Current Account Challenges |
The current account deficit continued to widen in early 2012, which is negative for the Kenyan shilling. The Central Bank of Kenya (CBK) left the Central Bank Rate (CBR) unchanged at 18% on 3 May, largely for two reasons: first, latent food and fuel price pressures and, second, a current account deficit of 13.6% of GDP in Q1 2012, which was a surprise to us, because it implies the current account deficit continued to widen in the first quarter, from our estimate of 13.2% at the end of 2011. This was despite monetary policy tightening in the last quarter of 2011 that we had expected to slow import demand. The CBK attributes the wider current deficit to a high oil price. Kenya imports its fuel from Dubai and the average price of Dubai crude oil increased 15.9% year on year (y/y) in Q1 2012 to USD116.1 per barrel. In addition to a higher oil price, the volume of Kenya’s oil imports has also increased, as is expected in a growing economy. Added to that, capital equipment and machinery imports intended for infrastructure projects, particularly geothermal plants and road construction, remained strong in Q1 2012. The upside is that these imports are investment-related, and it is for this reason the CBK is not too concerned about the large current account deficit.
The negative current account impact of strengthening imports is exacerbated by weak exports, largely due to frost in early 2012 that undermined tea production, Kenya’s biggest export, which represents about one-fifth of total exports, by around 20%. Moreover, we expect the imposition of a new levy on tea exports, which is estimated to raise KES1bn (USD11.8m) in revenue, to further undermine export earnings. A strong oil price – the general expectation is USD115 per barrel – and a poor start for Kenya’s biggest export, tea, added to tepid demand for horticulture and tourism from Kenya’s biggest market, the EU, implies to us that the current account is not out of the woods yet. Added to that, remittances, which have grown strongly in recent months, appear to have plateaued. There is also concern that the financing of the current account deficit may be at risk as yields fall, thus slowing portfolio inflows that are partly financing the deficit.
We think these headwinds in part explain the reluctance of the CBK to loosen monetary policy for fear of a shilling blowout from present levels of KES83/USD1. Nevertheless, we believe the loosening of monetary policy is likely to begin in the near term and as such we expect the shilling to weaken to the KES85-90/USD1 region by the end of 2012. Owing to the headwinds the current accuont faces, we revise our year end CBR projection from 10% to 14%.
CBR Cuts from June?
Policy rate cuts could begin in June. Kenya’s inflation has dropped by a third since it peaked at 19.7% y/y in November 2011, to 13.1% y/y in April 2012. However, the CBK is quick not to ascribe the significant slowdown to tight monetary policy alone, as the base effect in itself almost guarantees a slowdown in 2012. It is for this reason that other than a slowdown in y/y inflation, the CBK wants to see further evidence that inflation is under control including a sustained decline in non-food and fuel inflation and the stabilisation of food prices. Up until March, non-food and fuel inflation exhibited no trend and simply moved sideways for a few months in the narrow band of 10.6-11.2%. However, in April, it slowed to 9.4% y/y, suggesting to the CBK the start of a downward trend. The CBK thinks this is a genuine monetary policy effect and is in accordance with the CBK’s view that it takes about six months for policy decisions to take effect. We thus expect the CBK to commence its rate-cutting cycle in June.
Technical changes in measuring retail trade imply that 2011 GDP growth was underestimated. Kenya’s economy grew 4.2% y/y in the first nine months of 2011, compared with 5.0% y/y in the same period of 2010, according to provisional government estimates. The delayed GDP numbers for Q4 2011 are expected to be released this week (7-11 May). We estimated growth of 4.5% for 2011, premised on the estimates for the first nine months of the year. However, during our visit we were made aware of a technical change in the way the retail trade sector was measured. Wholesale and retail trade make up around 12% of GDP and were the third-biggest driver of growth in the first nine months of 2011. This may have resulted in the sector’s official growth being understated in 2011, implying real GDP growth was likely closer to 5.0% than 4.5%. One of the implications, of stronger growth and a slightly bigger GDP, is that the current account deficit is a little less ugly than present estimates suggest.
There may be an upside to GDP growth in 2012. We were witness to how Nairobi’s traffic is further slowed by rains as we weaved our way through it to make our appointments. The long rainy season has certainly begun, albeit late and heavier than would be best for some agricultural crops, particularly vegetables. That said, the general view was that agriculture production would normalise in 2012 following last year’s Horn of Africa drought, which notably did not affect the sector, and by implication GDP, as adversely as had generally been expected. Moreover, we expect existing infrastructure investment to support growth. However, there are concerns that some construction and real estate activity may be dampened by the high interest rates. There is also the added risk to growth of a slowdown in demand for Kenya’s exports and tourism from its traditional markets.
Republished with kind permission by Renaissance Capital. For more information or the full report, please contact Yvonne Mhango on