94697 December 2014 | Edition No. 11 Anchoring High Growth Can Manufacturing Contribute More? Anchoring High Growth Can Manufacturing Contribute More? TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS .................................................................................................................. i FOREWORD ....................................................................................................................................................... ii ACKNOWLEDGEMENTS ................................................................................................................................... iii MAIN MESSAGES AND KEY RECOMMENDATIONS .......................................................................................... iv EXECUTIVE SUMMARY .................................................................................................................................... v THE STATE OF KENYA’S ECONOMY ................................................................................................................... 1 1. Economic Performance in 2014 ..................................................................................................................... 2 1.1 Rebasing reveals that Kenya’s economy is larger than previously estimated ......................................... 2 1.2 Kenya’s economy is strong ....................................................................................................................... 5 1.3 Fiscal policy was expansionary, increasing the deficit and the debt burden ........................................... 9 1.4 The Central Bank’s monetary policy stance supported growth ............................................................... 16 1.5 Kenya’s external balance deteriorated in 2014 but is set to improve in 2015, thanks to falling oil prices 18 2. Growth Outlook for 2014 - 15 ...................................................................................................................... 22 2.1 Kenya’s growth prospects are favorable in the near to medium term .................................................... 22 2.2 Risks have diminished, although they remain significant ........................................................................ 23 SPECIAL FOCUS: ............................................................................................................................................... 25 3. Why is manufacturing important? ................................................................................................................ 26 3.1 Introduction .............................................................................................................................................. 26 3.2 The contribution of manufacturing to GDP and exports has been stagnant .......................................... 27 3.3 Allocative inefficiency is low and hinders job creation ............................................................................ 31 3.4 A good business environment allows firms to grow and create jobs ...................................................... 36 3.5 What obstacles and constraints do firms face? Evidence from Enterprise Surveys ................................. 38 3.6 What can policy makers do to spur manufacturing? ............................................................................... 44 REFERENCES ...................................................................................................................................................... 47 ANNEXES ........................................................................................................................................................... 49 List of Figures Figure 1: Kenya’s economy is larger than previously estimated and among the fastest-growing in the region v Figure 2: Kenya’s growth compares favorably with its peers ........................................................................ v Figure 3: Value added per worker in Kenya’s manufacturing sector is a fraction of what it was 30 years ago x Figure 1.1: Kenya’s economy is larger than previously estimated ................................................................... 2 Figure 1.2: Rebasing GDP revealed that Kenya grew more rapidly than previously estimated ...................... 2 Figure 1.3: Kenya’s now has the ninth-largest economy in Africa ................................................................... 4 Figure 1.4: GDP rebasing increased the contribution of some sectors and decreased the contribution of others 4 Figure 1.5: Growth was robust ......................................................................................................................... 5 Figure 1.6: Tea production remained constant and prices declined significantly ........................................... 6 Figure 1.7: Other industry saw the fastest growth .......................................................................................... 6 Figure 1.8: Generation of electricity rose, and geothermal generation became the largest source of energy 7 Figure 1.9: Growth in the services sector slowed .......................................................................................... 7 Figure 1.10: Mobile money payments continued to soar ................................................................................ 8 Figure 1.11: Inflation was low—albeit higher than in 2013 ............................................................................. 8 Figure 1.12: Gasoline prices fell—but by much less than international crude oil prices ................................. 9 Figure 1.13: Kenya’s fiscal deficit has increased since 2006/07 ....................................................................... 9 Figure 1.14: Total government spending rose, but spending by the central government fell ......................... 10 Figure 1.15: Public debt has been rising but remains sustainable ................................................................... 10 Figure 1.16: Kenya’s debt position is below the average of its middle-income peers ..................................... 11 Figure 1.17: All types of tax revenues rose ....................................................................................................... 12 Figure 1.18: Budget execution of ministerial expenditure varied widely across sectors ................................. 13 Figure 1.19: County budget execution in 2013/14 was weak .......................................................................... 14 Figure 1.20: The lion’s share of county spending went to recurrent expenditures, not development ........... 15 Figure 1.21: Revenue collection varied widely across counties ........................................................................ 15 Figure 1.22: In cross-county comparisons, low budget execution is associated with poor revenue collection 16 Figure 1.23: Both short- and long-term rates declined ..................................................................................... 16 Figure 1.24: The growth of monetary aggregates boosted private sector credit ............................................. 17 Figure 1.25: Credit to the private sector was brisk ........................................................................................... 17 Figure 1.26: Kenya’s stock market underperformed the Dow .......................................................................... 18 Figure 1.27: Kenya’s external sector remains out of balance, with exports failing to keep up with imports .. 18 Figure 1.28: Short-term flows dominated the capital and financial account ................................................... 19 Figure 1.29: The export coverage ratio has declined since 2000 ..................................................................... 20 Figure 1.30: The shilling demonstrated mixed performance ............................................................................ 20 Figure 1.31: The real exchange rate shows the shilling has appreciated significantly since 2000 ................... 21 Figure 1.32: Remittances reached an all-time high .......................................................................................... 21 Figure 2.1: The outlook for economic growth in Kenya is strong .................................................................. 22 Figure 2.2: The current account balance is projected to improve significantly as a result of lower oil prices 23 Figure 2.3: Foreign direct investment in Kenya is much lower than in peer countries ................................. 24 Figure 3.1: Value added per worker in Kenya’s manufacturing sector is a fraction of what it was 30 years ago 26 Figure 3.2: Manufacturing growth trailed overall economic growth in Kenya between 2010 and 2013 ...... 28 Figure 3.3: Manufacturing growth in comparator countries was more rapid than in Kenya ........................ 28 Figure 3.4: The manufacturing sector’s contribution to Kenya’s GDP was similar to that of comparator countries in 2013, but sector growth was much slower .............................................................. 28 Figure 3.5: The East African Community reduced its imports from Kenya in 2013 ....................................... 29 Figure 3.6: Kenya’s share of imports of chemicals, plastics, and paper by the East African Community has been falling ................................. ............................................................................................ 30 Figure 3.7: Labor productivity (log of value added per worker-lva_l) varies widely across manufacturing subsectors ............................................................................................................ 32 Figure 3.8: In many subsectors in Kenya, lower-productivity firms employ more workers than higher-productivity firms .............................................................................................................. 35 Figure 3.9: “Old” firms in the United States create twice as much employment as “old” firms in Kenya .... 36 Figure 3.10: The strongest aspects of Kenya’s business environment are starting a business, obtaining construction permits, and paying taxes ....................................................................................... 38 Figure 3.11: Manufacturing firms’ perceptions of obstacles to doing business changed between 2007 and 2013 39 Figure 3.12: Average change in perceived obstacles by manufacturing subsector (2007-2013) .................... 40 Figure 3.13: Average change in de facto obstacles by manufacturing subsector ............................................ 42 Figure 3.14: Kenya’s business environment first stagnated and then deteriorated, while conditions in most of its peer countries improved ........................................................................................ 44 List of Tables Table 1.1: Selected indicators before and after GDP rebasing ...................................................................... 3 Table 1.2: Policy implications of GDP rebasing for macroeconomic indicators (percent of GDP) ................ 5 Table 1.3: Both recurrent and development spending rose in 2013/14 (percent of GDP) .......................... 11 Table 1.4: County governments registered a surplus in 2013/14 (millions of KSh) ...................................... 14 Table 3.1: Growth rates and shares of manufacturing subsectors in Kenya, 2013 (percent) ...................... 28 Table 3.2: Kenya’s top 10 manufacturing exports and top 2 export destinations, 2013 .............................. 30 Table 3.3: Labor productivity in Kenya, by manufacturing subsector, 2010 ................................................. 33 Table 3.4: Correlation between productivity growth and firm size in Kenya, by sector ............................... 34 Table 3.5: Severity of obstacles to firm performance in the manufacturing sector, 2007 and 2013 ........... 40 Table 3.6: Perceived obstacles and their de facto counterparts in Enterprise survey .................................. 41 Table 3.7: Most important obstacles to doing business in selected comparator countries (all sectors) ..... 43 Table 3.8: Most important obstacles to doing business in selected comparator countries (manufacturing sector) .................................................................................................................. 43 List of Boxes Box 1.1: Why rebase GDP? ......................................................................................................................... 3 Box 3.1: Data used in the analysis .............................................................................................................. 27 ABBREVIATIONS AND ACRONYMS AGOA African Growth and Opportunity Act CBK Central Bank of Kenya CBR Central Bank Rate COMESA Common Market for East and South Africa EAC East African Community eSWS Electronic Single Window System FDI Foreign Direct Investment FLSTAP Financial and Legal Sector Technical Assistance Project FY Fiscal Year GDP Gross Domestic Product GNI Gross National Income ICT Information Communication and Technology IFMIS Integrated Financial Management Information System IMF International Monetary Fund ITC International Trade Center KSh Kenyan Shilling kbrr Kenya Banks Reference Rate KNBS Kenya National Bureau of Statistics KPMG Klynveld Peat Main Goerdeler (a professional services company) KWh Kilowatt-hour L Labor Lao PDR Lao People’s Democratic Republic LAPSSET Lamu Port-South Sudan-Ethiopia-Transport MTPII Second Medium Term Plan NEO Net Errors and Omissions NSE Nairobi Securities Exchange NTBs Non-Tariff Barriers OECD The Organization for Economic Co-operation and Development OP Olley-Pakes PAYE Pay As You Earn PFM Public Finance Management SADC Southern Africa Development Community SGR Standard Gauge Railway SMEs Small and Medium Enterprises SSA Sub-Saharan Africa Tbill Treasury Bill TFP Total Factor Productivity U.S United States U.S Fed United States Federal Reserve UK United Kingdom UN United Nations UN COMTRADE United Nations Commodity Trade Statistics Database UNCTAD United Nations Conference on Trade and Development VA Variance VAT Value Added Tax WDI World Development Indicators WTO World Trade Organization December 2014 | Edition No. 11 i FOREWORD It is my pleasure to present the 11th edition of the Kenya Economic Update. Kenya begins 2015 in a sound economic position. It is experiencing solid growth, driven by sustained infrastructure investments, strong growth in other industry sector, and strong agricultural production. At last Kenya is emerging as one of East Africa’s growth centers. Kenya’s macroeconomic policies have laid a strong foundation for future growth. Its expansive fiscal policy allowed it to finance infrastructure projects without putting excessive pressure on domestic financial markets while keeping public debt within the 50 percent threshold. Its accommodative monetary policy stance has supported economic activities without triggering inflation or putting pressure on the exchange rate. This overall positive outlook is, however, not without risks. The tourist sector has been hobbled through reports and concerns about security that has hit economic activities at the coast especially hard. This Economic Update (KEU edition 11) has three main messages. First, Kenya is poised to be among the fastest-growing economies in the region in the next three years, with growth projections of 6.0 percent in 2015, 6.6 percent in 2016, and 7.0 percent in 2017. External and internal balances are expected to improve significantly, thanks to falling oil prices, and public investment, mainly in infrastructure (energy and the standard gauge railway), is expected to firm up growth in the medium term. Second, the external sector remains vulnerable, as import growth continue to outpace export growth and short-term flows finance the current account deficit. Sluggish external demand for exports and declining production for export is widening the current account deficit. These trends point toward underlying structural weaknesses that need to be addressed. Third, Kenya needs to increase the competitiveness of the manufacturing sector so that it contributes more to growth and employment. Over a long period, the relative size of the sector has been stagnant, it has lost market share abroad, and it is struggling with structural inefficiencies. Low overall productivity and large productivity differences in firms across subsectors point to lack of competition; a more efficient sector would do a better job of allocating resources from low-to high-productivity firms, allowing them to grow faster and hire more employees. As in the past, we are proud to have worked with many Kenyan stakeholders during the preparation of this Kenya Economic Update. We hope that it will contribute to their discussions of policy issues that will contribute to helping Kenya grow, permanently reduce poverty, and bring shared prosperity to all Kenyans. Diariétou Gaye Country Director for Kenya World Bank ii December 2014 | Edition No. 11 ACKNOWLEDGEMENTS T his Eleventh edition of the Kenya Economic Update was prepared by a team led by John Randa and Maria Paulina Mogollon supervised by Apurva Sanghi. The core team consisted of Xavier Cirera, Penelope Fidas, Nikola Kojucharov, Kennedy Opala, Angélique Umutesi, Gerard Kambou, Barbara Karni, and Anne Khatimba. The team acknowledges contributions from Georgia Dowdall and Robert Waiharo. The report benefitted from the insights of several peer reviewers including Yutaka Yoshino, Ravi Ruparel, Prof. Terry Ryan, Alvaro Gonzalez and Jane W. Kiringai who provided insightful comments. The team also received overall guidance from Albert Zeufack (Practice Manager, Macroeconomic and Fiscal Management), Thomas O’Brien (Country Program Coordinator for Kenya, Rwanda and Eritrea) and Diarietou Gaye (Country Director for Kenya, Rwanda and Eritrea). Partnership with key Kenyan policy makers was instrumental in the production of this report. On February 24, 2015, a draft of the report was presented at the 17th Quarterly Economic Roundtable. The meeting was attended by senior officials from the Ministry of Devolution and Planning, the Central Bank of Kenya, the Kenya School of Monetary Studies, the Kenya Vision 2030, the Kenya Institute of Public Policy Research and Analysis, the International Monetary Fund, the Kenya National Bureau of Statistics and the Ministry of Industrialization and Enterprise Development. December 2014 | Edition No. 11 iii MAIN MESSAGES AND KEY RECOMMENDATIONS Main messages Kenya begins 2015 in a sound economic position. After growing an estimated 5.4 percent in 2014, its economy is poised to be among the fastest growing in the region, with growth projected at 6.0 percent in 2015, 6.6 percent in 2016, and 7.0 percent in 2017. External and internal balances are expected to improve significantly, thanks to falling oil prices, and public investment, mainly in infrastructure (energy and the standard gauge railway), is expected to firm up growth in the medium term. The external sector remains weak and vulnerable, as import growth continue to outpace export growth and short- term flows finance the current account deficit. Sluggish external demand for exports, especially from the Euro area and emerging economies, has contributed to the widening of the current account deficit in the recent past. The large deficit points to underlying structural weaknesses in Kenya’s economy, which need to be addressed. Kenya needs to increase the competitiveness of the manufacturing sector so that it can grow, export, and create much-needed jobs. As a share of GDP, Kenya’s manufacturing sector has been stagnant in recent years, and it has lost international market share. Low overall productivity and large productivity differences in firms across subsectors point to lack of competition (which allows low-productivity firms to remain in business). The weak business environment is a key constraint for the manufacturing sector. Obstacles to doing business affect this sector more than many others because manufacturing needs access to capital for investments, infrastructure to import inputs and export and distribute finished products, affordable and reliable electricity to produce, labor to man operations, and fair and streamlined regulations and trade policies that allow firms to compete. Several policy actions could help anchor growth and galvanize the manufacturing sector: Key recommendations to anchor and sustain growth at high level 1. To anchor and sustain growth, Kenya needs to boost productivity and regain its competitiveness to encourage production of exports. To maintain high growth rates, Kenya needs to continue investing in infrastructure and human capital, improve the business and regulatory environment, and diversify exports. Increasing exports, is crucial for creating the thousands of low-skilled jobs needed to reduce high unemployment, particularly among young people, unemployment among whom poses a threat to social stability. 2. Address the risks associated with fiscal expansion, and rebuild policy buffers in the short to medium term to address fiscal sustainability. Recent public investment initiatives have started to generate a virtuous cycle between economic growth and debt sustainability. But the reduced fiscal space has left the economy vulnerable to exogenous shocks. In a similar way, the recent Eurobond issue helped integrate Kenya into global markets but increased its vulnerability to external shocks. To protect against such vulnerabilities and be in a position to handle adverse shocks, the government needs to preserve and rebuild fiscal policy buffers. Key recommendations for increasing the contribution of the manufacturing sector 3. Adopt cross-sectoral policies, such as removing market distortions and implementing industry-wide productivity policies, to complement sector-specific approaches. Policies should address inefficiencies in the capacity of the economy to allocate resources from low- to high-productivity firms. This means that trade policy, business regulatory frameworks, labor market laws, and access to finance should facilitate and enable firms to compete, both domestically and internationally. 4. Support the manufacturing sector, by: • Helping raise firm productivity growth by facilitating the stock and flow of skills, technology, and information among firms; • Levelling the playing field between formal and informal firms, by reducing and streamlining regulation, and ensuring their even and fair application; • Decreasing the cost of doing business by addressing critical issues related to energy, access to finance, and cross-border trade (both cargo clearance and non-tariff barriers), as well as devolution and counties’ revenue-raising business levies • Streamlining the process for starting a business and simplifying the insolvency framework iv December 2014 | Edition No. 11 EXECUTIVE SUMMARY K enya may be emerging as one of East Africa’s growth centers. It is experiencing solid growth, driven by sustained infrastructure investments, buoyant manufacturing and other industry sectors, and strong agricultural production. Buoyed by declines in the price of crude oil, annual growth is projected to pick up from an estimated 5.4 percent in 2014 to 6.0–7.0 percent in 2015-17, making Kenya one of the fastest-growing economies in Sub-Saharan Africa. There is a challenge to ensure that most Kenyans benefit from this high growth as poverty rates and inequality remained high. To ensure that Kenya’s growth momentum is sustainable in the medium term, key steps for Kenya to take include fully implementing the business reform agenda, completing reforms at the port of Mombasa, improving the efficiency of its massive infrastructural projects, strengthening governance, and continuing to maintain macroeconomic stability. K Figure 1: Kenya’s economy is larger than previously estimated enya’s economy is larger and growing faster and among the fastest-growing in the region than previously estimated. Rebasing of its GDP GDP in Kenya under old and new basing, 2006-13 reveals that Kenya’s economy is the ninth largest in 60 Africa and fifth largest in Sub-Saharan Africa (after 50 Nigeria, South Africa, Angola, and Sudan). GDP GDP (billions of US$) is estimated at US$55.2 billion (up from US$44.1 40 billion before rebasing) – see Figure 1, with GDP 30 per capita standing at US$1,246 (up from US$994). 20 Kenya is now a lower-middle-income country, according to the World Bank classification, with 10 gross national income (GNI) per capita of US$1,160 0 in 2013.1 The economy is estimated to have grown 2006 2007 2008 2009 2010 2011 2012 2013 5.4 percent in 2014 and is poised to be among the GDP (old) GDP (new) fastest-growing economies in the region in the next Source: Kenya National Bureau of Statistics. three years (Figure 2). Figure 2: Kenya’s growth compares favorably with its peers Average annual growth in selected countries in East Africa, 2010-13 Annual growth rate in selected middle income economies, 2013 8 8 7.1 7 6.7 7 6.2 6 5.7 Annual growth (percent) Annual growth (percent) 6 5.4 5.3 5.0 5 5 4.1 4 4 3 3 2 2 1 1 0 0 Rwanda Tanzania Kenya Uganda SSA (excl. Burundi ZAF) Source: Kenya National Bureau of Statistics and World Economic Outlook (IMF). 