By Kosta Kioleoglou
The prolonged and uncertain election period has seriously challenged Kenya’s economy and property market. The turmoil of the extended Presidential election triggered several side effects that had been developing behind the scenes. The country’s bad economic performance with several microeconomic factors showing signs of weakness and unsustainability are now monopolising the local and international analyst’s interest.
Over the last few months, a number of reports have given negative signs for the Kenyan property market and the Kenyan economy. The property market has been under pressure for almost two years. Marginal price increases, which are now further slowing down, are creating a new environment for investors. Beginning of November 2017, the Kenya Bankers Association released the House Price Index for the third quarter 2017. According to the report, there was a 0.42% increase in overall house prices during the third quarter of 2017 compared to the previous quarter’s 0.98%. This is an indication that there is no respite for the declining trend in the rate of house prices increase since the third quarter of 2015 (Figure 1). The trend on growth in house prices mirrors that of credit growth to the private sector. Credit is evidently integral in influencing the demand and supply dynamics in the housing market. With the generally depressed demand in the economy and the slowdown in credit expansion, households relying on the credit market towards home acquisition have been adversely affected. This has consequently influenced the house prices trend.
The sluggish demand environment has provided little incentive for increase supply of housing units, a situation that is compounded by the constrained supply of financing. Since the base period of the first quarter of 2013, house prices have risen by 17.59% up to the end of the third quarter of 2017 as shown on the fixed base index.
The political environment has definitely played a key role to the economic underperformance of the country.
Another report released by the national statistician shows that the value of buildings approved for construction by Nairobi County in the first seven months of 2017 declined by 18.4% to Sh149.5 billion down from Sh183.2 billion in the same period last year. This means the economy lost a massive Sh33.7 billion during this period.
One more report which was recently released by KNBS paints a bleak picture of a struggling housing sector in which activities, both in residential and non-residential buildings, were subdued in what many analysts blame on the toxic political climate in the country.
The value of residential buildings approved, according to the report, declined by 17.4% to Sh88.5 billion in 2017 from Sh107.2 billion in 2016. Commercial building approvals dipped by 15.1% to Sh61 billion in 2017 compared to Sh76.1 billion last year.
KNBS also attributed the slowdown in the construction sector to poor credit extension. According to the report, credit to building and construction activities declined by 1.2%. This reflects a further relatively less activity in the sector during the second quarter of 2017. Analysts are expecting further decline the second half of the year. The report showed that the gross domestic product or the total value of goods and services produced between April and June 2017 grew by 5% compared to a growth of 6.3% in the same period in 2016. It was the slowest second quarter growth since 2012.
The 7.5% growth of the construction sector was, however, slower than in the same period last when the sector expanded by 7.6%. The slow growth was also evidenced by 6.3% decline in cement consumption, which is a key input in the sector. Declines in the volume of imports of construction materials such as iron and steel, and cement by 28.9% and 27.1% respectively, also explain the slowdown in the sector.
Performance of the construction sector over the last five years in the third quarter is anything but impressive, growing steadily from a low of 7% in 2012 before hitting a high of 16.5% in the second quarter of 2014. The growth then began to slow down to 12.1% before it plunged to 7.6% last year. The current political instability is adding more pressure to the sector. It looks like it will be heady days for the sector that for a while has given the country’s economy the Midas touch, particularly after the country rebased the way in which it calculated its GDP and included real estate in its computation.
The property market, real estate and construction sector is indissolubly linked with the macroeconomics, the economic performance and growth of the country. If the country’s economy will not manage to sustain a steady growth and create the required environment for the property and construction market sector to grow then there is no way to stop this market downturn that will result to loss of a huge part of the monies invested during the last decade.
Analysts believe that on top of the general economic slowdown there are two key factors that are affecting the property market.
The first key factor is the fact that developers have concentrated on high-end residential properties and commercial properties such as malls, many of which remain largely unoccupied and or unsold. In several areas supply overcomes demand as the majority of buildings are targeting high-end clients, when there is a greater need to build affordable houses for low-income earners.
The second and extremely important factor is finance. Easier access to finance and cheaper loans are key for the property market sustainability. Unfortunately, the banking sector is facing huge challenges. Despite the effort of CBK to support and monitor the banking sector more intensively since 2015 Kenya banks seem not to be able to overcome their problems. On top of the local pressure and problems that the banks have to face including the CBR increase and the interest rate cap, the Global ratings agency Moody’s has warned of a likely downgrade of credit and deposit scores of three Kenyan banks, citing the country’s deteriorating debt situation.
The agency said it had placed on review for downgrade the B1 global scale long-term local-currency deposit ratings and the b1 baseline credit assessment (BCA) of Kenya Commercial Bank (KCB), Equity Bank, and Co-operative Bank. In reality, this is the result of the country’s general economic performance. Global credit rating firm Moody’s has also placed Kenya’s B1 long-term issuer rating on review for downgrade, exposing the country’s high credit risk profile.
Moody’s action to downgrade the country’s rating has a potential of rolling back gains in the economic arena as this will lead international lenders to be wary of Kenya’s ability to repay loans so far advanced. For those intent on financing Kenya will do that cautiously and at higher interest rates. The flipside of this will be an active government competing for commercial loans in the local market. Banks are always accommodative in financing governments than other borrowers. This in turn will crowd out the small-scale borrowers who are the engine of our economy from the domestic market.
According to available reports and market analysis, inflation, unemployment, account balance deficit, public and private debt and shrinking growth are some of the main indicators that are not performing well creating negative atmosphere to the country’s image.
