ABSA - East Africa Trip Notes Aug 03 2010

8/9/2019 ABSA - East Africa Trip Notes Aug 03 2010

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PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 9

AFRICA STRATEGY 3 August 20

EAST AFRICA: TRIP NOTESRidle Markus

+27 (0)11 895 5374

[email protected]

Dumisani Ngwenya

+27 (0)11 895 5346

[email protected]

www.barcap.com

We visited East Africa recently and met with various stakeholders, including the

finance ministries, central banks, multilaterals and the private sector. The economic

growth outlook for the region is promising, driven largely by infrastructure

investments and policy support. However, the fiscal situation remains challenging

due to expansionary fiscal stances to support economic growth. Furthermore, the

political landscape, particularly in Uganda and Kenya, is clouded with uncertainty.

Kenyas economic recovery is strengthening while those of Tanzania and Uganda remainsolid as the region recovers from the impact of the global slowdown.

Governments have focused on reducing substantial infrastructure gaps (specificallyelectricity and transport), cutting the cost of doing business and engaging the

private sector to speed up economic development.

The commencement of the East Africa Communitys Common Market on 1 Julypromises substantial long-term benefits although its implementation is marred by

teething problems.

Ugandas positive oil story is somewhat dampened by the news that commercial oilflows may only take place in 4-5 years time.

We expect Tanzanian elections in October 2010 to go smoothly but we are morecautious on the political outlook in Uganda (elections in 2011) and Kenya (2012).

Fiscal conditions remain challenging. Though all three governments have discussedpotential Eurobond issuances, we believe it is unlikely during 2010.

Market opportunities in domestic fixed-income assets are limited as East Africanmarkets have seen downward shifts in their yield curves since 2009.

Figure 1: Fiscal situation showing strain (deficits, % GDP)

-8

-7

-6-5

-4

-3

-2

-1

0

2006/07 2007/08 2008/09 2009/10 2010/11

Kenya Tanzania Uganda Source: IMF, National agencies, Absa Capital

Absa Capital is a division of Absa Bank Limited


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Absa Capital, affiliated with Barclays CapitalEast Africa: Trip Notes

3 August 2010 2

Promising but challenging time ahead

During our visit, much of the discussion centred on the recent formation of the East Africa

Community (EAC) Common Market, infrastructure backlogs, Ugandas oil plans and the

upcoming elections in the region. The formation of the common market, which commenced

on 1 July, and the potential impact on the region was a major point of discussion. The EACs

key objective is to widen and deepen cooperation among its partner states, Burundi,

Rwanda, Kenya, Tanzania and Uganda, in political, economic and social fields. It is also

working towards becoming a fully-fledged customs union. The establishment of a common

market is taking it closer to achieving this goal as it allows for freer movement of people,

services, capital, labour and goods in the EAC countries although it may still take some time

for it to be fully implemented. Included in the objectives of the common market are the

acceleration of growth and development of partner states and the strengthening,

coordination and regulation of economic and trade relations among the EAC partners.

Common market ushers in

higher level of integration with

long-term benefits

With a population of 127mn and a combined GDP of nearly USD80bn, the common market

hopes that the benefit of free movement of all production factors will result in a more

efficient allocation of factors of production, increasing productivity further. However, there

are still many teething problems that need to be addressed as not all the laws of member

countries have been aligned. EAC originated goods are supposed to be traded freely but

taxes are still being charged. While EAC originated goods, which need an EAC certificate of

origination, are exempted from import duties, taxes such as VAT, excise duties and

withholding taxes, where applicable, are still payable. Moreover, non-tariff barriers are seen

as a major obstacle in allowing the smooth flow of trade. Labour movement is still not free

as individual states immigration laws remain in place. Infrastructure problems in the region

also mean that the smooth movement of goods is still problematic, while not all border

posts are ready to adopt common market procedures. Despite these problems, the

implementation of the common market protocol will be progressive and the benefits will

therefore only be seen in the long run. The EAC countries are working towards the

establishment of a monetary union in 2012 and ultimately the formation of a politicalfederation. Although the East African Monetary Union (EAMU) is envisaged by 2012,

indications following joint ministerial meetings in March this year and during our visit were

that the establishment of the union is likely to be delayed.