1 Kenya is still eligible for International Development Association (IDA) support, because its per capita GNI in 2013 (US$1,160) was below the IDA eligibility cut-off level of US$1,215. The World Bank’s upper threshold for middle-income countries is US$12,746. December 2014 | Edition No. 11 v Executive Summary Growth in 2014 was broad based. On the supply side, The external sector remained weak and vulnerable, agricultural production saw robust growth, driven as import growth outpaced export growth and by increased use of high-quality inputs; increased short-term flows financed the current account livestock output, as a result of better pasture; deficit. Sluggish external demand for exports, and expanded credit to the sector. A favorable especially from the Euro area and emerging macroeconomic environment—low inflation, a economies, contributed to the widening of the stable exchange rate, expanded private credit—as current account deficit. The level of the deficit points well as more reliable supply and lower prices of to underlying structural weaknesses in Kenya’s electricity boosted manufacturing output. On the economy that need to be addressed. Merchandise demand side, aggregate demand was the main driver exports have weakened significantly since 2012, of growth, as private consumption rose, as a result and high oil prices (until 2014) drove import of increased credit, and government consumption growth. Import needs and financing inflows for large increased at both the national and subnational infrastructural investment projects added pressure level. Public investment, mainly in massive road and on the balance of payments. Exports of services and energy projects, also spurred growth. remittances inflows remain strong. The vulnerability of the external account emanates from the fact that Kenya’s growth compares favorably with other the current account is financed mainly from short- countries. It no longer lags its regional peers or term flows, which can easily reverse should the global other lower-middle-income countries. economic environment change. Average growth between 2010 and 2013 was 6.2 percent—significantly The outlook for the near and higher than the 5.3 percent average Average growth medium term is strong… between 2010 and F for Sub-Saharan Africa (Figure 2, panel or the first time in years, Kenya a). Kenya’s 2013 growth rate of 5.7 2013 was 6.2 percent— begins a new year in a sound percent was above the 5.0 percent significantly higher than economic position. The economy average growth rate for lower-middle- the 5.3 percent average is expected to grow 6 percent income countries (Figure 2, panel b). for Sub-Saharan Africa in 2015; external and internal balances are expected to improve Kenya’s macroeconomic policies remained generally significantly, thanks to falling oil prices; and public accommodative. The government continued investment, mainly in infrastructure (energy and to finance larger fiscal deficits without creating the standard gauge railway), is expected to firm excessive pressure on domestic financial markets and up growth in the medium term. The perennial keeping public debt within the 50 percent threshold. downside risk factors of drought and higher food The additional spending went to infrastructure prices and their consequences for overall inflation projects and to finance activities at subnational and electricity prices are no longer significant in the levels of government. The Central Bank maintained forecast horizons. its accommodative monetary policy stance, in order to support economic activities without triggering Falling global oil prices are a boon to Kenya’s inflation or putting pressure on the exchange rate. economy, boosting real income and reducing Credit growth to the private sector grew, as a result inflationary pressure. The rise in real income is of declining inflation and accommodative monetary expected to trigger significant increases in private policies. Thanks to proceeds of the Eurobonds, the consumption, the engine of Kenya’s economy. Higher Central Bank was able to build enough reserves to aggregate demand is also likely to incentivize private finance the current account deficit and support the investment, particularly in the manufacturing sector. exchange rate. World Bank simulations suggest that a 30 percent vi December 2014 | Edition No. 11 Executive Summary decline in the price of oil from the baseline price of spending led to growth spurts—but it also increased US$65/barrel could increase GDP growth by up to the fiscal deficit and public debt. These episodes 1.2 percentage points in 2015. raise the question of whether the growth Kenya has experienced is organic (and therefore sustainable) or The World Bank projects that Kenya’s GDP will fiscally propelled (and therefore unsustainable). grow 6.0 percent in 2015, 6.6 percent in 2016, and 7.0 percent in 2017. Rapid growth mainly reflects It is important for Kenya to allocate fiscal space increased aggregate demand emanating from the to public investment, in order to generate a fall in oil prices and ongoing infrastructural projects. virtuous cycle between economic growth and debt Higher public investment spending on infrastructure, sustainability. Kenyan’s entry into the sovereign especially the standard gauge railway, will also bond market integrated it with global markets, enhance Kenya’s competitiveness, but it increased its vulnerability to particularly beginning in 2016, and external shocks. To protect against help boost output in the medium such vulnerabilities and be in a term. The positive externalities of Kenya’s economy has position to handle adverse shocks, the massive infrastructural projects benefited immensely the government needs to preserve (roads, railway, and energy) and from the stimulus by the and rebuild fiscal policy buffers. As devolved county spending will also U.S. Federal Reserve, in the Ghanaian experience has shown, stimulate the economy. foreign investors tend to discriminate terms of both short- and more clearly between countries with … but challenges remain long-term capital flows strong fundamentals and those in A lthough the fall in oil prices reduces the size which imbalances have been allowed to build up of the current account deficit, easing pressure when they turn risk averse. on the shilling, the external account problem will remain, because export growth is slow. However, The security situation continues to pose a threat an improved outlook for the shilling will decrease to growth. Fear of terrorism has hurt the tourism the likelihood that the Central Bank will tighten sector, forcing several coastal hotels to close.2 monetary policy, allowing consumer and business Further deterioration of the security situation confidence to increase. could affect private investment decisions and force the government to divert resources away from Kenya’s expansionary fiscal position remains productive purposes toward security. worrisome, as public debt continues to build up. Even with the recent GDP rebasing, the size and Policy changes in the United States and lack of trend of fiscal indicators remain big concerns. The growth in Europe may slow growth in Kenya. government’s commitment to fiscal discipline is Kenya’s economy has benefited immensely from the proving to be a challenge. Tax revenues have been stimulus by the U.S. Federal Reserve, in terms of both rising, but increased spending has made narrowing short- and long-term capital flows. With the ending both the overall fiscal deficit and the primary of the Fed’s monetary stimulus, the flow of cheap balance difficult. Large increases in government capital that has been funding the current account spending relative to revenue were fueled mainly could dry up, as risk-averse foreign investors exit the by expenditures associated with devolution, region, creating volatility in the foreign exchange constitutional offices, and the infrastructure market and putting pressure on the Central Bank to necessary for high sustainable growth. Past fiscal raise interest rates, which could choke growth. The strong dollar in the fourth quarter of 2014 and early 2 Tourists may also have stayed away from Kenya in 2014 as a result of the Ebola scare. Some tourism market analyst argues that high-end tourism has not been affected while conference tourism actually picked up. December 2014 | Edition No. 11 vii Executive Summary 2015 has already weakened the shilling, offsetting Improving manufacturing performance some of the benefits of low international oil prices. and the business environment is critical K In addition, a depressed Euro area will dampen enya needs to create a competitive the growth pick-up, as Europe is one of the main manufacturing sector if it is to meet its ambitious destinations of Kenya’s merchandise exports, a main goal of becoming a “globally competitive and source of tourists, and the source of most equity prosperous upper-middle-income country with funds. a high quality of life by 2030” (Vision 2030). The manufacturing sector is particularly important The drop in global oil prices does not obviate the given the demographic structure in Kenya, which is need to undertake reforms to reduce the structural adding more than half a million people to the labor imbalance in the external account. Kenya’s current force every year. Absorbing such a large number account is projected to fall from 8.3 percent of GDP of new entrants into the formal sector requires in 2013 to 4.7 percent in 2017 as a result of falling massive employment creation, ideally in higher- oil prices. Lower oil prices are expected to reduce productivity jobs. the urgency of the structural reform agenda to enhance competitiveness and boost exports. The The formal manufacturing sector is small, and structural imbalance problems have not gone away, trends are not promising. It contributed just 11 however. Kenya’s export sector has been lagging percent of GDP in 2013 and employed a mere since the mid-1990s (the last tea and coffee boom). 280,000 people (12 percent of the 2.3 million people As a result, Kenya relies too heavily on short-term in Kenya’s labor force). It accounted for 26 percent capital flows to service its current account. In order of Kenya’s merchandise exports, 40 percent of to service and reduce external indebtedness, Kenya which were exported to the East African Community needs to increase the production of traded goods. (EAC). Its largest subsectors are food, beverages and tobacco, and chemicals. Although the contribution Correcting the structural imbalance requires of the manufacturing sector to GDP is in line with reforms that the government has already started comparator countries, sector growth trails that of implementing. The infrastructure investment the Kenyan economy as a whole and of comparator underway not only boosts domestic demand in the countries. There are also worrisome indications that short term, it also increases potential output down the sector is losing competiveness. the road, by supporting export growth. Manufacturing exports are losing Structural reforms to raise growth ground in the EAC to exports from and its inclusiveness should focus on creating the conditions for higher Kenya’s economy has India and China. Moreover, the productivity and capital spending, benefited immensely “mortality rate” among exporters is high, and there is little dynamism including by addressing shortcomings from the stimulus by the in export relationships. in infrastructure provision and the U.S. Federal Reserve, in business environment. Without such terms of both short- and These negative trends reflect reforms, the growth Kenya is currently long-term capital flows structural issues, as suggested enjoying will not be sustainable. by firm-level analysis based on data from the Structural reforms will help raise medium-term Census of Industrial Production and the World growth, create jobs, and improve living standards Bank’s Enterprise Survey. The value added per and equity. Business climate and governance worker in Kenyan manufacturing firms has declined reforms and greater trade are critical to reducing steadily since the 1970s (Figure 3). Moreover, firms’ operating costs and increasing employment. productivity differences across firms are very high viii December 2014 | Edition No. 11 Executive Summary in some subsectors. In a competitive market, these productivity policies, and calls for caution on the differences should be small, as very low-productivity over-use of narrow, sector-specific approaches. firms are driven out of business; the fact that they are large suggests lack of competition. Inefficiencies The weak business environment is a key constraint in the capacity of the economy to allocate resources for the manufacturing sector. Manufacturing from low- to high-productivity firms (known as firms are particularly dependent on the business “allocative efficiency”) is also manifested by the poor environment for the success of their operations. correlation between the number of employees in a They need access to capital for their investments, firm and productivity. In an efficient economy, one infrastructure to import inputs and export and would expect that more productive firms grow more distribute finished products, affordable and reliable (in terms of employment); in Kenya firms with fewer electricity to produce, skilled labor to man their employees appear to be more productive than firms operations, and fair and streamlined regulations that with more employees. In addition, high-productivity allow them to compete. firms in Kenya are not growing and employing as many people as they could, constraining the ability In 2013 firms in Kenya reported that the obstacles of the sector to create employment. In the United that most constrained them were costly and States, for example, older firms (more than 35 years unreliable electricity; inadequate access to finance; old) employ six times more people than younger difficulties in trading across borders; competition firms (less than 5 years old). In Kenya older firms from the informal sector; and crime, theft, and employ just two to three times as many people as disorder (Enterprise Survey 2013). younger firms. The Government has already made substantial Figure 3: Value added per worker in Kenya’s manufacturing sector is a fraction of what it was 30 years ago improvements to alleviate business environment 400 constraints. It has simplified business registration, land registry, and property transactions; established 350 the Huduma one-stop shops; and streamlined Value added per worker (KSh) 300 customs procedures at the Mombasa Port. For 250 electricity, the recent drop in oil prices, combined 200 with the government’s infrastructure projects, will 150 reduce prices, increase generation, and improve 100 distribution. 50 Much more remains to be done, however. The 0 manufacturing sector is stuck, with large productivity Total economy Manufacturing differences and a difficult business environment Source: Based on data from de Vries, Timmer, and de Vries 2013. constraining sector growth and employment. Addressing inefficiencies in the capacity of the Despite some variance among sectors, large economy to allocate resources from low to high differences in productivity are prevalent across productivity firms, removing market distortions, and subsectors. This underlines the importance of improving the business environment should be top prioritizing cross-sectoral approaches that remove priorities. Some actions the government could take market distortions and emphasize industry-wide include the following: December 2014 | Edition No. 11 x Executive Summary • help raise firm productivity growth by facilitating of electricity; increasing access to finance, the stock and flow of skills, technology, and particularly through lower interest rates; information among firms (through management improving the speed and accuracy of cargo and technology extension services, or incentives to clearance by customs and other border agencies; improve firms’ knowledge base and equipment); and reducing the prevalence of nontariff barriers; • level the playing field between formal and informal and firms, by reducing and streamlining regulation, • ensure that devolution and the new revenue- and ensuring their even and fair application; raising business levies imposed by counties do not • decrease the cost of doing business by: further hamper business growth and employment. reducing the price and increasing the reliability x December 2014 | Edition No. 11 The State of Kenya’s Economy The State of Kenya’s Economy 1. Economic performance in 2014 K enya is where it wants to be—on a higher growth path. Massive investments in infrastructural investments, a favorable external borrowing environment, and a strong economy have helped boost aggregate domestic demand and growth. The rebased national accounts data depict a more diversified economy than previously thought, with a larger role played by the traditional sectors of agriculture and manufacturing and the emerging sectors of financial intermediation, real estate, and business services. Expansionary fiscal policy has been key in boosting aggregate demand, while accommodative monetary policy has helped support growth by increasing private sector credit and keeping inflation low. As a result, the economy is estimated to have grown 5.4 percent in 2014 and is forecasted to grow 6.0 percent in 2015. Macroeconomic indicators are solid, with inflation expected to remain within the Central Bank target of 5 percent; public debt remaining below 50 percent of GDP; and the current account deficit, which has perennially remained high as a percent of GDP, expected to declined significantly to 4.7 percent in 2017. Risks remain, however. On the domestic front, the weak security environment and fiscal position pose significant risks to growth prospects. On the external front, the winding down of monetary easing by the U.S. Federal Reserve and the subsequent tightening of global financial conditions could trigger new volatility, which may reduce growth in Kenya, as risk-averse foreign investors change their minds about Kenya, leading to capital outflows. In addition, a deflated Euro area will dampen the export growth pick-up the economy expects to see in the near to long term. 1.1 Rebasing reveals that Kenya’s economy is was 5.0 percent in the new GDP series, up from 4.3 larger than previously estimated percent in the old series (Figure 1.2). Rebased GDP K enya’s economy is larger and growing more growth was stronger than earlier estimates had rapidly than previously estimated. In 2014 the indicated in four out of seven years.1 Based on the national accounts were rebased (to a base year of new series, Kenya is a lower-middle-income country, 2009) (Box 1.1). As a result, estimated GDP for 2013 with GDP per capita of US$1,246 and GNI per capita was 25 percent larger than previously estimated of US$1,160 in 2013. (Figure 1.1). Average annual growth for 2007–13 Figure 1.2: Rebasing GDP revealed that Kenya grew more rapidly Figure 1.1: Kenya’s economy is larger than previously estimated than previously estimated 5,000 9 8.4 8 4,000 7 7.0 6.9 GDP (billions of KSh) 6.1 Annual growth (percent) 6 5.8 5.7 3,000 5 4.6 4.7 4.4 4.5 4 2,000 3.3 3 2.7 1,000 2 1.5 1 0.2 0 0 2006 2007 2008 2009 2010 2011 2012 2013 2007 2008 2009 2010 2011 2012 2013 GDP (old) GDP (new) GDP growth, 2001 = 100 GDP growth, 2009 = 100 Source: Kenya National Bureau of Statistics. Source: Kenya National Bureau of Statistics. 2 The earlier series excluded certain activities the new series includes. In 2009, 2010, 2011, and 2013, these activities grew faster than the average rate. In years in which the old series revealed higher growth, growth of the excluded activities was slower than the average growth rate. 2 December 2014 | Edition No. 11 The State of Kenya’s Economy Table 1.1: Selected indicators before and after GDP rebasing Indicator 2006 2007 2008 2009 2010 2011 2012 2013 GDP (old) KSh billion 1,623 1,834 2,108 2,376 2,570 3,047 3,404 3,798 GDP (new) KSh billion 1,862 2,151 2,483 2,864 3,169 3,726 4,255 4,758 Percent change 14.8 17.3 17.8 20.5 23.3 22.3 25.0 25.3 Exchange rate (average) 72.1 67.3 69.2 77.4 79.2 88.8 84.5 86.1 GDP (old) US$ billion 22.5 27.2 30.5 30.7 32.4 34.3 40.3 44.1 GDP (new) US$ billion 25.8 32.0 35.9 37.0 40.0 42.0 50.3 55.2 GDP per capita (old) US$ 612 720 787 771 792 816 933 994 GDP per capita (new) US$ 703 847 926 930 978 998 1166 1246 Source: Kenya National Bureau of Statistics. With a GDP of US$55.2 billion, Kenya is currently 22.6 percent to 24.0 percent, as a result of new data the ninth-largest economy in Africa and the fifth- from the cost of agriculture survey, livestock census largest in Sub-Saharan Africa. Within Sub-Saharan data from the population census, and research (Figure Africa, only Nigeria, South Africa, Angola, and Sudan 1.4). Manufacturing’s share of GDP increased from are larger than Kenya, which is now larger than 9.7 percent to 11.9 percent, as a result of analysis of Ethiopia and Ghana (Figure 1.3). Kenya’s GDP per new data from the census of industrial production, capita ranking also improved, elevating it from 12th which revealed that manufacturing of food, place to ninth place in Sub-Saharan Africa. beverages, and tobacco and other manufacturing had been underestimated. Real estate’s share rose Real estate, financial services, agriculture, and from 5.3 percent in the old series to 8.3 percent in manufacturing accounted for most of the change the new series, as a result of a significant increase in Kenya’s gross output as a result of rebasing. The in the stock of high-quality dwellings, data from share of agriculture in gross output increased from the 2009 census, and more accurate estimates of Box 1.1: Why rebase GDP? The Kenya National Bureau of Statistics (KNBS) uses System of National Accounts (SNA) guidelines in compiling the national accounts statistics. It rebased Kenya’s GDP in 2014 following the recommendations of the 2008 SNA. This revision was the sixth, similar exercises having been conducted in 1957, 1967, 1976, 1986, and 2005. GDP rebasing involves replacing old base-year volume and price measures with a more recent base year or process structure. It yields a more accurate snapshot of the economy by updating the production structure; structural changes in relative prices of various products; and consumption patterns, utilization, and acquisition of capital goods. It also incorporates product changes caused by developments and innovations. In Kenya, for example, the mobile revolution has greatly affected the nature and structure of the economy—something the old national accounts did not capture well. The rebasing of 2014 involved changing the base year from 2001 to 2009; updating the production structure; updating structural changes in the relative prices of various products and incorporating product changes made because of new developments and innovations; updating the consumption patterns, utilization, and acquisition of capital goods; and adopting the current classification of economic activities. The KNBS invited a team of statisticians and economists from the World Bank Group and other international experts to peer review the rebasing exercise. Their findings confirmed that Kenya conducted the rebasing exercise with professionalism, with integrity, and in accordance with the latest international technical standards. The new numbers are credible and constitute an important improvement in Kenya’s economic and statistical knowledge base. Source: World Bank. December 2014 | Edition No. 11 3 The State of Kenya’s Economy Figure 1.3: Kenya’s now has the ninth-largest economy in Africa 600 25,000 Total GDP (US dollar current, 2013) GDP per capita (US dollar current, 2013) 500 20,000 400 15,000 300 10,000 200 Kenya after GDP rebasing US$ 55.2 billion Kenya after GDP rebasing 100 5,000 US$ 1,246 Kenya before GDP rebasing Kenya before GDP rebasing US$ 44.1 billion US$ 994 0 0 Liberia Swaziland Sierra Leone Mauritania Niger Madagascar Mali Burkina Faso Namibia Niger Madagascar Guinea Eritrea Bissau Guinea Uganda Mozambique Togo Rwanda Sierra Leone Tanzania Mali Benin Comoros Zimbabwe Kenya Old Senegal Kenya New Cameroon Cote d'Ivoire Zambia Ghana Nigeria Sao Tome and Principe Comoros Gambia, The Seychelles Eritrea Malawi Togo Guinea Rwanda Benin Mauritius Chad Mauritania Lesotho Djibouti Sudan Guinea-Bissau Djibouti Cabo Verde South Sudan Zimbabwe Chad Botswana Swaziland Morocco Congo, Rep. Egypt, Arab Rep. Cabo Verde Algeria Namibia Angola South Africa Botswana Mauritius Gabon Libya Seychelles Lesotho Burundi Congo, Rep. Senegal Equatorial Guinea Mozambique Uganda Zambia Cameroon Cote d'Ivoire Kenya New Algeria South Africa Nigeria Malawi Central African Rep. Liberia Gambia, The Burkina Faso South Sudan Tunisia Gabon Congo, Dem. Rep. Tanzania Kenya Old Ethiopia Ghana Libya Morocco Angola Egypt, Arab Rep. Burundi Congo, Dem. Rep. Ethiopia Tunisia Sudan Sao Tome and Principe Equatorial Guinea Central African Rep. Source: World Development Indicators. Figure 1.4: GDP rebasing increased the contribution of some sectors encourage them to borrow more. However, Kenya’s and decreased the contribution of others ability to pay (revenue generation) fell from 23.4 Real estate, renting, business services 3.0 Manufacturing 2.1 percent of GDP to 19.4 percent, and its exports to Agriculture, forestry and fishing 1.5 Financial intermediation 1.4 GDP ratio fell significantly (Table 1.2). Public administration 0.9 Construction 0.6 Hotels and restaurants 0.4 Rebasing makes Kenya’s debt metrics look Education 0.4 Mining and quarrying 0.3 favorable, but the new figures may not justify Electricty and water 0.0 additional borrowing. After rebasing, government Other services -0.3 Transport and storage -0.3 spending in 2013/14 as a share of GDP declined Financial intermediation services indirectly measured -1.3 from 31.2 percent to 25.9 percent, the fiscal deficit Information and communication -2.2 Taxes on products -3.1 fell from 7.4 to 6.2 percent, and public debt dropped Wholesale and retail trade -3.4 from 52.0 to 43.1 percent in net terms. These -4 -3 -2 -1 0 1 2 3 4 Percentage change in shares by economic activities relative changes could be interpreted as indicating that to new GDP numbers, average 2006-2013 Source: Kenya National Bureau of Statistics. additional development spending could be financed through public borrowing. But the rebasing also average rentals. Financial services rose from 4.0 affected revenues, which fell from 23.4 percent of percent to 5.5 percent. Wholesale and retail trade GDP to just 19.4 percent. Kenya’s ability to cover saw significant declines, based on data from a survey its external debt (measured as total debt service as of trade margins. a share of exports) was eroded, as exports’ share of GDP also declined. The appropriate metric for The rebasing of Kenya’s GDP affected a number of determining whether Kenya should take on more macroeconomic indicators, with implications for debt to finance viable projects is the ability to pay, as policy makers. Because most critical indicators are measured by the ratio of revenue to GDP and total shares of GDP, a larger economy reduces the ratios, debt service, but only the scope to borrow. Efforts with serious macroeconomic consequences. Gross to find new ways to fund the government—such as public debt as a share of GDP fell from 58.9 percent reintroducing the capital gains tax in the 2014/15 of GDP to 47.2 percent (from 42.0 percent to 43.1 budget and adopting tax administration measures percent in net terms) in 2013/14. This decline might aimed at increasing taxation from rental income— seem to take debt pressure off policy makers and increase this ratio and are therefore welcome. 4 December 2014 | Edition No. 11 The State of Kenya’s Economy Table 1.2: Policy implications of GDP rebasing for macroeconomic indicators (percent of GDP) Old New Macroeconomic indicator Comment series series Government revenue 23.4 19.4 Old series overestimated revenue effort, given the size of economy. More needs to be done to improve resource mobilization. Government expenditure 31.2 25.9 Size of government is not as alarming as previously thought. Wages and salaries 6.8 5.6 Wages and salaries are no longer a hot-button issue at the national (central government) level. The combined wage and salaries at National and County level is 7.1 percent of GDP, which can be considered high. Fiscal deficit 7.4 6.2 The fiscal deficit remains an issue that needs to be addressed. Gross public debt 56.9 47.2 The fiscal space has expanded: public debt is now below the target Net public debt 52.0 43.1 of 50 percent. However, the decision to borrow more should be based on the ability to pay (government revenue to GDP or Kenya’s exports earning). Current account deficit 10.9 8.7 The external position has improved, but exports still lag far behind Imports (merchandise) 38.7 30.9 imports. Exports (merchandise) 13.2 10.5 Source: World Bank calculations. 