Fitch Affirms Kenya at ‘B+, constrained by budget deficits and political risks

Fitch Ratings has affirmed Kenya’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘B+’ with a Negative Outlook.

“The ‘B+’ ratings reflect Kenya’s solid growth record, strong medium-term growth potential, and favourable business environment. However, the ratings are constrained by Kenya’s low GDP per capita, sizeable current account and budget deficits, and political risks.”

The issue ratings on Kenya’s senior unsecured foreign-currency bonds are also affirmed at ‘B+’.

The Country Ceiling has been affirmed at ‘BB-‘ and the Short-Term Foreign and Local Currency IDRs at ‘B’.

Fitch forecasts GDP growth to slow to 5.4 percent in 2017, down from the 5.8 percent out-turn in 2016. In 1Q17, growth slowed to 4.7 percent  year on year, as the agricultural sector contracted 1.1 percent due to drought conditions.

Slowing credit growth and uncertainty around the August elections are also weighing on the economy.

However, Fitch continues to assess Kenya’s medium-term growth potential as strong, sustained by improved security that has fuelled a recovery in tourism and high public spending that supports the construction sector.

Fitch’s baseline scenario envisages some limited disruption around the 8 August general elections, in which incumbent President Uhuru Kenyatta and his ruling Jubilee coalition will face opposition candidate Raila Odinga, who leads the newly constituted National Super Alliance (NASA) coalition.

Read: Elections: Kenya needs a courageous Judiciary more than ever

“We do not foresee violence at the level of 2007; however, the opposition’s frequent disputes with the Independent Electoral and Boundaries Committee raise the prospect that an NASA loss could lead to protests.”

Fitch estimates that the general government deficit in the fiscal year that ended in June 2017 widened to 8.3 percent of GDP, above both the government’s revised target of 6.9 percent, published in the Medium Term 2017 Budget Policy Statement and the 7.5 percent  outturn in FY16.

The deterioration in the fiscal deficit relative to the prior year was largely due to an increase in execution of capital expenditure to fund ongoing infrastructure projects, including the just-completed Phase 1 of the Standard Gauge Railway, and election-related current expenditure. General government expenditure was an estimated 29.4 percent of GDP in FY17, up from an average of 25.2 percent in the previous five years.

Kenya’s FY17/18 Budget signals that the government plans to shrink the deficit and prioritise public debt sustainability. Fitch forecasts the fiscal deficit to narrow to 6.4 percent of GDP in FY18, as expenditure falls closer to average historical levels and improvements to revenue administration and collection begin to show results.

Fitch’s forecast is more conservative than the government’s budget target of 6 percent of GDP, reflecting downside risks from slower-than- expected growth and lower revenue collection. General government debt reached 56 percent of GDP at FY17 (measured by the nominal value of debt), a level comparable to ‘B’ rated peers; however, debt servicing costs consume an outsized portion of Kenya’s revenue. Both total debt and interest payments as a percentage of revenue, at 262% and 16.5 percent respectively, are higher than the ‘B’ medians of 227 percent and 9.6 percent.

The key downside risk to public debt sustainability would be the government’s inability to implement the fiscal consolidation envisaged in the FY17/18 Budget and the Medium Term Expenditure Framework.

Over the medium term, the failure to translate newly built infrastructure into private sector growth and higher tax revenue would also be a threat to fiscal consolidation and to debt sustainability. The drop in agricultural output has contributed to higher food prices and pushed inflation higher so far in 2017.

Headline inflation peaked at 11.7 percent in May, before falling to 9.2 percent in June, well above the Central Bank of Kenya’s (CBK) 5%/-2.5% inflation target.

The CBK will likely hold off on further monetary easing until inflationary pressures subside.

Fitch forecasts the current account deficit will widen slightly to 5.8 percent of GDP in 2017 from 5.6 percent in 2016, but will remain well below the average of 9.2% recorded in 2011 to 2015.

Lower oil prices, higher remittance flows and stabilising capital imports have all contributed to the narrowing current account deficit. Kenya’s continued compliance with its IMF stand-by arrangement, which would make up to USD1.5 billion available in the event of a negative balance of payments shock.

Banking Sector

The Kenyan banking sector is highly fragmented, with large domestic banks characterised by healthy funding and balance-sheet liquidity and small banks, into which we have little insight.

Asset quality has deteriorated, with non-performing loans rising to 10% of total loans as of end-April 2017 from 6% at end-2015.

Additionally, the full effects of the interest rate cap that was instituted in September 2016 have yet to become clear, but initial indications show evidence of credit rationing. Initial results suggest that the cap has had a marginal downward effect on credit growth, particularly in credit to SMEs and other high-risk segments of the credit market. Overall private sector credit growth has slowed further, to 3.3% at end-March 2017, continuing a trend in place since 2015 when it grew 17.8%.

Kenya has continued to improve its rank in the World Bank’s Doing Business Index, rising to 92 in the 2017 ranking from 113 in the previous year. However, structural factors constrain the rating. The country is in the 22nd percentile of the UN Human Development Index. Kenya’s governance indicators are weaker than the ‘B’ range median.

Fitch’s proprietary SRM assigns Kenya a score equivalent to a rating of ‘B+’ on the Long-Term Foreign Currency IDR scale. Fitch’s sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign Currency IDR Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three year-centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

 The main factors that could individually, or collectively, trigger a downgrade are:

• – Failure to implement planned fiscal consolidation and stabilise government debt/GDP; – Deterioration in the political or security environment undermining Kenya’s long-term growth performance;
• – Widening of the current account deficit that stresses macroeconomic stability and leads to significant foreign exchange reserves drawdown.

The Outlook is Negative.

Consequently, Fitch does not currently anticipate developments with a high likelihood of leading to positive rating action.

Developments that could, individually or collectively, result in the Outlook to being revised to Stable include:

• – Effective implementation of fiscal consolidation plans and stabilisation of government debt/GDP;
• – A longer track record of prudent economic management and successful implementation of structural reforms that foster an improved business environment and faster economic growth.