By Thys Louw, Assistant Portfolio Manager, Emerging Market Fixed Income, Investec Asset Management
On a recent research trip to sub-Saharan Africa, we included a visit to Kenya to gain a better understanding of the country’s economic health after a disastrous 2017. Whilst there, we met with the central bank, IMF, Ministry of Finance, advisers and a domestic stock broker. Each helped form a unique insight into Kenya’s economy and we left feeling somewhat confident a recovery is finally beginning to take place.
Coming out the other side…
2017 was a year to forget for Kenya. A combination of a mismanaged national election, drought, weak economic growth and a restrictive interest rate cap on debt were all factors weighing on the government’s debt balance, the current account deficit and economic growth.
Our trip, however, helped paint a different picture with cyclical factors laying the foundations for a mild economic recovery.
- The drought
After a severe drought which saw food imports spike to 3x their historical average, the return of rain to the main food producing areas will help bring significant relief to the Kenyan economy. Agriculture accounts for almost 25% of GDP, and remains an important source of income for a large part of the population. The lower burden from food imports and some pick-up in agricultural exports will also help offset the impact of strong oil prices on the trade balance (Kenya is a net oil importer).
Despite the circus that was the Kenyan election, risks are now mostly in the rear-view mirror with Uhuru Kenyatta confirmed as president at the tail end of last year. Despite the opposition leader likely to continue making some noise, we expect to see a revival in business and consumer confidence. Increased political clarity will also help promote foreign direct investment which was severely lacking last year. The improvement in the political climate will not only assist in spurring investment, but should also support industries such as tourism. A recent announcement of direct flights starting from the United States signals increased foreign confidence in Kenyan political stability.
- The interest rate cap
The implementation of a cap on the amount of interest being charged by banks (4% above the policy rate) has had a serious impact on Kenyans’ ability to obtain credit and only amplified the economic slowdown. However, our meeting with policymakers confirmed they are looking to amend the design of the cap, after lengthy discussions with banks to ensure that credit does start to flow once again. Over time, we expect its removal or amendment will help in restoring credit growth.
A cyclical bounce in growth likely, but risks remain
For some time now, we’ve seen a persistent unwillingness to address the fiscal deficit which is starting to put pressure on the relationship with multilateral donors like the IMF. Historically, Kenya has been entitled to almost US$1.5 billion in emergency credit. Our meeting with the IMF suggested the country would be unlikely to have this agreement renewed in its current form until the government starts to take serious measures aimed at tackling the fiscal deficit. We do, however, expect that the relationship with the IMF will continue, but the terms of the agreement will most likely change.
Despite the government’s ambitious capital expenditure programme being a positive for the long-term health of the economy, over the short term it places continued pressure on debt sustainability. It also implies the government is placing a one-sided bet on economic growth, which needs to start materialising over the next 3-5 years to ensure the debt rebalances to more sustainable levels.
The unloved investment opportunity
Subsequent to our trip, Kenya came to the market with a 10- and 30-year euro-bond issuance. The market focused on the potential non-renewal of the IMF programme, and these securities were priced at a significant discount to similarly rated peers. We participated in the deal as this issuance offered exposure to an underappreciated and ignored story, while economic growth and the fiscal and current account are likely to improve materially this year.
We will continue to keep you updated on developments in the region and believe frontier opportunities like these add significant diversification benefits for our clients’ portfolios.
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