Confusing fiscal policies worry Kenya investors

Kenya's fiscal and monetary policies have been conflicting, raising concerns among investors who rely on them to make decisions. The Central Bank of Kenya (CBK) has moved towards a more accommodative stance to encourage commercial banks to boost lending to the private sector.

Its Monetary Policy Committee (MPC) in January cut the Central Bank Rate by 25 basis points to 8.25 percent, saying the economy was operating below its potential.

This was a consecutive cut made from 9.00 percent in last November. The policy stance to encourage private sector lending is, however, likely to run into headwinds in the form of increased Treasury appetite for domestic debt.

There has been a gradual rise in the interest rates for short-term government securities, attributable to the fact that the Treasury is under pressure to meet its domestic borrowing target.

And this despite fiscal consolidation touted by the Treasury from the second half of fiscal year 2019/2020.

“Conversation with players in capital markets is that the policies are coming out as a sticky issue. The movement in yields speaks of borrowing pressure to attract investors to Treasury bills and bonds in the first half of 2020,” Churchill Ogutu, senior researcher at Genghis Capital, said.

“There was a plan on fiscal consolidation but by in large, we don’t see it happening even with the supplementary budget that has an increase in expenditure, raising the conflict. The market is in a confused mode.”

The supplementary budget for 2019/2020 effected a net increase of Sh78.1 billion on the initial budget to Sh3.13 trillion, necessitating an upward adjustment in domestic borrowing from the initial Sh300.3 billion to Sh391.4 billion.

The deficit, inclusive of grants in the 2020/2021 fiscal year, is projected to reduce to Sh569.4 billion from Sh715.2 billion in 2018/2019. But gong by past practice the Treasury has found it hard to implement these budget cuts.

To finance the fiscal deficit, net domestic borrowing is projected at Sh318.9 billion and foreign financing at Sh247.3 billion.

According to Mr Ogutu, banks may continue to lend government, helping meet their targets, meaning that the rate cap repeal in November may not fully entice the banks to lend to customers whose risk remains elevated.

“Banks are split on the direction to take in credit extension, and are still lending to government. Lending to private sector is not as robust as expected,” he said.

“They will be weighing the risks and opportunities to lending. The anecdotal evidence to lend after the rate cap repeal has not been so.”

The CBK is in the meantime trying to revive private sector credit growth, the Genghis analyst said, alive to the fact that there are some fragilities in the economy.

This has been shown by the fact that consumption is still muted. Inflation as an indicator of private consumption stood at 5.78 percent in January compared to 5.82 percent in December, in spite of a rise in food prices.

This is indicative of the spill-over effects of contractionary fiscal policies that have seen an increase in taxes, while pending bills are still an issue and many Kenyans have lost jobs.

“There is still no much demand pressure in the economy from both households and businesses, hence a bit lower end of the projections in credit growth,” said Mr Ogutu.

Thus, conventional wisdom would point to an all-out effort to improve the circulation of money in the economy, with an improvement in private sector lending one of the options on the table.

Against an earlier expectation of 11.3 percent, private sector credit growth in the 12 months to December 2019 stood at 7.1 percent.

This was observed mainly in manufacturing (9.2 percent), trade (8.9 percent), transport and communication (8.1 percent), and consumer durables (26.0 percent).

Growth in private sector credit, particularly to micro, small and medium-sized enterprises (MSMEs), is expected to increase gradually due to the deployment of innovative MSME credit products, the repeal of interest rate caps and the continued easing of credit risk, as stated by the MPC.

“The repeal is a window for increased borrowing, but the appetite is not there due to the business environment they operate in may not be conducive. When this is addressed that is when we can see some uptick in private sector,” said Mr Ogutu.

“Company layoffs and property auctions speak to depressed disposable income.”

According to the analyst, the cap removal may bear fruit towards the last quarter of 2020 or early next year.

“The environment is still fragile and it will take much more than just a rate cut to stir banks to start lending. There is usually some lag with most of these measures hence the need for transmission to take effect, improving early next year,” he added.

The investment bank has projected real GDP growth rate of 5.7 percent in 2020, while the CBK set this at 6.2 percent, driven by service industry which account for 45 percent of the GDP and after years of steady growth.

However, escalated political noise around the BBI constitutional reforms and a possible referendum is expected to have an impact on the services sector.