S&P maintains Kenya’s rating at junk

PUBLISHED: Mon, 10 Apr 2017 10:18:20 GMT
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OVERVIEW
  • Upcoming elections, drought, and decelerating credit growth pose short-term risks to Kenya’s 2017 economic growth and budgetary performance.
  • Over the longer term, however, we consider Kenya’s economic growth prospects remain strong, underpinning our projections of gradual fiscal consolidation of still-high public deficits.
  • We are therefore affirming our ‘B+/B’ ratings on Kenya.
  • The stable outlook reflects our expectation that, commencing next year, government debt as a percentage of GDP will start trending downward, and per capita GDP growth will recover to above 3% per year.
RATING ACTION
On April 7, 2017, S&P Global Ratings affirmed its 'B+/B' long- and short-term 
foreign and local currency sovereign credit ratings on Kenya. The outlook is 
stable.

RATIONALE
Our ratings on Kenya are supported by its monetary flexibility, liquid 
domestic financial markets, track record of strong headline and per capita GDP
growth, and increasingly diversified economic base. In March 2016, the 
government signed a new stand-by agreement with the International Monetary 
Fund (IMF), totaling $1.5 billion over the next 18 months, which would support
external financing needs if necessary. We believe that the arrangement will 
likely act as a policy anchor while it is in force.

Our ratings on Kenya are constrained by the country's history of ethnic 
tensions, low GDP per capita and wealth levels, high government fiscal 
deficits and debt stock, and susceptibility to balance-of-payments pressures. 
Since 2014, the lion's share of Kenya's net external financing needs has been 
provided by official rather than commercial lenders.

In 2017, we expect the Kenyan economy to grow at 5.3%, slower than the 
estimated 6% in 2016. Higher oil prices, drought conditions in the Rift 
Valley, and weaker credit growth (reflecting the government's introduction of 
interest rate caps) will weigh on the economy this year; as will the approach 
of elections in August 2017, if tensions between political parties and along 
ethnic lines escalate. In the medium term, Kenya's economic growth prospects 
remain strong, averaging 6% per year over 2018-2020 reflecting a diversified 
economic base, a resilient tourism sector, and productivity gains from 
large-scale public infrastructure investments, alongside Kenya's favorable 
demographics.

Large infrastructure projects like the Standard Gauge Railway ($4 billion) 
have boosted economic activity. The first phase of the Standard Gauge Railway 
project has been completed and is undergoing tests before commissioning during
2017. The project seeks to connect Kenya, from the port of Mombasa, with the 
capital Nairobi and the neighboring Republic of Uganda. We expect that the 
railway will attract private-sector investment along a new and important 
regional trade corridor. Potential oil production could also lift economic 
growth, although we view this as a long-term prospect, beyond our forecast 
horizon. Tourism's contribution to economic growth remains subdued after 
terrorist attacks in the past few years, which could deter investors and 
tourists. We estimate wealth levels, measured by GDP per capita, at $1,600 in 
2017, while real GDP per capita growth will average 3% over 2017-2020. We 
expect strong economic growth performance will also underpin fiscal 
consolidation efforts and that government and external debt will stabilize 
close to or at current levels.

We estimate Kenya's fiscal deficit in 2016-2017 will remain elevated, at close
to 10% of GDP, owing to increases in one-off expenditure items related to the 
elections and drought support spending. This is one of the highest budgetary 
deficits of all rated sovereigns. At the same time, there are still shortfalls
in personal and corporate income taxes while capital expenditure 
implementation lags budget targets. Absent one-off factors experienced in 
2016-2017, we expect that large infrastructure-related expenditures will start
to decline and that the government will undertake consolidation measures, 
including improving tax collection. We expect fiscal imbalances will reduce 
more gradually and average close to 6% of GDP in 2017 and close to 4% by 2020.
We also understand that oversight at the Public Debt Management Office (PDMO) 
has been bolstered and new debt-management systems have been introduced. We 
view these factors as supportive of the government's creditworthiness.

We estimate that Kenya's high stock of debt will average 54% of GDP over 
2017-2020 on a net basis, while interest payments will also remain above 15% 
of revenues over the same period. While Kenya's debt stock is high, nearly 
half of the external debt is from multilateral creditors, while another third 
is from bilateral creditors. Commercial debt has increased in recent years, 
with Eurobond issuances at about $3 billion in 2014 followed by a loan 
syndication of $750 million maturing this year. We expect the maturing loan 
syndication to be refinanced in the same way in the near term.