1.2 Kenya’s economy is strong Although economic performance in the first Growth remains robust three quarters of 2014 was robust, growth was significantly lower than the 6.6 percent growth in K enya’s economy is estimated to have grown 5.4 percent in 2014, driven by good performance in agriculture, manufacturing, and other industry the same period in 2013. A sluggish services sector, which grew at 3.9 percent (down from 5.7 percent growth in 2013), was the main cause of lower (Figure 1.5).3 The performance of the services growth. Growth in 2014 was highest in the second sector, which anchored Kenya’s growth in the past, quarter, when the economy grew 5.7; growth was was lower than in previous years, as a result of 5.5 percent in the third quarter and 4.5 percent in security concerns. the first quarter. Fourth quarter growth is estimated at 5.9 percent. Figure 1.5: Growth was robust 8 7.3 6 5.7 7 5.4 6.3 Quarterly GDP growth, 2012-14 6.2 5 5.9 6 5.7 Annual GDP growth 2012-14 5.5 4.5 5 4.6 4.5 4 4.5 4.3 4.5 4 3 3.2 3 2 2 1 1 0 0 1 2 3 4 1 2 3 4 1 2 3 4 2012 2013 2014 2012 2013 2014 Sources: Kenya National Bureau of Statistics and World Bank estimate. 2 The International Monetary Fund (IMF) projected growth of 5.3 percent in 2014,and the government forecast was 5.0–5.5 percent December 2014 | Edition No. 11 5 The State of Kenya’s Economy Agriculture grew at a healthy rate. Agriculture growth in construction, which reflects the booming grew 5.4 percent in the first three quarters of 2014, market for residential buildings, other buildings, and down from 5.6 growth in 2013. This performance civil works and construction of traditional dwellings, is remarkable given the mild drought in the fourth which propelled demand for cement, bitumen, and quarter of 2013, the delayed rains in early 2014, construction. Mining and quarrying picked up as well, and the decline in tea prices. The volume of tea growing 4.5 percent in the first three quarters of production rose 2.2 percent (from 432,135 metric 2014, after declining 6.6 percent in 2013. Growth in tonnes to 441,754 metric tonnes), but prices fell 13.8 the electricity and water supply subsector declined, percent (from KSh 224 to KSh 193 per kilo) (Figure from 6.5 percent in 2013 to 2.7 percent in the first 1.6). Good performance is attributable to continued three quarters of 2014, but generation increased 8.2 subsidized seeds and fertilizer; increased livestock percent, from 8,208 million to 8,881 million KWH. output, as a result of good pasture; increases in both Hydropower generation declined 22 percent, from coffee production, which rose 8 percent in 2014, and 4,387 to 3,411 million KWH; geothermal increased coffee prices, which rose 21.8 percent; improved 64 percent, from 1,781 to 2,917 million KWH; and statistics; and increased credit to the sector. thermal increased 25 percent, from 2,040 to 2,556 million KWH. A favorable macroeconomic environment boosted Figure 1.7: Other industry saw the fastest growth manufacturing output, which rose 6.9 percent 14 during the first three quarters of the year. Modest 12.3 First three quarters growth (percent) 12 inflation, a stable exchange rate, lower electricity prices, and improved access to private credit drove 10 8.9 up manufacturing output. Greater demand for 8 7.6 6.9 manufactured goods by Uganda and Rwanda also 6 5.6 5.4 6.0 5.7 helped the sector. 4.9 3.9 4 2.8 2 Other industry (construction, mining and quarrying, (0.9) and electricity and water supply) showed strong 0 performance in 2014, growing 8.9 percent in the -2 Agriculture Manufacturing Other industry Services first three quarters of the year, up sharply from 6.0 2012 2013 2014 percent in the same period in 2013 (Figure 1.7). This Source: Kenya National Bureau of Statistics. extraordinary growth is explained by the 12.9 percent Figure 1.6: Tea production remained constant and prices declined significantly Tea producti on, 2013-2014 Tea aucti on prices, 2013-2014 50 310 Tea producti on in metric tonnes, thousands 290 45 270 Price in KSh per kilo 250 40 230 35 210 190 30 170 25 150 2013 2014 2013 2014 Source: Kenya National Bureau of Statistics. 6 December 2014 | Edition No. 11 The State of Kenya’s Economy Figure 1.8: Generation of electricity rose, and geothermal generation became the largest source of energy Total domestic electricity generation Domestic electricity generation by source, 2012-2014 800 450 Local electricity generation, million of KWh 750 400 350 700 300 Million KWh 650 250 600 200 150 550 100 January March May July September November January March May July September November January March May July September November 500 2012 2013 2014 2013 2014 Hydro Geo-thermal Thermal Source: Kenya National Bureau of Statistics. Geothermal generation is now the main source of however. Finance and insurance grew 10.3 percent, power in Kenya. The most significant development wholesale trade 10.9 percent, and ICT 14.6 percent. in the subsector was geothermal generation, which In addition, education, which grew 7.8 percent in became the largest source of energy, overtaking 2013, rose just 4.8 percent. hydroelectric power generation (Figure 1.8). This development is significant, because it will delink The hotel and restaurant sector has shrunk almost or reduce the negative impact of drought on 30 percent since 2012, as a result of security electricity prices. incidents and threats. The sector shrank 14.2 percent in the first three quarters of 2014, after contracting The security environment in 2014 dragged down by 5.2 percent in 2013. Some tourist hotels in coastal performance of the services sector. Services output areas have closed, eliminating many thousands jobs. grew 3.9 percent in the first three quarters of 2014, much lower than the 5.7 percent growth in 2013 The good news in the services sector is the (Figure 1.9). Leading subsectors in terms of growth continuing ICT revolution. The number of mobile were finance and insurance (9.1 percent), wholesale money transfer customers in 2014 stood at 26 and retail trade (8.5 percent), and information and million, and the number of transactions increased communication technology (ICT) (8.2 percent). All 24 percent, to 86 million (Figure 1.10). The value of these subsectors grew less rapidly than in 2013, of transactions of mobile payments increased 24 percent, to KSh 226 billion, and the number of Figure 1.9: Growth in the services sector slowed mobile agents rose 9 percent to 123,703. Financial and insurance Wholesale and retail trade Information and communication Inflation remained within target levels and Health declining oil prices reduced upside risks L ower energy and food prices and prudent Education Real estate monetary policy kept inflation low. Average Other services Transport and storage overall inflation stood at 6.9 percent in 2014, within Professional, administration the government target of 5.0 percent plus or minus and support Public administration 2.5 percentage points (Figure 1.11). The 2014 Accomodation and restaurant average inflation was higher than the 2013 average -25 -20 -15 -10 -5 0 5 10 15 (5.7 percent), as a result of higher prices of food (up First three quarters growth, percent 2014 2013 8.7 percent, from 7.3 percent in 2013) and transport Source: Kenya National Bureau of Statistics. (up 9.1 percent, from 4.8 percent in 2013). December 2014 | Edition No. 11 7 The State of Kenya’s Economy Figure 1.10: Mobile money payments continued to soar Mobile money payment 250 200 150 100 50 0 Jan Feb Mar Ap May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Ap May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Ap May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Ap May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Ap May Jun Jul Aug Sep Oct Nov Dec 2010 2011 2012 2013 2014 Number of customers (millions) Transactions (millions) Value of transactions (billions of KSh) Agents (thousands) Source: Central Bank of Kenya. Energy inflation is easing, thanks to lower Declining international oil prices should lower international oil prices, which have been pushing prices and boost aggregate demand. Kenya is oil electricity, gas, and transport prices down. The dependent, with about a quarter of its import bill average cost of a barrel of crude oil fell 39.3 percent attributed to oil. Most production use factors that between June and December 2014, from US$108.4 to use oil as an input, and the pass-through of changes US$ 60.7.3 Kenya’s energy inflation, which averaged in oil prices to domestic inflation is very high. 9.1 percent in June and July, dropped throughout Declining oil prices will boost the domestic economy the rest of year, standing at 6.0 percent in December. through both first- and second-round effects. First- round effects affect goods and activities that use Food inflation remains the main driver of inflation oil directly (for example, transport and electricity). in Kenya. In December 2014, it accounted for 45.8 Second-round effects occur through goods that use percent of total inflation. Energy accounted for 26.6 oil as inputs (for example, shipping costs, fertilizer percent,and items that constitute “core” inflation prices). There is a threat that most of these benefits accounted for 27.7 percent. may not be passed on to consumers. Between Figure 1.11 Inflation was low—albeit higher than in 2013 15 Contribution of food, energy and core inflation to overall inflation rate, May 2010 - December 2014 13 100 Inflation rate (percent) 11 80 9 60 7 5 40 3 20 1 0 -1 Food inflation Transport inflation Core inflation Overall inflation Food Energy Core Source: Kenya National Bureau of Statistics. 3 GEM commodities, Commodity price data (Pink sheet), World Bank. 8 December 2014 | Edition No. 11 The State of Kenya’s Economy September 2014 and February 2015, crude oil prices size and trend of fiscal indicators remain concerns. fell 48 percent but the price of unleaded gasoline The government’s commitment to fiscal discipline fell just 18 percent and the price of diesel just 19 is proving to be a challenge (Figure 1.13). Tax percent (Figure 1.12). Taking the lag effects of price revenues rose in 2013/14, but increased spending transmission to the domestic economy into account, made narrowing both the overall fiscal deficit and prices should have fallen by 39 percent. the primary balance a challenge. Large increases in government spending relative to revenue Figure 1.12: Gasoline prices fell—but by much less than international crude oil prices were fueled mainly by expenditures associated 120 with devolution, constitutional offices, and the infrastructure necessary for sustained growth. Total 100 government expenditure reached 25.9 percent of GDP in 2013/14, up from 24.8 percent in 2012/13. US$ per litre 80 Revenue rose from 18.8 percent to 19.4 percent of GDP during the same period. The fiscal deficit 60 stood at 6.2 percent of GDP in 2013/14, up from 5.1 percent in 2012/13. The primary balance (cash basis) fell 1.1 percentage points, from 2.4 percent to 3.5 40 percent of GDP. Figure 1.13: Kenya’s fiscal deficit has increased since 2006/07 Unleaded Diesel Murban ADNOC, crude oil Lagged crude oil 30 Source: Kenya National Bureau of Statistics (Leading Economic Indicators, various issues). 25 20 In the recent path, Kenya’s economic growth has been driven by higher public spending. Since 15 Percent of GDP 2008, growth has been jumpstarted by various 10 fiscal expansion measures that have led to growth 5 spurts: the economic stimulus program of 2009– (0.9) (2.5) (2.4) (3.5) 0 10 enhanced growth as did the devolution and (3.0) (4.5) (5.1) (6.2) increase in spending on public infrastructure in -5 2012/13 and 2013/14; recent public investment in -10 2006/07-2010/11 2011/12 2012/13 2013/14 the standard gauge railway project, roads, energy Government revenue Fiscal balance, after grants, cash basis Government expenditure Primary deficit, after grants, cash basis and the LAPSSET projects4 will enhance growth and Sources: National Treasury (Quarterly Economic and Budgetary Review, November strengthen economy’s ability to repay external debt. 2014) and Kenya National Bureau of Statistics. The procylical nature of Kenya’s fiscal policy raises questions about the sustainability of its growth The government tapped international markets to path and whether growth in Kenya is organic (and finance its budget. For the first time, the government therefore sustainable) or fiscally propelled (and issued a sovereign bond, worth US$2.75 billion, the therefore unsustainable). We discuss Kenya’s fiscal proceeds of which were used to repay a US$600 policy and outturns in the next section. million syndicated loan and finance energy and infrastructural projects. The issue was one of the 1.3 Fiscal policy was expansionary, increasing most successful Eurobonds in Africa in 2014, in the deficit and the debt burden terms of both the volume of the subscription and the K enya’s expansionary fiscal position needs to be under watch, as public debt continues to build up. Even with the recent GDP rebasing, the priced offered. External borrowing during 2013/14 increased by 2.9 percent of GDP, a significant increase over 2012/13. Domestic borrowing increased by 4 LAPSSET is the Lamu Port Southern Sudan-Ethiopia Transport—a transport and infrastructure project. December 2014 | Edition No. 11 9 The State of Kenya’s Economy 2.3 percent of GDP. Domestic borrowing remained moved off the national government rolls and on to dominated by Treasury bonds (82.1 percent of county budgets.5 However, the overall government total domestic borrowing) and Treasury bills (16.6 wage bill rose to 7.1 percent of GDP, up from 6.1 percent). The large share of longer maturities muted percent in 2012/13. Total government expenditure the effect on the debt service burden. on operations and maintenance fell to 6.1 percent of GDP in 2013/14, down from 8.1 percent (Table 1.3). Spending pressures are growing T he combined budgets of the central and local Development spending was marked by the governments expanded, although central commencement of several major projects in government spending declined slightly. Recurrent 2013/14. These included expansion of the Olkaria expenditure reached 17.6 percent of GDP, and geothermal plants and the start of construction of the development spending stood at 7.1 percent of GDP Standard Gauge Railway from Mombasa to Nairobi. (Figure 1.14). The decline in both recurrent and development central government spending reflected The public debt load rose, as a result of increased the devolution of functions and funding to county borrowing to finance planned and ongoing governments. Recurrent expenditure by the central infrastructure projects. In 2013/14 Kenya’s (net) government contracted 2.6 percentage points in public debt experienced the largest expansion since 2013/14, from 17.5 percent to 14.9 percent of GDP, 2000/01, increasing 24.9 percent (Figure 1.15). and development spending fell from 6.6 percent Public debt stood at 43.1 percent of GDP at the end to 6.4 percent of GDP. National transfers to county of 2013/14, following an uptick in both external and governments amounted to KSh 193.4 billion. Total domestic debt. The increase in external debt was county-level expenditure reached KSh 169.4 billion driven by the US$2 billion Eurobond issued in June (KSh 132.8 billion in recurrent spending and KSh 36.6 2014, an additional US$750 million in December billion in development spending). 2014 from the same issue. In addition, during the fourth quarter of 2013/14, the government The overall wage and salaries bill rose, and spending borrowed US$3.6 billion from China to finance on operations and maintenance fell. Wages and the 500-kilometer Standard Gauge Railway from salaries at the national level declined, falling from Mombasa to Nairobi. Consequently, external debt 6.1 percent of GDP in 2012/13 to 5.6 percent of GDP rose from 18.7 percent of GDP at the end of 2012/13 in 2013/14, as up to 60,000 former civil servants to 21.6 percent of GDP at the end of 2013/14. Figure 1.14: Total government spending rose, but spending by the central government fell Figure 1.15: Public debt has been rising but remains sustainable 18 50 16 45 40 14 35 25.6 22.2 Percent of GDP Percent of GDP 12 20.2 19.5 21.9 21.5 23.3 18.6 30 10 25 8 20 20.0 19.1 20.2 18.9 21.0 19.4 18.7 21.6 6 15 4 10 2 5 8 9 0 1 2 3 4 /0 /0 /1 /1 /1 /1 /1 0 07 08 09 10 11 12 13 20 20 20 20 20 20 20 Recurrent (national) Recurrent (central government) Development (national) Development (central government) External debt Domestic debt Total debt, net Sources: National Treasury (Quarterly Economic and Budgetary Review, November Sources: National Treasury (Quarterly Economic and Budgetary Review, November 2014) and Kenya National Bureau of Statistics. 2014) and Kenya National Bureau of Statistics. 5 “Over 60,000 Civil Servants Transferred to the Counties,” Daily Nation, January 28, 2014. http://mobile.nation.co.ke/news/Over-60000-civil-servants-transferred-to-the-counties/-/1950946/2164286/-/format/xhtml/-/tf9g6h/-/index.html 10 December 2014 | Edition No. 11 The State of Kenya’s Economy Table 1.3: Both recurrent and development spending rose in 2013/14 (percent of GDP) 2010/11 2011/12 2012/13 2013/14 Recurrent spending 17.2 16.3 17.5 17.6 Central government 17.2 16.3 17.5 14.9 Counties n.a n.a n.a 2.6 Wages and Salaries 5.8 5.5 6.1 7.1 Central government 5.8 5.5 6.1 5.6 Counties n.a n.a n.a 1.5 Interest payments 2.2 2.1 2.7 2.6 Pensions 0.7 0.7 0.6 0.6 Operations and maintainance 8.5 8.1 8.1 6.1 Transfers to counties _ _ 0.2 3.9 Development spending 6.4 7.4 6.6 7.1 Central government 6.4 7.4 6.6 6.4 Counties n.a n.a n.a 0.7 Judicial service _ _ 0.3 0.3 Parliamentary services _ _ 0.3 0.4 Total expenditure and net lending 23.5 23.7 24.8 25.9 Fiscal balance, cash basis after grants (3.4) (4.5) (5.1) (5.1) Central government (3.4) (4.5) (5.1) (6.2) Counties n.a n.a n.a 1.1 Sources: National Treasury (Quarterly Economic and Budgetary Review, November 2014); Kenya National Bureau of Statistics; and Office of the Controller of Budget. Note: —Not available. n.a. Not applicable. Domestic debt reached 25.6 percent of GDP, up from Figure 1.16: Kenya’s debt position is below the average of its middle-income peers 23.3 percent the previous fiscal year. Mauritius South Africa Public debt levels remain sustainable in the Middle-income Africa medium term. The joint World Bank–IMF Debt Middle-income Africa Sustainability Analysis results released in October (without South Africa) Kenya 2014 indicated low risk of distress for Kenya’s Tanzania domestic and external debt, with all debt indicators Zambia below debt burden thresholds. In addition, a large Uganda share of Kenya’s external debt is on concessional Sub-Saharan Africa rather than commercial terms, which lightens the Ethiopia debt service burden. The economy continues to rely on macroeconomic stability and resilient growth to 0 10 20 30 40 50 60 Public debt as percent of GDP, 2013 keep public debt within the government’s threshold Sources: National Treasury (Quarterly Economic and Budgetary Review, November of 45 percent of GDP. Kenya’s level of public debt 2014); Kenya National Bureau of Statistics; and World Economic Outlook (International Monetary Fund). is below the average of its middle-income peer countries (Figure 1.16). December 2014 | Edition No. 11 11 The State of Kenya’s Economy Revenues rose All sources of revenue exceeded targets. VAT R evenue collection rose significantly (Figure 1.17). revenues rose 13.1 percent, to stand at 4.6 percent Total tax revenue represented 19.4 percent of of GDP. Strong performance reflected reforms that GDP at the end of 2013/14, a 15.3 percent increase increased the VAT base by taxing some previously over the previous year. The increase followed zero-rated/exempt products and increasing the tax reforms and other measures implemented in number of VAT taxpayers in key business outlets. VAT 2013/14, including the VAT Act of September 2013 revenues reached KSh 232.6 billion, exceeding the and increased collection from rental income. Value- target of KSh 231.0 billion. Import duty collection added tax (VAT) on imports, import duty, excise duty, exceeded the target of KSh 67.3 billion to stand at and corporate tax were all above budgeted targets. KSh 67.6 billion (1.3 percent of GDP). Excise duty stood at KSh 102.0 billion (2.0 percent of GDP), Figure 1.17: All types of tax revenues rose against a target of KSh 101.2 billion. 10 9 The government continues to embark on initiatives 8 to increase tax revenue and narrow fiscal deficits. 7 Tax Procedure Bill 2014 would simplify the tax system Percent of GDP 6 by introducing uniform tax procedures for major tax 5 laws and enable automation. Customs and Excise 4 Duty Bill 2014 would impose a 25 percent duty on 3 steel (there is currently no duty).6 Both bills are 2 1 expected to be presented to Parliament in 2014/15. 0 In addition, the government will consider introducing 2006/07- 2011/12 2012/13 2013/14 an extractive industry tax and making changes to the 2010/11 Income tax VAT Import Duty Excise Duty income tax to reflect best international practices. Sources: National Treasury (Quarterly Economic and Budgetary Review, November These endeavors would facilitate investment by 2014) and Kenya National Bureau of Statistics. reducing the cost of doing business. Income tax remained the main source of tax Budget execution remains weak revenue. Income tax revenues represented 9.0 percent of GDP, up from 8.3 percent of GDP in 2012/13. The increase reflected good performance L ow budget absorption remains a challenge, despite slight improvement in ministerial implementation.7 The overall execution rate of of pay-as-you earn and corporation tax achieved ministerial expenditure stood at 86 percent, the after including county payrolls in the base. Income highest in five years. The average execution rate tax accounted for 46.1 percent of total revenue, of the recurrent budget since 2008/09 was 92 followed by VAT (23.9 percent), excise duty (10.5 percent. The development budget recorded low percent), and import duty (6.9 percent). Income tax execution rates, as a result of several challenges, is a tax on sources of production (labor and capital), including inadequate use of the Integrated Financial which can act as a distortion to economic activities Management Information System (IFMIS) for cash if overutilized. management, slow procurement, and insufficient local technical expertise and financial ability to implement projects.8 According to the Quarterly 6 National Treasury. 2014. Medium Term Budget Policy Statement. February Edition; and Highlight of the 2014/15 Budget by the Cabinet Secretary, National Treasury Henry Rotich. 7 There are large disparities between Quarterly Budget and Economic Review (QBER) and Office of the Controller of Budget (COB) data, for both gross estimates and actual spending. For example, the QBER indicates that 77 percent of the development budget was executed, whereas the COB gives a figure of 52 percent. 8 Office of the Controller of Budget. 2014. National Government Annual Budget Implementation Review report for 2013/14. 12 December 2014 | Edition No. 11 The State of Kenya’s Economy Budget and Economic Review, 77 percent of the of GDP); it is projected to stand at KSh 1.8 trillion 2013/14 development budget was executed, above (28.6 percent of GDP) in 2015/16 and reach KSh 2.0 the 65 percent average between 2008/09 and trillion (26.9 percent of GDP) in 2016/17. Because 2012/13. Although more public finance data have of major infrastructural projects highlighted in the been made available in recent years, there is scope Second Medium Term Plan (MTPII), the development for better consistency across budget documents. budget for the central government is estimated at Better funds flow is needed from the National 10.1 percent of GDP in 2014/15, 10.4 percent of Treasury, and procurement procedures need to be GDP in 2015/16, and 9.3 percent of GDP in 2016/17.9 improved if the economy is to reap greater benefits Although the government continues to strike a from public spending. balance between consolidating its fiscal position, supporting county governments, developing Execution rates varied widely across sectors. infrastructure, and creating employment, risks The Ministry of Health recorded the lowest could undermine this effort. These risks include execution rates, in both recurrent (73 percent) and growing expenditure pressures emanating from high development (56 percent) spending (Figure 1.18). recurrent expenditure on debt service and wages, Energy infrastructure and ICT ministries, which as well as the implementation risk of devolution. In accounted for 20 percent of the ministerial budget, addition, low economic growth would result in wide implemented 78 percent of their budgets. The deficits and high public debt. largest share of the budget (26 percent) went to human resource development through education. Counties ran surpluses but delayed This sector, which includes the Ministry of Education implementation of the development agenda C and the Teachers Service Commission, implemented ounties’ poor budget execution led to overall 91 percent of its budget. fiscal surplus in the first year of devolution. Unlike the central government, they registered The medium-term outlook shows fiscal budget surpluses in their first year of operations. consolidation—but not without risks These surpluses were achieved, however, at the F iscal expansion will continue in 2014/15, but the National Treasury projects fiscal consolidation in 2015/16 and 2016/17. Government expenditure in expense of executing the development budget. During their first fiscal year, county governments budgeted KSh 288.6 billion, to be financed mainly 2014/15 is estimated at KSh 1.7 trillion (30 percent by national transfers (KSh 210 billion), own revenue Figure 1.18: Budget execution of ministerial expenditure varied widely across sectors Ministerial expenditure for FY 2013/14 Overall ministerial budget implementation for FY 2013/14 Education National Security Energy, Infrastructure and ICT Education Public Administration and International Relations General, Economic and Commercial Affairs Governance, Justice, Law and Order Governance, Justice, Law and Order National Security Public Administration and International Agriculture, Rural and Relations Urban Development Social Protection, Culture and Recreation Environmental Protection, Water Environmental Protection, Water and Natural Resources and Natural Resources Health Energy, Infrastructure and ICT Social Protection, Culture and Recreation Agriculture, Rural and Urban Development General, Economic and Commercial Affairs Health 0 50 100 150 200 250 300 350 Billion, Ksh 0 20 40 60 80 100 120 Target Actual Percent Source: National Treasury (Quarterly Economic and Budgetary Review, November 2014). 