Corruption, security concerns and lower tourism receipts will remain a drag on the economy, denting the boost from infrastructure investment and lower energy prices. The government’s growth target of 6.9% in 2015 will likely have to be revised closer to the 6 percent-mark, as the government battles a depreciating shilling by tightening its monetary policy. At the same time, higher spending on security and on the Mombasa – Nairobi railway project forced the authorities to revise the budget deficit target upwards, amid concerns over higher borrowing and rising levels of public debt.
In the first quarter of 2015, the economy slowed down to 4.9% on the year compared with 5.5% in the final quarter of 2014. The culprit was easy to point out, with tourism sector shrinking by 7.5% marking its fifth consecutive quarterly contraction. The number of foreign tourists was down 25.4% on the year in the first five months, attributed to fears of further Al Shabaab attacks. At the same time, vegetable exports fell 3.3% in the first quarter due to lower than expected rainfall. Construction, on the other hand, was up 11.3% on the back of large infrastructure projects.
On a positive note, the absence of high-profile terrorist attacks since April led to tentative signs of a possible pick-up in the tourism industry. The number of foreign visitors climbed in June by 33.4% on the year to 63,085. The pace of decline in visitor numbers in the first half of the year slowed to 18.9% year-on-year, compared to a 21.9% fall in the same period in 2014. Officials hope that a weaker currency and publicity around Obama’s visit will attract more tourists in the second half of the year. Nevertheless, the economy remains extremely vulnerable to terrorist violence.
Concerns over Spending, Weakening Currency
Government spending will remain a key driver of growth. The Finance Ministry’s presentation of the budget for the 2015/16 fiscal year ending in June introduced an extra $1.4 billion funds for the Mombasa-Nairobi railway, and a 12% increase to the budget for the military and security forces. Accordingly, officials raised the deficit target for the $20.6 billion spending plan to 8.7% of GDP. Chronic under-performance in revenue collection poses upside risks to the target, though this will likely be offset by delays to the execution of government-funded projects.
Higher borrowing raises doubts over the long-term sustainability of the government’s spending levels. The government plans to increase domestic borrowing to 3.4% of GDP, up from 2.9% of GDP. Officials also plan to resort to international markets, buoyed by the $2 billion Eurobond issued last year, but the costs of borrowing are now likely to be higher. Borrowing related to infrastructure funding will push public debt beyond 50% of GDP by the end of the fiscal year – still sustainable but vulnerable to lower-than-projected economic growth and a weaker currency.
The shilling has dropped around 10% in value since January, weighed down by a strong US dollar, robust import demand, and lower tourism receipts. In a bold move, the Central Bank of Kenya (CBK) launched two consecutive rate hikes of 150 basis points each, raising its benchmark interest rate to 11.5% over June-July. Foreign exchange reserves dropped by $1 billion since the start of the year to a seven-month low of $6.4 billion in July – equivalent to around 4 months of import cover – as the central bank pumped money into the market to shore up the shilling.
The rate hike was a strong signal of the monetary authorities’ readiness to intervene to stabilize the exchange rate, and further, albeit smaller, tightening later this year cannot be ruled out. Inflation has been creeping up toward the upper end of the official 2.5% – 7.5% target range, running at 6.62% in July. The impact of drier weather on agriculture and higher food prices will pose upside inflationary risks, with average annual inflation running at 6.5%.
The drop in oil prices will relieve some of the pressure on the current account in 2015. Moreover, stronger tea prices on the global market offset a fall in domestic production, resulting in a 12.1% annual jump in export receipts in the first half of the year. Still, the additional spending on railway infrastructure in the new budget will push up the import bill. In the absence of a tangible and sustained rebound in tourism, the current account deficit will remain high at around 8% of GDP.