 3,459 839 39 0.69 395 1.20 Thika 3,242 5,541 611 19 0.50 690 2.10 Nakuru 1,563 3,147 345 22 0.28 475 1.40 Nyeri 752 1,246 203 27 0.17 148 0.40 Eldoret 722 900 134 19 0.11 53 0.20 Kisumu 578 1,025 105 18 0.09 134 0.40 Meru 392 703 90 23 0.07 93 0.30 Malindi 244 419 89 36 0.07 53 0.20 Embu 141 218 45 32 0.04 23 0.10 Other 363 1,340 35 10 0.03 293 0.90 Garissa 112 113 26 23 0.02 0.4 0.00 Kakamega 228 366 24 11 0.02 41 0.10 TOTAL 456,600 567,852 122,464 27 100 33,376 100 Source: World Bank computation based on data from Kenya Revenue Authority (KRA) December 2017 | Edition No. 16 39 Special Focus 6.3.5. Carry out a comprehensive review of the sectors. The financial, manufacturing, health and social corporate income tax exemptions regime with a work activities, account for 88 percent of total exemptions. view to rationalize it. There exist over 30 tax exempt Any rationalization of the exemptions regime therefore, income categories in Kenya. The more exemptions and should have a focus on these sectors, to the extent that the differentiated rates exist in any country, both within and specific tax exemptions being enjoyed in these subsectors across sectors, the more complicated the tax regime. are no longer a priority within the national development This increases the risk of non-compliance. International agenda. Similarly, the level of tax exemptions is also skewed best practice recommends a simplified tax regime. In this in favor of a few tax stations, hence the need to focus regard, several countries are moving towards a tax regime on these areas to minimize leakages. These include the with lower statutory rates, to a large extent financed Medium Taxpayers Office, West Nairobi and North Nairobi, through rationalization of exemptions and preferential which jointly account for 41 percent of all exemptions yet rates. Compared to its East African peers, statutory contribute only 11.4 percent to CIT revenues (Table 4). corporate income tax rates in Kenya remain competitive at 30 percent, similar to that of Ethiopia, Tanzania, Uganda 6.3.8. A fiscal governance framework is required to and Rwanda. However, Kenya can focus on limiting prevent the future burgeoning of exemptions. Tighter exemptions to simplify the tax regime, and thereby reduce approval processes are required for introducing new the slowdown in revenue growth. A comprehensive review exemptions, regular monitoring of existing exemptions of all existing exemptions by policy makers to examine to and the introduction of sunset clauses to ensure they do what extent each existing exemption and or preferential not persist beyond their utility period. Further, a systematic rate is still consistent with the current medium term approach to regularly monitoring the cost and benefits of development plan. This is all the more important as several tax expenditures to inform the discontinuation of benefits of the tax exemptions may have outlived their objectives. when the costs exceed benefits. Other measures could In reviewing the CIT, specific measures to limit revenue include the promotion of a unified authorizing environment; gaps include modifying reduced preferential CIT rates for a review of the practice of granting tax expenditures by new companies and negotiating fade out schemes for administrative decree, and strengthening advisory and established companies; as well as limiting accelerated monitoring functions. Further fiscal transparency could depreciation to 100 percent of acquisition costs. be strengthened by reporting on tax expenditures and including tax expenditure estimates in the annual budget 6.3.6. There remains significant scope to increase preparation and budget document. corporate income tax revenues by widening the tax base. Our analysis shows a significant variation between 6.3.9. Strengthen tax administration. Administrative sectoral contributions to GDP and their contributions to measures that could further boost CIT revenues include: corporate income tax revenues. Only a few sectors, mostly ensuring regular updates of taxpayer data (tax liabilities, those with a higher share of large tax payers, contribute filing, payment and economic sector), improving risk- a disproportionately higher share of corporate income tax based audits, and validating the CIT database with third revenues. Given the degree of CIT revenue concentration party sources. Regular verification exercises could be in certain sectors, there remains significant scope to widen conducted by matching the largest importers with the the tax base. The tax base could be enlarged by expanding largest tax payers and checking if the largest government the definition of business income, since this would bring contractors are paying reasonable taxes. more income streams and businesses into the tax net. Secondly, the tax base can also be widened by clarifying 6.4 Improving Value Added Tax collection in Kenya and introducing prohibitions to deductible expenses. Wider usage of the KRA electronic filing system could enhance 6.4.1. The Value-Added Tax (VAT) Act governs VAT in compliance, and increase the tax base and revenues. Kenya. VAT is chargeable on goods and services supplied in and imported into Kenya. Liability falls on the person 6.3.7. Enhance tax revenue in areas where the tax making the supplies of goods and services. The applicable gap is the greatest. While opportunities to widen the VAT rate is 16 percent, with a nil rate applicable to zero- tax base remain, it is important to recognize that current rated goods. Zero-rated goods are determined by the levels of tax exemptions are skewed in favor of a few Minister of Finance, and are specified in the VAT Act. 40 December 2017 | Edition No. 16 Special Focus Additionally, the applicable VAT rate is deductible from Figure 59: VAT performance goods that are exempt as specified by law. Kenya’s VAT 6 rate of 16 percent is lower than that of; Rwanda, Uganda 5.0 and Tanzania respectively whose VAT rate is 18 percent. It 4.4 4.6 4.5 4.4 4.3 4.1 is however higher than Ghana, Nigeria and South Africa at 4 Percent of GDP 15, 5 and 14 percent respectively. 6.4.2. Kenya operates a VAT withholding system by 2 ensuring 6 percent of the value of taxable supply is withheld by a VAT agent and remitted directly to the KRA. Most taxpayers subject to withholding tax are below the 0 VAT threshold, which leads them to accumulate significant 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17* credits carried forward, thereby creating contingent Source: National Treasury Note: * denotes preliminary results liabilities on the Treasury. The government reintroduced VAT withholding in response to compliance gaps. However, 6.5 Options for enhancing VAT collections Kenya’s new Tax Procedures Law repealed the authority of Findings the VAT Act to impose and collect withholding tax without 6.5.1. There are substantial forgone revenues in VAT adding a replacement provision in the new law. The KRA revenues arising from the indiscriminate application has nonetheless continued to administer withholding tax, of exemptions. Using the foregone revenue approach to with amendments in the June 2016 Budget anticipated to resolve the policy gap. quantify VAT revenue losses24, our analysis shows that there is a leakage of up to 3.1 percent in VAT revenues arising 6.4.3. Overall, the performance of VAT revenue from various exemptions. Given that VAT collections are declined in recent years. Revenue from VAT moderated 4.3 percent of GDP, the forgone revenue is to more than between FY10/11 and FY12/13 (5.0 to 4.1 percent of GDP). 