9 The National Treasury. 2015. Medium Term Budget Policy Statement. February Edition. December 2014 | Edition No. 11 13 The State of Kenya’s Economy (KSh 67 billion), and the equalization fund (KSh 3.4 Poor expenditure performance was attributed billion). They managed to spend only KSh 169.4 to transitional challenges, including inadequate billion, 59 percent of the budget estimate (Figure capacity at the beginning of 2013/14, which affected 1.19). County governments’ total revenue consisted budget preparation, management, and execution. of national transfers (KSh 193.4 billion), own revenue Because there was no link between the budget cycle generation (KSh 26.3 billion), and KSh 4.3 billion and planning (as counties were operating in their rolled over from 2012/13, yielding a KSh 54.7 billion first fiscal year), frequent budget revisions were fiscal surplus (Table 1.4). needed. Most county governments have not yet Figure 1.19: County budget execution in 2013/14 was weak fully implemented the IFMIS, which affects funds County budget implementation flow management. These constraints appeared to 300 be transitional, however; both expenditure and 250 revenue implementation rates improved from quarter to quarter, with much improvement in the 200 123.4 second half of the year. Ksh billion 150 36.6 County budget execution remains a challenge, 100 165.2 132.8 particularly for development spending. Budget estimates were in line with 2012 Public Finance 50 Management Act thresholds, with counties 0 allocating 43 percent of their overall budget to Estimates Actual development expenditure. However, only a handful Recurrent Development Source: Office of the Controller of Budget. Table 1.4: County governments registered a surplus in 2013/14 (millions of KSh) 2012/13 2013/14 2014/15 Item (actual) Estimates (budgeted) Actual (budgeted) Revenues Total revenues 20,176 280,788 224,046 323,200 Transfers 13,420 213,400 193,419 229,300 Equitable share 9,658 190,000 193,419 226,700 Conditional grants (donors) 20,000 2,600 Equalization fund 3,400 3,400 Local Authority Transfer Fund 3,763 Roll over from previous fiscal year 4,331 27,420 Own revenues 6,756 67,388 26,296 63,080 Expenditures Total expenditure 16,226 288,625 169,352 311,050 Recurrent 14,912 165,221 132,799 176,490 Wages and salaries 6,530 74,740 77,376 Operations and maintenance 6,687 51,712 Other recurrent Debt payments 1,695 3,711 Development 1,313 123,404 36,553 134,560 Balance 3,951 (7,837) 54,694 12,150 Source: Office of the Controller of Budget and National Treasury (Medium Term Budget Policy Statement). 14 December 2014 | Edition No. 11 The State of Kenya’s Economy of counties achieved the minimum 30 percent of If not addressed, weak budget execution will total spending on development stipulated in the act. result in uneven development across counties. Actual development expenditure stood at KSh 36.6 Top performers in recurrent budget included Meru billion, just 22 percent of total expenditure (Figure (115 percent), Nyeri (108 percent), Murang’a 1.20). Personnel emoluments, which absorbed (102 percent), and Vihiga (100 percent). Bottom 46 percent of total expenditure (KSh 77.4 billion), performers included Turkana (36 percent), Garissa dominated county government spending, crowding (51 percent), and Lamu (53 percent). Outstanding out spending on development. Counties executed development spending was observed in Bomet 80 percent of the recurrent budget but less than (92 percent), Wajir (78 percent), and Trans Nzoia 30 percent of development expenditure. This large (74 percent). The lowest absorption rates were in disparity is explained by the fact that unlike recurrent Mombasa (2.4 percent), Tana River (2.7 percent), expenditure, development expenditure requires and Kisumu (4.0 percent). project preparation that must follow procurement procedures. Funding of the development agenda Few counties achieved their local revenue collection was also affected by delays in transfers by the targets. County governments generated only KSh national government, particularly in the first quarter. 26.3 billion, 39 percent of the annual target of KSh Figure 1.20: The lion’s share of county spending went to 67 billion. Weak revenue collection partly reflected recurrent expenditures, not development unrealistic projections made at the beginning of the Development expenditure Debt repayment fiscal year, which had to be revised in every quarter. Ksh 36.5 and pending bills 21.6% KSh 3.7 Remarkably, four counties overachieved their 2.2% revenue targets: West Pokot (155 percent), Kericho (110 percent), Marsabit (105 percent) and Tharaka Nithi (102 percent) (Figure 1.21). Low own revenue not only delays fiscal autonomy, it also affects project implementation. Cross-county comparisons showed a positive correlation between Operations and Personnel emoluments budget absorption rate and own revenue collection maintainance Ksh 77.4 billion Ksh 51.7 (45.7%) (Figure 1.22). (30.5%) Source: Office of the Controller of Budget. Figure 1.21: Revenue collection varied widely across counties Ratio of actual to target local revenue 160 Ratio of actual to target local revenue 140 120 100 80 60 50 percent target 40 20 0 ta M. N. ave a eyo rak aT Elg Tha Tait Source: Office of the Controller of Budget. December 2014 | Edition No. 11 15 The State of Kenya’s Economy Figure 1.22: In cross-county comparisons, low budget execution kept the rate constant (at 8.5 percent) for 21 is associated with poor revenue collection consecutive months ending in December 2014 (the 105 last policy rate change was in April 2013). Although the transmission mechanism has been slow, short- Expenditure (actual percent of estimates) 95 85 and long-term rates declined while private credit growth increased in response to lower interest 75 rates (Figure 1.23). 65 Short-term rates declined in line with the monetary 55 policy stance. The government’s demand for short- 45 term liquidity from commercial banks declined in 35 2014, easing pressure on short-term rates. The 0 20 40 60 80 100 120 140 160 reduction in demand was as a result of liquidity Local revenue (actual percent of target) injection by the Central Bank after monetizing Source: Office of the Controller of Budget. proceeds of the Eurobond. The weighted interbank National transfers to counties are estimated at rate fell 220 basis points, from 9.1 percent in KSh 229.3 billion in 2014/15, an 18.6 percent December 2013 to 6.9 percent in December 2014. increase over 2013/14.10 Transfers are expected to The 91-day Treasury bill rate fell 90 basis points, increase to KSh 256.3 billion in 2015/16 and KSh from 9.5 percent in December 2013 to 8.6 percent 282.9 billion in 2016/17. However, delivering the (average) in December 2014. devolution promise at the county level will require both prioritization of the development agenda Long-term rates also fell, although transmission of and continuous capacity building for better budget monetary policy to long-term rates remains weak. formulation and implementation. To enhance the transmission of policy rates on long-term rates, in July 2014 the National Treasury 1.4 The Central Bank’s monetary policy stance introduced the Kenya Banks Reference Rate (KBRR), supported growth an average of the central bank rate and the Treasury- T bill rate. Between December 2013 and December he Central Bank’s policy of keeping the central 2014, weighted lending rates declined 1 percent, bank rate constant paid off, as most market falling from 17 percent to 16 percent. Deposit rate rates declined. The Monetary Policy Committee Figure 1.23: Both short- and long-term rates declined Short-term interest rates, August 2010 - December 2014 Long-term interest rates, June 2007 - December 2014 30 30 Long-term interest rate (percent) 25 25 Interest rate (percent) 20 20 15 15 10 10 5 5 0 0 10 10 1 1 11 r-12 12 12 r-13 13 13 r-14 14 14 07 07 08 08 09 -09 -10 -10 -11 -11 -12 -12 -13 -14 -14 g- c- r-1 g- 1 c- g- c- g- c- g- c- n- c- n- c- un- c n c n c n c n n c Au De Ap Au De Ap Au De Ap Au De Ap Au De Ju De Ju De J De Ja De Ju De Ju De Ju Ju De Interbank 91-Day Tbill Central bank rate Deposit Lending Interest rate spread Source: Central Bank of Kenya. 10 The National Treasury. 2015. Medium Term Budget Policy Statement. February Edition. 16 December 2014 | Edition No. 11 The State of Kenya’s Economy Figure 1.24: The growth of monetary aggregates boosted private sector credit 40 40 Change in money supply (percent) 35 35 Annual growth (percent) 30 30 25 25 20 20 15 15 10 10 5 5 0 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 4 4 -1 -1 0 -5 ar- ep- ar- ep- ar- ep- ar- ep- ar- ep- ar- ep- ar- ep- - ar Sep Dec M S M S M S M S M S M S M S M 11 11 11 11 12 12 12 12 12 12 13 13 13 13 13 13 14 14 14 14 14 14 n- g- t- c- b- r- n- g- t- c- b- r- n- g- t- c- b- r- n- g- t- c- -10 Ju Au Oc De Fe Ap Ju Au Oc De Fe Ap Ju Au Oc De Fe Ap Ju Au Oc De Reserve money M0 M1 M0 M1 Private sector credit growth Source: Central Bank of Kenya. rose from 6.6 percent to 6.8 percent, and savings Credit to the private sector soared in 2014, rate increased from 1.6 percent to 1.8 percent. As increasing 22.2 percent, up from a 20.2 percent in a result, the interest rate spread (the difference 2013. The growth of credit increased in all sectors between lending and deposit rates) narrowed by except private households, consumer durables, 110 basis points, from 10.3 percent in December building, and construction and mining. 2013 to 9.2 percent in December 2014. Growth in credit to most sectors was in the double The Central Bank operationalized its policy stance digits. Credit to finance and insurance increased by allowing monetary aggregates to grow more 68.4 percent in 2014, after having contracted 8.5 rapidly in 2014. Reserve money rose 11.2 percent in percent in 2013 (Figure 1.25). Credit to transport September 2014, up from 9.2 percent in December and communication rose 45.6 percent, up from 2013; M2 rose 18.8, up from 11.1 percent; and M3 18.1 percent a year earlier. Credit to real estate grew 20.9 percent, up from 13.3 percent (Figure grew 32.4 percent, up from 22.5 percent. Credit to 1.24). This monetary expansion allowed credit to the private households rose 39.1 percent, up from 29.8 private sector to increase. percent in 2013. A few sectors saw slower increases Figure 1.25: Credit to the private sector was brisk Private sector credit growth by sector, December 2013 - December 2014 Contribution to credit growth, December 2013-December 2014 Finance and insurance Private households Transport & communication Real estate Private households Manufacturing Real estate Trade Manufacturing Transport & communication Agriculture Business services Business services Finance and insurance Trade Consumer durables Consumer durables Agriculture Building & construction Building & construction Mining & quarrying Mining & quarrying Other activities Other activities -40 -20 0 20 40 60 80 -6 -4 -2 0 2 4 6 8 Change in volume of credit to private sector (percent) Contribution to credit growth (percentage points) 2014 2013 2014 2013 Source: Central Bank of Kenya. Note: Unweighted growth is annual percentage growth. Weighted growth is annual growth times each sectors’ share of credit. December 2014 | Edition No. 11 17 The State of Kenya’s Economy in credit in 2014, though credit growth remained Figure 1.26: Kenya’s stock market underperformed the Dow robust. Credit to business services grew 25.0 percent 5500 19,000 in 2014, down from 52.6 percent in 2013; credit to 18,000 mining and quarrying decelerated by 15.8 percent, 5000 Dow Jones Industrial average 17,000 NSE index (1966 = 100) down from 11.0 percent in 2013. In terms of 16,000 4500 contribution to credit growth (weighted growth), the 15,000 top sectors were private households (5.8 percentage 4000 14,000 points), real estate (4.2 percentage points), 13,000 manufacturing (3.6 percentage points), trade (3.5 3500 12,000 percentage points), transport and communication 11,000 (2.6 percentage points), and business services (2.2 3000 10,000 percentage points). NSE 20-share index Dow Jones Industrial average Stock market performance was tepid, because Source: Central Bank of Kenya. of uncertainty about the capital gains tax vulnerability remain (Figure 1.27). The level of the P erformance of the Kenyan stock market was weak relative to global markets. The Nairobi Securities Exchange (NSE) stock index rose 3.8 percent, to deficit points to underlying structural weaknesses in Kenya’s economy that need to be dealt with in order to increase exports as a share of GDP, reduce 5,113, in 2014 (Figure 1.26). Over the same period, nonessential imports, or both. However, falling the Dow Jones rose 7.5 percent. Security concerns global oil prices may relegate the urgency of any and the imposition of a capital gains tax of 5 percent reform to a later date, as the current account deficit on sold stocks dampened performance. is forecast to decline to 4.7 percent by 2017. 1.5 Kenya’s external balance deteriorated in 2014 Higher non-oil imports and weak merchandise but is set to improve in 2015, thanks to falling exports are driving the current account deficit. oil prices Non-oil imports accounted for 23.5 percent of GDP, K enya’s external balance deteriorated in 2014, but the position is poised to improve in 2015. The current account deficit averaged 8.1 percent while merchandise exports accounted for just 10 percent. Merchandise imports grew 7.6 percent in 2014, up from 2.0 percent in 2013. Most of the of GDP during 2010–14. It reached 9.0 percent in growth was driven by non-oil merchandise imports, 2014, higher than the 8.7 percent level of 2013, which grew 8.5 percent in 2014, up from 4.5 percent confirming fears that threats to Kenya’s external in 2013. At the same time, merchandise exports Figure 1.27: Kenya’s external sector remains out of balance, with exports failing to keep up with imports 15 30 20 10 10 5 Percent of GDP Percent of GDP 0 0 -10 -5 -20 -30 -10 2006 2007 2008 2009 2010 2011 2012 2013 2014 -40 2006 2007 2008 2009 2010 2011 2012 2013 2014 -15 (Nov) (Nov) Current account Short-term flows (including net errors and ommissions) Exports (fob) Nonfactor services Imports (non-oil) Oil imports Other flows Overall balance Balance of trade Balance of trade (non-oil) Source: Central Bank of Kenya. 18 December 2014 | Edition No. 11 The State of Kenya’s Economy continued to be lower, growing at 1.3 percent, after Kenya’s major export crops underperformed in having contracted 5.8 percent in 2013. The tepid 2014. Merchandise exports grew marginally, at 3.9 performance of exports suggests that current policy percent in the 12 months ending November 2014— stances needs to be reviewed over the medium term. an improvement over 2013, when they declined 5.8 percent. Poor export performance was driven The vulnerability of the external account emanates by declines in major export goods, including tea from the fact that the current account is financed (exports of which fell 12.4 percent), manufactured mainly from short-terms flows, which can easily goods (down 15.6 percent), and chemicals (down reverse should the global economic environment 4.0 percent). On the positive side, exports of other change. In 2014 the current account deficit was goods—including nonfactor services (up 13.3 US$5.5 billion (9.0 percent of GDP). Long-term percent), coffee exports (up 20.1 percent), and flows totaled US$2.2 billion (3.7 percent of GDP), up horticulture exports (up 10.9 percent)—rose. from US$481 million (0.9 percent of GDP) in 2013. The difference was financed by short-terms flows, Exports are critical to reinvigorating Kenya’s growth US$4.7 billion (US$2.8 billion of which was errors and prospects, but policy makers have not taken omissions), equivalent to 7.8 percent of GDP (errors direct actions to promote production for export. and omissions represented 4.5 percent of GDP). Increasing exports, particularly in manufacturing, is crucial for creating the thousands of low-skilled jobs Kenya is still not attracting enough foreign direct needed to reduce high unemployment, particularly investment to finance its development. Capital among young people, whose unemployment poses account inflows are very small, accounting for just a threat to social stability. 2.6 percent of capital and financial account in 2014, from 1.8 percent in 2013. The significant inflows are After a significant slowdown in 2013, imports in the financial account. However, long-term flows recovered in 2014. Imports of merchandise grew accounted for only 15.0 percent of US$924 million in 7.6 percent, driven by machinery and transport (up 2014, up from 6.2 percent (US$334 million) in 2013 30.3 percent), chemicals (up 5.7 percent), and oil (up (Figure 1.28).11 4.0 percent). The growth in imports reflects some Figure 1.28: Short-term flows dominated the capital positive sentiment about Kenya’s growth prospects and financial account but mainly the import of equipment for geothermal 7 projects, the standard gauge railway, and, to a lesser 6 extent, oil and gas equipment. 5 Billions of dollars 4 The exports coverage ratio—often seen as a 3 crude indicator of an economy’s ability to pay for 2 its imports—continued to fall. Kenya’s ability to 1 finance its imports from exports has been declining 0 since 2006 (Figure 1.29). Merchandise exports were -1 able to finance 48 percent of merchandise imports 2014 2010 2011 2012 2013 (Nov) in 2006, 34.1 percent in 2013, and 33.1 percent in Capital account Financial account Official, medium and long-term Private, medium and long-term 2014. Adjusting for nonfactor services, the coverage Short term (including portfolio flows) Net errors and omissions (NEO) ratio deteriorated from 70 percent in 2006 to 56 Source: Central Bank of Kenya. percent in 2014.12 11 The credibility of balance of payment numbers, especially the classifications and recording of inflows, has been called into question. The debate is fueled by the high level of errors and omission in the balance of payments (which is not unusual) and by the sources of funding of some capital imports, which may not be recorded. 12 Nonfactor services include travel, transportation, and other services, including receipts and payments in dollars in the central bank foreign exchange statistics corresponding to embassies, UN agencies, development agencies, and receipts and payments relating to insurance, royalties, and license fees. December 2014 | Edition No. 11 19 The State of Kenya’s Economy Figure 1.29: The export coverage ratio has declined since 2000 The nominal exchange rate demonstrated mixed 80 performance in 2014. The shilling fell 4.2 percent against the U.S. dollar, remained stable against 70 the British pound (depreciating 0.5 percent), and 60 rose against the Euro (appreciating 5.0 percent) Percent 50 (Figure 1.30). 40 Weighted exchange rates indicate the need for 30 further adjustment. In the past 10 years, the shilling appreciated 33 percent in real terms and depreciated 20 2014 7 percent in nominal terms (Figure 1.31). Because 2006 2007 2008 2009 2010 2011 2012 2013 (Nov) Kenya’s competitiveness has been eroded, its exports Ratio of exports plus nonfactor services to imports Ratio of exports to imports have performed poorly in global markets. As a result, Source: Central Bank of Kenya. the share of exports inGDP has declined. These undesirable changes require policy consideration. Figure 1.30: The shilling demonstrated mixed performance Exchange rate versus the dollar, pound, and euro, January 2011 - December 2014 170 K sh per unit of foreign currency 160 150 140 130 120 110 100 90 80 70 Jan Mar April May June July Aug Oct Nov Dec Jan Mar Apr May Jun Jul Aug Oct Nov Dec Jan Mar April May June July Aug Oct Nov Dec Jan Mar May Aug Oct Dec Feb Sep Feb Sep Feb Sep Feb April June July Sep Nov Jan 2011 2012 2013 2014 2015 U.S. dollar British pound Euro Exchange rate versus the dollar, pound and Euro, December 2010 = 100 140 Index December 2010 = 100 130 120 110 100 90 Dec Jan Mar Feb April May June July Aug Oct Mar Apr May Sep Nov Dec Jan Feb Jun Jul Aug Oct Sep Nov Dec Jan Mar Feb April May June July Aug Oct Sep Nov Dec Jan Mar Feb April May June July Aug Oct Sep Nov Dec Jan 2011 2012 2013 2014 2015 Source: Central Bank of Kenya. U.S. dollar British pound Euro 20 December 2014 | Edition No. 11 The State of Kenya’s Economy Figure 1.31: The real exchange rate shows the shilling Remittances remained robust in 2014. Remittances has appreciated significantly since 2000 150 increased 11 percent in U.S. dollar terms in 2014, 140 from KSh 1.3 billion (2.3 percent of GDP) to KSh 1.4 130 billion (2.4 percent of GDP) (Figure 1.32). The boom Index (January 2003 = 100) 120 reflects both improved data collection by the Central 110 Bank and improved economic activity in North 100 America (the source of 50 percent of remittances) 90 and Europe (the source of 27 percent). These funds 80 are an importance source of financing for the current 70 account deficit. 60 Dec-01 Dec-06 Dec-11 Oct-02 Oct-07 Oct-12 Aug-03 Aug-08 Aug-13 Apr-05 Apr-10 Jan-04 Nov-04 Jan-09 Nov-09 Jan-14 Nov-14 Sep-00 Feb-01 Sep-05 Feb-06 Sep-10 Feb-11 May-02 May-07 May-12 Jun-04 Jun-09 Jun-14 Jul-01 Jul-06 Jul-11 Mar-03 Mar-08 Mar-13 Nominal effective exchange rate Real effective exchange rate Source: Central Bank of Kenya. Figure 1.32: Remittances reached an all-time high Sources: Central Bank of Kenya and Kenya National Bureau of Statistics. December 2014 | Edition No. 11 21 The State of Kenya’s Economy 2. Outlook for 2015–17 T he World Bank projects that Kenya will grow at 6.0 percent in 2015, 6.5 percent in 2016, and 7.0 percent in 2017. The new projections reflect the stimulus effect of the massive infrastructure investments currently being undertaken by the government and the effects of falling oil prices. These high growth figures are predicated on a sustained demand boost from infrastructure projects as they start coming on line; expansion of productive capacities, especially in electricity production and construction; increased manufacturing output, as a result of cheaper electricity and a weaker shilling; and lower crude oil prices. 2.1 Kenya’s growth prospects are favorable In the baseline scenario, GDP is projected to in the near to medium term grow 6.0 percent in 2015 and 6.6 percent in 2016, T he World Bank projects that economic growth thanks mainly to increased aggregate demand in Kenya will rise to 6.0 percent in 2015, after as a result of the ongoing infrastructural projects estimated growth of 5.4 percent in 2014. These and the fall in oil prices. The boost in real income estimates are higher than earlier projections, as a will allow a robust increase in private consumption, result of the ongoing infrastructural projects, lower the engine of Kenya’s economy. Higher public oil prices, and the 2014 rebasing of GDP, which investment spending on infrastructure, especially improved estimation of national accounts and on the standard gauge railway, will also stimulate reflected the new growth sectors, which had been the economy and enhance Kenya’s competitiveness, omitted. Average growth is projected to rise to 6.5 particularly beginning in 2016. Private investment in percent in 2016–17, supported by strong domestic the manufacturing sector will rise, supporting a rapid demand and tailwinds from lower oil prices (Figure increase in industrial production. A gradual pick-up 2.1). Growth will exceed the average for Sub-Saharan in tourism and continued recovery in agriculture will Africa, making Kenya one of the fastest-growing further support growth. In contrast, the contribution economies in the region over the next three years. of net exports is expected to be marginal. Although the fall in oil prices will reduce the current account Figure 2.1: The outlook for economic growth in Kenya is strong deficit, it will remain relatively large, because of slow Growth outlook, 2015 - 2016 export growth. 7.2 7.0 6.7 6.5 6.6 In the high-growth scenario, GDP will grow 6.5 6.2 6 percent in 2015 and 7.0 percent in 2016. Lower inflation—as a result of falling oil prices and the Percent 5.7 5.7 5.6 5.4 5.6 standard gauge railway—will provide the main boost 5.2 to the economy.13 The decline in the price of oil 4.7 will also reduce the current account deficit, easing 4.5 pressure on the shilling.14 Simulations suggest that 4.2 a 30 percent decline in the price of oil from the 2012 2013 2014 2015 2016 estimate forecast forecast baseline—that is, a price of US$45 a barrel—could Baseline High case scenario Low case scenario increase GDP growth by up to 1.2 percentage points Source: World Bank estimates. Note: Figures for 2014 are estimates. Figures for 2015 and 2016 are forecasts. in 2015. The positive externalities of the massive infrastructural projects (roads, railway, and energy) 13 The simulation results refer to 2015 not 2016. In the baseline forecast, GDP growth rises to 6 percent in 2015, from 5.4 percent in 2014. In the high-case scenario, GDP growth rises to 6.5 percent in 2015, a full 1 percentage point increase over 2014. A case could be made that growth could reach 7 percent in 2015. 14 In the baseline, the price of oil is relatively high (albeit lower than the oil baseline); security concerns continue to hurt tourism;and the current account deficit, though improving, remains relatively large, keeping Kenya vulnerable to a slowdown in capital inflows. Given the relatively large current account deficit, the shilling is likely to remain under pressure. As a result, inflation will be higher than it would otherwise have been, possibly prompting the Central Bank to raise interest rates. All of these risks are reduced in the high-case scenario. 