Current account deficits are narrowing close to 5% of GDP over 2017-2020 
compared with at least 8% of GDP over 2012-2015. The narrowing deficit is 
being supported by higher economic growth; lower import volumes and stable 
tourism receipts; as well as stable tea, coffee, and horticulture exports, 
which contribute at least 50% of export receipts and strong remittances from 
abroad. The funding, however, is volatile and relies largely on a combination 
of mostly official external debt and inward foreign direct investment (FDI). 
In 2016, inward FDI fell below 1% of GDP from almost 2% in 2014-2015, leaving 
the rest of the financing to external borrowing. External borrowing by both 
the public and private sector has increased in recent years, resulting in our 
estimates of narrow net external indebtedness to current account receipts 
(CARs) and gross external financing needs to CARs plus usable reserves both 
remaining above 100% over 2017-2020.

Kenya does not produce stock data for private sector external debt, which 
makes it difficult to measure accurately the extent of private sector external
debt. The balance of payments data in 2015 and 2016 also shows errors and 
omissions of close to 2% of GDP, suggesting potential classification errors. 
We believe that the efforts by Kenya National Bureau of Statistics in 
conducting the 2016 Foreign Investment Survey will be integrated into revised 
2016 Balance of Payments data and an International Investment Position dataset 
will be published for the first time in May 2017. Should the external 
environment become difficult to access due to changes in global liquidity or 
uncertainties associated with domestic elections, we believe that the recently
signed stand-by arrangement with the IMF would act as a financing cushion.

The central bank of Kenya follows a floating exchange rate system. The Kenyan 
shilling depreciated against the U.S. dollar in 2014 and 2015 by over 10% 
cumulative before stabilizing last year in line with the gradually narrowing 
external deficits. We expect that the shilling will remain stable over 
2017-2020. The drought in the Rift Valley is weighing on food prices and 
inflation in 2017, which we expect to average 9%. In 2018, however, we expect 
the central bank will be able to maintain inflation closer to its 5% target 
range (our forecast is 6%). While the banking sector is small, with banking 
sector gross assets at 70% of GDP, there are pressures on some banks' 
profitability, asset quality, and capitalization levels. Since November 2016, 
when the Banking Amendment Act took effect, which caps lending rates by banks,
credit growth has significantly slowed to less than 5% as banks have become 
more risk averse, and nonperforming loans have deteriorated to about 10% in 
February 2017, from 6.5% a year earlier. The law to cap banks' lending rates 
could have wide-ranging effects on monetary policy transmission mechanisms, 
from policy rates to the commercial banking sector.

Kenya operates a functioning parliamentary democracy that engages in national 
debate over key policy issues, but which has also witnessed significant 
election-related ethnic violence in the past. The country faces an upcoming 
general election in August 2017 with parties formed along ethnic lines. 
Electoral amendments passed by the senate in January 2017 have been criticized
by opposition parties, as they are perceived to not address the key issues 
that could lead to disputed election results. However, although there have 
been sparks of discontent very early in the election process, we expect that 
tensions will be broadly kept in check.

Recent attacks by insurgency groups continue to pose security risks that could
impact economic growth. That said, we note that, more recently, these attacks 
have been concentrated in the north of the country, away from the main tourism
areas and business infrastructure.

OUTLOOK
The stable outlook reflects our expectation that strong growth prospects will 
facilitate fiscal consolidation and contain increases in external indebtedness
over the next year.

We could lower the ratings if political tensions flared up and undermined 
stability-oriented economic policy-making, or if fiscal consolidation were 
markedly slower and increased government debt or the country's external 
private sector debt increased more than we currently expect.

We could raise the ratings if we see prospects for sustained political and 
economic stability, including declining budgetary imbalances, supported 
particularly by expenditure control, alongside sustained improvement in 
Kenya's external accounts.

