Kenya

major macro economic indicators

(e): Estimate (f): Forecast *Fiscal year from 1 July to 30 June; year 2023 from July 2022 to June 2023

RISK ASSESSMENT

Comfortable and steady economic growth driven by private investment

Despite the uncertain environment surrounding the August 2022 general elections and the contraction of the agricultural sector (37.5% of GDP) due to the severe drought in the Horn of Africa, Kenya has continued its post-pandemic economic rebound which has been driven by robust activity in the services sector (46.5% of GDP). In 2023, economic growth will continue despite fiscal and monetary tightening, durably high inflation and a deteriorating global economic environment. Increased private investment, driven by credit growth and renewed investor confidence following the peaceful transfer of power in government, will contribute to economic momentum. Despite the use of Public-Private Partnerships, public investment will be deterred by tighter fiscal policy and higher borrowing costs due to the large stock of public debt and high inflation. Export growth is also expected to decelerate, affected by the slowdown in demand from the European and US economies on the one hand, and the persistence of drought on the other. Kenya could suffer, for the fifth consecutive year, from a missed rainy season when its agricultural activity provides the bulk of exports. However, the slowdown in export growth will be more than offset by the slowdown in import growth due to lower world energy prices, so that the contribution of net exports to growth will be positive. Similarly, consumption (81% of GDP) will support economic activity as household disposable income increases, driven by falling inflation. While inflation rose in 2022 on back of the sharp depreciation of the exchange rate (10% against the dollar) and rising oil prices, the Central Bank of Kenya raised its benchmark interest rate by 250 basis points from May 2022, bringing it to 9.5% in March 2023. While this decision should help ease inflationary pressures, food prices, which are highly dependent on rainfall, pose a significant upside risk to inflation forecasts in 2023.

Twin deficits persist despite fiscal consolidation efforts

Kenya continued its fiscal consolidation and reduced its deficit during the 2021-2022 fiscal year, supported by higher revenues due to improved tax collection and moderation in capital spending. Resumed privatisation of state-owned enterprises, with the prospect of additional revenue gains, and expenditure restraint such as the end of the petrol subsidy, will allow for a further small reduction in the budget deficit in 2022-2023. However, if the government maintains its commitment to fiscal consolidation, its high recurrent expenditure (large public sector wage bill, poor management of capital expenditure, etc.) will hamper the deficit reduction. The deficit will be financed by domestic bond issues as well as by external concessional and, secondarily, bank financing, as Kenya has benefited from significant IMF support since April 2021. On that score, having received more than USD 2.4 billion in financing, of which USD 1.55 billion has already been disbursed, the IMF programme reduces the risk of debt distress and ensures that the country will be able to honour its short-term debt commitments. The IMF funding line will not, however, be enough to prevent Kenya's external liquidity from deteriorating. With external debt estimated at 34% of GDP, debt service obligations will be high in 2023-2024 (16.6% of current external revenue in 2023 and up to 24% in 2024), particularly given the maturity of a USD 2 billion eurobond in June 2024. Foreign exchange reserves will therefore remain under pressure in 2022-2023.

After widening in 2022, on back of higher commodity prices, the current account deficit will narrow slightly in 2023, driven by a reduction in the structural trade deficit and an increase in the services surplus. While export growth will weaken, affected by decreased demand from Europe and the United States and by possible crop failures owing to persistent drought, the faster slowdown in import growth will lead to a slight reduction in the trade deficit. Given the weight of energy and capital goods imports in Kenya's trade deficit, lower global prices will damp foreign exchange outflows. In addition, the surplus on the services balance will increase due to the uptick in tourism (9% of GDP) and transport services. Kenya has become a genuine maritime hub of East Africa thanks to the development of its transport infrastructure, such as the port of Mombasa which is now the largest port in East Africa. Given the pressure on foreign exchange reserves (about 5 months of imports), the current account deficit will be financed by new borrowing and FDI inflows, mainly from Kenya's largest bilateral creditor, China, which holds almost half of the country's external debt.

A peaceful political environment amid a peaceful transfer of power

The August 2022 presidential elections saw William Ruto, a member of the Kwanza coalition and of the Kalenjin ethnic group (13% of the population and the third-largest ethnic group) become head of Kenya. Despite the low turnout (65%) and incumbent President, Raila Odinga challenging the results, the transfer of power took place peacefully on 13 September 2022. Parliamentary elections, which were held simultaneously, confirmed the tiny majority of the Kwanza coalition, which now controls both houses of Parliament. With 179 out of 349 seats in the National Assembly, it will govern against 157 members of the opposition Azimio coalition and 13 members of independent parties. While ethnic voting seems to have been overcome in the last elections, communal conflicts will make the small Kwanza majority vulnerable to parliamentary revolts.

Externally, Kenya will deepen its involvement in the East African Community (EAC) and is playing a leading role in securing the membership of the Democratic Republic of Congo, which poses new security challenges within the regional intergovernmental organisation. Furthermore, the country will maintain close ties with its multilateral and bilateral partners, in particular with the United States and the United Kingdom, Kenya's main military partners. On the trade front, the free trade agreement with the United States is still under negotiation, so Kenya is struggling to reconcile national interests with regional integration.

Last updated: June 2023