70 percent of actual revenue. Exemptions on domestic Coinciding with the twin policy and administration reforms supplies was estimated at 1.36 percent of GDP after of 2013, (elimination of VAT exemptions and introduction including an adjustment for standard exempt supplies. of the online tax administration system), VAT revenue A second significant source of foregone revenue was increased by 0.5 percentage points to 4.6 percent of GDP the zero-rated supplies at 1.06 percent of GDP. The third in FY13/14. Since then however, VAT revenue has taken a significantly important source of forgone VAT revenues is downward trend to settle at 4.4 percent of GDP in FY16/17, from exempt imports which is estimated at 0.49 percent of which is low compared to SSA peers. GDP (Table 5). Table 5: Revenue foregone from exemptions, 2015 Summary of VAT exemptions Forgone revenue Forgone revenue (KSh, millions) (Percent, GDP) VAT on Exempt Imports 30,804 0.49 VAT on Supply to EPZ & SEZ Units at Zero-Rate 1,410 0.02 VAT on Supply from EPZs to Domestic Economy 287 0.01 VAT on declared Domestic Exempt Supplies 84,516 1.36 (Adjusted for Standard Exempt Items)* Remissions and Waivers 11,429 0.18 Zero-rated Supplies** 66,141 1.06 Total 194,588 3.13 Total GDP (for Comparison) 6,224,400 6,224,400 Source: Kenya Revenue Authority databases, EPZ Authority Report 2015 and World Bank 24 The foregone revenue approach calculates VAT on exemptions to determine foregone revenue. See the Kenya Tax Policy Studies: VAT 2017 for a more detailed discussion on the foregone revenue approach. December 2017 | Edition No. 16 41 Special Focus 6.5.2. The largest VAT refunds were claimed by smaller equity objectives, as are compensatory transfers on the taxpayers below the registration threshold. Data from expenditure budget. Specific measures to rationalize VAT 2015 indicates that nearly 98 percent of tax payers are exemptions could include repealing domestic exempt below the VAT registration threshold of Ksh 5 million (Table or zero-rated supplies incurring a loss of revenue, and 6). Unfortunately, this segment of taxpayers declared the requiring firms in export processing zones to file income most VAT refund claims and VAT credit carried forward, tax returns indicating forgone taxes. representing 75 percent and 61 percent, respectively of total VAT refunds and credit carried forward. 6.5.5. To maximize the revenue generation potential, it is important to focus on areas where the tax gaps Policy Options from the exemptions is the highest. One of the areas of 6.5.3. VAT revenues can be boosted by streamlining greatest VAT revenue losses stems from VAT on domestic the exemptions regime. Tax exemptions are set for exempt supplies. Taking into consideration international specific reasons. However, overtime, the initial objective best practice, the study finds that Kenya applies a relatively may become redundant yet the exemption may still be liberal VAT exemptions policy on domestic supplies. There in place leading to a loss of revenues. While exemptions is an additional 1.4 percent for VAT exemption provided on lower the effective tax rate, if applied correctly they need these supplies. After adjusting for exemptions on goods not lead to lower revenues since the boost in consumption in which exemptions are normally granted. This suggest that the effective tax rate engenders could promote that there are opportunities to improve VAT collection higher revenues. Against this backdrop, it is important to by streamlining exemptions on domestic supplies. Other undertake a comprehensive review of the VAT exemption areas for streamlining VAT exemptions with the potential to regime with a view to eliminating exemptions that have: augment revenues include zero-rated supplies and VAT on (i) already served their original intended purposes; (ii) not exempt imports. It will be important to raise the risk level for been effective in achieving their intended purpose; (iii) are audit purposes in sectors where high input tax claims exist no longer consistent with national development priorities; (see Box B.4 below). and (iv) have led to significant revenue losses. 6.5.6. Intensify tax administration to address 6.5.4. VAT exemptions may not be the most efficient compliance gaps and broaden the tax base. To overcome way to achieve equity considerations. VAT exemptions the problem of a large number of VAT refund claimants, are often put in place with reference to reducing living the VAT tax register could be cleaned to ensure that it costs on basic items for low-income households. Empirical includes an accurate number of taxpayers, accurate master evidence suggests that the VAT is inefficient in achieving data, and confirm that only tax payers declaring turnovers such equity concerns given that the absolute subsidy to above Ksh 5 million are on the VAT register, or that those the middle and higher income brackets is often much below the threshold are generating revenue and are not higher than to low-income groups, and the revenue loss is net refund claimants. The KRA’s adoption of an electronic hence substantive in achieving minor subsidies to lowest system is a step in the right direction and should contribute income. Excises taxes are much more efficient in targeting to ensuring a wider base coverage. Table 6: VAT details by turnover, 2015 (Ksh Millions) Band Taxpayers Tax Input Output VAT Credit Refund number payable VAT VAT withholding brought claim tax forward 0 - 5m 106,376 25,205 312,546 333,881 6,224 652,177 8,157 5 - 7.5m 550 6,797 8,652 15,228 184 442 0 7.5 - 10m 300 5,015 5,854 10,705 94 391 63 10 - 15m 257 6,834 7,015 13,732 99 796 138 15 - 20m 158 4,954 5,911 10,761 235 257 0.093 > 20m 190 54,347 57,850 111,517 1,603 1,350 49 Total 107,831 103,153 397,829 495,824 8,439 655,412 8,407 Source: Kenya Revenue Authority (KRA) 25 A World Bank Staff analysis of consumption tax for the Kenyan economy shows that at high levels of consumption tax, individuals substitute saving for consumption thereby increasing consumption with a consequent decline in savings and investments in the economy. The utility of exemptions is thus important as it can be applied to different groups to encourage consumption while ensuring that savings remain intact. 42 December 2017 | Edition No. 16 Special Focus Intensify tax administration to address compliance gaps and broaden the tax base. Photo: © Kenya Revenue Authority 6.6 Conclusion poorest are considered suppressed. In many cases, a better targeted and less costly solution on the expenditure side 6.6.1. There is potential for Kenya to increase its of the budget can be made, in the form of subsidization of domestic revenue mobilization to levels observed in social services or targeted entitlement programs, such as other middle income countries. With forgone revenues lump-sum transfers. of about 5 percent of GDP, Kenya has the potential to increase its tax to GDP ratio from about 17-18 percent to 6.6.3. Beyond streamlining exemptions, the fiscal 20-22 percent, consistent with the experience in other governance framework on the provision of tax middle income countries. This will provide support to the expenditures could be enhanced to avert future revenue government of Kenya’s medium term fiscal consolidation plans while maintaining its strong focus on bridging the losses. The nature of tax expenditures—to reduce tax infrastructural deficit to improve upon the competitiveness obligations for certain groups of taxpayers and/or on of the economy. certain products and economic activities—implies that a fiscal gap is created by not collecting the tax revenues as 6.6.2. The analysis finds that there are opportunities to accrued, had the tax code been applied equally. However, significantly reduce forgone CIT and VAT revenues. There the fiscal scrutiny on the utility of tax expenditures and are significant revenue potential losses due to extensive and evidence