KEY STATISTICS

Table 1

Republic of Kenya Selected Indicators
2011201220132014201520162017201820192020
ECONOMIC INDICATORS (%)
Nominal GDP (bil. KES)3,7264,2614,7455,3986,2247,1267,9168,93610,09811,410
Nominal GDP (bil. $)425055616369768596107
GDP per capita ($000s)1.01.21.31.41.41.51.61.71.92.0
Real GDP growth6.14.65.75.35.66.05.36.06.06.0
Real GDP per capita growth3.31.82.92.62.93.32.63.33.33.3
Real investment growth4.812.71.214.85.25.55.05.65.75.6
Investment/GDP24.423.119.922.919.520.519.619.419.118.8
Savings/GDP15.314.811.113.112.615.114.214.113.913.5
Exports/GDP21.619.818.116.915.815.114.714.313.813.4
Real exports growth9.2(0.2)0.55.3(0.9)5.24.04.54.54.5
Unemployment rateN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
EXTERNAL INDICATORS (%)
Current account balance/GDP(9.1)(8.4)(8.8)(9.8)(6.8)(5.4)(5.4)(5.3)(5.2)(5.3)
Current account balance/CARs(29.5)(29.3)(33.5)(39.1)(30.3)(25.6)(25.9)(26.1)(26.4)(27.8)
CARs/GDP30.928.626.225.022.521.120.820.319.719.1
Trade balance/GDP(19.9)(18.5)(18.6)(18.4)(15.1)(13.0)(12.8)(12.7)(12.4)(12.2)
Net FDI/GDP3.32.31.71.71.70.91.81.81.71.7
Net portfolio equity inflow/GDP(0.1)0.50.51.50(0.3)0.20.20.20.2
Gross external financing needs/CARs plus usable reserves113.5120.7121.9126.1117.3122.0123.9127.0125.9130.1
Narrow net external debt/CARs51.953.973.877.2113.7112.1122.2122.9120.6118.8
Net external liabilities/CARs20.125.047.756.290.689.8111.2122.4129.5137.0
Short-term external debt by remaining maturity/CARs21.827.136.541.352.059.259.561.154.555.0
Usable reserves/CAPs (months)3.12.73.63.75.14.94.74.54.13.8
Usable reserves (mil. $)4,2655,7126,5997,9117,5487,8798,2298,2208,2778,443
FISCAL INDICATORS (%, General government)
Balance/GDP(4.9)(5.7)(6.3)(10.5)(8.3)(9.7)(6.5)(6.0)(5.5)(4.5)
Change in debt/GDP5.45.911.87.812.48.26.16.05.54.5
Primary balance/GDP(2.7)(2.9)(3.5)(7.1)(4.8)(6.4)(2.7)(2.3)(1.8)(0.9)
Revenues/GDP20.520.821.726.520.422.020.520.520.520.5
Expenditures/GDP25.426.628.037.128.631.727.026.526.025.0
Interest /revenues10.713.713.112.917.014.918.518.218.017.6
Debt/GDP43.043.550.852.557.958.859.158.357.155.0
Debt/revenues209.7208.8234.7198.1284.6266.9288.1284.4278.6268.5
Net debt/GDP39.039.842.147.850.954.155.254.954.152.4
Liquid assets/GDP4.03.78.74.87.04.73.83.43.02.7
MONETARY INDICATORS (%)
CPI growth14.09.45.76.96.66.39.06.06.06.0
GDP deflator growth10.89.45.48.09.18.05.56.56.66.6
Exchange rate, year-end (KES/$)85.0786.0086.3190.50102.31103.00104.50105.00106.00106.50
Banks’ claims on resident non-gov’t sector growth31.311.818.222.817.36.08.013.013.013.0
Banks’ claims on resident non-gov’t sector/GDP32.932.234.236.937.534.733.733.833.833.8
Foreign currency share of claims by banks on residentsN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
Foreign currency share of residents’ bank deposits19.116.518.416.617.616.516.516.516.516.5
Real effective exchange rate growth(5.3)17.23.94.55.83.8N/AN/AN/AN/A
Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. KES–Kenyan shilling. CARs–Current account receipts. FDI–Foreign direct investment. CAPs–Current account payments. N/A–Not applicable. The data and ratios above result from S&P Global Ratings’ own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings’ independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.
RATINGS SCORE SNAPSHOT

Table 2

Republic of Kenya Ratings Score Snapshot
Key rating factors
Institutional assessmentWeakness
Economic assessmentWeakness
External assessmentWeakness
Fiscal assessment: flexibility and performanceWeakness
Fiscal assessment: debt burdenWeakness
Monetary assessmentNeutral
S&P Global Ratings’ analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). Section V.B of S&P Global Ratings’ “Sovereign Rating Methodology,” published on Dec. 23, 2014, summarizes how the various factors are combined to derive the sovereign foreign currency rating, while section V.C details how the scores are derived. The ratings score snapshot summarizes whether we consider that the individual rating factors listed in our methodology constitute a strength or a weakness to the sovereign credit profile, or whether we consider them to be neutral. The concepts of “strength”, “neutral”, or “weakness” are absolute, rather than in relation to sovereigns in a given rating category. Therefore, highly rated sovereigns will typically display more strengths, and lower rated sovereigns more weaknesses. In accordance with S&P Global Ratings’ sovereign ratings methodology, a change in assessment of the aforementioned factors does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the assessments.
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