22 December 2014 | Edition No. 11 The State of Kenya’s Economy and devolved county spending will also stimulate the problems have not gone away, however. Kenya’s economy. Lower inflation, and an improved outlook export sector has been lagging since the mid-1990s for the shilling, will decrease the likelihood that the (the last tea and coffee boom). As a result, Kenya central bank will tighten monetary policy, allowing relies too heavily on short-term capital flows to consumer and business confidence to increase. service its current account. In order to service and reduce external indebtedness, policy makers need to Even in the low-growth scenario, growth will be focus on increasing the production of traded goods higher in 2015 and beyond. Under this scenario, in order to enhance capacity to generate foreign GDP is projected to grow 5.6 percent in 2015 and exchange. Kenya will need to shift resources toward 2016 and 5.7 percent in 2017. The low-growth the export sector. scenario assumes that security concerns continue to hurt tourism. Another large-scale security incident 2.2 Risks have diminished, although they remain could significantly weaken the tourism industry, significant T with adverse spillovers to the rest of the economy. he risks to Kenya’s outlook are similar to those This scenario also assumes that investment remains highlighted in the June 2014 Update. On the constrained or delayed by the government’s focus on domestic front, the weak security environment current expenditure and security sector. In addition and fiscal position pose significant risks to growth the current account deficit remains high, despite the prospects. On the external front, the winding down fall in the price of oil, as a result of weaker recovery of monetary easing by the U.S. Federal Reserve of exports, keeping Kenya vulnerable to a slowdown and the subsequent increase in interest rates in in capital inflows. Pressures on the shilling could the United States may reduce growth in Kenya. A lead to interest rate hikes. deflated Euro area will dampen the growth pick-up the economy expects to see in the near to long term. The drop in global oil prices is a boon for Kenya, but it does not obviate the need to undertake reforms The security situation threatens growth. The Al to reduce the structural imbalance in the external Shabaab terrorists, who escalated their attacks in account. Kenya’s current account is projected to 2014, continue to be a threat to national security. drop from 8.3 percent of GDP in 2013 to 4.7 percent Terrorist activities have scared away tourists and in 2017 as a result of falling oil prices (Figure 2.2). potential investors. Tourist arrivals and hotel Lower oil prices will reduce the urgency of the occupancy rates have plummeted, and several structural reform agenda. The structural imbalance coastal hotels have closed. Tourism’s contribution to Figure 2.2: The current account balance is projected GDP declined by one third in 2014. to improve significantly as a result of lower oil prices Current account outlook, 2015-2016 The current expansionary fiscal path is not -4.0 2012 2013 2014 2015 2016 sustainable and presents a risk to growth. estimate forecast forecast Devolution added pressure to the fiscal position, -5.0 -5.5 but it is the lack of rationalization of spending after -5.8 devolution, the duplication of functions at the Percent -6.0 -6 - -6.5 national and county level, and the strong appetite -6.7 -7.0 -7.4 -7.0 for spending at both levels of government that have worsened Kenya’s fiscal position. Although -8.0 -8.3 heavy infrastructural spending is a boon for Kenya’s -8.5 production space and future growth, the short- to -9.0 medium-term macro-fiscal framework is shaky Baseline High case scenario Low case scenario should there be a macroeconomic shock. Source: World Bank estimates. December 2014 | Edition No. 11 23 The State of Kenya’s Economy Kenya remains vulnerable to the winding down of Structural reforms are needed to increase Kenya’s the U.S. monetary stimulus. Kenya’s economy has attractiveness as a destination for long-term benefited immensely from the Fed stimulus, in capital. Long-term capital inflows to Kenya represent terms of both short- and long-term capital flows. less than 2 percent of GDP. Foreign direct investment Yields on shilling-denominated assets have been (FDI) as a share of GDP is the lowest in the region high, outstripping the depreciation risks and large (Figure 2.3). Several reforms could help attract long- interest rate differentials, making Kenya a more term capital. First, Kenya could improve the business attractive destination for world capital than many climate, as discussed in Part 3 of this Update. Second, other emerging economies or Africa as a whole. With it could improve the macroeconomic environment, the ending of the Fed’s monetary stimulus, the flow to make export activities more profitable, so that of cheap capital that has been funding the current exports do not continue to lag imports. Third, it account could dry up, creating volatility in the foreign could initiate reforms that could lead to the real exchange market and prompting the Central Bank to depreciation of the exchange rate. Since 2003 the raise interest rates, which could choke growth. The real exchange rate has appreciated at an average strong dollar in the fourth quarter of 2014 and early annual rate of 3 percent. The interest rates on 2015 has already offset part of the benefits of low Treasury bills and other Kenyan securities continue international oil prices. to attract capital inflows, as the yields on shilling- denominated assets are high given the interest rate Deflation in the Euro area poses a risk to exports. differentials with other markets. As a result, the Weak exports will continue to drag down growth. shilling has been kept artificially strong, discouraging Europe is one of the main destinations of Kenya’s exports and encouraging imports (most consumer merchandise exports. It is also a main source of goods in Kenya are imported, as a walk down the tourists to Kenya, as well as the source of most aisle of any supermarket will attest). Fourth, Kenya equity funds. A continued or deeper slowdown in could create a more favorable tax regime. Recent tax Europe would hurt Kenya’s growth prospects. reforms will discourage FDI. Figure 2.3: Foreign direct investment in Kenya is much lower than in peer countries 800 2.5 Ghana 6.7 700 Tanzania 5.6 2.0 Uganda 600 5.3 US dollar, million Middle income 3.0 500 Sub-Saharan Africa 1.5 Percent (developing only) 2.4 400 South Africa 2.3 300 1.0 Lower middle income 2.1 Rwanda 1.5 200 0.5 Nigeria 1.1 100 Kenya 0.9 0 0 Burundi 0.3 2006 2007 2008 2009 2010 2011 2012 2013 0 1 2 3 4 5 6 7 FDI inward flow FDI inward flow, percent of GDP Foreign direct investment percent of GDP, 2013 Sources: UNCTAD and Kenya National Bureau of Statistics 24 December 2014 | Edition No. 11 Special Focus: Manufacturing and the Business Environment in Kenya Special Focus 3. Why is manufacturing important? 3.2 Introduction The contribution of the sector to aggregate K enya has set an ambitious development target productivity has still not recovered from the 1980s, that requires a significant contribution from suggesting inefficiencies in the economy’s ability to the manufacturing sector. In October 2013, the reallocate resources from low- to high-productivity government formulated the Second Medium-Term firms (“allocative efficiency”). Labor productivity Plan (MTP-2) to implement its Vision 2030. The in the manufacturing sector plummeted during the aim of Kenya Vision 2030 is to create “a globally 1980s and 1990s and has remained flat since the competitive and prosperous country with a high 2000s. The trends shown in Figure 3.1 suggest that quality of life by 2030” and to move Kenya into firms are unable to increase productivity and that the upper-middle income category. Achieving allocative efficiency in Kenya is low. these ambitious goals depends in large part on a Figure 3.1: Value added per worker in Kenya’s manufacturing sector is a fraction of what it was 30 years ago competitive manufacturing sector. 400 The contribution of the manufacturing sector is 350 especially important given Kenya’s demographic Value added per worker (KSh) 300 structure. As a result of reductions in mortality 250 rates and high birth rates, more than half a million 200 people are joining the labor force in Kenya every year, and this figure is expected to rise to 1 million a 150 year by 2030 (UN 2011). Only a little more than half 100 the current labor force is employed in the formal 50 sector and youth unemployment rate is twice that 0 of the overall population, according to the 2009 Kenya Census. Absorbing such a large number Total economy Manufacturing of new entrants and youth into the formal sector Source: de Vries, Timmer, and de Vries 2013. requires massive employment creation in higher- productivity jobs. Low allocative efficiency likely reflects distortions in the use of factors of production, such as labor Manufacturing performance over the past seven and capital, some of which can be explained by a years was disappointing, with manufacturing weak business environment.1 Barriers to firm entry growth (3.1 percent) significantly lagging overall and exit, limited access to information technology, economic growth (5.0 percent). The sector’s market distortions, and burdensome regulations contribution to value added and merchandise constrain allocative efficiency. As a result, firms exports decreased or stagnated relative to other grow less than their potential, severely constraining sectors. There are indications that firms are operating the ability of the manufacturing sector to generate below their capacity and that employment growth employment and contribute to poverty reduction is far below potential. Moreover, the relative size of and shared prosperity. Kenya’s manufacturing sector has been stagnant, the sector has lost international competitiveness, and it is struggling with low productivity and structural inefficiencies. 1 Land is also a factor of production. Limited data precluded it from the analysis. 26 December 2014 | Edition No. 11 Special Focus This Kenya Economic Update Special Topic examines 3.2 The contribution of manufacturing to GDP the structural factors underpinning the poor and exports has been stagnant M performance of the manufacturing sector. Drawing anufacturing has an important role to play on recent firm-level data from the 2010 Industrial in putting Kenya on a higher growth path Census and the 2013 Enterprise Survey (Box 3.1), because it can create productive employment.3 it investigates the extent to which the sector’s lack With its strong linkages to virtually all other of dynamism reflects problems in Kenya’s business sectors of the economy, manufacturing stimulates environment, which compares poorly to regional more economic activity than any other sector. neighbors’ on several manufacturing-relevant Some subsectors, such as clothing and leather, are dimensions.2 particularly labor intensive. If competitive, they have the potential to absorb thousands of workers. This Special Topic is structured as follows. The Manufacturing is also a source of tradable goods, next section describes the performance of the potentially strengthening a country’s terms of trade manufacturing sector in recent years. Section and facilitating global integration and knowledge 3.3 analyzes its allocative efficiency. Section 3.4 spillovers, which are critical in promoting structural describes the business environment in Kenya and transformation (the reallocation of economic its importance for the manufacturing sector. Section activity across the broad sectors of agriculture, 3.5 looks at specific factors that manufacturing firms manufacturing, and services). Manufacturing can perceive as obstacles to business and how both the also contribute to the diversification of the economy, perception and manifestation of these obstacles thereby helping mitigate volatility. have changed over time. It also compares Kenya’s business environment with that of other countries. Section 3.6 proposes policies that could help relieve constraints and boost growth. Box 3.1: Data used in the analysis The main datasets used in this analysis are the World Bank’s 2007 and 2013 Enterprise Surveys, the Kenya National Bureau of Statistics (KNBS) 2010 Census of Industrial Production, the KNBS monthly surveys of industrial production, and the World Bank’s 2015 Doing Business report. Both Enterprise Surveys are available at www.enterprisesurveys.org. The Census of Industrial Production dataset and the monthly surveys of industrial production are available upon request from the KNBS (www.knbs.or.ke). Doing Business can be accessed at www.doingbusiness.org. The datasets complement one another. The 2013 Enterprise Survey includes both qualitative and quantitative information on the business constraints firms face. It is based on a sample of 781 firms, 414 of which are in the manufacturing sector. Eighty-three of these firms, including 51 manufacturing firms, also participated in the 2007 Enterprise Survey. The KNBS 2010 Census of Industrial Production sampled 2,246 firms, 2,089 of which are in manufacturing. Subsequent data on manufacturing firm performance collected through the monthly KNBS surveys of industrial production (which are based on a smaller sample of firms) are benchmarked to this 2010 census, allowing for some comparisons over time. For the manufacturing sector, the Census and Enterprise Survey samples are similar in terms of average firm age and subsector size. Doing Business measures regulations that enhance and constrain business activity at the subnational and national levels. It presents quantitative indicators on business regulations and the protection of property rights that can be compared across 189 economies and over time. Subnational Doing Business reports are available for Kenya for 2009 and 2012. The 2012 report covers 13 localities. Source: World Bank 2 The informal sector makes an important contribution to growth, value added, and employment in the manufacturing industry. Although the size of the informal sector is difficult to ascertain—the last survey was conducted in 1999—ongoing research suggests it may account for more than 60 percent of leather industry employment and more than 50 percent of furniture industry production. This Special Topic covers formal firms only. Ongoing work on informal firms and microenterprises will analyze the informal sector. For other research on manufacturing, see “Firm-Level Innovation and Productivity in Kenya” (World Bank 2015). In addition to the paper on informal firms and microenterprises, the World Bank is preparing a paper on firm competitiveness in the manufacturing and services sectors, and conducting in-depth research on key subsectors in the manufacturing industry, including leather and leather products, furniture and metal fabrication, food processing, and textiles and apparel. 3 Except were indicated otherwise, the data used in this section are from the KNBS Economic Survey and Statistical Abstract 2014. December 2014 | Edition No. 11 27 Special Focus Kenya’s manufacturing sector is small relative Figure 3.3: Manufacturing growth in comparator countries was more rapid than in Kenya to agriculture and services. In 2013 the sector 18 accounted for 11 percent of GDP (World 16 Development Indicators), 26 percent of merchandise 14 exports, and 12 percent of total formal employment, 12 with about 280,000 people employed (KNBS 2013b). Percent 10 Real output growth in the sector was 5.9 percent 8 in 2013, with the nominal value of output reaching 6 KSh1,480 billion. 4 2 Growth in manufacturing trails that of the overall 0 economy, and the percentage contribution of -2 2008 2009 2010 2011 2012 2013 manufacturing to GDP and merchandise exports Bangladesh Vietnam Ethiopia has stagnated. Growth of the sector (4.3 percent) Kenya Tanzania Source: World Development Indicators. lagged average growth of the economy (6.2 percent) between 2010 and 2013 (Figure 3.2) and was slower in Kenya than incomparator countries Food production is the dominant manufacturing (Figure 3.3). In addition, the sector’s share of GDP activity in Kenya, accounting for 32 percent of declined, from 13 percent in 2006 to 12 percent in total manufacturing output in 2013. The food 2011 and 11 percent in 2012 and 2013. This share subsector leverages Kenya’s large agricultural is similar to the average for Sub-Saharan Africa, but economy and strong domestic demand. Other key sector growth was much lower than incomparator subsectors are beverages and tobacco products countries (Figure 3.4). The share of manufacturing (8.3 percent of manufacturing output), chemicals in merchandise exports hovered between 26 and (5.5 percent), printing and reproduction of 28 percent between 2009 and 2013. Performance recorded media (5.1 percent), and rubber and in 2014 was better. Manufacturing grew 7.9 in the plastic products (4.8 percent). first quarter and 9.1 percent in the second quarter, second only to the construction sector and stronger Dairy products, pharmaceuticals, and metals were than overall GDP growth, according to KNBS the fastest-growing manufacturing subsectors statistics updated after GDP rebasing. between 2009 and 2013 (Table 3.1).4 Dairy Figure 3.4: The manufacturing sector’s contribution to Kenya’s GDP Figure 3.2: Manufacturing growth trailed overall economic growth was similar to that of comparator countries in 2013, but sector in Kenya between 2010 and 2013 growth was much slower 9 11.7 20 12 8 18 11.6 10 16 Contribution to GDP (percent) 7 Contribution to GDP b(percent) 11.5 Average annual growth 14 8 6 12 11.4 5 10 6 11.3 Percent 4 8 11.2 4 6 3 11.1 4 2 2 2 11.0 1 0 0 0 10.9 2010 2011 2012 2013 -1 10.8 Manufacturing growth rate GDP growth rate Contribution to GDP Contribution to GDP in 2013 Average annual growth rate, 2008 -2013 Source: Kenya National Bureau of Statistics. Sources: World Development Indicators and Kenya National Bureau of Statistics. 4 This list is disaggregated further from Table 3.1 to include subsectors within the food products manufacturing sector as well as some of the subsectors grouped under “other manufacturing” subsectors. 28 December 2014 | Edition No. 11 Special Focus Table 3.1: Growth rates and shares of manufacturing subsectors in Kenya, 2013 (percent) Compound annual Share of total Subsector growth rate manufacturing in 2009–13 2013 Total food products 4.8 32.0 Other manufacturing (jewelry, musical instruments, sports goods, games 14.7 16.4 and toys, and other articles) Beverages and tobacco products 0.5 8.3 Chemicals and chemical products 4.3 5.5 Printing and reproduction of recorded media 0.3 5.1 Rubber and plastic products 4.2 4.8 Fabricated metal except machinery and equipment 12.9 4.2 Other nonmetallic mineral products 7.5 4.1 Coke and refined petroleum products –17.2 4.0 Basic metals 10.6 3.5 Paper and paper products 3.5 2.8 Micro and small enterprises (based on KNBS classification) — 9.3 Source: Kenya National Bureau of Statistics 2013a, 2013b. Note: — Not available. products grew by a compound annual rate of 18.0 40 percent of Kenya’s manufacturing exports go to percent, pharmaceutical products by 15.9 percent, the EAC, according to COMTRADE mirror import fabricated metals by 12.9 percent, and basic metals data. Traditionally, Kenya was the largest exporter of by 10.6 percent. Subsectors in decline included various manufactured goods to the EAC. Its market petroleum products (–17.2 percent), machinery share has declined for a range of products, however, and equipment (–6.9 percent), fish processing (–6.8 including plastics, chemicals, and paper (Figure 3.6). percent), wearing apparel (–3.9 percent), and wood and wood products (–0.2 percent). Figure 3.5: The East African Community reduced its imports from Kenya in 2013 12 1400 The competitiveness of Kenya’s manufacturing exports has been slowly declining. Kenya’s 10 1200 manufacturing exports represented about 0.02 Market share (percent) Value (million US $) 1000 8 percent of global manufacturing exports in 800 2013, down from 0.06 percent in 1994 and 0.18 6 percent in 1980s (World Development Indicators). 600 In 2013 South Africa, the regional champion in 4 400 manufacturing exports, produced 0.3 percent of 2 200 global manufacturing exports—15 times more than Kenya. 0 2009 2010 2011 2012 2013 0 Value of manufacturing imports from Kenya Share of total EAC manufacturing imports The share of manufactured goods imported by Source: UN COMTRADE. the East African Community (EAC) from Kenya Note: Manufacturing exports are broadly defined to include animal and vegetable declined, from 9 percent of total manufacturing oils, fish and meat preparations, sugar and confectionery, flour and cereal preparations, vegetable and fruit preparations, beverages, cement and tobacco imports in 2009 to just 7 percent in 2013 (Figure manufactures, and other manufactures. 3.5). These changes are significant because almost December 2014 | Edition No. 11 29 Special Focus Figure 3.6: Kenya’s share of imports of chemicals, plastics, and paper by the East African Community has been falling Chemicals - EAC import partners by market share Plastics - EAC import partners by market share Paper - EAC import partners by market share 20 25 45 18 40 16 20 35 Market share (percent) Market share (percent) Market share (percent) 14 30 12 15 25 10 20 8 10 15 6 4 5 10 2 5 0 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Kenya India Kenya Saudi Arabia Kenya China & India Source: UN COMTRADE. Note: Chemical imports include sodium bicarbonate, metal silicates(used in cement and textile processing), carbon dioxide, and sulphur dioxide. Chemicals exported from Kenya do not include fertilizers, most of which are reexports. Kenya sells about 60 percent of its manufactured Kenya has many exporting firms, but the average exports outside the EAC. Key importers include value of their exports is relatively low. Between the Common Market for East and Southern Africa 2006 and 2009, about 5,000 firms a year exported (COMESA); the United States (apparel under the from Kenya, according to the World Bank’s Exporter African Growth and Opportunity Act [AGOA] treaty); Dynamics Database, which comprises data received India (chemicals and leather); Italy (leather); and from national customs authorities. This figure is China (leather, copper articles) (Table 3.2). several times larger than the exporter base of regional Table 3.2: Kenya’s top 10 manufacturing exports and top 2 export destinations, 2013 Compound Exports annual Percentage 2013 growth rate of total Top two Commodity (thousands of exports manufacturing destinations, 2013 of dollars) 2009–13 exports (percent) Articles of apparel and clothing accessories 332,541 11.8 14.7 United States, Canada Preparations of vegetables, fruit, and nuts 143,220 5.3 6.3 France, Germany Inorganic chemicals 103,156 7.4 4.5 Uganda, Tanzania Tobacco and manufactured tobacco substitutes 91,187 3.6 4.0 Mauritius, Zambia Boilers, machinery,and mechanical appliances and 90,815 –3.3 4.0 Tanzania, Uganda parts thereofa Raw hides and skins (other than furskins) and 89,511 20.3 3.9 Italy, China leather Iron and steel 81,682 10.6 3.6 Uganda, Rwanda Plastics and articles thereof 81,278 13.8 3.6 Uganda, Tanzania Soap, organic surface-active agents 75,153 11.2 3.3 Tanzania, Uganda Electrical machinery and equipmenta 69,606 –1.1 3.1 Tanzania, Uganda Source: UN COMTRADE. Note: Manufacturing exports are broadly defined to include processed food products, such as animal and vegetable oils, fish and meat preparations, sugar and confectionery, flour and cereal preparations and vegetable and fruit preparations; beverages; cement; and tobacco manufactures. a Potential reexport. 30 December 2014 | Edition No. 11 Special Focus comparators (Farole and Mukim 2013). However, 3.3 Allocative inefficiency is low and hinders Kenya’s average merchandise export value per job creation M exporter is the lowest among its peers, including EAC isallocation, distortions, and inefficiencies countries. For 2006–09 the average annual export undermine productivity growth. value per Kenyan exporter was US$817,961—far Misallocation—the underutilization of labor lower than the average for Tanzania (US$1,293,260) and capital by more productive firms (or the or (Uganda) US$1,179,209. The median Kenyan overutilization of these factors by less productive exporter exported just US$17,500 worth of goods firms)—represents a critical constraint to annually—less than in the Arab Republic of Egypt productivity growth. It occurs because of distortions (US$64,588), South Africa (US$29,434), and even in financial, labor, and factor markets or regulations Tanzania (US$18,000). that constrain firm growth. Restuccia and Rogerson (2008) estimate that misallocation explains about 60 The survival rate of exporting manufacturing firms percent of the differences in aggregate total factor is low. One of the main challenges to sustainable productivity (TFP)6 between rich and poor countries. export growth in developing TFP differences ultimately translate countries is the high mortality rate into differences in standards of of exporters, particularly in the first living. few years of entering export markets. One of the main This problem is particularly acute for challenges to Misallocation undermines firm Kenya, which has the second-lowest sustainable export growth and entry. The intuition survival rate of exporters among growth in developing behind the growing body of a group of countries that includes literature on the critical effect of countries is the high other EAC countries, South Africa, misallocation is simple. Market and Nicaragua (Farole and Mukim mortality rate of 2013). Among sampled firms in exporters, particularly distortions, policies, and market failures, such as costly regulations Kenya, about 65 percent exited the in the first few years of or unequal access to finance, export market by their second year entering export markets disproportionally affect firms that of operation. In addition, export are more productive. For example, churning—defined as the difference in new export inefficient financial markets may under-finance relationships between firms created and finished those more productive projects from younger and in one year—is very small in Kenya compared with more productive companies. As a result, more peer countries, and the number of new export productive firms use less capital and labor than they relationships has been decreasing.5 otherwise would and grow below their potential, and potentially competitive ventures cannot enter These export competitiveness problems suggest the market. At the same time, less productive firms significant inefficiencies. Low churning implies amass more resources than they should and are less the inefficient allocation of resources in the likely to exit the market. Together these distortions domestic economy: the most productive firms are undermine one of the fundamental drivers of not entering into new export relationships and/ productivity growth: allocative efficiency. or inefficient firms are not exiting (less plausibly, it could indicate that inefficient firms enter and fail to survive in export markets). The next section explores the extent of these inefficiencies in Kenya’s manufacturing sector. 5 An export relationship is a contractual agreement in which a firm sells goods or services to another entity in the international market. 