May 21, 2021/Cordros Report

We initiate coverage of the Kenyan economy and discuss our views on growth, inflation, balance of payment, currency, monetary policy and fiscal policy.

The Great Lockdown Derails Fragile Growth

The Kenyan economy was on a positive growth trajectory until the COVID-19 pandemic dealt a significant blow to the economy. Although supply chain disruptions pressured food prices, inflationary pressure in the economy was tapered by a VAT reduction by 200bps to 14.0%, lower oil prices, and domestic demand reduction. Despite obtaining non-conditional multilateral financing (USD1.00 billion) from the IMF, the loan support was insufficient to offset the impacts of (1) the decline in FX earnings and (2) capital flight to safe-haven assets, which led to a 7.2% depreciation of the local currency. Meanwhile, the Monetary Policy Committee of the Central Bank of Kenya (CBK) reduced the key policy rate by 150bps, in line with global central banks’ measures to limit the impact of the pandemic. At the same time, the Government also supported with fiscal expansion programme.

Economy to Recoup Pandemic-Induced Losses amidst Fiscal Risks

We expect the economic growth of Kenya to surpass pre-pandemic levels in 2021 given (1) the full re-opening of the economy, (2) the low base effect from the prior year and (3) recovery in the external sector. In the same vein, we believe the increased demand stemming from the normalisation of economic activities will keep domestic prices elevated in 2021, especially in Q2-21 and Q3-21, due to unfavourable weather conditions, which will impact harvests negatively. We expect the persistent increase in import demand to weigh the current account, leading to a moderate widening of the current account deficit. So far, in 2021, the KSH has appreciated by 1.2% against the USD, and we think it has to do with the euphoria that came with the IMF loan announcement (USD2.34 billion) rather than the fundamentals. However, our balance of payments (BOP) model suggests that imports could rise faster in H2-21 as consumer demand surges with improved domestic macroeconomic conditions amid growth in the external sector. Accordingly, we expect that the demand and supply dynamics, particularly in H2-21, lead to a moderate depreciation in the currency amid an FX reserve drawdown pending the timing of the Eurobond issuance. We forecast inflation to average 6.67% in 2021FY, within the CBK’s target band of 2.5% and 7.5%. The preceding will allow the CBK to maintain its accommodative policy stance throughout 2021. The Government expects to present the 2021/2022 fiscal year’s budget to the Parliament on 10th June. We expect the fiscal deficit to moderate slowly in 2021, as recovery in the broad economy supports revenue generation.

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