of value-added is much less developed in generous use of tax exemptions, and preferential CIT rates. Kenya compared to spending on the other expenditure The estimated loss of revenue stemming from CIT and VAT items in the budget. Similarly, the accountability and only amount to 5 percent of GDP. Further in-depth review fiscal transparency of tax expenditures is less developed, of specific solutions is required in clarifying alignment with given that there is no repository that provides an the Vision 2030 plan with the view to suppress inefficient overview on level and composition of tax expenditures and generous schemes of tax expenditures, towards (or forgone revenues). Hence, fiscal governance solutions achieving revenue improvements in the amount of 2-4 are required to ensure efficiency, including suppressing percent to GDP just in CIT and VAT areas. In this context, generous exemptions in order to increase domestic careful considerations on impact on equity should be taken, revenue mobilization. when tax expenditures related to items consumed by the December 2017 | Edition No. 16 43 Special Focus Box B.4: Potential sectors to further streamline VAT tax exemptions Gaps in VAT performance are prevalent in specific sectors. The following sectors were identified as having gaps in VAT performance: i) Water supply; sewerage and waste management; ii) Agriculture, forestry and fishing; ii) Activities of households as employers; iii) Financial and insurance activities; iv) Mining and quarrying activities; and v) Human health and social work services. Sectors with VAT gaps were also identified as the refund oriented sectors, in addition to being the sectors with highest ratios of zero-rated or exempt supplies. In 2016, the agriculture sector was reported to have a ratio of refunds to VAT of -236 percent, with the water supply sector reporting -109 percent. A sectoral review of the tax exemption policy may enhance VAT revenue collection. Exemptions essentially lower the tax rate and maybe justifiable for disadvantaged groups who would otherwise not be able to afford certain goods and services. In addition, exemptions can have behavioral change effects that are income enhancing. Sector specific examples include: I. Water Supply: The zero-rated VAT in the water sector is meant to benefit final consumption for the poor. However, since the exemptions are not specifically defined as for final consumption, the industrial sector also benefit from zero-rated water supply as an intermediate input, which creates a distortion in the VAT chain, in addition to increasing the administrative burden for processing VAT refunds. II. Agriculture, Forestry and Fishing: Where the legal framework does not clearly define a farmer by the activities that a farmer undertakes, but offers exemptions on equipment deemed to be used in farming, then individuals who use such equipment but are not farmers may make refund claims in error. III. Education Services: Broadly, the education sector is exempt in Kenya. However, in 2015, the claims for input tax exceeded tax charged in the sector. The likely factors for excess input tax are weak reliability of registration data and failure to apply proper apportionment rules where mixed (exempt and standard rate) supplies are made. IV. Financial and Insurance Services: The financial and insurance services sector in Kenya supports Islamic banking which has a broadly exempt status. With no clear definition of exempt products, banks can apply exemptions at their discretion on their Islamic product offerings. To enhance revenue in this sector, clear guidelines on exempt products would be beneficial. Beyond tax expenditures rationalization, the following policy recommendations could enhance VAT revenue performance for the sectors with significant tax gaps: • Draft regulations providing an inclusive definition of farmers, and clean the tax register; • Consider raising risk levels in sectors such as education, and investigate causes of high input tax claims, and confirm registration validity; and • Concerning VAT Withholding, the GoK should carry out analysis of the optimum rate that may not cause refund and cash flow problems in economic sectors. 44 December 2017 | Edition No. 16 REFERENCES Africa Development Bank. (2011). Middle of the Pyramid: Dynamics of the Middle Class in Africa. Market Brief. Akhtar, M. A. (1994). Causes and Consequences of the 1989-92 Credit Slowdown: Overview and Perspective. Federal Reserve Bank of St. Louis. Choi et al., (2017). Fiscal Stabilization and Growth: Evidence from Industry-level Data for Advanced and Developing Economics. IMF Working Paper WP/17/198. Čihák, M., Aslı D. K., Erik F., and Ross L. (2012). “Benchmarking Financial Development Around the World.” World Bank Policy Research Working Paper 6175. World Bank, Washington, DC. Vienna Initiative. (2016). CESEE Deleveraging and Creadit Monitor, May 30 issue. Central Bank of Kenya. (2017). Quarterly Economic Review (QER) April-June. Volume 2 No.2. Government of the Republic of Kenya. (2013). Second Medium Term Plan, 2013-2017. State Corporation Advisory Committee. (2013). Report of The Presidential Taskforce on Parastatal Reforms. Greetje Everaert, G., Che, N., Geng, N., Gruss, B., Impavido, G., Lu, Y., Saborowski, C., Vandenbussche, J., Zeng, L., (2015), Does Supply or Demand Drive the Credit Cycle? Evidence from Central, Eastern, and Southeastern Europe, IMF Working paper: WP/15/15 Grigoli F., Mansilla M., and Saldías M. (2016). Macro-Financial Linkages and Heterogeneous Non-Performing Loans Projections: An Application to Ecuador. IMF Working paper: WP/16/236. Griffith J. S., Ortiz A. and Ocampo J. A. (2009). Building on the counter-cyclical consensus: A policy agenda. Foundation for European Progressive Studies. Gupta et al. (2017). Governments and Promised Fiscal Consolidations: Do They Mena What They Say? IMF Working Paper WP/17/39. Holmstrom B. and Tirole J. (1997). Financial Intermediation, Loanable Funds, and the Real Sector. The Quarterly Journal of Economics, Vol. 112, No. 3 (Aug.,1997), 663-691. Ikhide, S. (2003). “Was There a Credit Crunch in Namibia Between 1996-2000?” Journal of Applied Economics, Vol. VI, No. 2, pp. 269-90. Kenya National Bureau of Statistics. (2017). Economic Survey. Nairobi. Lown C., and Wenniger J. (1994). “The role of the banking system in the credit slowdown”, in studies on the causes and consequences of the 1989-92 Credit Slowdown, Federal Reserve Bank of New York. Michael B., and Manuela F. (2016). Inflation and Fiscal Deficits in Sub-Saharan Africa. Journal of African Economies, 4: 529-547. National Treasury. Quarterly Budget and Economic Review, various issues. Nairobi. National Treasury. (2017). Budgetary Review and Outlook Paper. September. Nairobi. Paligorova, T., and Santos J.A.C. (2014). Rollover Risk and the Maturity Transformation Function of Banks, Bank of Canada Working Paper, 2014-8, March. Patricia McCoy. (2016). “Countercyclical Regulation and Its Challenges.” Arizona State Law Journal 47, no.5 (2016): 1181-1237. Poghosyan T. (2010). Slowdown of Credit Flows in Jordan in the Wake of the Global Financial Crisis: Supply or Demand Driven? IMF Working paper: WP/10/256. Republic of Kenya. (2017). Concept Note on Medium Term Plan, 2018-2022. World Bank Group. (2017). Africa’s Pulse, No. 16, October. World Bank. (2016). Kenya Economic Update, Edition 14. World Bank. (2017). Kenya Tax Policy Studies: Value Added Tax and Corporate Income Tax. December 2017 | Edition No. 16 45 STATISTICAL TABLES Statistical Tables Table 1: Macroeconomic environment 2009 2010 2011 2012 2013 2014 2015 2016 GDP growth rates (percent) 3.3 8.4 6.1 4.6 5.9 5.4 5.7 5.8 Agriculture -2.3 10.1 2.4 3.1 5.4 4.3 5.5 4.0 Industry 3.7 8.7 