6 TFP is a measure of efficiency calculated as the portion of output that is not explained by the amount of inputs, capital and labor that is used in production. It reflects how efficiently these inputs are being used and is calculated as the residual from subtracting output from the contribution of the factors of production. December 2014 | Edition No. 11 31 Special Focus Empirically, economies with low allocative figure shows that dispersion is very great: 10 on the efficiency tend to suffer from the following log scale is equivalent to a difference of about KSh characteristics: 22,000 in value added per worker for firms in the • low firm entry and exit same sector. • large productivity differences within and across sectors Value added per worker reveals significant • low correlation between size and productivity productivity differences across subsectors. Labor • higher employment growth in older firms than in productivity is particularly low in textiles and in newer firms. wood products and furniture (Table 3.3). Although Kenya’s Census of Industrial Production Within-subsector productivity differences are very does not provide information on entry and exit, large. The right-hand column in table 3.3 shows the it allows the calculation of other indicators of ratio of the productivity of the 80th percentile of firms allocative efficiency—productivity dispersion, the to the productivity of the 20th percentile of firms. relationship between firm size and productivity, and These ratios are large. To put them in perspective, the relationship between firm age and employment in India and Mexico,the average productivity of the growth—that shed light on how misallocation is top 90 percent of firms is five times the average affecting manufacturing. productivity of the bottom 10 percent of firms in the same subsector, according to Hsieh and Klenow The extremely large differences in productivity (2011).7 The fact that the aggregate definition of across Kenyan manufacturing firms suggest the sectors used is broad and the industrial base small presence of significant distortions in the allocation may have raised the values somewhat (ideally, of factors that allow low-productivity firms to one would compare firms producing very similar remain in the market. Figure 3.7 shows a box plot products), but the results nevertheless suggest of labor productivity, measured as the log of value that productivity dispersion within subsectors and added per worker for all manufacturing sectors. The resource misallocation is great. Figure 3.7: Labor productivity (log of value added per worker-lva_l) varies widely across manufacturing subsectors Other mining OUTLIER Food products More than 3/2 times of upper quartile Beverages Textiles MAXIMUM Wearing apparel Greatest value, excluding outliers Leather Wood UPPER QUARTILE Paper and paper products 25% of data greater than this value Printing Chemicals and chemicals products Basic pharmaceuticals Rubber and plastics products MEDIAN Other non-metallic minerals 50% of data is greater than this value; Basic metals middle of dataset Fabricated metal products Machinery and equipments Motor vehicles, trailers LOWER QUARTILE Furniture 25% of data less than this value Other manufacturing Repair and installation of machinery MINIMUM Water collection Less value excluding outliers OUTLIER -10 -5 0 5 Less than 3/2 times lower quartile Labor productivity (log of value added per worker-Iva_I) Source: World Bank, based on data from the 2010 Industrial Census. Note: Each box shows the difference in productivity between the 25th percentile and the 75th percentile of firms. The line in the middle of each box represents the median firm in terms of labor productivity. The narrow lines indicate the dispersion of productivity; the dots outside the line are the extreme values. Labor productivity is measured by value added per worker. See “How to Read a Box Plot” (http://practicalstats.labanca.net/index.php?title=The_Box_Plot). 7 The 80/20 measure is superior to the 90/10 measure, because it reduces the impact of extreme values. 32 December 2014 | Edition No. 11 Special Focus Table 3.3: Labor productivity in Kenya, by manufacturing subsector, 2010 Ratio Value added Olley and Pakes between most productive ISIC Number per worker covariance Standard 80 percent ISIC code and least code of firms relative to the terma Standard deviation productive textile sector deviation 20 percent of firms All 1,653 18.8 –0.3 1.8 14.6 08 Mining and quarrying 42 41.0 0.2 1.8 18.7 10 Food products 552 23.1 –0.1 1.6 13.5 11 Beverages 39 60.3 0.7 1.8 17.1 13 Textiles 93 1.0 –2.5 2.1 19.6 14 Wearing apparel 45 11.2 –0.4 1.4 7.9 15 Leather and related products 26 35.9 0.4 1.7 6.6 16 Wood and products of wood 64 4.2 –0.9 2.0 23.9 17 Paper and paper products 40 39.8 0.2 1.4 9.7 18 Printing and reproduction of recorded material 143 70.0 0.8 1.7 14.2 20 Chemicals and chemical products 97 32.3 –0.2 1.6 8.9 21 Basic pharmaceutical products 20 19.0 –0.3 2.1 53.6 22 Rubber and plastics products 92 38.5 0.3 1.4 7.8 23 Other nonmetallic minerals 35 59.9 0.6 1.4 9.6 24 Basic metals 26 37.1 0 2.3 12.5 25 Fabricated metal products 70 57.0 0.6 1.7 7.9 27 Electrical equipment 14 32.3 0 2.0 87.8 28 Machinery and equipment 22 13.7 0.9 2.6 21.8 29 Motor vehicles, trailers 40 34.4 0.3 1.6 9.5 31 Furniture 43 6.9 0.3 1.8 18.9 32 Other manufacturing 22 23.2 0.3 1.5 10.3 33 Repair and installation of machinery 57 77.2 –0.2 2.0 37.5 35 Electricity, gas, steam, and air conditioning 14 371.3 0.8 2.0 6.1 36 Water collection, treatment, and supply 57 18.7 0.1 1.4 7.1 Source: World Bank, based on data from the 2010 Industrial Census. a. When this term is zero, productivity growth is distributed randomly across firms of all sizes. When this term is positive and large, firm productivity and size are correlated (more productive firms grow in size, and less productive firms shrink or exit the market). Larger firms in Kenya are not more productive level for an industry or economy as the sum of than smaller firms simple-average productivity and the covariance I f resources are efficiently distributed, productivity between firm size and productivity. This covariance should be correlated with firm size. If resources term measures the extent to which allocation are reallocated from low-productivity firms to high- is efficient: if it is zero, productivity growth is productivity firms, high-productivity firms grow in distributed randomly across firms of all sizes. If it is size and market share. Based on this simple notion, positive and large, productivity and firm size move in Olley and Pakes (1996) define a metric for the extent the same direction, meaning more productive firms of resource reallocation using cross-sectional data. become larger and less productive firms become They decompose the weighted-average productivity smaller or even exit the market. December 2014 | Edition No. 11 33 Special Focus Higher-productivity firms in Kenya tend to of labor productivity in the average manufacturing be smaller, suggesting significant allocative industry is 0.5 in the United States and 0.2–0.3 in inefficiency. Table 3.4 shows the within-subsector Europe. Negative covariance values are seen only and overall Olley-Pakes (OP) covariance term for in Central and Eastern European countries at the two measures of total factor productivity and one beginning of their transition to a market economy. measure of labor productivity.8 The last two rows show the industry total, the first using all firms Textiles and wood products appear to have the lowest and the second weighting the within-subsector allocative efficiency; the largest manufacturing OP covariance terms. For labor productivity (value subsector in terms of employment—food—also added per worker), the covariance is–0.28, indicating shows significant inefficiencies. Covariance terms that productivity changes and size are negatively vary significantly by subsector. Leather, beverages, correlated. This result is the opposite of what one and printing have positive and large covariance finds in economies with efficient mechanisms terms, which suggest that larger firms are reaping for allocating resources. To put these figures in about 50 percent of the productivity gains compared international perspective, the OP covariance index with a random allocation of productivity across all Table 3.4: Correlation between productivity growth and firm size in Kenya, by sector ISIC OP(value added/ Subsector OP-TFP1 OP-TFP2 code labor)) 08 Other mining and quarrying 0.1 –0.2 0.2 10 Good products –0.1 –0.1 –0.1 11 Beverages 0.2 0.3 0.7 13 Textiles –0.3 –0.4 –2.5 14 Wearing apparel –0.2 –0.3 –0.4 15 Leather and related products 0.7 0.4 0.4 16 Wood and of products of wood –0.3 –0.7 –0.9 17 Paper and paper products –0.3 –0.1 0.2 18 Printing and reproduction of recorded material 0.2 0.5 0.8 20 Chemicals and chemical products –0.4 0.4 –0.2 21 Basic pharmaceutical products 0.0 –0.5 –0.3 22 Rubber and plastics products 0.1 0.2 0.3 23 Other nonmetallic minerals 0.2 0.4 0.6 25 Fabricated metal products 0.3 0.4 0.6 29 Motor vehicles, trailers 0.0 0.1 0.3 31 Furniture –0.2 –0.5 0.3 32 Other manufacturing 0.0 –0.1 0.3 33 Repair and installation of machinery –0.2 –0.5 –0.2 36 Water collection, treatment, and supply –0.3 –0.1 0.1 Industry OP –0.1 –0.1 –0.3 Industry OP weighted –0.1 –0.1 –0.2 Source: World Bank, based on data from the 2010 Industrial Census. Note: Table shows Olley and Pakes (OP) covariance terms. OP TFP1 is calculated by estimating a Cobb-Douglas production function for each subsector and regressing output on capital, labor, and materials. OP TFP2 is the residual of estimating a regression of value added on capital and labor for each sector. 8 OP TFP1 is calculated by estimating a Cobb-Douglas production function for each subsector, where output is regressed on capital, labor, and input materials. OP TFP2 is the residual of estimating a regression of value added on capital and labor for each subsector. 34 December 2014 | Edition No. 11 Special Focus sizes. The food, textiles, and wood subsectors, with Misallocation of resources constrains their low allocative efficiency, are driving down the employment growth M industry aggregate. As a result, more productive isallocation reduces aggregate productivity. firms in Kenya’s manufacturing sector are not on When misallocation is prevalent, high- average becoming larger. productivity firms lack the resources required to grow, while low-productivity firms remain in the In some subsectors—and for the manufacturing market and are too large for their productivity level. sector as a whole—low-productivity firms employ The result is a drag on the economy: firms’ growth more workers than high-productivity firms. over the life cycle is significantly constrained, and Figure 3.8 shows the average employment level aggregate productivity is reduced. Hsieh and Klenow for the most productive (90th percentile) and least (2009) estimate that if India and China allocated productive (10th percentile) firms compared with their existing resources as efficiently as the Unites average employment of the median firm (50th States, aggregate total factor productivity could percentile). In the “other mining and quarrying” increase by 30–50 percent in China and 40–60 subsector, low-productivity firms are almost as percent in India. large as the median productivity firm while high- productivity firms are three times larger than the Misallocation constrains firms’ growth. Hsieh and median productivity firm, which is what should Klenow (2011) show how the growth of a firm in the be expected in an allocative efficient economy. United States, Mexico, and India varies over the life However, for the manufacturing sector as a whole, cycle. Figure 3.9 shows that the life cycle dynamics the results are striking -less productive firms are of Kenya are similar to those of India: “old” firms larger than more productive firms. In addition, in employ two to three times as many workers as most subsectors where more productive firms are young firms. In contrast, in the United States, such larger, differences in employment tend to be small. firms employ more than six times as many workers. This result contrasts with results for the European Thus relative to a young firm, an old firm in the Union, where low-productivity firms are always United States creates twice the employment of an smaller than the median-productivity firm and high- old firm in Kenya. productive firms are 5–12 times larger than the median-productivity firm. Figure 3.8: In many subsectors in Kenya, lower-productivity firms employ more workers than higher-productivity firms Other mining and quarrying Food products Beverages Textiles Wearing apparel Leather and related products Wood and of products of wood Paper and paper products Printing and reproduction of recorded material Chemicals and chemical products Basic pharmaceutical products Rubber and plastic products Other non-metallic minerals Fabricated metal products Motor vehicles, trailers Furniture Other manufacturing Repairs and installation of machinery Water collection, treatment and supply Industry aggregate 0 1 2 3 4 5 6 7 Size as the ratio of the size of the median productivity firm 90th percentile 10th percentile Source: World Bank, based on data from the 2010 Industrial Census. Note: Firm size refers to number of employees. December 2014 | Edition No. 11 35 Special Focus Figure 3.9: “Old” firms in the United States create twice as much 3.4 A good business environment allows firms to employment as “old” firms in Kenya 7 grow and create jobs versus number of employees in younger firms (<5 years) 6 A healthy business environment—including the Ratio of number of employees in older firms 5 legal, regulatory, and institutional framework for doing business—is a key contributing factor 4 Kenya to country income and growth. Although it is not 3 USA always the deciding factor—many countries with 2 Mexico poor business environments enjoy high income and 1 growth, often thanks to large markets or natural resources—it can have profound effects on the 0 <5 5-10 10-14 15-19 20-24 25-29 30-34 >35 potential of firms to enter a market, operate, and Age of the firm (years) grow. Key aspects of the business environment Average employment 2009 in relation to young firms Hsieh and Klenow USA Hsieh and Klenow Mexico include the following: Source: World Bank, based on data from the 2010 Industrial Census and Hsieh and Klenow (2011). • ease of firm entry, corruption, and informality (Djankov and others 2002) Allocative inefficiencies are constraining the ability • ease of entry and the growth of existing versus of Kenya’s manufacturing sector to contribute to new firms (Fisman and Allende 2004) the employment objectives set in Vision 2030. • credit information and the ratio of private credit The significant misallocation of resources in Kenya’s to GDP (Djankov, McLiesh, and Ramalho 2006) manufacturing sector hampers the ability of firms • contract enforcement and informality (Quintin to absorb the large numbers of new labor market 2003) entrants and create the higher-productivity jobs • property rights and growth (Acemoglu and necessary to achieve the goals of Vision 2030. Robinson 2006) • investor protection and financial market Removing the distortions that prevent greater development (Castro, Clementi, and MacDonald allocative efficiency could substantially boost 2004) productivity and employment. Evidence from • labor and product market regulation and entry other countries suggests that potential culprits lie of small and medium-size firms (Scarpetta and in trade policy, regulatory frameworks related to others 2002). the business environment, market failures related to access to finance, and labor market distortions. Kenya, represented by Nairobi, ranks in the Protective tariffs, which provide shelter to inefficient bottom half of the 189 economies assessed by and uncompetitive firms,increase input costs the 2015 Doing Business report on these key for firms in the formal sector. A weak regulatory aspects of the business environment. Nairobi has environment disproportionately hurts formal sector the most economic activity in Kenya, but it is also firms and can deter investment from the most the most difficult place in the country to comply productive firms while promoting overinvestment with local regulations affecting entry and contract in the informal sector. Inadequate access to credit enforcement.9 A difficult business environment may can act as barrier when high productivity firms have distort the market, causing allocative inefficiencies difficulty accessing capital. Labor market distortions toward less productive firms and away from more are another potential deterrent, as the formal sector competitive ones. can face skills shortages and taxation can reduce demand for labor in the formal sector. Research is needed to assess the prevalence and magnitude of these potential distortions in Kenya. 9 Doing Business in Kenya 2012 compares Nairobi with 12 other Kenyan cities on starting a business, dealing with construction permits, and registering property and enforcing contracts. The top-ranked cities in Kenya were Malaba, Narok, and Thika. 36 December 2014 | Edition No. 11 Special Focus The business environment is a key input Kenya’s business environment is challenging, in manufacturing particularly for the manufacturing sector T he business environment is particularly salient for manufacturing firms, especially firms deciding whether or not to enter a market E nterprise Surveys and the annual Doing Business indicators offer a quantitative basis for assessing Kenya’s business environment relative or to grow within an existing one (Li 2000). to regional and international comparators. These Certain aspects of the business environment have rankings and benchmarks cover the legal, regulatory, important effects on the entry and operation and institutional dimensions that comprise the of firms in manufacturing. Start-up procedures, business environment, as well as various physical including both administrative and industry-specific constraints, such as electricity and infrastructure. licenses, are a typical constraint. Such regulations Although Doing Business provides useful high-level may be the symptom of policies that reinforce an information on business regulations for local firms, uneven playing field in certain subsectors, brought it provides only a partial assessment of the business about by political connectedness, protection of environment, to be complemented by qualitative national industries, and industrial policy, among data, as well as other metrics. other reasons. Globally, tax payment, trade logistics, labor The manufacturing sector is capital intensive at regulations, and electricity are generally most entry. Access to finance may therefore affect the salient for existing manufacturing firms. Despite entry and growth of manufacturing firms. In contrast, being one of the better features of the business continuing operations may be labor intensive, environment in Kenya, paying taxes is a complex as costs tilt toward labor and initial investments process. Kenyan firms make 30 contributions a year, transition to maintenance costs. Labor regulations taking 201 staff hours to calculate, file, and pay their (and labor skills) may affect operational costs and taxes. For traders, logistics are a major hindrance. productivity. Property and building regulations, On average, the procedures and documentation as well as environmental controls, may be most needed to import or export take 26 days to relevant for firms at entry and expansion, whereas complete in Kenya. Nine documents are required for tax rates and administration are recurring hurdles imports and eight for exports. The export process in that may have a stronger impact on operations. Tanzania, Rwanda, and Uganda is simpler, requiring just seven documents. The time to export from Other factors not traditionally considered part Kenya is 26 days, compared with 18 in Tanzania, 26 in of the business environment may also constrain Rwanda, and 28 in Uganda (Rwanda and Uganda are manufacturing firms. These factors include landlocked). Labor regulations are not particularly electricity (price, access, and reliability) and rigid in Kenya; hiring is flexible, although there are transport infrastructure. The key constraints some restrictions on lay-offs, which require third- typically cited by manufacturing firms may thus be party notifications. Kenya ranks 151th out of 189 grouped into the following categories: economies on obtaining an electrical connection. • business entry and licenses Connecting to the grid in Nairobi requires 6 steps, • property, building, and environmental regulations takes more than 5 months, and costs 10 times • labor regulations and skills average Gross National Income (GNI) per capita. The • tax compliance cost of electricity is also onerous: in 2013 Kenyan • electricity and infrastructure (Ishengoma and manufacturers paid US$0.20 per kilowatt-hour, Kappel 2011; Deloitte 2014). many times the rate in Tanzania (US$0.08) or South Africa (US$0.05).10 10 Kenyan tariff data are from the Kenya Power and Lighting Company. South African tariff data are from Eskom South Africa Tariffs.Tanzania tariff data are from the Tanzania Electricity Supply Company. December 2014 | Edition No. 11 37 Special Focus Cumbersome processes required to start a Figure 3.10: The strongest aspects of Kenya’s business environment are starting a business, obtaining construction permits, and paying taxes business and difficulty accessing finance to acquire or lease property or build a warehouse represent Starting a business initial hurdles for entrepreneurs. The numerous (74.02) Resolving indolvency Dealing with construction permts procedures and documentation required for (33.31) (71.02) standard business procedures, such as business start-up, licenses, import/export, and tax payments, Enforcing contracts Getting electricity (48.96) (58.85) privilege informal arrangements over official channels, which are slow and bureaucratic. For Trading across borders Registering property example, it takes 10 steps and 1 month to start a (54.49) (56.88) business and 9 steps and 2.5 months to transfer a property title in Nairobi. Although business start-up Paying taxes (71.49) Getting credit (35.00) is Kenya’s best aspect of the business environment Protecting minority investors (45.83) as measured by DB, it is still a long way from global Source: Doing Business (World Bank 2014b). or regional best practices. Conditions are better Note: Proximity to frontier is on a 0–100 scale, with 100 representing global best elsewhere in Kenya: although these processes are practice. The “getting electricity” indicator is excluded from the overall distance metric (left), and uses data from Doing Business 2010 (the earliest year available) regulated at the national level, the length of time it instead of Doing Business 2006. takes to register a property varies across cities. In Mombasa it takes just 28 days, compared with 72 questions: relative perceptions (“what was the days in Nairobi and 93 days in Isiolo. Kenya ranks biggest obstacle confronting your firm?”), absolute relatively highly in terms of overall access to finance perceptions (“to what degree was this specific factor (116/189 economies). But it scores 7 (out of 12) an obstacle?”), and quantitative manifestations on the legal rights index and 0 (out of 8) on credit (“what was the estimated loss in sales due to this information. Its private credit bureau covers less factor?”). Although this multidimensional approach than 5 percent of the adult population, and lending makes the assessment more comprehensive, it also interest rates are high, at about 17 percent.11 These complicates interpretation of the results, because figures suggest that access to finance may continue the responses to the three sets of questions are to be an issue for both potential and existing not always consistent. Comparisons across time firms. In the apparel and footwear subsector, an must also be interpreted with care, because important constraint is competition with imported although many of the questions in the 2013 survey second-hand clothing and accessories donated were also asked in the 2007 survey, the sample of by foreign charities, which are sold at prices far manufacturing firms in the two years was different below those of Kenyan products, and competition (just 51 firms participated in both surveys). with new apparel smuggled in with second-hand clothing (see Figure 3.10). What are the biggest obstacles? (relative perceptions) 3.5 What obstacles and constraints do firms face? Evidence from Enterprise Surveys K enyan firms perceived competition from the informal sector, electricity, and lack of access to W hile the Doing Business indicators paint a finance as the top obstacles in 2013. When asked picture of the legal rules and procedures to identify the biggest obstacle to business, 18.5 for starting and operating a business in Kenya, the percent of firms cited “practices of competitors in the Enterprise Survey asks firms about actual obstacles informal sector,” 16.5 percent cited “electricity,” and and binding constraints they face. Obstacles 12.7 percent cited “access to finance” (Figure 3.11). are assessed on the basis of three categories of Tax rates, corruption, and trade regulations were 11 In December 2013, the average lending rate was 17.3 percent in Kenya, 11.9 percent in Egypt, and 9.25 percent in South Africa (Central Bank of Kenya and www. tradingeconomics.com). 38 December 2014 | Edition No. 11 Special Focus Figure 3.11: Manufacturing firms’ perceptions of obstacles Meanwhile, informality, trade regulations, and to doing business changed between 2007 and 2013 lack of access to finance became more important Change in percentage of firms (2007-2013) constraints. The number of manufacturing firms Practices of the informal sector 9.9 Electricity (1.1) rating these factors as their top obstacle in 2013 Access to finance Tax rates 4.3 was significantly higher than in 2007. For access (4.8) Corruption 1.1 to finance, the increase is consistent with the rise Customs and trade regulations 5.2 Political instability 4.9 in lending rates from 13.3 percent in 2007 to 17.3 Crime, theft and disorder Transportation (5.9) percent in December 2013, although these rates 15.5) Labor regulations 2.2 have since begun to recede. tax administration 0.5 Access to land 1.4 Inadequately educated workforce Business licensing and permts 0.3 2.2 How severe are the obstacles? (absolute Courts 0.6 perceptions) O 5 0 10 15 20 Percentage of firms n an absolute scale, firms still perceived 2013 2007 Source: World Bank, based on data from the 2007 and 2013 Enterprise Surveys electricity, competition from the informal for Kenya. sector, corruption, and tax rates to be among the most severe obstacles to business in 2013, the next most cited responses. It is not immediately although political instability was also a concern. apparent which “practices of the informal sector” On a scale of 0–4, with 0 indicating no obstacle businesses are referring to and further research is and 4 a very severe obstacle, electricity averaged needed to better understand the constraint and 2.1 in 2013, the highest of 16 obstacles firms were design an appropriate solution. Regarding electricity, asked to assess. Corruption, political stability, and businesses typically refer to its high cost and poor informality came in at 1.7, with obstacles related to reliability. Access to finance refers to high lending tax rates not far behind (Table 3.5). rates, which prohibit most firms from borrowing (an analysis of the top 100 midsized firms in Kenya revealed the high cost of credit as the main reason However, unlike in the case of relative perceptions for cash flow challenges).12 (where, by definition, the importance of some obstacles must rise at the expense of others), Transportation, crime, theft, and disorder became a decline in the perceived absolute severity of less important constraints for the manufacturing obstacles was reported across almost all categories sector between 2007 and 2013. Less than 4 between 2007 and 2013. Firms perceived the percent of firms cited transportation as their top severity to have fallen most for telecommunications obstacle in 2013, down from 19 percent in 2007. (likely related to rapid technological improvements This change likely reflects the completion of major over this period, particularly the penetration of infrastructure rehabilitation projects—such as mobile networks and devices). The severity of expansion of the Thika-Nairobi highway, which was crime, tax rates and tax administration, transport, completed in 2007—after decades of neglect. The and workings of the courts also declined.14 The only importance of crime, theft, and disorder fell from obstacle firms perceived to have risen in severity fourth place in 2007 to eighth in 2013. This change was the availability of educated workers. The same probably reflects the unrest leading up to the 2007 broad-based decline in perceived obstacle severity election, the increase in security provision, the is observed among the 51 firms that participated in crackdown on political violence in the aftermath of both survey years, suggesting that the results of the the turbulent election period, and the peaceful first larger sample are representative. eight months of the 2013 election period, when most firms were surveyed.13 12 Top 100 Mid-Sized Companies is an annual survey by auditing firm KPMG East Africa and Nation Media Group. 