The government’s undeniable optimism in the country’s economic growth projections cannot be understated. During the budget reading for the 2019/2020 fiscal year, the Treasury Cabinet Secretary underscored the government’s belief that the impressive economic growth momentum recorded in 2018 will be maintained this year. That is to say, the economic expansion will be close to its 6.00% potential. This is despite the negative impact of the delayed onset of the long rains season, in the first quarter of the year, on the agriculture and agro-processing sectors as well as sustained tightness in credit markets.
Meanwhile, the government introduced various tax proposals to help boost revenue efforts. The lodestar for the tax reforms seems to be ‘broadening the tax base with pockets of tax increases’. As a result, revenues could rise to KES 2.10 Trillion, about to 19.70% of GDP, up from the current year’s budget of KES 1.74 Trillion. This is against an expected government spend of KES 2.80 trillion, 25.70% of GDP, with approximately 16.00% of the planned expenditure channeled towards Big 4 projects and their enablers. According to Treasury, this should help narrow the fiscal deficit (including grants) to 5.60% of GDP from 6.80% in the current fiscal year.
With that said, narrowing the fiscal deficit may be an onerous task given that slower than expected growth could weigh on tax revenues. Unless the government implements fiscal restraint in its spending commitments, that have usually meant reducing much needed development spending, the pace of fiscal consolidation may be dented thus elevating debt sustainability concerns.
Meanwhile, approximately KES 324.30Bn and KES 283.50Bn in external debt and net domestic financing will plug the deficit. Preference for the external market may be informed by the need to avoid crowding out the private sector in domestic credit markets. To be sure, private sector growth remains fragile and below 5.00% (on average) following the introduction of the interest rate cap. Moreover, efforts by the central bank to stimulate private sector credit growth through a reduction of the Central Bank Rate (CBR) have failed owing to challenges in transmission.
To this end, Treasury has proposed to repeal section 33B of the Banking (Amendment) Act, 2016, that introduced the interest rate cap. This is the second time Treasury has made this proposal after lawmakers rubbished it in 2018. While it remains unclear whether the law capping interest rates will be repealed, it is clear the interest rate cap has constrained the effectiveness of the CBR as a monetary policy tool.
I therefore believe the central bank will steer clear from using the CBR as a monetary policy tool as it awaits more clarity into developments around the possible removal of the interest rate cap. Until then, the central bank will be in favour of banking sector reforms and innovations such as Stawi that will enhance credit to the private sector, primarily to MSMEs and SMEs.
Already, the central bank is dealing with consumer protection issues in the banking sector to strengthen financial access. This will complement the government’s own efforts to revive private sector activity through reforms in the banking sector and credit markets. These reforms include but are not limited to:-
I. A proposal to repeal section 33B of the Banking (Amendment) Act, 2016 that will end the regime of interest rate capping and unlock credit to the private sector. (As earlier mentioned)
II. A proposal to amend the Tax Procedures Act to grant exemption from the Pin requirement, in certain circumstances, when opening a commercial bank account. This seems directed towards visiting foreigners, privileged persons and foreign investors investing in the country’s financial markets.
III. The launch of the SME Credit Guarantee Scheme, which, together with the Biashara Kenya Fund and SME Fund, will deepen access to credit by SMEs and address the reason for the introduction of the law capping interest rates.
Until then, government (local) borrowing and inflation expectations may remain key to driving interest rate expectations. For one, inflation is expected to remain within the government’s target band (5% +/- 2.50%) this year supported by comparably stable food prices and subdued demand side pressures. Secondly, the government’s debt appetite could remain tame following successful fundraising efforts in external markets.
This will be complemented by ample interbank liquidity conditions that are set to receive a further boost from the settlement of ‘audit-free’ pending payments to government suppliers with Treasury prioritizing KES 10.90Bn to be paid before the end of June 2019. Furthermore, the President of Kenya recently signed into law the Supplementary Appropriation Bill to release KES 161.00Bn from the Consolidated Fund to various Government departments in the month of June 2019.
The aforementioned should offer a further boost to the current liquidity landscape driving interest rates lower. As majority of this liquidity may sit with commercial banks (the largest investors of government securities), it is expected that investor demand for government securities will remain healthy, outpacing the government’s need for debt, thus curbing any upward pressure on Treasury yields. In addition to contained inflation, this could support lower interest rate expectations going forward.