Common market has 127mn

people and a total GDP

of close to USD80bn

Despite the expected benefits of the single market for its partner states, it appeared to us

that of the three larger countries in the region, Kenya is best prepared and placed to take

advantage. Kenya also appears to be more excited about the benefits of the new common

market than the other countries. Tanzania seems less equipped and less competitive than

its stronger neighbour (Kenya). During our discussions, it was viewed that productivity and

innovation was highest in Kenya, while Tanzania was lagging the region somewhat in these

aspects. However, it is hoped that the increased competition will lift productivity across the

region, create jobs and spur more investment opportunities.

Kenya well positioned to take

advantage of single market

Continuing investment in infrastructure projects, started during the boom periods, has been

a key aspect in supporting growth during the global economic crisis. East Africa, like the rest

of the continent, has significant physical infrastructure gaps spanning different spheres -

electricity, transport, water, and social infrastructure such as education and health. To

unlock growth and reduce the high cost of business, east African governments have made

infrastructure projects their priority and have encouraged the private sector to assist

through Private Public Partnerships (PPPs). Tanzania has recently enacted the PPP Bill,

which will govern the cooperation and relationship between the public and private sector.

Infrastructure projects have

become the priority for East

African governments


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3 August 2010 3

Kenya already has a PPP law in place, while Ugandas President Museveni earlier this year

instructed parliament to come up with a policy on PPPs.

The acute electricity shortage means that the expansion of electricity capacity has been the

priority area for development and one that has many interesting opportunities for

investment. Electricity shortages in East Africa, which relies heavily on hydroelectric power,

are at critical levels and are having a severe impact on overall economic activity andcompetitiveness. As a result, the Uganda government plans to accelerate rural electrification

and a number of small projects (hydropower plants like Buseruka and Ishaha) are near

completion, while larger projects such as Bujagali (250MW) are being constructed. The

Karuma Falls project (potential of 700MW) will also be developed soon. Uganda has

liberalised the electricity sector as it needs substantial financing and has started to privatise

generation and distribution businesses. Kenya has been restructuring its electricity sector

and has indicated that the total cost of investment in additional capacity may be as much as

USD5bn. Kenya, like other countries in the region, is in the process of diversifying into

geothermal energy, mini-hydropower and other new techniques and a number of projects

are in the pipeline (Sangoro, Lake Turkana Wind Power project, etc). Similarly, in Tanzania,

several large projects are being planned in order to meet electricity demand.

Energy crisis acute means

there are many opportunities

for investment

In Uganda, there was a lot of excitement about the countrys positive long-term outlook

following the discovery of oil. Vast oil reservoirs (estimated at 2.5bn barrels and a 20-25-

year lifespan) have been found by exploration companies in the past four years and there is

substantial upside potential, according to these companies. Since the discovery of oil in

2006, the process towards commercial production has been slow and fraught with delays.

The Early Oil Production Scheme (EPS) is expected to start towards the end of 2010 or 2011

and will produce just 5,000bpd, all of which is expected to be used to boost thermal

electricity generation and reduce the substantial electricity shortages the country is

currently experiencing. As oil production is gradually ramped up (maximum output is

expected to be around 200,000bpd), the government plans to focus on refining the crude

oil for local and regional markets and will be exporting the surplus crude oil. The planning

process for the building of refineries and the transportation of the oil is underway, and thegovernment expects the development of the first refinery to start in 2011. Ugandas

government has decided that more value can be gained from exporting refined fuel instead

of crude oil, which means revenues from oil production can only be expected once the

refineries are completed in 4-5 years time. Disappointingly, details on revenue sharing and

fiscal planning are not available. As such, with first oil flows only expected by 2014/15,

Uganda cannot be seen as another Ghana.

Ugandas positive oil story

dampened by the news that oil

windfalls will only be seen in 4-5

years time

Upcoming elections and referendums in East Africa mean that the region needs closer

monitoring over the next few months. Tanzanias elections are being held on 31 October

2010, while Uganda and Kenyas elections are scheduled for February/March 2011 and

2012, respectively. Kenya, however, is planning a referendum on 4 August on the adoption

of the new constitution. The key changes proposed by the new constitution include thereintroduction of regional governments, curtailment of presidential powers and the creation

of the position of prime minister. The new constitution is aimed at limiting presidential

authority in an effort to reduce the possibility of abusing these powers and also enshrines

separation of power and checks and balances which is aimed at reducing corruption. The

referendum in itself holds few political risks provided the new constitution is accepted.

