Why I Am Bearish On Kenya

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Summary

The country heads to election in August.

Corruption is a big challenge to the country.

Huge infrastructural projects might not pay off.

Introduction

Kenya is an East African country known for its wildlife, athletics and being the birthplace of Obama's father. It is the largest economy in East Africa with a GDP of $63.39 billion. Kenya has a population of approximately 46 million people.

Kenya

In the recent past, Kenya's place in the financial scene has been evident. The country has continued to attract some of the world's biggest brands like General Electric (NYSE: GE), IBM (NYSE: IBM), Yum Brands (NYSE: YUM) and Uber (Private:UBER), among others. In fact, as shown below, it is anticipated that FDI inflows to the country will increase in the next 3 years.

Source. Trading Economics

The continued increase in FDI can be attributed to a number of factors, key among them the country's ease of doing business. While the country is still lower in the World Bank's ease of doing business ranking, it has shown some improvement as shown below.

Source: Trading Economics

This improvement can be attributed to a number of factors such as the government's investment in infrastructure projects, simplification of business permit application, removal of non-tariff barriers and the 'reduction' in energy prices.

However, despite the progress, I believe that the country is headed in the wrong direction. I am not alone. In a poll conducted in August, it was established that the majority of Kenyans felt that the country was headed in the wrong direction. The stock market has also had a similar response. In 2016, the NSE 20 Share index returned -15.6% while the MSCI Kenya (^MSKE) made a 12.6% loss. In this article, I explain a number of reasons why I am bearish on the country.

Upcoming election

On 8th August, Kenyans will head to the polls to elect their new leaders. The current president Uhuru Kenyatta will be defending his seat. The opposition parties are yet to name their flag bearer though it is believed that former prime minister Raila Odinga will be trying his luck for the 4th time. In the previous election, Mr. Kenyatta beat Mr. Odinga who challenged the election result in the Supreme Court. Recent opinion polls indicate that Kenyatta would beat Odinga easily if elections were held today.

The last elections were peaceful. However, many experts, including the previous chief justice, have warned that drums of war were beating. The opposition parties have also threatened mass action (read protests) in case the electoral reforms are not put in place. Also, Mr. Odinga has vowed not to go to the court again in case of a disputed election.

While the campaigns will kick off in June, party nominations will start before then. In the country, nominations are usually marred by violence. Therefore, I am bearish on Kenya because I foresee business activity being interrupted with the rising political temperatures. Historically, the local currency (Kenyan shilling) and the stock market have fallen in the election year. In fact, the Kenyan shilling is currently trading at the lowest levels in years.

Source: Investing.com

The 2008 election led to more than 1300 deaths and more than 100,000 people displaced. The same can happen this year if measures are not put in place.

Corruption

Corruption is alive and well in the country. According to Transparency International, Kenya ranks 138 out of 165 in corruption. Another report by PriceWaterHouseCoopers ranked Kenya as the third most corrupt country in the world. In the recent past, the country has seen a spike in high-profile, corruption-related cases. For instance, in 2014, the country issued a $2.3 billion eurobond. From the funds, an audit revealed that more than $2 billion was unaccounted for. The government has refuted the claims. The auditor general has also revealed that more than $50 million was lost in the health ministry in procurement related cases. The auditor who identified the crime was demoted to lighter duties. In addition, in the last financial year, the auditor revealed that more than $70 million was unaccounted for (read stolen).

Development projects

The government has embarked on an aggressive infrastructural project funded by China. The most ambitious projects include a $10-billion standard gauge railway line from Mombasa to Uganda, a 1000Mw coal plant ($1.6 billion) and the construction of 10,000-km roads. At a distance, these developments look great for a developing economy like Kenya.

A number of analysts have written about the standard gauge railway and concluded that it's a sham. A recent article in Business Daily concluded that the railway line does not make sense for a number of reasons. First, the railway line is funded by China. The repayment of the loan is expected to take 10 years. When fully used, the railway line will make a gross profit of $320 million. This means it should take tens of years for the railway to repay itself. Second, the railway's cost per kilometer is far more expensive than better lines built in the neighboring Ethiopia. Tanzania's SGR will be cheaper than Kenya's. Third, the railway line passes through a national park. With tourism being a major source of income for the country, this will affect the Nairobi National Park. A renowned Kenyan economist, David Ndii, has published a number of articles on SGR which you can read here and here.

External debt

Kenya is a heavily indebted nation and I believe that ratings agencies will soon review their ratings for the country. Here are the facts. Kenya's annual budget is $21 billion. Kenya Revenue Authority [KRA] collects slightly above $10 trillion. The difference of the budget is funded by donors and through borrowing. It was also reported that the country spends a fifth of its budget on loan repayment. In addition, the country spends 80% of its budget on wage bill. As we speak, doctors have been on strike for more than a month seeking higher wages. The chart below shows the rise in Kenya's debt to $30 billion.

Source. Trading Economics

Further, the finance minister has floated the idea of a new eurobond. As stated before, the previous eurobond's proceeds have not been well accounted for. IMF has already issued a warning on Kenya's debt sustainability. Therefore, I believe the country cannot continue successfully like this.

Conclusion

All is not lost on Kenya. I believe that the country can turn around. The recent oil discoveries can help the country boost its revenues. However, the history of oil in Africa has not always been promising. It has led to conflicts and deaths. To become successful, the government must commit to stopping corruption, especially in procurement. The country must stop overpaying for basic products. In addition, the government must collaborate with the international community to repatriate stolen funds held in foreign banks. The US is working on this with Nigeria. The country must also shift focus from aid to trade with the rest of the world. Last but not least, the country must cut back on infrastructural spending.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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