Kenya cut on COVID-19 concerns

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Kenya’s outlook has been dropped from stable to negative by S&P Global Ratings on concerns of the impact of the coronavirus disease 2019 (COVID-19) crisis on already weak public finances.

The rating agency has however maintained Kenya’s long-term and short-term sovereign credit rating at B+ and B respectively. This is on the expectation that Kenya’s diversified economic base and flexible monetary policy settings will balance the shocks from the COVID-19 crisis.

S&P expects the economic fallout of the COVID-19 shock to drive real gross domestic product (GDP) growth down to 1% in 2020, followed by a rebound to 4% in 2021.

Growth remained reasonably strong in the first quarter of 2020, a period not heavily affected by the COVID-19 pandemic.

Real GDP grew by 4.9% year-on-year in first-quarter 2020 down from 5.5% in the fourth-quarter 2019. The agricultural sector also grew by 4.9%, despite locust infestation and flooding in some parts, up from 4.0% in fourth quarter 2019.

The economic shock will also widen Kenya’s twin fiscal and external deficits. S&P projects that general government deficit will widen to 8.7% of GDP in the fiscal year ending June 2020, before falling slightly to 7.9% in 2021.

S&P expects the deficit to rise to 8.7% of GDP in 2020, from a pre-pandemic planned 6.3% – and forecasted at 7.9% in 2021, from a planned 4.9%.

The deficits are forecasted to fall from 2022, but could be affected by pre-election spending – which are to be held in 2022, while a referendum is planned for 2021.

In response to the pandemic, the Kenyan government issued a tax law amendment act in April 2020.

This slashed a number of tax rates including personal and corporate income tax and value-added tax, while raising expenditure on health, social, and employment schemes by about 0.4% of GDP. Combined, these measures led to a significantly higher fiscal deficit.

The increased deficit in 2020 was partially financed by an International Monetary Fund (IMF) rapid credit facility of $739 million and a $1 billion loan from the World Bank.

Kenya expects to finance the 2021 fiscal year budget with a mix of domestic and not-yet-fully-defined external lending sources. About 4.4% of GDP is expected to be raised from the domestic market and 3.1% externally.

The tax and spending measures initiated in the 2020 and 2021 fiscal year are expected to be temporary and will be rolled back in the 2022 budget.

Kenya’s government may also attempt to address the tax exemption schemes in 2022, which by S&P’s estimates amount to lost revenues of up to 6% of GDP.

The country’s stock of general government debt, net of liquid assets, will rise to an average of 61.2% of GDP in 2020 to 2023, from 52.6% in 2019 and 37.7% in 2015. Debt servicing costs will increase and average a high of 26% in 2020 to 2023.

Kenya’s current account deficit as a share of GDP is forecasted to stand at 5.9% of GDP in 2020.

S&P expects the current account deficit to average 5.1% of GDP over 2021 to 2023 against a backdrop of relatively low energy prices and recovering exports and non-oil imports.

The rating agency estimates that Kenya’s external debt, net of liquid public and financial-sector external assets will increase to 193% of current account receipts (CARs) in 2020. These are expected to average 188% in 2020 to 2023.

S&P forecasts gross external financing needs – payments to non-residents to average a high 138% of CARs plus usable reserves between 2020 and 2023.

Foreign exchange reserves stood at $9.7 billion in June 2020, buoyed by IMF and World Bank remittances.  S&P expects foreign currency reserves to remain just under $9 billion by the end of 2020, still over four months of current account payments (CAPs).

On the upside, Kenya has enjoyed reasonably good access to international capital markets in recent years and last issued $2.1 billion in Eurobonds in May 2019. This included a $1.2 billion and a $900 million Eurobond.

Kenya does not face any immediate Eurobond maturity and almost two-thirds of its external debt is concessional by nature with low interest rates and long tenors.

S&P expects the Kenyan shilling to depreciate to below the KSh110/$ threshold by the end of 2020 due to COVID-19 pressures.

Inflation trends are expected to remain broadly under control and within the Kenyan central bank’s 2.5% to 7.5% range.

Prior to the pandemic, Kenya’s banking system was relatively sound. Even so, high nonperforming loans, which stood at 13% in May 2020 will remain a risk to the sector.

A recovery in economic activity in the second half of 2020 could lead to a rebound in domestic credit.

The central bank cut rates to 7% in May 2020 and reduced reserve ratio requirements to 4.25%.

S&P would consider downgrading the rating if the ultimate economic fallout from the COVID-19 pandemic and weaker policy momentum derailed Kenya’s efforts to curb its twin deficits.

The rating agency would revise the outlook to stable if there is a significant and sustained improvement in Kenya’s fiscal and external accounts.

S&P would also consider upgrading the rating if Kenya reverts to strong GDP growth and fiscal consolidation more rapidly than expected, which would in turn help address debt vulnerabilities.

This comes after Fitch Ratings dropped Kenya’s outlook from stable to negative on concerns of the impact of the COVID-19 crisis on the economy, earlier in 2020.

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