Currently, the main disagreements centre on the peripheral issues on abortion, Muslim

courts and land reforms and the Reds (those favouring a no vote) are campaigning hard

to have the new constitution blocked. A rejection of the new constitution by voters,

however, would be a huge blow to reforms in the country although our sense was that the

Kenyas constitutional

referendum is being held

on 4 August


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3 August 2010 4

population may accept the constitution. Recent opinion polls (allAfrica, 16 July) indicated

that 62% of Kenyans are likely to vote yes with 20% stating that they will reject the

proposed constitution.

In Uganda, the situation ahead of the 2011 elections is more worrying. The recent militant

attacks in Kampala, which appear unrelated to next years elections, does have the potential

to divide the country ahead of the elections and also pose a long-term threat. However, withnearly 80% of the population Christians, we do not expect these attacks or the long-

standing instability in the north of the country to have a major impact on medium-term

stability or the election outcome. Instead, we expect two other issues to become topical

ahead of the elections. Attempts by the Buganda tribe to become more autonomous may

have some impact on support for President Museveni, while opposition parties refusal to

accept the electoral committee may cause some volatility closer to elections. Yet, despite

these issues, the dominance of the ruling National Revolutionary Movement (NRM) means

that the party will remain in power in 2011, in our view.

Ugandas elections may see

some volatility; however, we

expect the ruling NRMto retain power

Tanzanias elections are likely to go smoothly, in our view. The ruling CCM is the dominant

party and given its access to resources for campaigning and the weak opposition, we expect

the party to win the October 2010 elections comfortably. Though Zanzibar has traditionally

been a political hotspot around election time, the referendum on 31 July in which voters

adopted (66% in favour) the proposal to change Zanzibars constitution to allow for a unity

government, has raised hope that the political problems of the island are in the past. This

will substantially reduce political risk on the island and pave the way for a peaceful run-up

to the October elections.

Tanzanias elections are

likely to go smoothly

Economic growth solid

East Africas economic growth has been solid despite global economic difficulties. Although

the region escaped the initial impact of the financial crisis, the decline in trade and capital

inflows dampened economic activity. Policymakers eased monetary policy, continued with

infrastructure programmes started before the crisis and engaged multilaterals for support in

an effort to cushion the economy from the full impact of the global crisis. The worst-hit

economy during the past three years was Kenya, which suffered a double whammy as the

Economic growth solid, driven by

infrastructure investment and

policy support

Figure 2: East Africa GDP growth outlook upbeat

0

2

4

6

8

10

12

2006 2007 2008 2009 2010F 2011F

Kenya Tanzania Uganda

Source: Central banks, Absa Capital


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3 August 2010 5

global crisis hit shortly after the post-election violence had already affected the economy.

However, following growth of 1.6% in 2008, Kenyas economy grew 2.6% in 2009. Ugandan

and Tanzanian economic growth, in contrast, remained solid in 2009 (5% and 6%,

respectively) although growth moderated from pre-crisis highs. Similar to Kenya,

governments in these two countries supported growth by relaxing monetary policy and

continuing with large infrastructure programmes. The Bank of Uganda continued its

accommodative monetary policy stance to support demand amid a fall in credit demand,while improved exports also boosted growth from Q2 09. Ugandas long-term economic

outlook has improved significantly with the discovery of vast oil reservoirs (holding up to

2.5bn barrels of oil) although the benefits may only be seen in 4-5 years time.

Despite structural impediments, we remain positive on the regions growth prospects as

investment in infrastructure will be supportive of growth. Furthermore, a stronger agricultural

sector, improved export and tourism revenues and continuing policy support should further

support growth. Oil-related investment will be positive for Ugandas growth prospects.

We remain positive on growth

despite structural impediments

Benign inflation environment

Inflation has fallen sharply in the three large east African countries in recent months.

Following a change in inflation methodology and a reweighting of the basket, Kenyas

inflation fell from 5.3% y/y in December 2009 to 3.6% in July 2010, while Ugandas inflation

rate declined from 11% to 3.2%. Tanzanias inflation also eased from 12.2% y/y in

December 2009 to 7.2% in June. Improved agriculture conditions this year and improved

food supplies resulted in substantially lower food inflation, falling from the high teens to

single digits. Coupled with lower fuel inflation, it dragged overall inflation across the region

lower. The medium-term outlook for inflation remains favourable and we expect inflation

for Kenya, Uganda and Tanzania to end the year at 5.1%, 4.3% and 4.8% y/y, respectively.