13 Most of the Enterprise Survey was conducted before the Westgate terrorist attack at the end of September 2013 and the security incidents that followed it. 14 The World Bank’s Financial and Legal Sector Technical Assistance Project (FLSTAP) likely played a role in improving the perceived functioning of the courts. December 2014 | Edition No. 11 39 Special Focus Table 3.5: Severity of obstacles to firm performance in the manufacturing sector, 2007 and 2013 (0 = no obstacle, 4 = very severe obstacle) Enterprise survey: Obstacles to firm performance in manufacturing sector (0 = no obstacle, 4 = very severe obstacle) Full sample Panel of 51 firms in both surveys Obstacles Increase (+) / Increase (+)/ 2007 2013 2007 2013 decrease (-) decrease (-) Inadequately educated workforce 0.9 1.1 + 1.0 1.3 + Electricity 2.5 2.1 - 2.4 2.0 - Political instability 2.3 1.7 - 2.3 1.7 - Corruption 2.4 1.7 - 2.7 1.8 - Practices of competitors in informal sector 2.2 1.7 - 2.3 1.8 - Tax rates 2.5 1.6 - 2.7 1.6 - Transport 2.3 1.5 - 2.4 1.6 - Access to finance 1.8 1.5 - 1.6 0.9 - Customs and Trade regulations 1.9 1.4 - 2.0 1.5 - Crime theft and disorder 2.4 1.4 - 2.5 1.3 - Tax administration 2.2 1.3 - 2.2 1.5 - Access to land 2.0 1.3 - 2.1 1.0 - Labor regulations 1.3 1.2 - 1.4 1.2 - Telecommunications 2.6 1.2 - 2.6 1.1 - Business and licensing permits 1.7 1.0 - 1.4 0.9 - Courts 1.9 1.0 - 2.1 1.0 - Source: World Bank, based on data from the 2007 and 2013 Enterprise Surveys for Kenya. Note: 0 = no obstacle, 4 = very severe obstacle. The changes in obstacle severity are less clearcut Figure 3.12: Average change in perceived obstacles by manufacturing subsector (2007-2013) across subsectors and depend on the subset of 0 firms analyzed. For the full sample of manufacturing firms in the 2007 and 2013 surveys, firms involved -0.2 Index point (on 0-4 scale) in machinery and equipment manufacturing -0.4 perceived the largest average decline in their obstacles to business (Figure 3.12). Among the 51 -0.6 firms surveyed in both 2007 and 2013, the largest -0.8 perceived declines occurred for firms engaged in -1 chemicals and metal manufacturing. Wood, wood products -1.2 metal products Machinery and manufacturing and furniture Non-metallic equipment Metal and Chemicals Garments -1.4 minerals Textiles Other Food Full sample Panel Source: World Bank, based on data from the 2007 and 2013 Enterprise Surveys for Kenya. 40 December 2014 | Edition No. 11 Special Focus Quantitative manifestations of obstacles 3.6). The correlation between the two measures is T he relative and absolute perceptions of firms surprisingly low. Moreover, for most categories, were not necessarily consistent with the the change in the de facto obstacles from 2007 to quantitative manifestation of obstacles they 2013 ran in the opposite direction of the perceived reported in other questions in the survey. In addition obstacles. In the case of crime, theft, and disorder, to rating the perceived severity of various obstacles, for example, manufacturing firms perceived a 40 firms were asked supplementary questions about percent decline in the severity of this obstacle but the de facto manifestations of these obstacles (Table reported that their sales losses from theft, robbery, Table 3.6: Perceived obstacles and their de facto counterparts in Enterprise survey Correlation with Units of 2007 2013 Change perceived obstacle measurement Electricity 0-4 scale 2.4 2.0 - Losses due to power outages 0.08 % of sales 4.6 5.6 + Electricity from own or shared generator 0.07 % of total 16.4 13.1 - electricity Crime, theft, and disorder 0-4 scale 2.5 1.3 - Value of products lost in transit due to theft -0.25 % of total 1.4 0.5 - value Expenses on security -0.21 % of sales 1.5 6.0 + Losses due to theft, robbery, vandalism or arson 0.05 % of sales 2.1 3.8 + Customs and Trade regulations 0-4 scale 2.0 1.5 - Avg. days for exported goods to clear customs -0.12 days 6.5 8.0 + Avg. days for imported goods to clear customs -0.14 days 10.8 15.6 + Regulatory burden, licensing and permits 0-4 scale 1.4 0.9 - Senior management time spent on compliance 0.04 % of total 8.2 10.6 + with government regulations hours Days to obtain business operating license 0.04 days 13.9 12.1 - Days to obtain import license 0.05 days 11.4 8.4 - Tax administration 0-4 scale 2.2 1.5 - Frequency of visits/inspections by tax officials 0.05 # per year 5.4 2.5 - Corruption 2.7 1.8 - Informal payments made 0.12 % of sales 2.6 1.0 - Avg. payment in informal gifts to government to 0.04 % of contract 8.1 0.9 - secure contract? value Access to finance 0-4 scale 1.6 0.9 - Average annual interest rate of the most -0.03 % 13.7 17.3 + recently approved overdraft facility Average annual interest rate on most recent 0.02 % 14.6 16.9 + credit line or loan Value of collateral required as percent of loan -0.01 % 136.4 145.4 + amount Inadequately educated workforce 0-4 scale 1.0 1.3 + Educational attainment of typical production 0.03 1-4 scale* 3.1 3.6 - ** worker Source: World Bank, based on data from the 2007 and 2013 Enterprise Surveys for Kenya. * 1=0-2 years; 2= 3-6 years; 3= 7-12 years; 4= over 13 years ** Since average years of education increased, the implied constraints related to inadequately educated workers decreased. December 2014 | Edition No. 11 41 Special Focus vandalism, or arson had more than doubled, as This finding may suggest that although the de facto had their expenditures on general security. These burden of these obstacles increased, firms became discrepancies may partly be explained by the better at dealing with them and therefore did not tendency of some firms to use different respondents perceive them to be as detrimental to business for different questions of the survey: the high-level performance as they had earlier. “perceptions” questions are generally answered by managers or executives, while the quantitative Are perceptions consistent with questions (e.g. impacts on sales) tend to be delegated reported realities? W to staff in the finance or accounting departments. hile the perceptions of firms are good But while this may explain inconsistencies among indicators of how they rate the severity select firms, the contradicting pattern across the of various obstacles, the quantitative impact whole survey sample raises broader concerns about assessments appear to be the better barometer of the extent to which perception surveys accurately the magnitude of various obstacles’ severity and reflect day-to-day business realities. its change over time. The Enterprise Survey results portray a deteriorating business environment in For firms in manufacturing activities where the Kenya. Compared with 2007, manufacturing firms contrast between perceived obstacles and their in 2013 faced increased difficulties in financing de facto business impacts is most pronounced, the investments (because of higher interest rates); difference may reflect a certain degree of “adaptive operating in a safe and cost-effective manner coping. Firms in the chemicals and nonmetallic (because of higher crime, theft, and disorder, more minerals subsectors saw the average quantitative unreliable access to electricity, and higher costs impact of obstacles rise the most between 2007 of regulatory compliance); and getting electricity and 2013, particularly with regard to customs (because of cost and lack of reliability). The regulations and crime, theft and disorder, even worsening of these problems helps explain why the though they perceived a significant easing in the manufacturing sector struggles to grow, productivity severity of these obstacle categories (Figure 3.13). remains low, and resources in the sector continue to Figure 3.13: Average change in de facto obstacles be misallocated. by manufacturing subsector 1 How does Kenya’s business environment 0.5 compare with regional and international comparators’? Standard deviati on from the mean F 0 irms in many comparator countries cite -0.5 inadequate access to finance as the top constraint, both across sectors (Table 3.7) and -1 in manufacturing (Table 3.8).15 Other top factors Wood, wood products -1.5 include political instability (Bangladesh), practices metal products of the informal sector (the Lao People’s Democratic Machinery and manufacturing and furniture Non-metallic equipment Metal and Chemicals Garments -2 Republic), and electricity (Uganda). minerals Textiles Other Food Full sample 51 firms surveyed both in 2007 and 2013 Source: World Bank, based on data from the 2007 and 2013 Enterprise Surveys for Kenya. 15 Access to finance is the top constraint globally, in East Asia, and in Sub-Saharan Africa;firms in South Asia typically point to political instability as their top concern. In some countries, manufacturing firms are more likely than the average firm to cite constraints in electricity and infrastructure, tax administration, business regulations, property and building regulations, and labor laws and skills. 42 December 2014 | Edition No. 11 Special Focus Table 3.7: Most important obstacles to doing business in selected comparator countries (all sectors) (percent of firms citing obstacle as top constraint) Bangladesh Ethiopia Ghana Kenya Lao PDR Tanzania Uganda Zambia Obstacle 2013 2011 2013 2013 2012 2013 2013 2013 Access to finance 13.8 33.2 49.5 9.7 13.1 37.9 12.4 27.5 Access to land 2.9 22.9 6.2 4.7 4.0 5.0 6.6 8.6 Business licensing and permits 0.5 0.1 0.5 2.7 2.9 3.1 7.8 3.7 Corruption 7.9 2.7 3.9 12.5 4.9 2.5 2.5 2.5 Courts 0.0 0.4 0.5 0.4 0.3 0.0 0.0 0.1 Crime, theft and disorder 0.9 0.1 0.6 4.2 2.6 1.9 0.7 2.6 Customs and trade regulations 1.4 5.2 6.5 4.6 3.1 3.2 1.7 0.9 Electricity 27.8 12.2 18.7 9.9 4.0 24.9 23.2 13.1 Inadequately educated workforce 4.0 1.8 0.8 1.6 17.1 1.7 0.4 2.6 Labor regulations 0.4 0.4 0.8 1.2 1.0 1.2 0.4 2.3 Political instability 36.7 0.1 1.4 9.6 0.2 1.1 1.6 0.5 Practices of the informal sector 1.2 4.5 2.9 24.1 17.6 6.1 19.8 22.5 Tax administration 0.5 7.1 1.4 2.9 6.4 1.3 1.3 6.9 Tax rates 1.4 7.0 5.3 9.0 14.7 8.3 18.1 5.2 Transportation 0.6 2.2 1.2 2.9 8.3 1.9 3.5 1.1 Source: World Bank Enterprise Survey. Note: Surveys were conducted in 2013 in all countries except Ethiopia (2011) and Lao PDR (2012). Table 3.8: Most important obstacles to doing business in selected comparator countries (manufacturing sector) (percent of firms citing obstacle as top constraint) Bangladesh Ethiopia Ghana Kenya Lao PDR Tanzania Uganda Zambia Obstacle 2013 2011 2013 2013 2012 2013 2013 2013 Access to finance 14.4 31.1 48.3 12.7 19.0 42.0 17.8 32.6 Access to land 2.9 12.9 6.4 2.1 0.6 3.6 5.2 6.5 Business licensing and permits 0.5 0.7 0.4 0.3 5.9 2.9 4.9 1.8 Corruption 9.6 10.0 3.0 8.4 6.7 1.1 1.3 7.6 Courts 0.0 0.2 0.2 0.0 0.0 0.0 0.1 0 Crime, theft and disorder 1.1 0.8 0.6 6.4 0.0 1.1 1.6 2.4 Customs and trade regulations 1.4 3.3 6.1 8.3 0.8 1.6 1.8 2.8 Electricity 27.9 14.4 22.3 16.5 6.0 32.4 28.5 11.7 Inadequately educated workforce 4.9 1.8 0.9 1.1 13.2 0.3 0.4 2.4 Labor regulations 0.5 0.2 0.6 3.0 1.6 0.4 0.5 2.3 Political instability 33.4 0.4 0.8 8.3 0.0 1.2 5.4 0.2 Practices of the informal sector 1.6 6.7 3.4 18.5 17.1 2.1 10.8 20.3 Tax administration 0.6 5.0 1.7 2.4 8.3 0.6 1.4 1.6 Tax rates 0.9 4.8 4.1 8.7 15.8 8.0 15.6 5.2 Transportation 0.3 7.8 1.1 3.3 4.9 2.8 4.8 2.6 Source: World Bank Enterprise Survey. Note: Surveys were conducted in 2013 in all countries except Ethiopia (2011) and Lao PDR (2012). December 2014 | Edition No. 11 43 Special Focus Kenya steadily narrowed the distance to the global Figure 3.14: Kenya’s business environment first stagnated and then deteriorated, while conditions in most of its peer countries improved good practice frontier between 2008 and 2014, 70 but progress was slow. It introduced and improved electronic systems for filing taxes, registering 65 Distance to the frontier businesses, and submitting customs forms. It created 60 more efficient systems for handling commercial disputes in the courts and sharing consumer credit 55 information. Most of these reforms have spread 50 beyond Nairobi, with improved ease of doing business reported across 13 Kenyan cities (World 45 Bank 2012). Doing Business 2015 noted Kenya’s 40 efforts to enhance the regulatory framework for 2010 2011 2012 2013 2014 sharing and retaining positive credit information, Bangladesh Ethiopia Ghana Kenya Lao PDR Tanzania Uganda but it also noted some backtracking in the form of Zambia Source: World Bank 2014b. increased fees for construction permits in Nairobi. 3.6 What can policy makers do to spur The government implemented other welcome manufacturing? M reforms that are not reflected in Doing Business. anufacturing accounted for 11 percent of It streamlined business registration, establishing Kenya’s GDP in 2013, 12 percent of formal the Huduma one-stop shops, where citizens employment, and 26 percent of merchandise can electronically access and pay for an array of exports. It has been growing much more slowly in government and public services. It began improving Kenya than in comparator countries, however, and improve the efficiency of the land registry and there is a risk that it may be hollowed out as firms property transaction, and it increased the use of move to more attractive locations. information and communications technology in providing solutions to business operations. The i-Tax Low productivity and poor “allocative efficiency” and the electronic Single Window System (eSWS) –shown by the large productivity differences are expected to ease tax compliance, and improved prevalent across sectors—constrain sector growth customs procedures at the Mombasa Port will and employment. This underlines the importance facilitate trade. of prioritizing cross-sectoral approaches that remove market distortions and emphasize industry- Despite these reforms, Kenya has lost ground to wide productivity policies, and calls for caution on peer countries. The first Doing Business report, the over-use of narrow, sector-specific approaches. released in 2003, ranked Kenya as the best place in the EAC to conduct business. Since then its ranking The government can facilitate growth in the sector has fallen. Reform in Kenya has lagged the fast pace in order to maximize its contribution to the of reform in Rwanda, particularly in the past five economic prosperity envisaged by Vision 2030. years (Figure 3.14). Some actions the government could take to make manufacturing in Kenya more attractive include the following: 16 The “Distance to frontier” metric compares an economy’s performance with the global best practice for each indicator using a 0–100 scale, where 0 represents the worst performance and 100 the frontier of global best practice. The metric is an absolute measure, not a relative one. It is not affected by the rankings of other countries. 44 December 2014 | Edition No. 11 Special Focus 1. Help raise firm productivity growth by facilitating 3. Decrease the cost of doing business by the stock and flow of skills, technology, and addressing critical issues related to energy, information among firms. Specific analyses interest rates, and cross-border trade. Specific of key manufacturing subsectors show that measures include the following: firms operate using outdated technology, in • Reduce the cost and increase the reliability silos within their respective value chains, and of electricity. New transmission and with a skills deficit both at the managerial distribution lines and substations, the new and technical levels. Low productivity levels 5,000-megawatt energy generation plan, and and large differences in productivity within the recent drop in oil prices are expected to sectors can be partially attributed to this lack of reduce the cost and increase the reliability competition, and to the difficulties firms may face of electricity markedly in 2015. These in leveraging innovation and technology to move improvements will provide welcome relief to higher productivity levels. To address this the for the manufacturing sector. In conjunction Government could directly support productivity with these developments, the government programs, such as management and technology could incentivize manufacturing firms to extension services, or provide incentives to increase their energy efficiency through improve firms’ knowledge base and equipment equipment upgrading schemes. Specific (through technology transfer programs, research analyses of key manufacturing subsectors and development [R&D] instruments, R&D show that machinery is several decades old centers, and prototyping facilities, among others). and consumes significantly more energy than 2. Level the playing field between formal and modern equivalents. informal firms, by reducing and streamlining • Increase access to finance. The Special regulation, and ensuring their even and fair Topic of the Ninth Kenya Economic Update, application. Eighteen percent of firms surveyed released in December 2013, focused on by the Enterprise Survey perceived that the credit. It emphasized that the interest practices of the informal sector were their top rate structure in Kenya reflects several business environment constraint. González and factors, such as the monetary policy rate, Lamanna (2007) show that some formal sector the competitive structure of the financial firms in developing countries have characteristics sector, and the range of savings and loan similar to informal sector firms and compete in products available. The recommended menu the same market segment. Informal firms have of solutions includes adoption of a regular a cost advantage over formal firms, particularly government debt issuance policy to lower the in sectors with low barriers to entry to informal volatility of the return on government debt; firms or with high regulatory burdens on formal development of key financial infrastructure, firms. Firms in Kenya may also be confronted with such as a creditor rights framework and a discretion and discrimination in the application collateral registry; and provision of technical of regulation, making it particularly onerous assistance to enterprises to bridge the gap for formal firms to comply with it. Finally, between supply and demand for long-term competition from counterfeit, substandard, capital from private equity funds or the stock and smuggled goods which enter the market market. In 2014, the government introduced informally may also pose challenges. To address the Kenya Bank Reference Rate, a new base this situation the Government could level the rate that Kenyan banks are required to use playing field among firms by streamlining and when pricing loans. Despite these measures, reducing regulation, and ensuring enforcement interest rates remain high, constraining the is even and fair implementation. ability of the manufacturing sector to finance its growth. December 2014 | Edition No. 11 45 Special Focus • Accelerate and facilitate trade. The and one month to start a business in Nairobi— government could improve the speed and more than the Sub-Saharan Africa average of 8 accuracy of cargo clearance by customs and procedures and 27 days and more than twice the other border agencies and reduce nontariff OECD averages of 5 procedures and just 10 days. barriers. Kenya ranks 153th position in trading Kenya ranks 134th in resolving insolvency, four across borders. It takes 26 days for Kenyan position better than the previous year. Companies manufacturing firms to export, down from in crisis spend 4.5 years resolving their situation, 29 days in 2007. Tanzania went from 26 and creditors recover just 27.5 cents on every to 18 days over the same period. Further dollar of their investment. The courts present a reductions are essential to reduce the cost of major bottleneck in this process, as evidenced by international trade. Steps worth considering the fact that it takes 465 days and 44 procedures include reducing the document requirements to resolve a commercial contract in Nairobi for trade, streamlining border clearance courts. The ability of firms to easily enter an exit and permit application processes, and fully the market is a critical component of a healthy implementing the electronic Single Window and competitive manufacturing sector. System (eSWS). As a member of the regional 5. Curb county revenue-raising schemes that tripartite arrangement (the Common Market increasingly hamstring businesses. As county for Eastern and Southern Africa [COMESA], governments struggle to raise revenue, they the Southern Africa Development Community are increasingly turning to business licenses, [SADC], and the EAC), Kenya has reduced a fees, taxes, and other levies. Delivery vans number of the nontariff barriers recorded in reportedly require separate corporate branding the online reporting system established by the licenses from each county, and construction three regional blocs. However, manufacturers licensing and permits are said to have jumped continue to face new barriers introduced by 300 percent in Nairobi County. These problems various government agencies.[1] highlight the need for counties to take a national 4. Support firm entry and exit by streamlining the view to managing private investment and for the process for starting a business and simplifying national government to step in to curb county the insolvency framework. Kenya ranks 143rd in revenue-raising schemes that increasingly facilitating opening a business—9 positions worse handicap businesses. than the previous year. It takes 10 procedures   [1] In addition, although nominal tariffs have been reduced, tariff harmonization requirements are sometimes flouted. In November 2014 Kenya raised its duty on paper to 25 percent, despite the regionally agreed to rate (common external tariff) of 10 percent. The move derailed progress and set a precedence for other countries to not ignore the tariff harmonization goals of the EAC. 46 December 2014 | Edition No. 11 REFERENCES • Acemoglu, D., and A. J. Robinson. 2006. “De Facto Political Power and Institutional Persistence.” American Economic Association Papers and Proceedings 96 (2): 325–30. • Castro, R., G. L. Clementi, and G. MacDonald. 2004. “Legal Institutions, Sectoral Heterogeneity, and Economic Development.” Society for Economic Dynamics, Meeting Paper 162. • de Vries, G., M. Timmer, and K. de Vries. 2013. “Structural Transformation in Africa: Static Gains, dynamic Losses.” GGDC Research Memorandum 136, Groningen Growth and Development Centre, University of Groningen, the Netherlands. • Deloitte. 2014. “Survey on Business Regulatory Environment for Manufacturing: State-Level Assessment. Report prepared for the Planning Commission, Government of India.” http://www.planningcommission.gov.in/reports/ genrep/rep_enf0705.pdf. • Djankov, S., R. La Porta, F. Lopez-de-Silanes, and A. Shleifer. 2002. “The Regulation of Entry.” Quarterly Journal of Economics 117 (1): 1–37. • Djankov, S., C. McLiesh, and R. M. Ramalho. 2006. “Regulation and Growth.” http://ssrn.com/abstract=893321 or http://dx.doi.org/10.2139/ssrn.893321. • Eskom South Africa Tariffs. 2014. “South African Tariffs 2013/2014.” www.eskom.co.za/CustomerCare/ TariffsAndCharges/Pages/Tariffs_And_Charges.aspx. • Farole, T., and M. Mukim. 2013. “Manufacturing Export Competitiveness in Kenya. Policy Note: NLTA on Revitalizing and Diversifying Kenya’s Manufacturing Sector.” Report ACS6849, World Bank, Washington DC. • Fisman, R. J., and V. S. Allende. 2004. “Regulation of Entry and the Distortion of Industrial Organization.” NBER Working Paper 10929, National Bureau of Economic Research, Cambridge, MA. • González, A. S., and F. Lamanna. 2007. “Who Fears Competition from Informal Firms? Evidence from Latin America.” World Bank, Washington, DC. https://wdronline.worldbank.com/handle/10986/7258. • Hsieh, C. T., and P. J. Klenow. 2009. “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics 124 (4): 1403–48. • ———. “The Life Cycle of Plants in India and Mexico.” Quarterly Journal of Economics 129: 1035–84. • IMF (International Monetary Fund). 2014. “World Economic Outlook Database.” October. Washington, DC • Ishengoma, E. K., and R. Kappel. 2011. “Business Environment and Growth Potential of Micro and Small Manufacturing Enterprises in Uganda.” African Development Review 23 (3): 352–65. • Kenya National Bureau of Statistics. 2010. “Census of Industrial Production.” www.knbs.or.ke. • ———. 2013a. “Economic Survey.” Nairobi. • ———. 2013b. “Statistical Abstract.” Nairobi. • ———. 2014a. “Economic Survey.” Nairobi. • ———. 2014b. “Leading Economic Indicators.” Various Issues. Nairobi. • ———. 2014a. “Statistical Abstract.” Nairobi. • Kenya Power and Lighting Company. 2013. “Commercial Power Tariffs.” http://www.kplc.co.ke/. • Li, Lynn Ling X. 2000. “Manufacturing Capability Development in a Changing Business Environment.” Industrial Management & Data Systems 100 (6) 261–70. • Office of the Controller of Budget. 2014a. “Annual County Budget Implementation Review Report, 2013/14, August.” Nairobi. • ———. 2014b. “County Budget Implementation Review Report.” First Quarter 2014/15, November. Nairobi. • ———. 2014c. “National Government Annual Budget Implementation Review Report,” 2013/14, August. Nairobi. • Olley, S., and A. Pakes. 