7.2 4.2 5.3 6.1 7.3 5.8 Manufacturing -1.1 4.5 7.2 -0.6 5.6 2.5 3.6 3.5 Services 6.2 7.3 6.1 4.7 5.4 6.0 5.9 7.1 Fiscal Framework (percent of GDP)/1 Total revenue 19.4 19.1 18.7 19.2 19.2 19.0 18.4 18.2 Total expenditure 24.0 23.8 23.7 25.1 25.6 28.1 26.6 27.4 Grants 1.0 0.6 0.4 0.5 0.5 0.5 0.4 0.3 Budget deficit (including grants) -5.8 -3.5 -4.5 -5.7 -6.1 -8.4 -7.4 -8.9 Total debt (net) 36.6 39.1 37.0 38.5 43.7 44.6 47.9 51.5 External Account (percent of GDP) Exports (fob) 12.2 13.1 13.6 12.5 10.6 10.4 9.8 8.2 Imports (cif ) 25.6 28.7 33.0 31.3 29.3 28.3 23.4 19.5 Current account balance -4.6 -6.0 -9.2 -8.3 -8.8 -10.4 -6.7 -5.2 Financial account -10.2 -8.1 -8.2 -11.0 -9.4 -11.4 -8.0 -5.9 Capital account 0.7 0.6 0.6 0.5 0.3 0.4 0.4 0.3 Overall balance -3.0 -0.4 2.1 -2.4 -0.7 -2.4 0.4 -0.2 Prices Inflation 10.5 4.1 14.0 9.6 5.7 6.9 6.6 6.3 Exchange rate (average Ksh/ US$) 77.4 79.2 88.8 84.5 86.1 87.9 98.2 101.5 Source: Kenya National Bureau of Statistics, National Treasury, Central Bank of Kenya and World Bank End of FY in June (e.g 2009 = 2009/2010) 1/Figures for 2015 are actuals for 2015/16 Table 2: GDP growth rates for Kenya and EAC (2014-2019) 2010 2011 2012 2013 2014 2015 2016 Kenya 8.4 6.1 4.6 5.9 5.4 5.7 5.8 Uganda 5.7 9.4 3.8 3.6 5.1 5.2 4.7 Tanzania 6.4 7.9 5.1 7.3 7.0 7.0 7.0 Rwanda 7.3 7.9 8.8 4.7 7.6 8.9 5.9 Average EAC 6.9 7.8 5.6 5.3 6.2 6.6 5.9 Source: World Bank (MfMod) 48 December 2017 | Edition No. 16 Statistical Tables Table 3: Kenya annual GDP Year GDP, current prices GDP, 2009 GDP/capita, GDP growth (Ksh Billions) constant prices current prices (Percent) (Ksh Billions) (US$) 2007 2,151 2,766 839 6.9 2008 2,483 2,772 917 0.2 2009 2,864 2,864 920 3.3 2010 3,169 3,104 967 8.4 2011 3,726 3,294 987 6.1 2012 4,261 3,444 1,155 4.6 2013 4,745 3,647 1,229 5.9 2014 5,402 3,842 1,335 5.4 2015 6,261 4,062 1,350 5.7 2016 7,159 4,299 1,455 5.8 Source: Kenya National Bureau of Stastics and World Development Indicators Table 4: Broad sector contribution to GDP growth (Quarterly, percent) Year Quarterly Agriculture Industry Services GDP Q1 0.8 0.7 2.6 4.1 Q2 0.5 1.2 2.5 4.2 2012 Q3 0.6 2.3 2.3 5.2 Q4 0.8 1.0 2.9 4.7 Q1 1.4 2.7 2.0 6.1 Q2 1.7 2.1 3.7 7.5 2013 Q3 1.1 1.7 3.6 6.4 Q4 0.7 0.1 2.7 3.5 Q1 1.1 1.7 2.4 5.2 Q2 1.1 2.2 2.8 6.0 2014 1.4 1.1 2.1 4.6 Q4 0.3 1.7 3.6 5.6 Q1 2.1 1.6 2.1 5.8 Q2 1.1 1.7 2.8 5.6 2015 0.8 2.3 2.9 6.1 Q4 0.8 1.8 2.9 5.5 Q1 1.1 1.2 3.1 5.3 Q2 1.7 1.5 3.1 6.3 2016 Q3 0.7 1.5 3.5 5.7 Q4 0.0 1.5 4.6 6.1 Q1 -0.3 1.4 3.6 4.7 2017 Q2 0.3 1.0 3.6 5.0 Source: World Bank, based on data from Kenya National Bureau of Statistics Note: Agriculture = Agriculture, forestry and fishing Industry = Mining and quarrying + Manufacturing+Electricity and water supply+Construction Services = Whole sale and retail trade + Accomodation and restaurant + Transport and storage + Information and communication + Financial and insurance + Public administration + Proffessional administration and support services + Real estate + Education + Health + Other services +FISIM +Taxes on products December 2017 | Edition No. 16 49 50 Table 5: Contribution by Broad sub-sectors (Quarterly, percent) Agricul- Industry by sub sector contribution Service by sub sector contribution ture con- Mining Manufac- Electricity Construc- Industries Accomo- Transport Real Informa- Financial Quarterly tribution and quar- turing and water tion dation and stor- estate tion and and insur- Other Services to GDP rying supply and age communi- ance restaurant cation Q1 0.8 0.1 -0.1 0.2 0.7 0.9 0.2 0.5 0.4 0.4 0.0 1.0 2.4 Q2 0.5 0.2 -0.2 0.1 0.3 0.4 0.0 0.5 0.3 -0.2 0.3 2.3 3.3 2012 December 2017 | Edition No. 16 Q3 0.6 0.2 0.1 0.2 0.5 1.0 0.0 -0.1 0.3 -0.4 0.4 3.5 3.6 Q4 0.8 0.2 0.0 0.2 0.4 0.9 0.1 -0.1 0.3 0.5 0.6 1.6 3.0 Q1 1.4 0.2 1.0 0.1 0.4 1.7 -0.5 -0.6 0.3 0.4 0.6 2.7 3.0 Q2 1.7 -0.2 0.8 0.2 0.4 1.3 0.0 0.1 0.3 0.3 0.6 3.3 4.6 2013 Q3 1.1 0.0 0.6 0.2 0.4 1.2 0.2 0.2 0.4 0.4 0.4 2.6 4.1 Q4 0.7 -0.1 0.1 0.1 -0.1 -0.1 0.0 0.7 0.4 0.5 0.3 1.1 2.9 Q1 1.1 0.1 0.5 0.1 0.3 1.1 -0.3 0.2 0.4 0.4 0.4 1.9 3.0 Q2 1.1 0.2 0.8 0.1 0.7 1.8 -0.3 0.4 0.4 0.3 0.4 1.9 3.1 2014 Q3 1.4 0.0 0.1 0.2 0.4 0.7 -0.4 0.6 0.5 0.6 0.5 0.8 2.6 Q4 0.3 0.2 -0.3 0.2 0.9 1.0 0.0 0.3 0.5 0.7 0.6 2.1 4.2 Q1 2.1 0.1 0.3 0.2 0.6 1.2 -0.1 0.5 0.5 0.3 0.6 0.8 2.5 Q2 1.1 0.1 0.3 0.3 0.6 1.3 0.0 0.6 0.6 0.2 0.5 1.3 3.1 2015 Q3 0.8 0.2 0.5 0.2 0.8 1.7 0.0 0.7 0.6 0.2 0.7 1.3 3.5 Q4 0.8 0.1 0.4 0.1 0.7 1.3 0.1 0.4 0.7 0.3 0.5 1.4 3.4 Q1 1.1 0.1 0.2 0.2 0.5 0.9 0.1 0.5 0.7 0.4 0.5 1.1 3.3 Q2 1.7 0.1 0.6 0.2 0.4 1.3 0.1 0.5 0.7 0.3 0.5 1.2 3.3 2016 Q3 0.7 0.1 0.5 0.1 0.4 1.1 0.1 0.5 0.7 0.3 0.5 1.7 3.9 Q4 0.0 0.1 0.3 0.1 0.6 1.1 0.2 0.8 0.8 0.5 0.3 2.5 5.0 Q1 -0.3 0.1 0.3 0.1 0.4 0.9 0.2 0.6 0.7 0.4 0.3 1.8 4.0 2017 Q2 0.3 0.1 0.2 0.2 0.4 0.8 0.1 0.5 0.8 0.3 0.3 1.8 3.8 Source: World Bank, based on data from Kenya National Bureau of Statistics Note: Other = Whole sale and retail trade + Public admistration +Proffessional, admistration and support services + Education + Health +Other services +FISIM + Taxes on products Statistical Tables Table 6: Quarterly growth rates (percent) Agriculture Industry Services GDP Statistical Tables Quarter- Year-on- Four Quarter- Year-on- Four Quarter- Year-on- Four Quarter- Year-on- Four Year Quarter on-Quarter Year Quarter on-Quarter Year Quarter on-Quarter Year Quarter on-Quarter Year Quarter Moving Moving Moving Moving Average Average Average Average Q1 48.2 3.1 2.4 -5.1 5.2 6.6 -1.1 4.3 5.2 6.9 4.1 5.2 Q2 -10.2 2.2 2.1 -0.6 2.1 4.5 -1.2 5.3 5.2 -3.1 4.3 4.6 2012 Q3 -21.9 3.1 2.0 4.3 5.2 4.7 5.1 4.4 4.8 -0.7 5.2 4.5 Q4 0.3 4.2 3.1 6.0 4.2 4.2 2.1 4.9 4.7 1.7 4.7 4.6 Q1 49.8 5.3 3.8 -0.5 9.4 5.2 -2.0 4.0 4.6 8.3 6.1 5.1 Q2 -8.9 6.8 5.0 -2.8 6.9 6.4 1.3 6.7 5.0 -1.8 7.0 5.9 2013 Q3 -22.7 5.8 5.6 3.7 6.2 6.6 4.3 5.8 5.3 -1.7 6.4 6.2 Q4 -1.9 3.6 5.4 -0.8 -0.6 5.3 1.5 5.2 5.4 -1.1 3.5 5.9 Q1 50.7 4.2 5.1 5.9 5.8 4.5 -1.6 5.6 5.8 10.1 5.2 5.6 Q2 -8.7 4.4 4.4 0.9 9.9 5.3 1.6 5.8 5.6 -1.0 6.0 5.3 2014 Q3 -20.7 7.0 4.7 -2.4 3.5 4.6 3.6 5.1 5.4 -2.9 4.6 4.8 Q4 -6.6 1.8 4.3 0.9 5.3 6.1 3.8 7.5 6.0 -0.2 5.6 5.4 Q1 59.8 8.0 5.5 7.0 6.4 6.2 -3.8 5.2 5.9 10.3 5.8 5.5 Q2 -11.5 4.6 5.6 1.5 6.9 5.6 2.6 6.2 6.0 -1.2 5.6 5.4 2015 Q3 -21.1 4.1 5.0 -0.4 9.1 6.9 4.3 6.9 6.5 -2.5 6.1 5.7 Q4 -6.4 4.3 5.5 -1.4 6.7 7.3 2.4 5.4 5.9 -0.7 5.5 5.7 Q1 59.2 4.0 4.2 5.3 5.0 6.9 -2.4 7.0 6.4 10.1 5.3 5.6 Q2 -8.9 7.1 4.9 3.2 6.8 6.8 2.3 6.7 6.5 -0.3 6.3 5.8 2016 Q3 -23.5 3.8 4.9 -1.3 5.7 6.0 4.6 7.0 6.5 -3.0 5.7 5.7 Q4 -9.8 0.1 4.0 -1.3 5.8 5.8 3.0 7.6 7.1 -0.3 6.1 5.8 Q1 57.3 -1.1 2.4 4.5 5.0 5.8 -2.3 7.7 7.2 8.6 4.7 5.7 2017 Q2 -6.5 1.4 0.9 2.6 4.4 5.2 1.5 6.8 7.3 0.0 5.0 5.3 Source: World Bank and Kenya National Bureau of Statistics December 2017 | Edition No. 16 51 Statistical Tables Table 7: Growth outlook Annual growth (percent) 2014 2015 2016 2017e 2018f 2019f BASELINE GDP Revised projections 5.4 5.7 5.8 4.9 5.5 5.9 Previous projections (KEU 15) 5.4 5.7 5.8 5.5 5.8 6.1 Previous projections (KEU 14) 5.3 5.6 5.9 6.0 6.1 Private consumption 4.3 5.1 4.8 4.6 4.9 5.1 Government consumption 1.7 13.0 7.0 1.7 0.3 0.5 Gross fixed capital investment 14.2 6.7 -9.3 3.9 12.7 14.6 Exports, goods and services 5.8 6.2 0.6 3.9 4.0 4.2 Imports, good and services 10.4 1.2 -4.7 1.3 5.1 6.3 Agriculture 4.3 5.5 4 2.9 3.9 4.3 Industry 6.1 7.3 5.8 4.5 5.6 5.8 Services 6.3 6.1 6.5 6 6.2 6.6 Inflation (Consumer Price Index) 6.9 6.6 6.3 8 6.8 6.5 Current Account Balance, % of GDP -10.4 -6.7 -5.2 -6.5 -7.0 -8.2 Fiscal balance, % of GDP -8.1 -7.3 -9.0 -6.1 -5.9 -4.9 Debt (% of GDP) 48.8 51.3 55.6 54.9 52.9 53.3 Primary Balance (% of GDP) -4.4 -4.5 -5.1 -5.0 -2.5 -1.9 Source: World Bank and the National Treasury; Fiscal Balance is sourced from National Treasury and presented as Fiscal Years. Note: “e” denotes an estimate, “f” denotes forecast. 