All local and international organisations such as the National Treasury, the World Bank and IMF revised further downwards the 2017 GDP growth projection for Kenya to +/-5%. Several available reports are forecasting a further upward trajectory in government debt which will see debt-to-GDP surpass the 60% mark by June 2018 unless a decisive policy response is introduced. Figures from the CBK show that Kenya’s public debt moved from Sh3.82 trillion in December 2016 to Sh4.4 trillion in August this year, meaning the state is borrowing Sh86 billion a month on average. Latest Treasury data from the 2017 budget outlook and review paper shows that the country spent Sh271.3 billion in interest payments, of which Sh212.9 billion went towards domestic debt interest and Sh58.4 billion in external debt interest payments. The government spent 19% of its revenues on interest payments, up from 10.7% five years ago.
Several people argue that even at 60% Kenya is way below many countries around the world where the debt load stands at more than 80%. The reality, however, is that debt tipping points vary for each country depending on the debt servicing capacity. For emerging markets like Kenya, the mark is 64% of GDP — a number that should make us very afraid given that Kenya’s debt load as a fraction of GDP is expected to cross the 60% mark by the end of 2017/2018 financial year.
Meanwhile, the country’s external debt is increasing by more than 25% annually having moved from Sh1.7 trillion at the end of June last year to 2.3 trillion this year. This means Kenya is facing a double setback where if the shilling starts losing to the dollar, interest rates on these loans will suddenly spike upwards whilst the debt-service to revenue ratio already stands at a high of 41% (Sh700 billion in the 2017/2018 financial year) against the recommended threshold of 30%.
Then there is the monetary sector, which is the heartbeat of the economy. Here, the projected level of bank credit to private sector needs to be broadly consistent with projected GDP growth. Unfortunately, the introduction of interest rate cap is sinking the velocity of money through credit investment because banks cannot properly price risks on loans.
The Kenya Bankers Association in a recent report put credit growth year-on-year at a low of 1.7% but negative on month-on-month basis. The government is also crowding out private sector as internal borrowing rose from 26% of GDP as of June last year to 31% of GDP as of September this year.
In other words, the relationship between private sector, credit investment and economic growth is wearing out. Next is the fiscal sector, and it doesn’t look any better; Kenya’s fiscal deficit is moving towards 8% of GDP in 2017/2018 financial year. This means that Kenya’s recurrent expenditure is steadily increasing whilst the government is also spending so much on servicing debt, leaving little funds for development expenditure. Based on the above fundamental macroeconomic accounting and behavioural relationship between economic trends, Kenya seems to have entered the unchartered economic waters against the blowing tide of public debt.
The sluggish demand environment has provided little incentive for increased supply of housing units, a situation that is compounded by the constrained supply of financing. The Real estate sector is expected to further slowdown. Under the current circumstances following the downward trend of the HPI eventually we will have to face negative returns. Currently the biggest challenge for the sector’s future growth is the fact that huge amounts of money are hemmed in the ongoing or already finished but unsold projects around the country.
The constant increase of Non-Performing Loans (NPL’s) is adding more pressure minimizing the available financial facilities leaving fewer options for those who are interested to invest. Around Nairobi a new trend of developers offering internal interest free payments for up to 10 years is a sign of how bad the market conditions are. It is obvious that such offers are nothing else but panic moves, from desperate developers, who are trying to dispose their properties at any cost. Vacancies are increasing day after day while selling land becomes almost impossible at the current rates.
Year 2017 is coming to its end and 2018 is expected to be full of challenges for its economy. The extra load of the triple threat of austerity measures needed to cover the prolonged election costs, the slowing credit growth and the new accounting rules for banks, are increasing the risks for Kenya to miss the government’s forecast for 6% economic growth next year. With growing headwinds, there is no longer any room for complacency. Kenya’s economy has been on the back burner for the better part of the year.
Now key indicators for the EAC regional hub for multinationals including IBM Corp. and Toyota Motor Corp., are flashing warning signs, with the latest Purchasing Managers’ Index, a measure of private-sector activity, falling to a record low and bank loans growing the slowest in more than a decade.
The nation’s 2.6 trillion-shilling ($25.1 billion) budget was amended to include “austerity measures” for the current fiscal year to accommodate unplanned expenditures such as the rerun of the election. The Treasury has revised its 2017-18-budget deficit forecast to 8.5% of gross domestic product from 6.8%.
The country recorded a 9.2% shortfall in year through June 2017. It is obvious that cutting down public expenditure as well as any reduction in government spending is likely to stunt growth. Investors are already wary of the country’s economy after the disastrous presidential election, which is still open to further turmoil depending on the opposition’s attitude and reactions.
The interest rate cap on commercial lending rates has weighed on economic expansion, with lending to the private sector growing at the slowest pace in more than a decade. This could worsen in 2018 as new accounting rules for banks may double impairments next year. This means banks will likely be more selective on where their available capital goes, resulting in even less money being lent to certain sectors of the economy. Several people claim that the solution is lifting the rate cap. The problem is that while lifting the rate cap could boost lending, it will also raise the cost of domestic borrowing.
On top of all the economic challenges, the period of political instability is slowly destroying Kenya’s economy and international image creating unfavourable conditions for 2018. Despite all these facts, this is not a period to panic. This is the period to reconsider your strategy and peruse your portfolio carefully. In business sometimes we need to make decisions that will cause controlled losses. Risk management and decisions like this are vital for the long-term sustainability of a project or budget – losing a little money now rather than losing a lot of money in the near future.
Basic economics and business principles show that all markets operate in cycles, which depend on the sustainability and real growth of an economy as well as political and economic developments. Those who believe the property market is different are simply wrong. Kenya’s property market is no different. After almost 8 years of growth Kenya seems to be entering the downward part of its economic cycle. I highly suggest being proactive and following up with all the economic and political developments in order to be ready to act if and when needed.^