1996. “The Dynamics of Productivity in the Telecommunications Equipment Industry.” Econometrica 64: 1263–97. • Quintin, E. 2008. “Contract Enforcement and the Size of the Informal Economy.” Economic Theory 37 (3): 395–416. • Restuccia, D., and R. Rogerson. 2008. “Policy Distortion and Aggregate Productivity with Heterogeneous Plants.” Review of Economic Dynamic 11 (4): 7–20. • Scarpetta, S., P. Hemmings, T. Tressel, and T. Woo. 2002. “The Role of Policy and Institutions for Productivity and December 2014 | Edition No. 11 47 Firm Dynamics: Evidence from Micro and Industry Data.” OECD Economics Department Working Paper 329, OECD Publishing, Paris. • Tanzania Electricity Supply Company. 2014. http://www.tanesco.co.tz/index.php?option=com_content&view=article &id=63&Itemid=205. • National Treasury. 2014. “Budget Review and Outlook Paper.” September. Nairobi. • ———.. 2014. “Quarterly Economic and Budgetary Review,” Fourth Quarter 2013/14, August. Nairobi. • ———.. 2015. “Medium Term Budget Policy Statement.” Draft, February. Nairobi. • UN (United Nations). 2011. “World Population Prospects: The 2010 Revision, Volume I: Comprehensive Tables.” ST/ ESA/SER.A/313. Department of Economic and Social Affairs, Population Division, New York. • United Nations Commodity Trade Statistics Database. Statistics Division. http://comtrade.un.org/data/. • United Nations Conference on Trade and Development. Foreign Direct Investment Database. Geneva. • World Bank. Various years. “Global Development Indicators.” Washington, DC: World Bank. • ———. Various years. “Global Economic Prospects.” Washington, DC: World Bank. • ———. 2007. “Enterprise Survey.” Washington, DC: World Bank. www.enterprisesurveys.org. • ———. 2012. “Doing Business in Kenya 2012.” Washington, DC:World Bank. • ———. 2013a. “Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises.” Washington DC: World Bank. • ———. 2013b. “Enterprise Survey.” Washington, DC: World Bank. www.enterprisesurveys.org • ———. 2014a. “Africa’s Pulse: An Analysis of Issues Shaping Africa’s Economic Future, vol. 10.” Washington, DC: World Bank. • ———. 2014b. “Doing Business 2015: Going Beyond Efficiency.” Washington DC: World Bank. • ———. 2015. “Firm-Level Innovation and Productivity in Kenya.” Nairobi. • World Development Indicators (database). World Bank, Washington, DC. http://data.worldbank.org/data-catalog/ world-development-indicators. • World Economic Forum. 2012. “Manufacturing for Growth: Strategies for Driving Growth and Employment.” http:// www.weforum.org/reports/manufacturing-growth#executive. 48 December 2014 | Edition No. 11 ANNEXES Annexes Annex 1: Macroeconomic environment 2007 2008 2009 2010 2011 2012 2013 GDP growth Rates (percent) 6.9 0.2 3.3 8.4 6.1 4.5 5.7 Agriculture 5.1 -5.0 -2.3 10.0 2.4 2.9 5.1 Industry 6.1 0.0 3.7 8.7 7.2 4.2 5.0 Manufacturing 4.4 1.1 -1.1 4.5 7.2 -0.5 5.9 Services 7.0 2.7 6.2 7.3 6.1 4.9 5.5 Fiscal Framework (percent of GDP)* Total revenue 18.7 18.2 19.4 19.4 18.8 18.8 19.4 Total expenditure 23.1 22.3 24.0 23.5 23.7 24.8 25.9 Grants 1.1 0.7 1.0 0.5 0.4 0.5 0.5 Budget deficit (including grants) 0.3 -4.4 -5.8 -3.4 -4.5 -5.1 -6.2 Total debt (net) 33.4 35.4 36.6 39.1 37.0 38.5 43.1 External Account (percent of GDP) Exports (fob) 12.9 14.1 12.2 13.1 13.8 12.3 10.5 Imports (cif) 28.3 32.0 27.8 31.0 35.3 33.2 30.9 Balance of trade -9.4 -11.9 -10.5 -11.6 -15.3 -13.7 -13.7 Current account balance -3.2 -5.5 -4.5 -6.3 -7.9 -8.5 -8.7 Financial and capital account 5.9 4.2 6.6 6.7 7.8 11.0 9.9 Overall balance 2.6 2.7 -1.3 2.1 0.4 -0.1 2.5 Prices Inflation (average) 10.5 4.1 14.0 9.6 5.7 Exchange rate (average KSh/$) 77.4 79.2 88.8 84.5 86.1 Source: Kenya National Bureau of Statistics, International Monetary Fund and Central Bank of Kenya. Annex 2: GDP growth rates for Kenya SSA and EAC (2008-2013) 2009 2010 2011 2012 2013 2009-2013 Kenya 3.3 8.4 6.1 4.5 5.7 5.6 SSA (excluding South Africa) 4.0 3.8 4.2 4.0 4.5 4.1 Uganda 7.2 6.2 5.0 4.7 6.5 5.9 Tanzania 6.0 7.0 6.4 6.9 7.0 6.7 Rwanda 4.1 7.2 8.6 7.7 7.0 6.9 ‘Source: Global Economic Prospects (World Bank) and Kenya National Bureau of Statistics. 50 December 2014 | Edition No. 11 Annexes Annex 3: Kenya annual GDP Years GDP, current prices GDP, 2001 GDP/capita, GDP growth constant prices current prices KSh KSh US$ Percent Billions Billions 2006 1862 2588 2007 2151 2766 6.9 2008 2483 2772 0.2 2009 2864 2864 3.3 2010 3169 3104 8.4 2011 3726 3294 6.1 2012 4255 3441 4.5 2013 4758 3639 5.7 Source: Kenya National Bureau of Statistics and World Bank Development Indicators. Annex 4.a: Broad sectors growth (half year, percent) Year Half Agriculture Industry Services GDP 2010 H1 10.1 5.3 5.6 7.0 H2 10.0 11.9 8.2 9.9 2011 H1 3.0 9.3 7.7 7.4 H2 1.6 5.4 5.4 4.9 2012 H1 3.1 3.5 5.0 4.3 H2 2.7 4.8 4.8 4.6 2013 H1 5.5 7.2 6.0 6.8 H2 4.5 3.0 5.1 4.7 2014 H1 5.7 9.2 3.0 5.1 H2 Source: Kenya National Bureau of Statistics. Industry = Mining and quarrying + Manufacturing + Electricity and gas + Water supply and sewerage + Construction Services = Wholesale and retail trade + Accomodation and restaurant + Transport and storage + Information and communication + Financial and insurance + Public administration + Professional, administrative and support services + Real estate + Education + Helath + Other services + FISIM December 2014 | Edition No. 11 51 52 Annex 4.b: Quartely growth rates (percent) December 2014 | Edition No. 11 Years Quarters Q/Q-1 Q/Q-4 (Q:Q-3)/ Q/Q-1 Q/Q-4 (Q:Q-3)/ Q/Q-1 Q/Q-4 (Q:Q-3)/ Q/Q-1 Q/Q-4 (Q:Q-3)/ (Q-4:Q-7) (Q-4:Q-7) (Q-4:Q-7) (Q-4:Q-7) 1 42.6 2.8 7.9 -4.2 8.0 9.0 -0.4 7.9 7.8 7.4 7.8 8.7 2011 2 -9.3 3.2 5.8 2.4 10.8 10.5 -2.1 5.6 7.4 -3.5 6.6 8.4 3 -22.7 3.8 5.0 1.3 4.3 8.9 6.0 5.9 7.1 -1.6 5.8 7.9 4 -0.6 -0.6 2.4 7.0 6.3 7.2 1.6 5.1 6.1 2.2 4.2 6.1 1 49.1 3.9 2.7 -4.6 5.8 6.7 -0.9 4.5 5.3 7.7 4.5 5.3 2012 2 -10.8 2.3 2.5 -1.3 2.0 4.6 -1.3 5.4 5.2 -3.7 4.3 4.7 3 -22.9 2.0 2.1 3.8 4.6 4.7 5.3 4.7 4.9 -1.4 4.5 4.4 4 0.8 3.4 2.9 6.6 4.3 4.2 2.0 5.1 4.9 2.4 4.6 4.5 1 51.4 5.0 3.3 -0.8 8.5 4.9 -0.5 5.5 5.2 9.4 6.3 4.9 2013 2 -10.0 5.9 4.3 -3.3 6.2 5.9 -0.1 6.7 5.5 -2.8 7.3 5.7 3 -22.9 5.8 5.1 3.8 6.2 6.2 3.5 4.9 5.5 -2.5 6.2 6.1 4 -1.7 3.2 5.1 0.2 -0.3 5.0 2.1 5.0 5.5 -0.5 3.2 5.7 1 55.1 5.7 5.3 6.6 7.1 4.7 -2.7 2.7 4.8 10.9 4.5 5.3 2014 2 -11.0 4.5 4.9 -0.9 9.9 5.7 1.6 4.5 4.3 -1.7 5.7 4.9 3 -21.7 6.2 5.0 0.3 6.2 5.7 3.5 4.5 4.2 -2.6 5.5 4.8 Source: World Bank, based on data from Kenya National Bureau of Statistics. Annexes Annexes Annex 5: Inflation Year Month Overall Food inflation Energy Core inflation inflation inflation January 3.7 2.4 3.9 5.2 February 4.5 4.0 4.6 4.9 March 4.1 2.9 5.3 4.8 April 4.1 3.6 4.3 4.6 May 4.1 4.3 3.5 4.1 June 4.9 6.5 3.5 4.1 2013 July 6.0 8.4 4.6 4.4 August 6.7 9.7 5.3 4.3 September 8.3 12.6 5.7 5.4 October 7.8 12.0 4.8 5.4 November 7.4 10.7 5.1 5.5 December 7.1 10.4 5.1 5.1 January 7.2 10.1 5.5 5.4 February 6.9 9.1 5.6 5.5 March 6.3 8.3 4.7 5.4 April 6.4 8.1 5.9 5.3 May 7.3 8.9 8.1 5.6 2014 June 7.4 8.4 9.0 5.6 July 7.7 9.1 9.1 5.5 August 8.4 10.9 8.6 5.6 September 6.6 8.4 7.2 4.4 October 6.4 8.2 7.0 4.4 November 6.1 7.5 6.4 4.6 December 6.0 7.7 6.0 4.5 Source: World Bank, based on data from Kenya National Bureau of Statistics. December 2014 | Edition No. 11 53 Annexes Annex 6: Tea production and exports Year Month Production Price Exports Exports value (MT) (KSh/Kg) (MT) KSh million January 45,390 284 40,190 11,383 February 38,503 271 34,585 10,071 March 33,368 241 32,534 8,619 April 38,230 210 33,662 8,012 May 39,600 215 40,936 9,463 June 30,530 209 37,783 8,515 2013 July 26,229 212 43,761 9,911 August 26,338 208 36,175 8,236 September 32,800 191 34,082 7,635 October 44,283 174 33,532 6,977 November 35,463 187 40,054 7,834 December 41,719 212 38,741 7,991 January 44,970 236 38,652 8,784 February 33,774 203 33,514 7,317 March 33,336 187 37,642 7,938 April 39,975 188 37,439 7,782 May 41,186 179 36,216 7,380 2014 June 31,945 178 39,011 7,692 July 30,790 200 42,393 8,468 August 26,756 191 38,121 7,974 September 33,321 178 35,961 7,244 October 45,368 180 November 38,614 Source: Kenya National Bureau of Statistics. 54 December 2014 | Edition No. 11 Annexes Annex 7: Coffee production and exports Year Month Production Price Exports Exports value MT KSh/Kg MT KSh million January 3,938 344 2,790 1,062 February 4,825 320 3,955 1,429 March 4,074 327 3,179 1,188 April 6,038 279 3,986 1,362 May 4,482 230 5,164 1,790 June 2,307 207 5,238 1,778 2013 July 830 251 4,652 1,556 August 3,411 297 4,741 1,409 September 2,442 286 4,802 1,436 October 1,580 239 3,899 1,303 November 1,882 256 3,808 1,153 December 2,133 274 2,675 862 January 2,850 293 3,169 1,055 February 5,383 399 3,078 1,118 March 6,212 459 4,584 1,533 April 6,611 393 4,858 2,013 May 3,747 349 4,594 2,024 2014 June 2,860 358 4,587 2,007 July 1,292 315 5,425 2,383 August 3,214 381 3,313 1,474 September 3,424 404 3,944 1,722 October 2,801 November 1,703 Source: Kenya National Bureau of Statistics. December 2014 | Edition No. 11 55 Annexes Annex 8: Horticulture exports Exports Exports value Year Month (MT) (KSh million) January 18,398 9,071 February 21,576 9,198 March 19,814 7,061 April 19,790 5,228 May 17,135 5,924 June 15,181 6,996 2013 July 15,193 4,971 August 15,005 6,304 September 17,589 5,036 October 20,292 9,118 November 17,689 7,290 December 16,165 7,182 January 18,494 8,376 February 19,640 7,729 March 18,834 9,741 April 20,567 6,635 2014 May 19,857 7,533 June 17,980 6,495 July 17,114 6,138 August 16,459 5,203 September 18,488 5,479 Source: Kenya National Bureau of Statistics. 56 December 2014 | Edition No. 11 Annexes Annex 9: Local electricity generation by source Year Month Hydro Geo-thermal Thermal Total (KWh million) (KWh million) (KWh million) (KWh million) (KWh million) January 377 129 169 675 February 333 113 160 606 March 348 135 163 645 April 345 152 140 637 May 377 159 133 668 June 378 162 131 671 2013 July 386 158 157 701 August 377 158 182 717 September 377 153 175 705 October 385 151 211 746 November 358 151 222 731 December 347 161 198 705 January 339 179 226 742 February 270 145 257 673 March 287 171 279 737 April 308 170 240 717 May 250 191 296 737 2014 June 263 221 246 730 July 254 258 252 763 August 294 247 224 765 September 278 293 164 735 October 279 339 157 775 November 307 322 122 751 December 282 382 94 758 Source: Kenya National Bureau of Statistics. December 2014 | Edition No. 11 57 Annexes Annex 10: Soft drinks, sugar, galvanized sheets and cement production Galvanized Soft drinks Sugar Cement Year Month sheets litres (thousands) (MT) (MT) (MT) January 32,756 49,046 25,528 393,921 February 36,014 50,036 22,874 380,032 March 42,499 43,647 26,297 367,673 April 27,450 39,151 26,010 365,579 May 27,851 36,529 23,866 414,161 June 31,362 49,512 26,147 422,519 2013 July 28,909 61,802 25,007 454,288 August 28,143 58,687 27,398 432,938 September 36,474 50,303 25,051 453,542 October 35,258 52,751 27,588 487,594 November 36,777 54,752 26,421 464,834 December 43,534 53,994 22,965 422,048 January 38,408 64,298 28,609 454,960 February 38,710 60,044 18,573 442,636 March 39,871 63,365 21,267 478,416 April 38,341 47,278 24,954 468,022 May 40,222 44,094 26,398 486,695 2014 June 30,236 42,866 23,430 462,929 July 34,752 55,902 20,743 500,428 August 34,454 50,140 24,718 479,801 September 37,865 47,721 23,430 465,483 October 41,619 20,595 490,568 November 499,078 December 501,624 Source: Kenya National Bureau of Statistics. 58 December 2014 | Edition No. 11 Annexes Annex 11: Tourism arrivals Year Month JKIA MIA TOTAL January 85,538 26,446 111,984 February 48,970 24,031 73,001 March 52,103 17,850 69,953 April 61,685 6,739 68,424 May 69,751 4,772 74,523 June 91,083 6,692 97,775 2013 July 112,332 11,460 123,792 August 33,749 23,334 57,083 September 83,986 11,721 95,707 October 89,045 12,352 101,397 November 81,242 19,068 100,310 December 103,514 25,159 128,673 January 65,533 19,853 85,386 February 50,270 18,334 68,604 March 76,561 15,041 91,602 April 59,357 7,293 66,650 2014 May 54,334 3,967 58,301 June 42,549 4,758 47,307 July 78,902 7,764 86,666 August 82,465 10,962 93,427 September 53,743 6,778 60,521 October 52,606 6,323 58,929 Source: Kenya National Bureau of Statistics. December 2014 | Edition No. 11 59 Annexes Annex 12: New vehicles registration Month All body types Year (number) January 20,997 February 16,928 March 17,061 April 20,203 May 25,070 June 23,527 2013 July 23,223 August 15,224 September 15,749 October 15,803 November 15,995 December 12,398 January 15,411 February 17,779 March 15,629 April 12,789 May 14,109 2014 June 14,011 July 16,490 August 32,401 September 24,390 October 17,214 November 17,226 December 20,608 Source: Kenya National Bureau of Statistics. 60 December 2014 | Edition No. 11 Annexes Annex 13: Exchange rate Year Month USD UK pound Euro January 86.9 138.8 115.5 February 87.4 135.5 116.9 March 85.8 129.4 111.3 April 84.2 128.8 109.6 May 84.1 128.7 109.2 June 85.5 132.4 112.8 2013 July 86.9 131.9 113.7 August 87.5 135.5 116.5 September 87.4 138.5 116.7 October 85.3 137.3 116.3 November 86.1 138.6 116.2 December 86.3 141.4 118.2 January 86.2 142.0 117.5 February 86.3 142.8 117.8 March 86.5 143.8 119.6 April 86.7 145.1 119.8 May 87.4 147.3 120.1 2014 June 87.6 148.1 119.2 July 87.8 150.0 118.9 August 88.1 147.2 117.4 September 88.8 145.0 114.7 October 89.2 143.7 113.2 November 90.0 142.0 112.3 December 90.4 141.5 111.5 Source: Central Bank of Kenya. December 2014 | Edition No. 11 61 Annexes Annex 14: Interest rates Short-term Long -term Overall Interest Year Month 91-Treasury Average Interbank Central weighted rate bill deposit Savings bank rate lending spread rate rate January 5.9 8.1 9.5 6.5 1.7 18.1 11.6 February 9.0 8.4 9.5 6.3 1.6 17.8 11.6 March 8.8 9.9 9.5 6.5 1.4 17.7 11.2 April 7.9 10.4 8.5 6.4 1.5 17.9 11.5 May 7.2 9.5 8.5 6.5 1.5 17.5 10.9 June 7.2 6.2 8.5 6.7 1.7 17.0 10.3 2013 July 8.0 5.9 8.5 6.6 1.6 17.0 10.4 August 9.0 10.0 8.5 6.4 1.7 17.0 10.6 September 7.8 9.6 8.5 6.5 1.6 16.9 10.3 October 10.7 9.7 8.5 6.4 1.6 17.0 10.6 November 10.8 9.9 8.5 6.6 1.6 16.9 10.3 December 9.1 9.5 8.5 6.6 1.6 17.0 10.3 January 10.4 9.3 8.5 6.6 1.6 17.0 10.5 February 8.8 9.2 8.5 6.6 1.5 17.1 10.5 March 6.5 9.0 8.5 6.6 1.6 16.9 10.3 April 7.4 8.8 8.5 6.5 1.5 16.7 10.2 May 7.8 8.8 8.5 6.4 1.5 17.0 10.6 2014 June 6.6 9.8 8.5 6.6 1.5 16.4 9.8 July 8.1 9.8 8.5 6.6 1.3 16.9 10.3 August 11.8 8.3 8.5 6.5 1.5 16.3 9.8 September 7.4 8.4 8.5 6.6 1.5 16.0 9.4 October 6.8 8.7 8.5 6.6 1.6 16.0 9.4 November 6.9 8.6 8.5 6.7 1.5 15.9 9.2 December 6.9 8.6 8.5 6.8 1.8 16.0 9.2 Source: Central Bank of Kenya. 62 December 2014 | Edition No. 11 Annex 15: Credit to private sector 63 Business services communication Other activities Manufacturing Transport and sector annual Building and December 2014 | Edition No. 11 growth rates construction Total private Finance and households Mining and Agriculture Real estate Consumer quarrying insurance durables Private Month Trade Year January 12.0 13.3 16.9 9.0 33.6 -11.3 29.9 16.9 5.2 7.3 9.8 23.1 10.0 February 11.6 8.0 15.1 10.1 22.4 -12.9 -2.6 17.3 8.6 14.0 8.3 24.5 11.0 March 11.2 11.0 12.6 10.2 23.9 -15.3 -9.5 15.8 4.3 11.0 6.7 24.0 19.6 April 10.5 4.2 11.6 7.6 17.5 -12.1 -2.4 13.9 -17.7 16.5 8.2 27.1 16.9 May 9.5 2.0 4.9 7.3 13.2 -13.2 4.2 14.0 -9.8 24.8 7.7 37.4 -0.4 June 12.7 1.9 5.5 10.3 11.1 -7.2 11.0 -1.2 -16.0 27.1 13.5 45.5 34.8 2013 July 13.5 6.5 6.4 11.0 9.6 6.3 -0.8 17.5 -13.4 27.3 13.6 36.0 7.3 August 16.2 3.6 9.6 15.4 11.4 9.8 -3.5 16.9 17.4 26.6 13.3 42.1 10.9 September 17.4 -0.5 6.8 20.3 13.5 13.1 -12.4 14.7 18.8 32.9 18.3 35.5 15.0 October 18.0 -3.1 8.8 24.4 11.8 11.1 -25.2 16.6 19.5 26.5 25.0 41.3 16.7 November 20.0 2.9 13.6 23.2 10.2 14.7 -16.8 18.4 18.5 27.7 24.7 41.3 21.6 December 20.1 2.0 7.3 19.9 2.3 18.1 -8.5 22.5 11.0 29.8 18.1 52.6 27.0 January 20.5 -1.1 12.8 18.6 0.1 23.1 -13.6 23.3 -16.3 35.6 20.2 50.1 24.6 February 21.5 3.4 16.8 20.2 5.4 31.2 12.1 24.0 -14.0 30.9 20.4 48.1 15.1 March 22.7 7.7 17.3 25.2 2.0 44.8 39.0 28.4 -8.6 44.0 22.5 45.5 -14.6 April 23.9 16.1 22.8 24.5 4.4 45.4 31.2 33.2 5.9 35.2 21.8 51.0 -15.5 May 25.0 16.7 28.5 25.4 10.7 50.1 26.5 31.6 9.2 24.7 22.0 44.0 -3.4 2014 June 25.8 17.9 31.7 24.4 15.1 44.3 31.2 27.5 30.7 28.3 20.6 38.2 3.0 July 25.5 18.8 27.5 25.9 9.4 42.3 37.8 30.8 24.3 30.2 20.3 36.5 1.8 August 24.5 20.9 27.0 25.1 10.8 46.1 42.6 29.4 19.6 27.8 18.4 31.7 -0.2 September 24.5 30.8 35.2 20.7 11.8 43.8 40.4 36.5 -0.5 23.8 16.4 44.1 -12.3 October 23.6 36.8 32.7 18.7 10.3 45.4 75.1 35.7 3.5 38.0 11.4 27.5 -24.8 November 22.2 32.1 29.8 19.7 11.3 45.2 66.9 31.6 1.9 38.9 12.4 28.9 -29.9 December 22.2 27.9 30.7 21.2 13.6 45.6 68.4 32.4 -15.8 39.1 18.7 25.0 -32.3 Annexes Source: Central Bank of Kenya. Annexes Annex 16: Money aggregate Growth rates Broad money Money Money Year Reserve money (yoy) supply ( M2 ) ( M1 ) ( M0 ) January 18.2 16.1 11.5 12.2 February 17.0 15.5 17.6 23.9 March 15.8 17.8 16.0 11.5 April 18.5 20.0 13.6 9.5 May 17.8 21.9 14.9 18.9 June 15.6 20.7 16.6 11.7 2013 July 13.9 18.5 15.5 10.3 August 13.8 17.5 15.7 23.8 September 13.0 16.6 12.1 12.1 October 11.3 13.0 13.8 22.7 November 10.9 14.9 13.3 13.3 December 11.1 10.9 10.5 9.2 January 13.7 13.6 10.6 10.3 February 15.0 14.4 5.0 9.9 March 16.0 14.2 4.5 8.5 April 16.1 16.9 8.4 18.1 2014 May 17.3 17.6 9.2 17.3 June 18.5 20.6 6.9 12.6 July 18.8 18.9 8.6 7.3 August 20.0 21.0 7.9 15.2 September 18.8 16.0 7.9 11.2 Source: Central Bank of Kenya. 64 December 2014 | Edition No. 11 Annexes Annex 18: Nairobi stock exchange (20 share index) and the Dow Jones (New York) Year Month NSE (1966 = 100) Dow Jones January 4417 13,861 February 4519 14,054 March 4861 14,579 April 4765 14,840 May 5007 15,116 June 4598 14,910 2013 July 4788 15,500 August 4698 14,810 September 4793 15,130 October 4993 15,546 November 5101 16,086 December 4927 16,577 January 4856 15,699 February 4933 16,322 March 4946 16,458 April 4949 16,581 2014 May 4882 16,717 June 4885 16,827 July 4906 16,563 August 5139 17,098 September 5256 17,043 October 5195 17,391 November 5156 17,828 December 5113 17,823 Source: Nairobi Securities Exchange and New York Stock Exchange. December 2014 | Edition No. 11 65 Annexes Annex 19: Nominal and real exchange rate Year Month NEER REER 2003=100 2003=100 January 119 66 February 119 67 March 116 64 April 114 63 May 113 63 June 115 63 2013 July 116 64 August 117 65 September 117 64 October 115 63 November 116 63 December 116 63 January 116 62 February 116 62 March 117 62 April 117 62 May 118 62 2014 June 118 62 July 118 62 August 118 61 September 118 61 October 118 61 November 118 61 Source: Central Bank of Kenya. 66 December 2014 | Edition No. 11 Annexes Annex 20: Fiscal position Year 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14* Revenue and grants 19.4 19.8 18.9 20.5 19.9 19.2 19.2 20.0 Total revenue 18.6 18.7 18.2 19.4 19.4 18.8 18.8 19.4 Tax revenue 16.9 17.1 17.0 17.9 17.7 17.1 17.3 18.3 Income tax 6.2 6.8 6.9 7.2 7.5 7.8 8.3 9.0 VAT 4.8 4.8 4.7 4.9 5.0 4.4 4.1 4.6 Import duty 1.4 1.4 1.4 1.4 1.3 1.3 1.3 1.3 Excise duty 2.8 2.7 2.6 2.5 2.3 2.0 1.9 2.0 Other revenues 1.7 1.4 1.4 2.0 1.5 1.6 1.7 1.3 Railway levy 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Appropriation-in-aid 1.6 1.5 1.2 1.6 1.7 1.7 1.5 1.1 Grants 0.8 1.1 0.7 1.0 0.5 0.4 0.5 0.5 Expenditure and net lending 20.9 23.1 22.3 24.0 23.5 23.7 24.8 25.9 Recurrent 15.3 17.4 16.3 16.9 17.2 16.3 17.5 17.6 Wages and salaries 6.3 6.3 5.8 5.7 5.8 5.5 6.1 5.6 Interest payments 2.1 2.1 1.9 2.1 2.2 2.1 2.7 2.6 Development and net lending 4.0 5.7 6.0 7.1 6.4 7.4 6.6 7.1 Transfer to counties 0.0 0.0 0.0 0.0 0.0 0.0 0.2 3.9 Parliamentary service 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.4 Judicial service 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.3 December 2014 | Edition No. 11 67 68 Annex 20: Fiscal position (continued) Year 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14* Fiscal balance December 2014 | Edition No. 11 Deficit excluding grants (commitment basis) -2.3 -4.4 -4.0 -4.6 -4.2 -4.9 -6.0 -6.4 Deficit including grants (commitment basis) -1.5 -3.3 -3.4 -3.6 -3.6 -4.5 -5.6 -5.9 Deficit including grants (cash basis) -1.8 0.3 -4.4 -5.8 -3.4 -4.5 -5.1 -6.2 Financing Foreign 1.9 -0.6 2.8 5.0 2.6 1.6 3.7 4.0 Domestic borrowing -0.1 0.3 1.5 0.8 0.8 2.8 1.4 2.1 Public debt to GDP (net) 36.6 33.4 35.4 36.6 39.1 37.0 38.5 43.1 External debt 20.0 19.1 20.2 18.9 21.0 19.4 18.7 21.6 Domestic debt 20.2 18.6 19.5 21.9 22.2 21.5 23.3 25.6 Memo: GDP (Calendar year current market prices, KSh 2151.3 2483.1 2863.7 3169.3 3726.1 4254.8 4757.5 5280.8 billions) GDP (Fiscal year current market prices, KSh billions) 2006.7 2317.2 2673.4 3016.5 3447.7 3990.5 4506.2 5019.2 Source: Quarterly Budget and Economic Review, August 2014 (National Treasury) and Kenya National Bureau of Statistics. *Provisional Annexes Annexes Annex 21: Twelve months cumulative balance of payments 2006 2007 2008 2009 2010 2011 2012 2013 2014* 1. CURRENT ACCOUNT -511 -1034 -1973 -1671 -2512 -3330 -4253 -4786 -5475 Balance of trade -2226 -2996 -4260 -3892 -4642 -6440 -6893 -7584 -8049 2. MERCHANDISE ACCOUNT -3817 -4936 -6444 -5768 -7169 -9007 -10539 -11229 -12249 2.1 Exports (fob) 3516 4132 5048 4528 5225 5807 6183 5822 6055 Coffee 138 166 155 201 209 222 269 192 229 Tea 656 693 924 892 1159 1153 1199 1215 1069 Horticulture 509 607 763 692 725 678 695 741 813 Manufactured goods 422 513 625 526 608 729 700 705 596 Other 1792 2153 2580 2216 2525 3026 3320 2969 3348 2.2 Imports (cif) 7333 9069 11492 10296 12395 14814 16722 17051 18304 Oil 1745 1919 3051 2192 2673 4081 4081 3838 4064 Chemicals 1004 1156 1446 1324 1603 1947 2076 2279 2346 Manufactured goods 1065 1435 1589 1411 1774 2250 2302 2624 2651 Machinery and transport equipment 2252 2800 3063 3065 3808 3686 4748 4600 6046 Other 1267 1759 2343 2304 2537 2848 3251 3593 3036 3. SERVICES 3306 3902 4470 4097 4657 5676 6286 6443 6773 3.1 Non-factor services 1591 1940 2184 1876 2527 2566 3645 3646 4200 3.2 Income account -70 -143 -45 -38 -158 7 -164 -339 -342 3.3 Current transfers account 1785 2106 2331 2259 2288 3103 2804 3137 2916 of which remittances 408 574 611 609 642 891 1171 1291 1412 4. CAPITAL & FINANCIAL ACCOUNT 1186 1888 1505 2451 2675 3288 5514 5471 6347 4.1 Capital account 211 267 294 290 154 235 235 98 168 December 2014 | Edition No. 11 69 70 Annex 21: Twelve months cumulative balance of payments (continued) 2006 2007 2008 2009 2010 2011 2012 2013 2014* 4.2 Financial account 975 1621 1210 2161 2522 3053 5278 5373 6180 4.2.1.1 Official, medium and long-term -202 -16 106 466 308 340 1147 592 1298 4.2.1.2 Private, medium and long-term 38 592 72 44 176 35 -87 -258 -374 December 2014 | Edition No. 11 4.2.1.2.3 Direct investment (FDI) -11 438 153 127 106 107 107 218 203 4.2.1.3 Commercial banks (net) -156 -5 15 494 61 -213 854 49 526 4.2.2 Short term and net errorsand omissions 1296 1050 1017 1158 1977 2891 3364 4989 4730 (NEO) Short term (including portfolio flows) 714 1032 995 577 1130 1678 2429 2579 Net errors and omissions (NEO) 582 18 22 581 847 1213 935 2410 1978 5. OVERALL BALANCE 675 854 -469 781 163 -43 1261 685 872 Memo: Gross reserves 3331 4557 4641 5064 5123 6045 7160 8483 8964 Official 2415 3355 2875 3847 4002 4248 5702 6560 7274 Commercial banks 916 1202 1765 1217 1121 1797 1458 1923 1691 Imports cover (calender year) 3.5 4.0 2.7 4.1 3.5 3.1 3.8 4.3 4.5 Import cover (36 mths imports) 3.9 4.8 3.4 4.1 3.9 3.7 4.3 4.5 4.7 GDP market price (Kshs billion) 1862 2151 2483 2864 3169 3726 4255 4758 5281 GDP market price (US$ billiom) 25.8 32.0 35.9 37.0 40.0 42.0 50.3 55.2 60.6 Source: Central Bank of Kenya. * Cumulative 12 months to November 2014 Annexes Annexes Annex 22: Growth Outlook 2013 2014e 2015f 2016f 2017f BASELINE GDP Revised projections 5.7 5.4 6.0 6.6 6.5 Previous projections 4.7 4.7 4.7 4.1 Current account -8.3 -7.4 -6.7 -5.8 -4.7 HIGH CASE SCENARIO GDP Revised projections 5.7 5.4 6.5 7.0 7.0 Previous projections 4.7 4.8 5.0 4.0 Current account -8.3 -7.4 -6.0 -5.5 -4.5 LOW CASE SCENARIO GDP Revised projections 5.7 5.4 5.6 5.6 5.7 Previous projections 4.7 4.4 4.4 4.2 Current account -8.3 -7.4 -7.0 -6.5 -6.5 Source: World Bank. Note: e (estimate); f (forecast) December 2014 | Edition No. 11 71 Photos: World Bank Group Design: Robert Waiharo Anchoring High Growth Can Manufacturing Contribute More? Kenya is where it wants to be—on a higher growth path. Massive investments in infrastructural investments, a favorable external borrowing environment, and a strong economy have helped boost aggregate domestic demand and growth. The rebased national accounts data depict a more diversified economy than previously thought, with a larger role played by the traditional sectors of agriculture and manufacturing and the emerging sectors of financial intermediation, real estate, and business services. Expansionary fiscal policy has been key in boosting aggregate demand, while accommodative monetary policy has helped support growth by increasing private sector credit and keeping inflation low. As a result, the economy is estimated to have grown 5.4 percent in 2014 and is forecasted to grow 6.0 percent in 2015. The special focus of this update examines the structural factors underpinning the poor performance of the manufacturing sector. Drawing on recent firm-level data from the 2010 Industrial Census and the 2013 Enterprise Survey. It investigates the extent to which the sector’s lack of dynamism reflects problems in Kenya’s business environment, which compares poorly to regional neighbors’ on several manufacturing-relevant dimensions. The report has four main messages: First, Kenya begins 2015 in a sound economic position. After growing an estimated 5.4 percent in 2014, its economy is poised to be among the fastest growing in the region, with growth projected at 6.0 percent in 2015, 6.6 percent in 2016, and 7.0 percent in 2017. Second, the external sector remains weak and vulnerable, as import growth continue to outpace export growth and short-term flows finance the current account deficit. The large deficit points to underlying structural weaknesses in Kenya’s economy, which need to be addressed. Third, Kenya needs to increase the competitiveness of the manufacturing sector so that it can grow, export, and create much-needed jobs. As a share of GDP, Kenya’s manufacturing sector has been stagnant in recent years, and it has lost international market share; lastly, the weak business environmentis a key constraint for the manufacturing sector. Obstacles to doing business affect this sector more than many others because manufacturing needs access to capital for investments, infrastructure to import inputs and export and distribute finished products, affordable and reliable electricity to produce, labor to man operations, and fair and streamlined regulations and trade policies that allow firms to compete. World Bank Group Delta Center Menengai Road, Upper Hill Join the conversation: P. O. Box 30577 – 00100 Facebook and Twitter Nairobi, Kenya @WorldBankKenya Telephone: +254 20 2936000 Fax: +254 20 2936382 Send questions and comments: Website: www.worldbank.org/kenya #KenyaEconomicUpdate Produced by Macroeconomics & Fiscal Management, Trade & Competitiveness and Governance Global Practices Africa Region