52 December 2017 | Edition No. 16 Statistical Tables Table 8: National fiscal position Actual (percent of GDP) 2007/ 08 2008/ 09 2009/ 10 2010/ 11 2011/ 12 2012/ 13 2013/ 14 2014/ 15 2015/ 16 2016/ 17* Revenue and Grants 19.7 18.9 20.6 19.7 19.1 19.7 19.7 19.5 19.2 18.5 Total Revenue 18.6 18.2 19.6 19.2 18.7 19.2 19.2 19.3 19.0 18.5 Tax revenue 15.7 15.6 16.0 16.6 15.5 15.6 16.8 16.5 16.4 15.8 Income tax 6.8 6.9 7.2 7.9 7.8 8.3 8.9 8.7 8.6 8.1 VAT 4.8 4.7 4.9 5.0 4.4 4.1 4.6 4.5 4.4 4.4 Import Duty 1.4 1.4 1.4 1.3 1.3 1.3 1.3 1.3 1.2 1.2 Excise Duty 2.7 2.6 2.5 2.3 2.0 1.9 2.0 2.0 2.1 2.2 Other Revenues 1.4 1.4 2.0 1.5 1.6 1.7 1.3 1.3 1.3 1.1 Railway Levy 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.3 0.3 Appropriation in Aid 1.5 1.2 1.6 1.1 1.7 2.0 1.1 1.3 1.0 1.2 Grants 1.1 0.7 1.0 0.6 0.4 0.5 0.5 0.5 0.5 0.3 Expenditure and Net Lending 23.1 22.3 24.0 23.8 23.7 25.1 25.6 28.1 27.2 27.4 Recurrent 17.4 16.3 16.9 16.9 16.3 18.1 14.8 14.8 15.6 15.3 Wages and salaries 6.3 5.8 5.7 5.7 5.5 6.1 5.5 5.1 4.6 4.4 Interest Payments 2.1 1.9 2.1 2.3 2.1 2.7 2.7 2.9 3.2 3.5 Other recurrent 9.0 8.6 9.1 8.9 8.8 9.3 6.6 7.4 7.5 7.4 Development and net lending 5.7 6.0 7.1 6.8 7.4 6.8 6.3 8.8 7.0 7.9 County allocation 0.0 0.0 0.0 0 0 0.22 3.81 3.9 4.1 3.7 Contigecies 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.1 Parliamentary Service 0.0 0.0 0.0 0.0 0.0 0.0 0.44 0.39 0.3 0.31 Judicial Service 0.0 0.0 0.0 0.0 0.0 0.0 0.26 0.2 0.18 0.15 Fiscal balance Deficit excluding grants -4.4 -4.0 -4.6 -4.7 -4.9 -5.9 -6.4 -9.1 -8.4 -9.2 (commitment basis) Deficit including grants -3.3 -3.4 -3.6 -4.1 -4.5 -5.4 -5.9 -8.7 -8.0 -8.9 (commitment basis) Deficit including grants -0.3 -4.4 -5.8 -3.5 -4.5 -5.7 -6.1 -8.1 -7.3 -9.0 (cash basis) Financing Foreign Financing 0.3 1.5 0.8 0.8 2.8 1.9 2.1 3.7 4.2 5.0 Domestic Financing -0.6 2.8 5.0 2.6 1.6 3.8 4.0 4.3 3.1 4.0 Total Public Debt (net) 33.4 35.4 36.6 39.1 37.0 38.5 43.7 44.8 47.9 51.5 External Debt 19.1 20.0 18.9 21.0 19.6 18.7 25.3 24.4 26.8 29.8 Domestic Debt (net) 14.3 15.4 17.7 18.1 17.4 19.8 21.5 20.2 21.1 21.8 Memo: GDP (Calender year current 2,483 2,864 3,169 3,726 4,261 4,745 5,402 6,261 7,159 market prices, Ksh bn) GDP (Fiscal year current 2,317 2,673 3,017 3,448 3,994 4,503 5,074 5,828 6,508 7,711 market prices, Ksh bn) Source: 2017 Budget Review Outlook Paper (BROP) and Quarterly Budgetary Economic Review (First Quarter, Financial Year 2017/2018), National Treasury Note: *indicate preliminary results December 2017 | Edition No. 16 53 Table 9: Kenya’s public and publicly guaranteed debt, June 2014 to June 2017 54 14-Dec 15-Mar 15-Jun 15-Sept 15-Dec 16-Mar 16-Jun 16-Sept 16-Dec 17-Mar 17-Jun* 17-Sept* TOTAL PUBLIC DEBT (Net) 2,275,952 2394450 2,601,432 2,723,628 2,844,004 2,938,291 3,210,775 3,276,654 3,448,699 3,675,734 3,972,526 4,048,978 Lending -5,701 -5,701 -5,701 -5,701 -5701 -5,701 -5,701 -5,701 -5,701 -5,701 -5,701 -5701 Government Deposits -298,879 -275,083 -236,565 -208,869 -305496 -320,041 -394,856 -426,911 373,016 364,909 428,774 (432,113) Total Public Debt (Gross) 2,580,532 2,675,234 2,843,698 2,938,199 3,155,200 3,264,033 3,611,331 3,709,266 3,827,417 4,046,344 4,407,001 4,486,793 External Debt 1,272,583 1,278,108 1,423,253 1,550,233 1,615,183 1,617,506 1,796,198 1,854,711 1,896,443 2,101,391 2,294,736 2,310,198 Bilateral 389,083 384,607 445,057 482,203 481,282 478,883 548,351 545,652 641,763 689,119 724,823 742,064 December 2017 | Edition No. 16 Multilateral 612,353 618,456 684,631 754,599 751,154 762,089 798,842 839,936 781,256 806,922 841,899 842,814 Commercial Bank & Supplier Credit 271,147 275,044 293,565 313,430 382,747 376,534 449,005 469,123 473,424 605,350 728,014 725320 Commercial Banks 255,188 259,746 276,937 295,642 366,231 360,175 432,377 452,495 458,122 594,140 712,100 708,231 Suppliers Credit 15,959 15,298 16,628 17,788 16,516 16,359 16,628 16,628 15,302 11,210 15,914 17,089 Domestic Debt 1,307,949 1,397,126 1,420,444 1,387,966 1,540,017 1,646,527 1,815,133 1,854,555 1,930,973 1,944,953 2,112,265 2,176,595 Central Bank 58,286 64,835 63,335 107,637 101,386 102,648 99,856 58,945 85,528 85,316 55,061 79,201 Commercial Banks 649,940 715,011 730,419 682,694 764,399 829,688 927,307 969,790 947,030 975,803 1,141,889 1,148,296 Non Banks & Nonresidents 599,723 617,280 626,689 597,635 674,232 714,192 787,970 825,820 898,415 883,834 915,316 949,098 (%) of Total public debt(gross) External Debt 49.3 47.8 50.0 52.8 51.2 49.6 49.7 50.0 49.5 51.9 52.1 51.5 Domestic Debt 50.7 52.2 50.0 47.2 48.8 50.4 50.3 50.0 50.5 48.1 47.9 48.5 % of External debt Bilateral 30.6 30.1 31.3 31.1 29.8 29.6 30.5 29.4 33.8 32.8 31.6 32.1 Multilateral 48.1 48.4 48.1 48.7 46.5 47.1 44.5 45.3 41.2 38.4 36.7 36.5 Commercial Bank & Supplier Credit 21.3 21.5 20.6 20.2 23.7 23.3 25.0 25.3 25.0 28.8 31.7 31.4 Commercial Banks 20.1 20.3 19.5 19.1 22.7 22.3 24.1 24.4 24.2 28.3 31.0 30.7 Suppliers Credit 1.3 1.2 1.2 1.1 1.0 1.0 0.9 0.9 0.8 0.5 0.7 0.7 % of Domestic debt Central Bank 4.5 4.6 4.5 7.8 6.6 6.2 5.5 3.2 4.4 4.4 2.6 3.6 Commercial Banks 49.7 51.2 51.4 49.2 49.6 50.4 51.1 52.3 49.0 50.2 54.1 52.8 Statistical Tables Non Banks & Nonresidents 45.9 44.2 44.1 43.1 43.8 43.4 43.4 44.5 46.5 45.4 43.3 43.6 Source: National Treasury (Quarterly Economic Budgetary Review, November 2017) Note: *Provisional Table 10: 12-months cumulative balance of payments BPM6 Concept (US$ million) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017-July A. Current Account, n.i.e. -505 -796 -1,821 -1,713 -2,371 -3,821 -4,205 -4,838 -,5,98 -4,322 -3,653 -4,792 Statistical Tables Merchandise A/C -3,243 -4,222 -5,593 -4,952 -6,216 -8,355 -9,315 -10,243 -11,319 -9,577 -7,890 -9,653 Goods: exports f.o.b. 3,509 4,153 5,067 4,526 5,248 5,834 6,212 5,846 6,219 5,985 5,747 5,781 Goods: imports f.o.b. 6,752 8,375 10,659 9,479 11,464 14,189 15,527 16,089 17,538 15,563 13,637 15,434 Oil 1,745 1,919 3,051 2,192 2,673 4,082 4,081 3,838 4,026 2,500 2,087 2,489 Services 1,013 1,263 1,377 1,084 1,744 1,994 2,602 2,926 2,405 2,329 1,689 1,560 Services: credit 2,431 2,938 3,260 2,904 3,789 4,131 4,990 5,130 5,066 4,496 4,526 4,612 Services: debit 1,418 1,675 1,883 1,820 2,045 2,138 2,387 2,204 2,662 2,167 2,837 3,052 Income 1,725 2,162 2,395 2,156 2,101 2,540 2,507 2,479 2,889 2,795 2,548 3,301 B. Capital Account, n.i.e. 168 157 94 261 240 235 235 158 275 257 206 186 C. Financial Account, n.i.e. -677 -22,47 -1,423 -3,782 -3,252 -3,425 -5542 -5183 -7008 -5,070 -4,137 -5,487 Direct investment: net -27 -1,001 -384 -1,452 -1,117 -1,364 -1142 -920 -1045 -1,088 -235.1 -1,35.1 Portfolio investment: net 21 16 25 -81 -156 1 -218 -273 -3716 156 384.5 616.5 Financial derivatives: net 0 0 0 0 0 0 0 0 0 0 0 0 Other investment: net -671 -1,262 -1,064 -2,249 -1,979 -2,062 -4182 -3990 -2248 -4,139 -4,287 -5,968.1 D. Net Errors and Omissions 235 -805 -189 -1215 -947 -734 -348 -134 168 -1,260 -561 -815 E. Overall Balance -575 -802 493 -1115 -174 896 -1223 -369 -1453 255 -129 -66 F. Reserves and Related Items 575 802 -493 1115 174 -896 1223 369 1453 -255 129 66 Reserve assets 618 941 -480 1322 154 246 1455 859 1333 -361 38 -30 Credit and loans from the IMF -6 116 -17 199 -34 284 193 177 -119 -107 -91 -96 Exceptional financing 48 23 30 8 13 858 38 312 0 0 0 0 Gross Reserves (USD Million) 3,331 4,557 4,641 5,064 5,123 6,045 7,160 8,483 9,738 9,794 9,588 10,550 Official 2,415 3,355 2,875 3,847 4,002 4,248 5,702 6,560 7,895 7,534 7,573 8,135 Commercial Banks 916 1,202 1,765 1,217 1,121 1,797 1,458 1,923 1,843 2,259 2,015 2,415 Imports cover (36 mnths import) 3.9 4.4 3.1 3.9 3.9 3.4 4.0 4.3 4.9 4.8 5.0 5.4 December 2017 | Edition No. 16 Memo: 55 Annual GDP at Current prices (USD 25,826 31,958 35,895 37,022 40,000 41,953 50,411 55,101 61,395 63,398 70,092 