Lower food inflation has driven

overall inflation lower

Figure 3: Medium-term inflation outlook is benign

0

5

10

15

20

25

30

35

Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10


Source: Statistics offices, Absa Capital

The regions central banks have generally maintained accommodative monetary policies

throughout the crisis and after. While Tanzania and Uganda use open-market operations to

conduct monetary policy (Uganda is working towards adopting an inflation-targeting

regime though its implementation is still some way off), Kenya has reduced its benchmark

policy rate considerably. Over the past 18 months, the Central Bank of Kenya (CBK) has

reduced the policy rate by 300bp to 6%. We expect central banks from all three countries to

Accommodative monetary policy

to remain until at least 2011


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3 August 2010 6

continue with their accommodative monetary policy stance until at least 2011 in an effort

to boost credit lending and demand. With the economic recovery well underway, we do not

expect the CBK to lower its policy rate further after a very aggressive 75bp cut on 28 July.

However, despite the accommodative stances, commercial banks have generally failed to

materially reduce their lending rates and both the Kenyan and Ugandan central banks have

already indicated that they will continue to engage with commercial banks to lower lending

rates. Should they succeed, it will further support credit lending and overall demand.

Private sector credit lending in Uganda slowed from 40% y/y in May 2009 to 21% in May

2010, while in Tanzania, it eased from 32.2% to 13.7% over the same period. However, in

Kenya, private sector credit extension is recovering steadily, having risen from 12.2% y/y in

April 2009 to 17.7% in April 2010 (30% in mid-2008). The CBK, at its 28 July MPC meeting,

reiterated that commercial lending rates are still too high as it wants credit lending to grow

further to boost private sector investment.

Private sector credit lending

slowing in Uganda and

Tanzania; recovering in Kenya

Currencies have some upside potential

Since the second quarter of 2009, Ugandan exports showed some improvement while those

for Kenya and Tanzania showed no real increase despite higher commodity prices.

Positively, imports remained weak as a result of domestic economic difficulties, resulting in

improved trade balances in the region. Overall, current accounts improved in 2009 from the

previous year largely as a result of improved trade balances. Q1 10 data from Kenya and

Tanzania point to a worsening in trade balances as a result of higher imports. As such, we

expect current account balances to widen somewhat in 2010 on higher imports. That said

recent weaker currencies support external balances.

External accounts have improved

in 2009 but likely to deteriorate

in 2010 as imports pick up

After strengthening considerably in H2 09, East African currencies have been under

pressure so far this year as a result of the strong USD. The KES depreciated 7% YTD against

the USD, followed by the TZS (-10%) and the UGX (16%) with most of the depreciation

occurring in May. That said these currencies continued to perform well against other major

currencies such as the euro. Looking ahead, we expect currencies to strengthen marginally

on improved capital flows when risk appetite returns, as well as on our expectation of a

marginally weaker USD and firm export and tourism revenues.

Longer-term currency outlook

still upbeat despite

recent depreciation

Figure 4: Currencies have been under pressure in H1 10

95

100

105

110

115

120

125

Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10

USD/KES USD/TZS USD/UGX

Note: Exchange rates indexed to January 2010 = 100. Source: Reuters, Absa Capital


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3 August 2010 7

Fiscal positions under strain

East African countries presented their respective budgets during June with the focus firmly

on infrastructural investment. Hence, generally expansionary budgetary stances have been

maintained, resulting in somewhat larger fiscal deficits in Tanzania and Uganda, while Kenya

saw a small narrowing. Uganda is projecting a deficit of 3.5% of GDP (3% in 2009/10) in

2010/11 and has a medium- to long-term fiscal deficit target of 5%. The discovery of oil has

raised our expectations that the fiscus may benefit from oil inflows very soon, but during

our visit it became clear that actual oil revenues may still be 4-5 years away. As such, fiscal

challenges will remain in the interim. Ugandas government has also indicated that it will

continue to finance the fiscal gap through foreign and domestic financing and is not

planning to issue a sovereign bond any time soon. Likewise, Tanzanias government has

also been silent on earlier plans to issue a sovereign bond despite plans to increase its

borrowing to around to 4% of GDP in 2010/11 from a budgeted 3.5% in 2009/10.

