17 September 2018

Kenya: Weak or Strong? Kenya's Economy After Expiry of IMF Standby Loan

Nairobi — The expiry of the US$989.8 million International Monetary Fund (IMF) standby loan for Kenya has elicited mixed reactions, with a section of economists and experts warning it could have economic implications to the country.

Last Thursday, the National Treasury announced it will not renew the credit facility which expired on Friday, causing some uncertainty around the future of the economy.

The standby kitty has been in place since March 2016, offering a buffer to Kenya's economy from external shocks. It was scheduled to expire in March this year but was extended by six months to allow implementation of a number of reforms advised by the IMF.

The recent developments have raised questions over Kenya's economic stability as the country remains exposed to external shocks after the expiry of the facility.

Among major concerns has been stability of the local currency (Shilling) which is poised to depreciate while investor confidence dwindled.

Reduction of investor confidence in the country is based on international investors viewing Kenya as a high-risk investment destination. This would slow down economic growth, stifle access to capital and raise fears of an economic meltdown.

Another concern is adverse movements in Balance of Payments position which may arise from the vulnerabilities to exogenous shocks, such as increase in global oil prices, drought or adverse changes in the international financial markets.

"Kenya has become more integrated into the global financial system over the years, hence it is exposed to such possible occurrences in the future which could negatively affect the current account deficit due to increased outflows of foreign capital," Investment firm Cytonn noted in its weekly review.

The Thursday announcement by Treasury that the government will not be renewing the IMF facility triggered weakening of the shilling by 0.2 per cent against the dollar to cross 101.22 units to the dollar.

This forced the Central Bank of Kenya (CBK) to pump dollars into the market, helping the shilling regain marginally to close at 100.85 units to the dollar.

The Kenya shilling has in recent times enjoyed stability against the greenback as a result of increased inflows from export earnings, diaspora remittances and Foreign Direct Investments (FDIs).

The CBK forex reserves currently stands at US$ 8.5 Billion (Ksh850 billion) which the regulator believes will cushion the local currency against depreciation, now that Kenya chose not to renew the precautionary credit facility.

Experts have however argued that should the local currency weaken, the country's stock of dollar-denominated debt will rise sharply making it even more expensive for the country to service its debt obligations.

Last week, National Treasury Principal Secretary Kamau Thugge said lack of the IMF kitty will not necessarily have implications on the economy, noting that the country did not draw the facility even during last years' adverse drought that hit the country.

Treasury Cabinet Secretary Henry Rotich last week however hinted that the country will continue to engage IMF.

The fund on the other hand has quelled uncertainty in the country's economy saying its buffers remain strong to deal with any external shocks, even after access to the stand-by loan expired.

"Kenya's external position remains strong and foreign exchange reserves are at a comfortable level," IMF resident representative for Kenya Jan Mikkelsen noted.

Mikkelsen said IMF is ready to support Kenya but the fund insists on economic reforms.

IMF has been calling for fiscal consolidation in order to reduce the country's budget deficit and public debt through rationalization of expenditure.

It has also been concerned about the interest rate controls in the country which it wants repealed or significantly modified, with the law blamed for reduced lending to the private sector.

IMF is also keen to have Kenya modernize its monetary policy framework while deepening financial sector reforms, improve the transparency and efficiency of public spending and strengthen the quality of macroeconomic statistics.

To reduce the widening budget deficit, Treasury CS Henry Rotich proposed a number of taxes in the 2018/19 budget.

They include the 'Robin Hood' tax on bank transfers, which required banks to remit 0.05 per cent tax on transfers above Ksh500,000 and the Housing Development Fund Levy that required workers in formal employment to submit 0.5 per cent of their gross salary towards a National Fund for Affordable Housing, with employers required to match employee's contribution.

Rotich also proposed excise tax on mobile money transactions which saw taxes increased to 12 per cent from 10 per cent.

Treasury also proposed an increase in excise duty for cars above 2,500cc to 30 per cent from 20 per cent and a capital gains tax of 5.0 per cent on property transfers by insurance firms.

Investment firm-Cytonn says while the IMF facility is a nice to have, there is no immediate threat to the economy as a result of the failure to renew the facility.

According to the firm, Kenya has sufficient forex reserves of US$8.5 billion, which is equivalent to 5.7 months of import cover.

The firm also notes the stability of the shilling, having appreciated 1.9 per cent year-to-date despite the government having not drawn down on the IMF facility, and the expected narrowing of the current account deficit to 5.4 per cent of GDP by the end of the year, from 5.8 per cent in June 2018, according to the CBK.

"The government should continue with its efforts to work on a fiscal consolidation plan aimed at narrowing the fiscal deficit to 5.7 per cent of GDP from 7.2 per cent of GDP in the financial year 2017/18 and further to around 3.0 per cent of GDP by financial year 2021/22," Cytonn noted.

This can be achieved through revenue enhancement measures, which will in turn lead to reduced dependency on debt in a bid to reduce Kenya's public debt burden, the investment experts said.

"Therefore, despite the possible implications of failure by the government to renew the precautionary credit facility, we perceive no immediate adverse effects on the economy. However, the government needs to work on the conditions set by the IMF since the improvement in these areas stand to benefit the economy with or without the IMF precautionary credit facility," the firm said in its review.

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