74,496 Million) Source: Central Bank of Kenya Statistical Tables Table 11: Inflation Year Month Overall Inflation Food Inflation Energy Inflation Core Inflation January 5.5 7.7 4.5 4.1 February 5.6 8.7 3.3 4.1 March 6.3 11.0 2.9 3.9 April 7.1 13.4 1.5 4.0 May 6.9 13.2 0.3 4.2 June 7.0 13.4 0.2 4.4 2015 July 6.6 12.1 0.6 4.4 August 5.8 9.9 1.1 4.3 September 6.0 9.8 1.5 4.4 October 6.7 11.3 2.0 4.4 November 7.3 12.7 2.3 4.2 December 8.0 13.3 2.9 5.1 January 7.8 12.7 2.9 5.4 February 7.1 10.8 1.7 5.4 March 6.5 9.4 2.1 5.4 April 5.3 6.8 2.0 5.2 May 5.0 6.6 1.8 4.7 June 5.8 8.9 1.4 4.5 2016 July 6.4 10.8 0.9 4.4 August 6.3 10.9 0.1 4.6 September 6.3 10.9 0.2 4.6 October 6.5 11.0 0.1 4.6 November 6.7 11.1 0.6 4.7 December 6.3 11.2 0.1 3.8 January 7.0 12.5 0.7 3.3 February 9.2 16.7 3.0 3.3 March 10.3 18.8 3.3 3.3 April 11.5 21.0 3.7 3.5 May 11.7 21.5 3.5 3.6 2017 June 9.2 15.8 3.4 3.5 July 7.5 12.2 2.9 3.5 August 8.0 13.6 3.1 3.4 September 7.1 11.5 3.3 3.2 October 5.7 8.5 3.0 3.2 Source: World Bank, based on data from Kenya National Bureau of Statistics 56 December 2017 | Edition No. 16 Table 12: Credit to private sector Year Month Total Pri- Agriculture Mafuctu- Trade Building Transport Finance Real estate Mining and Private Consumer Business Other vate sector irng and con- and com- and insur- quarrying households durables services activities annual struction munication ance growth rates Statistical Tables January 21.8 25.2 30.1 19.8 17.6 43.0 76.1 33.4 -3.8 35.2 14.2 24.8 -31.3 February 20.7 24.7 27.5 21.5 11.6 38.6 79.6 29.1 -16.2 38.7 15.3 19.3 -31.4 March 19.6 22.3 21.1 18.8 12.7 31.3 47.5 19.6 -20.1 28.0 12.4 27.8 -8.9 April 19.9 20.8 21.6 23.6 12.6 32.3 49.2 17.7 -17.1 29.5 13.1 19.7 -8.9 May 20.9 20.5 25.8 23.0 14.5 27.0 50.8 21.3 -13.7 31.5 11.6 16.4 -3.9 June 20.5 24.0 20.0 25.9 15.5 33.8 43.3 19.4 -22.1 31.2 21.6 15.8 -11.1 2015 July 21.2 28.5 22.3 26.7 19.8 33.4 46.8 15.5 -17.9 28.6 21.5 25.3 -12.6 August 21.0 28.7 25.3 25.9 22.1 30.0 50.5 15.0 -18.0 28.5 21.0 22.5 -14.2 September 20.8 21.4 19.3 29.7 27.9 29.0 45.7 12.5 -5.4 26.6 19.0 15.9 -0.9 October 19.5 17.2 20.2 23.6 37.6 32.1 26.4 9.8 -15.5 18.2 18.0 24.1 8.6 November 18.7 12.5 20.8 22.2 34.0 32.3 28.5 10.6 -22.8 16.7 15.3 19.3 14.6 December 18.0 14.1 16.2 21.3 30.7 26.5 0.0 6.2 -11.3 9.1 14.3 63.5 -1.0 January 16.6 17.3 15.9 28.4 25.3 30.2 12.2 9.1 -9.3 14.6 12.8 13.8 4.1 February 15.5 21.0 18.7 25.4 20.5 27.7 11.1 10.2 1.7 12.0 7.3 16.2 -3.8 March 15.2 18.6 20.6 21.8 23.2 22.6 10.8 15.0 12.5 10.1 10.0 13.4 -8.6 April 13.2 15.5 15.2 21.8 23.1 20.5 13.4 13.4 5.3 10.2 7.5 7.8 -15.5 May 10.7 20.2 12.2 18.1 16.1 16.9 8.1 10.1 3.2 7.8 9.5 8.5 -18.7 June 8.9 13.7 13.3 12.3 13.2 14.1 9.1 11.9 -1.6 5.7 2.5 5.1 -11.8 2016 July 7.0 6.1 12.5 13.8 9.2 12.4 13.5 8.8 -4.5 3.1 4.3 -4.4 -12.9 August 5.3 1.8 -0.3 16.4 8.3 16.8 -2.5 9.4 -32.8 7.2 9.2 -11.1 -17.1 September 4.4 -0.5 -2.0 15.2 1.3 13.6 2.7 8.9 -33.7 10.5 5.6 -10.2 -24.3 October 4.6 0.4 -4.3 12.8 -4.9 14.7 1.2 9.3 -36.4 10.1 10.1 -2.0 -20.1 November 4.2 3.5 -4.1 15.7 -5.3 16.1 0.1 8.8 -21.3 10.6 10.6 -11.7 -30.6 December 4.1 0.9 -2.4 15.9 -2.8 14.9 16.7 11.0 -19.1 19.7 11.3 -34.8 -27.0 January 3.9 -2.6 -6.8 13.4 -0.8 10.2 -0.6 10.3 -17.5 14.7 11.1 -13.0 -30.7 February 3.5 1.4 -8.6 10.1 8.3 8.0 -4.6 9.7 -25.5 15.6 11.1 -13.7 -28.5 March 3.0 -7.7 -7.8 11.6 0.6 9.6 -9.2 12.4 -34.0 13.3 10.1 -15.5 -22.7 April 2.3 -8.8 -6.8 8.0 -2.3 7.6 -11.9 13.2 -34.2 10.4 11.9 -15.1 -19.0 2017 May 1.9 -12.6 -5.2 8.8 2.5 5.6 -2.8 11.8 -39.5 9.8 11.3 -21.8 -19.2 December 2017 | Edition No. 16 June 1.5 -12.3 -7.1 10.7 -0.7 3.2 -4.4 10.1 -37.8 10.9 7.5 -15.8 -25.0 July 1.4 -11.6 -6.6 9.0 0.5 0.6 -8.5 11.8 -41.0 12.1 3.3 -10.8 -28.1 57 August 1.6 -7.6 3.3 4.3 -1.5 -2.3 5.4 9.7 -7.6 6.2 -1.6 -6.5 -27.4 Source: Central Bank of Kenya Statistical Tables Table 13: Mobile payments Month Number of agents Number of Number of Value of customers transactions transactions (Millions) (Millions) (Billions) January 125,826 25.4 81.7 210.5 February 127,187 25.5 80.7 208.1 March 128,591 25.7 90.3 231.8 April 129,218 26.1 84.9 213.7 May 129,735 26.5 89.9 230.2 June 131,761 26.5 90.7 227.9 2015 July 133,989 26.7 94.0 238.9 August 136,042 27.0 94.1 248.2 September 138,131 27.3 96.3 247.5 October 140,612 27.5 102.8 255.8 November 142,386 28.1 101.3 236.4 December 143,946 28.6 107.4 267.1 January 146,710 29.1 108.1 243.4 February 148,982 29.5 114.1 257.2 March 150,987 30.7 121.7 273.6 April 153,762 31.4 120.2 269.8 May 156,349 31.3 122.6 277.9 June 162,465 31.4 121.8 271.0 2016 July 167,072 32.3 127.0 281.9 August 173,774 32.8 131.5 296.9 September 173,731 33.4 130.7 283.9 October 181,456 34.0 141.4 292.1 November 162,441 34.3 140.8 291.2 December 165,908 35.0 146.2 316.8 January 152,547 33.3 143.8 299.5 February 154,908 33.3 140.3 279.4 March 157,855 33.9 147.2 320.2 April 160,076 34.3 143.6 297.4 2017 May 164,674 34.2 156.9 315.4 June 165,109 34.2 150.3 299.8 July 169,480 34.6 153.1 308.9 August 167,353 35.3 145.9 286.3 September 167,775 35.6 146.6 300.9 Source: Central Bank of Kenya 58 December 2017 | Edition No. 16 Statistical Tables Table 14: Exchange rate Month USD UK Pound Euro January 91.4 138.5 106.3 February 91.5 140.2 103.9 March 91.7 137.5 99.4 April 93.4 139.6 100.7 May 96.4 149.1 107.5 June 97.7 152.2 109.7 2015 July 101.2 157.5 111.4 August 102.4 159.8 114.1 September 105.3 161.5 118.2 October 102.8 157.5 115.4 November 102.2 155.4 109.8 December 102.2 153.3 111.1 January 102.3 147.5 111.1 February 101.9 145.9 113.0 March 101.5 144.2 112.6 April 101.2 144.8 114.8 May 100.7 146.3 114.0 June 101.1 144.3 113.7 2016 July 101.3 133.4 112.1 August 101.4 132.9 113.7 September 101.3 133.2 113.5 October 101.3 125.4 111.9 November 101.7 126.3 110.0 December 102.1 127.7 107.7 January 103.7 128.0 110.2 February 103.6 129.5 130.4 March 102.9 126.9 109.9 April 103.3 130.4 110.7 2017 May 103.3 133.5 114.8 June 103.5 132.5 116.2 July 103.9 134.9 119.4 August 103.6 134.2 122.2 September 103.1 137.1 122.9 Source: Central Bank of Kenya December 2017 | Edition No. 16 59 Statistical Tables Table 15: Exchange rate (Index January 2016 = 100) Year Month NEER REER USD January 93.0 99.6 89.3 February 92.7 99.2 89.4 March 91.8 97.8 89.7 April 93.4 99.2 91.3 May 97.0 101.3 94.2 June 98.1 102.4 95.5 2015 July 101.2 105.7 98.9 August 102.1 106.2 100.1 September 104.8 108.3 102.9 October 102.4 105.8 100.5 November 100.7 103.4 99.9 December 100.5 101.9 99.9 January 100.0 100.0 100.0 February 100.1 100.5 99.6 March 100.0 100.3 99.2 April 100.6 100.7 98.9 May 99.9 99.7 98.5 June 100.2 99.5 98.9 2016 July 99.7 98.5 99.0 August 100.3 99.1 99.1 September 100.3 99.8 99.0 October 99.3 98.9 99.0 November 99.0 98.5 99.4 December 98.5 98.8 99.8 January 95.8 96.7 101.4 February 100.5 98.5 101.3 March 99.9 96.5 100.5 April 100.6 95.3 101.0 2017 May 101.2 104.3 100.9 June 97.5 101.1 101.2 July 103.6 106.0 101.5 August 101.2 September 100.8 Source: World Bank, based on data from Central Bank of Kenya 60 December 2017 | Edition No. 16 Statistical Tables Table 16: Nairobi Securities Exchange (NSE 20 Share Index) Year Month NSE 20 Share Index January 4,856 February 4,933 March 4,946 April 4,949 May 4,882 June 4,885 July 4,906 August 5,139 September 5,256 October 5,195 November 5,156 2015 December 5,113 January 5,212 February 5,491 March 5,248 April 5,091 May 4,787 June 4,906 July 4,405 August 4,177 September 4,174 October 3,869 November 4,016 December 4,041 January 3,773 February 3,862 March 3,982 April 4,009 2016 May 3,828 June 3,641 July 3,489 August 3,179 September 3,243 October 3,229 November 3,247 December 3,186 January 2,794 February 2,995 March 3,113 2017 April 3,158 May 3,441 June 3,607 July 3,798 August 4,027 September 3,751 Source: Financial Times December 2017 | Edition No. 16 61 Statistical Tables