Tanzanias budget remains very dependent on foreign assistance, whether in the form of

loans or grants. In the current fiscal year, 28% of expenditures will be financed from loans

and grants, down from 33% in the previous fiscal year. Tanzania plans to borrow a total of

USD0.9bn (around 4% of GDP) from domestic and foreign sources to finance priority

infrastructure projects.

Ugandas fiscal deficit expected

to widen in 2010/11;

disappointingly, no oil inflows for

next 4-5 years

Kenya is projecting a fiscal deficit equivalent to 6.8% of GDP in 2010/11 (estimated at 7% in

2009/10) and the government remains positive that tax revenues will be in line with

expectations, which will allow infrastructure projects to continue uninterrupted. Kenya,

which operates the regions largest bond market, plans to reduce its domestic borrowing to

3.8% of GDP from 5.1% of GDP in 2009/10. The government still plans to go ahead with a

USD500mn sovereign bond during the current fiscal year (July 2010-June 2011).

Kenya planning to go ahead with

sovereign bond issuance

in 2010/11

We believe that improved revenue flows from increased economic activity and stronger

exports will improve domestic revenues in east African countries. In our discussion, the

various governments noted that they expect improved fiscal positions over the next few

years despite upcoming elections as they do not see elections having a negative impact on

spending. The expansionary fiscal stances have resulted in external debt creeping higherpost debt relief.

Upcoming elections pose upside

risk to spending

Figure 5: External debt creeping higher (% GDP)

0

10

20

30

40

50

60

70

2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10


Source: Official offices, Absa Capital


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3 August 2010 8

Figure 6: Macroeconomic forecasts of selected countries in east Africa


2009 2010F 2011F 2009 2010F 2011F 2009 2010F 2011F

Real GDP (% y/y) 2.6 3.9 5.1 6.0 6.4 6.8 5.2 6.1 7.5

CA (% GDP) -5.5 -6.6 -6.1 -7.8 -9.6 -9.8 -2.6 -4.9 -3.8

FX reserves (eop) 3.9 3.6 3.2 3.2 2.8 2.7 External debt (%

GDP)123.9 24.3 23.2 33.9 34.1 12.7 13.3

Overall fiscal balance

(% GDP)1-3.7 -7.0 -6.8 -4.8 -5.7 -6.5 -1.7 -3.0 -3.5

CPI (% y/y, eop) 5.3 5.1 9.3 12.2 4.8 10.9 11.0 4.3 9.5

Currency per USD(eop)

75.85 79.10 76.50 1339 1399 1300 1900 2000 1850

Benchmark policy

rate (%, eop)7.00 6.00 7.50 n/a n/a n/a n/a n/a n/a

Note: 1Fiscal year ending. Source: BoG, IMF, Reuters, Absa Capital


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3 August 2010 9

Emerging EMEA Research Analysts

ABSA CAPITAL

Jeff Gable

Head of ResearchABSA Capital+27 (0) 11 895 5368

[email protected]

Ian Marsberg

Macro Strategist+27 11 895 [email protected]

Jeffrey Schultz

Macro Strategist+27 11 895 5349

[email protected]

Divya Vasant

Credit Analyst+ 27 11 895 [email protected]

Ridle Markus

Africa Strategist+27 11 895 [email protected]

Dumisani Ngwenya

Africa Strategist+27 11 895 [email protected]

Judy Padayachee

Technical Strategist+27 11 895 5350

[email protected]

Bulent Badsha

Rates Strategist+27 11 895 [email protected]

BARCLAYS CAPITAL

Piero Ghezzi

Head of Economics and EmergingMarkets Research+44 (0)20 313 [email protected]

Matthew Vogel

Head of Emerging EMEA Research+44 (0)20 7773 [email protected]

Koon Chow

Senior FX Strategist+44 (0)20 777 [email protected]

Christian Keller

Chief Economist - Emerging Europe+44 (0)20 777 [email protected]

Alia MoubayedSenior Economist Middle East &

North Africa+44 (0)20 313 [email protected]

Arko SenRates Strategist

+44 (0)20 3134 [email protected]

George ChristouEM Strategist+44 (0)20 777 31472

[email protected]

Donato GuarinoCredit Strategist+1 212 412 5564

[email protected]

Andreas KolbeCredit Strategist


Daniel HewittEMEA Economist



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We, Ridle Markus and Dumisani Ngwenya, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about

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ABSA - East Africa Trip Notes Aug 03 2010

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