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Fitch Affirms Kenya at 'B+'; Outlook Stable
Fitch Ratings-Hong Kong-April 30: Fitch Ratings has affirmed Kenya's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Kenya's ratings reflect strong and stable growth balanced against persistent twin deficits and high public and external debt levels.
GDP growth was 6.3% in 2018, an acceleration from 4.9% in 2017, which was depressed by lower agricultural output due to drought and a slowdown in economic activity around the elections. Fitch forecasts 2019 growth to slow slightly to 5.8% and to fluctuate around 6.0% in the medium term, as agricultural growth normalises but the service sector continues to support growth.
Kenya's fiscal deficit will narrow to 6.6% of GDP in the fiscal year ending June 2019 (FY19), but the deficit remains high compared with the current 'B' median of 4.3%. Our forecast is higher than the FY19 target published in the February 2019 Budget Policy Statement, reflecting revenue shortfalls over the first half of the fiscal year that are unlikely to be fully covered by a possible supplemental budget. A fall in capital expenditure relative to GDP helped bring the deficit down to 7% of GDP in FY18 from an average of 8.2% of GDP in FY15 to FY17. Fitch expects that the deficit will fall further in FY20 as Phase 2a of the Standard Gauge Railway is completed and other large infrastructure projects are submitted to new public investment guidelines.
Weak revenue growth presents a challenge to future consolidation. A combination of structural and administrative issues has caused revenue/GDP to stagnate in recent years. Some of this is the result of agriculture being a large component of the economy and most of the non-export agricultural output coming from untaxed smallholders. In addition, weak tax compliance and the expansion of tax exemptions have muted domestic revenue growth. The government is working to improve compliance and expand the tax base, which could improve revenue performance over the medium term. Fitch does not expect major revenue measures in the FY20 budget and expects that revenue growth will remain weak through the next fiscal year.
Fiscal policy was a key focus of Kenya's precautionary 2016 Stand-By Agreement with the IMF, which ended with only the first of four reviews completed. The authorities are currently in discussions with the IMF on a new programme, but Fitch believes that disagreement over the pace of fiscal consolidation has kept Kenya from coming to agreement with the Fund on a new programme. The successful negotiation of a new programme with the IMF would signal the government's commitment to narrowing the fiscal deficit at a pace faster than we currently expect.
Persistent fiscal deficits have led to elevated government debt, although at 58% of GDP at end-FY18, general government debt is in line with the current 'B' median. Strong growth and modest fiscal consolidation will lead to a slight decline to 57% of GDP in FY19, according to Fitch's forecasts. Interest payments increased to 21% of revenue in FY18 and will remain at this level through FY20. By comparison the 'B' median is 9% of revenue.
Kenya's current account deficit (CAD) has narrowed, but remains high. Better export performance, along with lower capital imports and lower global oil prices, reduced Kenya's trade deficit to 11% of GDP in 2018 from an average of 16% over 2008 to 2017 and tourist earnings and remittances have also increased. Fitch estimates the 2018 CAD at 5.2% of GDP and forecasts it to remain at around 5% in 2019 and 2020. Low levels of FDI increase Kenya's reliance on external debt flows to finance the CAD. At 31% of GDP, net external debt is well above the peer median of 15%.
Kenya's reserve position eases some of the vulnerability from high external debt. International reserves were USD8.2 billion as of January 2019 (approximately four months of CXP) and Fitch forecasts reserves to increase to USD8.9 billion by end-2019. The Kenyan shilling experienced a slight depreciation in 4Q18 but bounced back in January 2019 and remained stable through 1Q19.
Asset quality continues to be a problem for Kenya's banking sector, but the largest banks are stable and profitable. A number of smaller banks are opaque and as a group pose some systemic risk, but ongoing consolidation in the sector will ease some of those risks. Economic headwinds contributed to deterioration in asset quality in 2017, driven by the growth of non-performing loans (NPLs) in the corporate sector. Growth of NPLs began to slow in 2H18, but stagnation in loan growth has taken the ratio of NPLs to total loans to 12.8% as of February 2019, up from 9.7% in February 2017.
Credit growth has remained weak since 2016, reflecting a slowdown after earlier rapid growth exacerbated by the interest rate cap implemented in September 2016. In March, Kenya's High Court ruled the interest rate cap unconstitutional and gave the government one year to amend the law or allow it to expire. The court's ruling was on procedural grounds, which leaves the door open to parliament passing a new rate cap law. However, should the rate cap be removed or allowed to expire, Kenya would likely experience a significant positive credit growth shock.
Structural factors constrain Kenya's sovereign ratings. Kenya is in the 25th percentile of the UN Human Development Index. Kenya's governance indicators are weaker than the current 'B' median. Additionally, Kenya has a history of instability around national elections, the next of which is scheduled for 2022.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Kenya a score equivalent to a rating of 'B+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, the main factors that, individually or collectively, could lead to positive rating action are:
The main factors that, individually or collectively, could lead to a negative rating action are:
Fitch assumes the global economy evolves broadly in line with the projections in its latest "Global Economic Outlook".
The full list of rating actions is as follows:
Long-Term Foreign- and Local-Currency IDRs affirmed at 'B+'; Outlook Stable
Short-Term Foreign- and Local-Currency IDRs affirmed at 'B'
Country Ceiling affirmed at 'BB-'
Issue ratings on long-term senior unsecured foreign- and local-currency bonds affirmed at 'B+'