RenCap on Kenya’s Q2 GDP Growth
Thursday, 11 October 2012
High Interest Rates Subdue Growth
Real GDP growth slowed to 3.3% in 2Q12, from 3.5% YoY a year earlier, largely on account of softer growth in wholesale and retail trade, and financial intermediation. When we review the growth performance for 1H12, compared to the corresponding period of 2011, we note a sharper slowdown than that indicated by the 2Q growth numbers. Growth slowed to 3.4% YoY in 1H12, from 4.3% YoY in 1H11, largely due to weaker growth in wholesale and retail trade, financial intermediation, real estate and business services, and construction.

We believe high interest rates that subdued credit growth partly explain the weakening of the sectors’ growth. Credit growth slowed sharply to 18.0% YoY in June, compared to 32% YoY a year earlier, which we believe largely explains the halving of financial intermediation’s growth momentum to 5.0% in 1H12, from 10.3% YoY in 1H11. Credit growth’s sharp slowdown dampened activity in sectors most exposed to credit. This includes the trade, real estate and construction sectors that hold 17%, 12% and 5%, respectively, of total credit extended to the private sector.

Growth in construction activity slowed significantly to 2.2% YoY in 1H12, from 6.0% YoY in 1H11. This is reflected in the marked slowdown in cement production’s growth to 3.8% YoY in the year to May, compared to 13.0% YoY a year earlier. Wholesale and retail trade’s growth moderated to 5.3% YoY, from 7.2% YoY, while the real estate sector grew at a modest 2.4% YoY in 1H12, down from 3.6% in 1H11.

Agriculture’s Deferred Recovery

Kenya’s agriculture sector failed to deliver a recovery in 1H12, following 2011’s drought-like conditions – the sector grew at a modest rate of 1.9% YoY in 1H12, compared to 2.0% YoY a year earlier. The muted performance of the agriculture sector is largely attributed to a decline in exports of horticultural crops and tea. According to Kenya’s statistics office, three factors explain agriculture’s poor growth performance.

Firstly, severe frost negatively affected the production of tea and other vulnerable crops, including potatoes; tea production contracted by 2.5% in the year to May 2012. Secondly, late rains in the ‘long rains’ season (that typically begins in 2Q) undermined agricultural production, especially of food. We think the jump in maize prices (in the absence of production data) is evidence of the tightening of food supply. Lastly, demand for horticultural products from the main market, the EU, slowed.

Communications and Electricity Bucked the Trend
The strengthening of the transport and communications sectors’ growth to 5.4% YoY in 1H12, from 4.1% YoY in 1H11, is largely attributed to the communications sub-sector. Communications grew by 7.0% YoY in 2Q12, compared to 2.9% growth in the transport sub-sector. Electricity and water was the fastest growing sector in 1H12, expanding by 11.9% YoY in 1H12, compared to 0.6% YoY in 1H11. The utilities sector’s growth surge reflects an improvement in dam water levels due to relatively better 2012 rains that allowed for an expansion in the generation of hydro-electricity. Hydroelectric power generation has been increasing since May 2012, and exceeded the 350mn kWh mark in July for the first time in over three years.

This significant improvement in electricity generation failed to translate into stronger manufacturing activity. Manufacturing sector growth only edged up to 3.4% YoY in 1H12, compared to 3.3% YoY in 1H11. Manufacturing’s subpar performance was due to the non-food processing subsectors. Cement production, motor vehicle assembly and textile manufacturing grew by a relatively poor 1% in 2Q12. We think this partly reflects a decrease in household demand for discretionary goods on credit, like vehicles, owing to the sharp increase in interest rates. Households are the second-biggest recipient of credit extended to the private sector.

2H12 Expectations?
We have found that domestic energy consumption’s growth tracks real GDP growth rather closely. Kenya’s energy consumption growth peaked in 4Q10, and has trended downward since then, in line with the slowdown in GDP growth. We expect growth to be relatively flat in 3Q12 compared to that of 1H12, and to pick up moderately in 4Q12, owing to the ‘long-rains’ season harvest that we expect to boost agricultural production.

Yes, the Central Bank of Kenya (CBK) began cutting the policy rate in July. However, we do not expect that to have a material impact on credit growth until 1Q13, partly because Kenya’s lending rates tend to be sticky. As of August, the lending rate was still flat at 20.1%. We expect it to have moderated following September’s policy rate cut, but we only anticipate the effect on lending to be realised in 2013.

This means we do not see a meaningful recovery of the more interest-rate sensitive sectors such as trade, financial intermediation, real estate and construction before YE12. We thus believe real GDP growth will strengthen to 3.9% YoY in 2H12, from 3.4% YoY in 1H12, which implies a growth projection of 3.7% for 2012. We think credit growth will only begin to show a marked recovery from 1Q13, and that thereafter, the more interest-rate sensitive sectors will realise stronger growth.

Implications for Monetary Policy?
The slowdown in economic activity in 1H12 implies to us that there is room to loosen monetary policy; inflation’s downward trajectory YtD makes it easier for the CBK to do so. Inflation dropped to 5.3% YoY in September, from 17.3% YoY a year earlier. The CBK cut the policy rate in July and September by 5 ppts collectively, to 13%. Given our projection of c. 3% inflation at YE12, we think there is room for a further policy rate cut that we expect will bring down the policy rate to 11% at YE12.

We anticipate this will eventually translate into lower lending rates, particularly given the magnitude of the cuts. As we are projecting single-digit inflation for most of 2013, we expect further rate cuts during the year to 8% at YE13. This will be negative for the shilling, in our view, so we expect some shilling weakness over the short term. Our YE12 projection for the shilling is KES88/USD1.

For more information, contact Yvonne Mhango ( This e-mail address is being protected from spam bots, you need JavaScript enabled to view it )

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