Table 17: Central Bank Rate and Treasury Bills Year Month Central Bank rate 91-Treasury Bill 182-Treasury Bill 364-Treasury Bill January 8.5 8.6 9.6 12.1 February 8.5 8.6 10.0 11.0 March 8.5 8.5 10.3 10.7 April 8.5 8.4 10.3 10.6 May 8.5 8.3 10.3 10.7 June 10 8.3 10.4 11.0 2015 July 11.5 10.6 11.0 11.6 August 11.5 11.5 11.5 13.3 September 11.5 14.0 12.5 15.2 October 11.5 21.0 15.7 21.5 November 11.5 12.3 16.3 15.2 December 11.5 9.7 15.7 12.5 January 11.5 11.2 13.0 14.1 February 11.5 10.6 12.8 13.7 March 11.5 8.7 12.6 12.3 April 11.5 8.9 11.7 11.8 May 10.5 8.2 10.7 11.6 June 10.5 7.3 10.2 10.8 2016 July 10.5 7.4 9.9 10.9 August 10.0 8.5 10.8 11.7 September 10.0 8.1 10.8 11.0 October 10.0 7.8 10.3 10.4 November 10.0 8.2 10.3 10.8 December 10.0 8.4 10.5 10.6 January 10.0 8.6 10.5 11.0 February 10.0 8.6 10.5 10.9 March 10.0 8.6 10.5 10.9 April 10.0 8.8 10.5 10.9 May 10.0 8.7 10.4 10.9 2017 June 10.0 8.4 10.3 10.9 July 10.0 8.2 10.3 10.9 August 10.0 8.2 10.4 10.9 September 10.0 8.1 10.4 10.9 October 10.0 8.1 10.3 11.0 Source: Central Bank of Kenya 62 December 2017 | Edition No. 16 Statistical Tables Table 18: Interest rates Year Month Short-term Long-term Interest Rate Interbank 91-Treasury Central Average Savings Overall Spread Bill Bank Rate deposit weigheted rate lending rate January 7.2 8.6 8.5 6.7 1.6 15.9 9.3 February 6.9 8.6 8.5 6.7 1.5 15.5 8.8 March 6.8 8.5 8.5 6.6 1.5 15.5 8.8 April 8.9 8.4 8.5 6.6 1.9 15.4 8.8 May 11.1 8.3 8.5 6.6 1.5 15.3 8.7 June 11.9 8.3 10.0 6.6 1.9 16.1 9.4 2015 July 13.4 10.6 11.5 6.3 1.4 15.8 9.4 August 18.6 11.5 11.5 6.9 1.5 15.7 8.8 September 21.3 14.0 11.5 7.3 1.7 16.8 9.5 October 15.3 21.0 11.5 7.5 1.7 16.6 9.0 November 8.9 12.3 11.5 7.4 1.3 17.2 9.8 December 5.3 9.7 11.5 8.0 1.6 18.3 10.3 January 6.4 11.2 11.5 7.6 1.6 18.0 10.4 February 4.5 10.6 11.5 7.5 1.4 17.9 10.4 March 4.0 8.7 11.5 7.2 1.4 17.9 10.7 April 3.9 8.9 11.5 6.9 1.5 18.0 11.1 May 3.6 8.2 10.5 6.4 1.6 18.2 11.8 June 4.9 7.3 10.5 6.8 1.6 18.2 11.4 2016 July 5.5 7.4 10.5 6.6 1.7 18.1 11.5 August 5.0 8.5 10.0 6.4 1.7 17.7 11.2 September 4.9 8.1 10.0 6.9 3.8 13.9 7.0 October 4.1 7.8 10.0 7.8 6.1 13.7 5.9 November 5.1 8.2 10.0 7.6 6.5 13.7 6.0 December 5.9 8.4 10.0 7.3 6.4 13.7 6.4 January 7.7 8.6 10.0 7.2 6.1 13.7 6.5 February 6.4 8.6 10.0 7.7 6.8 13.7 6.0 March 4.5 8.7 10.0 7.1 5.9 13.6 6.5 April 5.3 8.8 10.0 7.0 5.7 13.6 6.6 May 4.9 8.7 10.0 7.1 5.9 13.7 6.6 2017 June 4.0 8.4 10.0 7.0 5.7 13.7 6.7 July 6.8 8.2 10.0 7.5 6.4 13.7 6.2 August 8.1 8.2 10.0 September 5.5 8.1 10.0 October 8.1 10.0 Source: Central Bank of Kenya December 2017 | Edition No. 16 63 Statistical Tables Table 19: Money aggregate growth rates (y-o-y) Year Month Money supply, M1 Money supply, M2 Money supply, M3 Reserve money January 11.4 17.0 16.0 15.8 February 10.0 17.2 18.6 11.5 March 11.9 16.4 16.4 11.8 April 13.4 17.2 17.3 12.0 May 10.0 14.8 16.5 15.0 June 9.6 16.4 18.6 14.9 2015 July 13.0 16.0 16.4 25.8 August 10.5 14.3 14.0 2.9 September 8.5 12.7 13.5 16.7 October 10.8 13.6 13.6 24.5 November 7.9 11.6 13.0 13.0 December 8.5 12.4 13.7 3.3 January 10.9 10.8 11.1 9.1 February 9.9 10.0 9.3 9.2 March 10.9 10.7 11.2 16.1 April 10.6 9.9 9.5 9.0 May 12.8 9.8 8.6 7.6 June 13.4 9.2 8.1 4.9 2016 July 9.4 7.8 6.9 4.3 August 9.5 6.9 6.8 6.8 September 26.1 8.8 8.0 4.3 October 24.3 6.8 6.8 -7.4 November 25.3 6.2 6.2 0.5 December 28.1 4.8 3.7 4.8 January 21.9 5.3 5.2 5.1 February 23.7 4.5 5.4 2.9 March 22.1 5.7 6.4 3.2 April 23.6 6.3 7.1 9.0 2017 May 21.8 6.2 6.7 5.2 June 22.7 5.6 6.0 2.9 July 24.6 7.5 8.3 5.0 August 22.5 7.5 7.7 7.7 Source: Central Bank of Kenya 64 December 2017 | Edition No. 16 Statistical Tables Table 20: Coffee production and exports Year Month Production Price Exports Exports value (MT) (Ksh/Kg) (MT) (Ksh Million) January 2,795 412 2,844 1,307 February 4,837 489 2,884 1,339 March 5,571 378 4,290 2,025 April 3,714 310 3,948 1,901 May 2,969 289 4,383 2,236 June 0 0 4,220 2,068 2015 July 2,086 339 3,938 1,943 August 3,286 371 3,991 1,790 September 2,643 364 3,405 1,617 October 1,768 320 4,400 2,019 November 1,268 337 2,769 1,244 December 1,282 435 2,528 1,092 January 3,432 462 2,449 1,184 February 5,220 486 3,277 1,636 March 6,835 437 4,169 2,206 April 4,513 340 4,804 2,540 May 4,735 263 4,814 2,170 June 1,747 268 4,983 2,369 2016 July 569 324 3,987 1,798 August 3,723 431 3,719 1,637 September 3,284 437 3,173 1,399 October 1,573 410 3,116 1,489 November 2,374 468 3,929 1,691 December 1,666 514 2,886 1,252 January 5,190 590 3,214 1,553 February 6,081 606 3,868 2,094 March 5,460 507 5,447 3,231 April 4,563 299 4,201 2,698 2017 May 1,639 276 5,424 3,117 June - - 4,443 2,501 July 762 420 3,598 1,971 August 2,319 443 2,649 1,311 Source: Kenya National Bureau of Statistics December 2017 | Edition No. 16 65 Statistical Tables Table 21: Tea production and exports Year Month Production Price Exports Exports value (MT) (Ksh/Kg) (MT) (Ksh Million) January 41,653 212 40,970 8,485 February 24,276 221 41,086 9,313 March 15,688 250 35,700 8,796 April 23,837 258 28,262 7,189 May 37,523 297 27,016 7,506 June 32,286 319 35,915 11,263 2015 July 30,942 344 30,623 10,146 August 28,410 330 27,687 9,481 September 36,484 327 33,528 11,413 October 41,343 333 40,246 13,538 November 40,382 313 36,714 12,126 December 46,387 309 42,779 13,768 January 50,308 279 36,575 11,013 February 43,969 253 43,292 12,200 March 45,330 234 37,571 9,887 April 37,571 214 39,313 9,517 May 36,573 223 44,901 10,658 June 35,603 243 52,175 12,613 2016 July 29,285 246 42,751 10,679 August 29,462 234 39,673 9,993 September 36,785 236 33,528 8,454 October 41,342 243 29,656 7,548 November 39,903 273 41,138 11,123 December 45,103 273 39,396 10,811 January 32,991 316 46,434 14,072 February 22,605 317 33,898 10,880 March 34,498 300 33,662 10,693 April 31,458 297 32,091 9,991 2017 May 38,822 304 39,329 12,354 June 40,538 325 42,370 13,485 July 31,565 310 41,437 13,442 August 32,693 300 29,628 9,269 Source: Kenya National Bureau of Statistics 66 December 2017 | Edition No. 16 Statistical Tables Table 22: Horticulture exports Year Month Exports Exports value (MT) (Ksh Million) January 18,170 6,413 February 20,599 7,892 March 21,259 10,510 April 21,410 6,223 May 19,160 6,300 June 16,904 5,140 2015 July 17,359 8,551 August 16,175 5,824 September 25,188 8,187 October 22,179 9,905 November 19,428 8,095 December 20,179 7,399 January 20,160 10,927 February 22,337 10,151 March 24,314 11,140 April 25,931 8,611 May 21,260 7,004 June 20,157 10,293 2016 July 17,981 5,577 August 19,650 7,293 September 20,924 6,659 October 23,327 8,312 November 22,772 7,641 December 22,294 7,906 January 27,033 11,555 February 27,452 10,934 March 27,892 13,606 2017 April 25,658 8,977 May 30,007 10,291 June 26,362 9,395 August 23,357 9,237 Source: Kenya National Bureau of Statistics December 2017 | Edition No. 16 67 Statistical Tables Table 23: Leading economic indicators year to date growth rates (Percent) Year Month Horticulture Coffee Tea January 0.5 13.6 -3.8 February -4.6 -7.4 -3.5 March -4.7 9.1 2.3 April -2.6 12.8 4.5 May 0.7 6.3 0.9 June 3.3 2.3 1.3 2014 July 4.5 4.6 0.5 August 5.0 -0.3 1.1 September 5.0 -2.5 1.6 October 4.1 -2.9 2.5 November 3.4 -2.9 1.9 December 3.0 -3.0 2.3 January -1.8 -10.3 6.0 February 1.7 -8.3 13.7 March 5.4 -7.5 7.2 April 5.0 -11.0 -0.8 May 3.3 -9.5 -5.7 June 1.6 -9.3 -6.1 2015 July 1.6 -12.5 -9.6 August 1.2 -9.3 -11.8 September 5.1 -9.7 -11.3 October 5.9 -7.0 -9.4 November 6.6 -8.5 -8.9 December 8.1 -8.1 -7.9 January 11.0 -13.9 -10.7 February 9.6 0.0 -2.7 March 11.3 -1.2 -0.3 April 13.9 5.3 7.4 May 13.3 6.3 16.5 June 14.2 8.5 21.5 2016 July 12.8 7.5 23.8 August 13.7 5.6 25.8 September 9.4 4.3 22.9 October 8.9 0.5 17.1 November 9.6 3.3 16.6 December 9.7 3.9 14.1 January 34.1 31.2 27.0 February 28.2 23.7 0.6 March 23.3 26.6 -2.9 April 16.5 13.8 -6.8 2017 May 21.1 13.5 -8.1 June 22.5 8.6 -10.3 July 23.0 6.0 -9.2 August 22.5 2.0 -11.1 Source: World Bank, based on data from Kenya National Bureau of Statistics 68 December 2017 | Edition No. 16 Statistical Tables Table 24: Local electricity generation by source Year Month Hydro Geo-thermal Thermal Total (KWh million) (KWh million) (KWh million) (KWh million) January 278 388 109 776 February 230 352 121 703 March 246 377 134 757 April 264 359 121 744 May 301 380 103 784 June 297 362 109 769 2015 July 305 353 143 801 August 319 378 112 808 September 306 389 99 794 October 310 402 100 812 November 300 393 89 782 December 307 387 92 786 January 322 392 93 808 February 297 392 95 784 March 335 383 112 830 April 303 394 102 800 May 334 403 92 830 June 348 342 113 803 2016 July 337 393 110 842 August 364 345 138 850 September 349 335 137 824 October 357 364 135 862 November 315 369 158 848 December 299 371 158 836 January 252 380 197 837 February 214 354 182 758 March 234 388 230 858 April 212 381 223 822 2017 May 229 394 224 849 June 180 376 274 834 July 193 402 271 867 August 251 415 159 829 Source: Kenya National Bureau of Statistics December 2017 | Edition No. 16 69 Statistical Tables Table 25: Soft drinks, sugar, galvanized sheets and cement production Year Month Soft drinks Sugar Galvanized sheets Cement Litres (thousands) (MT) (MT) (MT) January 41,348 63,227 21,304 511,298 February 41,440 57,917 20,078 465,471 March 48,865 63,389 22,797 550,556 April 42,148 46,280 20,674 537,452 May 36,874 44,081 23,132 516,513 June 36,274 46,098 20,358 516,185 2015 July 32,086 47,957 18,415 570,904 August 38,432 54,089 20,871 553,929 September 40,176 61,069 20,581 561,235 October 42,936 56,360 26,024 557,589 November 40,025 43,401 25,764 510,747 December 49,966 48,089 16,938 486,306 January 50,502 41,348 21,330 533,490 February 45,237 41,440 20,102 531,813 March 58,038 48,865 20,120 541,438 April 44,429 42,148 23,109 568,253 May 43,189 36,874 21,980 585,929 June 39,191 36,202 20,180 547,238 2016 July 42,393 32,158 18,320 575,193 August 39,331 38,508 24,190 591,612 September 48,884 40,291 21,045 528,494 October 46,131 43,203 18,328 573,034 November 41,877 40,141 19,143 584,780 December 52,185 49,966 19,431 545,956 January 50,491 53,071 23,271 565,440 February 43,941 49,094 21,696 491,307 March 46,585 41,936 22,165 570,522 April 41,814 26,230 21,999 535,061 2017 May 36,483 15,246 22,162 482,762 June 41,265 16,144 21,645 513,313 July 39,575 22,029 553,631 August 451,651 Source: Kenya National Bureau of Statistics 70 December 2017 | Edition No. 16 Statistical Tables Table 26: Tourism arrivals Year Month JKIA MIA Total January 40,846 10,107 50,952 February 45,141 7,882 53,053 March 66,121 6,958 73,079 April 49,933 4,020 53,953 May 50,764 2,511 53,275 June 59,867 3,218 63,146 2015 July 72,515 5,728 78,243 August 63,332 7,546 70,878 September 54,162 5,114 59,276 October 66,441 6,049 72,490 November 53,622 7,718 61,340 December 50,015 9,070 59,085 January 65,431 9,407 74,838 February 62,856 9,983 72,839 March 49,996 8,551 58,547 April 51,311 3,869 55,180 May 59,294 3,578 62,872 June 64,451 4,182 68,633 2016 July 81,729 7,832 89,561 August 87,141 9,817 96,958 September 67,249 8,381 75,630 October 63,229 9,015 72,244 November 61,224 7,990 69,214 December 67,602 10,267 77,869 January 67,053 12,637 79,690 February 62,119 10,611 72,730 March 63,568 8,382 71,950 April 62,982 4,102 67,084 2017 May 64,866 2,665 67,531 June 74,194 4,734 78,928 July 97,955 7,286 105,241 August 79,053 10,729 89,782 Source: Kenya National Bureau of Statistics December 2017 | Edition No. 16 71 Statistical Tables Table 27: New vehicle registration Year Month All body types (Numbers) January 15,366 February 17,409 March 25,067 April 20,730 May 22,837 June 25,070 2015 July 21,132 August 17,360 September 18,596 October 18,740 November 23,209 December 22,308 January 14,652 February 12,771 March 10,280 April 13,699 May 11,855 June 22,428 2016 July 23,442 August 18,288 September 18,527 October 13,018 November 27,286 December 27,431 January 23,889 February 20,748 March 27,720 April 23,074 2017 May 24,720 June 24,509 July 29,346 September 21,137 Source: Kenya National Bureau of Statistics 72 December 2017 | Edition No. 16 POISED TO BOUNCE BACK? Reviving Private Sector Credit Growth and Boosting Revenue Mobilization to Support Fiscal Consolidation This is a critical time for Kenya, as the incoming administrations at national and devolved levels face the high expectations of ordinary Kenyans to deliver on ambitious economic development agendas and hasten the attainment of Vision 2030. Against this backdrop, it is my pleasure to present the sixteenth edition of the World Bank’s Kenya Economic Update—a report which seeks to contribute to the policy discourse on pertinent economic issues. The report has three key messages. The Kenyan economy faced multiple headwinds in 2017. A drought in the earlier half of the year, the ongoing slowdown in private sector credit growth, and a prolonged election cycle weakened private sector demand, notwithstanding an expansionary scal stance. Nonetheless, re ecting the relatively diverse economic structure, these headwinds were partially mitigated by the recovery in tourism, better rains in the second half of the year, still low global oil prices, and a relatively stable macroeconomic environment. Consequently, GDP growth is projected to dip to 4.9 percent in 2017—its lowest in the past ve years, but still higher than the Sub-Saharan African average. With headwinds subsiding, economic growth is projected to rebound over the medium term, reaching about 5.8 percent in 2019. However, this rebound is predicated on policy reforms needed to address downside risks that have the potential to derail medium term prospects. Two macroeconomic risks are pertinent. First, there is a need to consolidate the scal stance in order not to jeopardize Kenya’s hard-earned macroeconomic stability—a critical ingredient to Kenya’s recent robust growth performance. Second, is the need to jumpstart the recovery of credit growth to the private sector; particularly to micro, small and medium size businesses and households. Further, e orts to mitigate weather-related risks by climate proo ng agriculture could be supportive of a robust and inclusive medium term growth agenda. We are pleased to present a rich menu of policy options tabled in this edition of the Kenya Economic Update, identifying opportunities for the consolidation of the scal stance, both from an expenditure and revenue mobilization perspective. This is complimented with speci c suggestions of macroeconomic and microeconomic reform measures that could help address the slowdown in credit growth and the broader issue of access to credit. Finally, policy options to climate proof the agriculture sector, to mitigate the worse e ects of adverse weather conditions are discussed. The World Bank remains committed to working with key Kenyan stakeholders to identify potential policy and structural issues that will enhance inclusive economic growth, keep Kenya on the path to upper middle income status, and attain Vision 2030. The semi-annual Kenya Economic Update o ers a forum for such discussions. We hope that you will join us in debating topical policy issues that can contribute to fostering growth shared prosperity and poverty reduction in Kenya. World Bank Group Delta Center Join the conversation: Menengai Road, Upper Hill Facebook and Twitter P. O. Box 30577 – 00100 @Worldbankkenya Nairobi, Kenya #KenyaEconomicUpdate Telephone: +254 20 2936000 Fax: +254 20 2936382 http://www.worldbank.org/en/country/kenya Produced by Macroeconomic & Fiscal Management, Finance & Markets, Governance, and Agriculture Global Practices