NAIROBI STOCK EXCHANGE THE IMPACT OF POLITICAL REFORMS ON SECURITIES EXCHANGES – KENYA’S...

NAIROBI STOCK EXCHANGE

THE IMPACT OF POLITICAL REFORMS ON SECURITIES EXCHANGES – KENYA’S

EXPERIENCE

Mr. Chris MwebesaChief Executive18th September 2006 at the 10th ASEA Conference

Table of Contents Preamble: Government of Kenya Reform Agenda-Economic

Recovery Strategy Macro-economic Reforms

Financial and Fiscal Reforms Pension Sector Reforms Institutional Reforms Trade and Industry Reforms

Governance Reforms Rehabilitation and Expansion of Infrastructure

Communication, Information, Technology Transport Energy Water

Social Reforms Impact of the reforms on the Economy Impact of the reforms on the Nairobi Stock Exchange


Preamble

PreambleGovernment of Kenya Reform Agenda-Economic Recovery

Strategy

The 27 December 2002 elections and the smooth handover of power that followed was historical in many ways, and was praised globally as an example of democratic maturity in an African country.

After 40 years in power the Kenya African National Union (KANU) lost a presidential election for the first time. The election was won on a reform agenda.

President Kibaki's victory, under the banner of the reformist National Rainbow Coalition (NARC) party, set the stage for long-awaited changes in the country's political, economic and social sectors.

The new NARC government inherited a country beset by economic, institutional and social failures.


Strategy

According to the Nairobi-based Institute of Economic Affairs, Kenya was lagging at least 20 years behind where it should have been in terms of development.

The new government would have to focus its energies on rebuilding institutions, and developing a meritocracy in which Kenyan citizens can feel empowered.

The new Government articulated its economic and social policies and objectives through a recovery strategy dubbed the “Economic Recovery Strategy for Wealth and Employment Creation (2003-2007)”(ERS).


Strategy

The four ERS Objectives or pillars are:

– • To establish and sustain macro economic stability– • To strengthen governance– • To rehabilitate and expand infrastructure– • To invest in initiatives to build human capital.

Reforms had to be formulated and implemented to achieve these objectives;

Investments had to be made and given time to mature;

The economic and social order had to be reengineered.

The Government has remained committed to the ERS. Some of these reforms have been very beneficial to the Nairobi Stock Exchange.


Reforms to Establish and Sustain Macro-Economic

Stability

MACRO-ECONOMIC STABILITY Financial and Fiscal Reforms

Interest Rate Management Formation of the Monetary Policy Advisory Committee: Chaired

by the Governor of the Central Bank of Kenya the objective of the Committee is to formulate credible monetary policy, leading to a stable macroeconomic environment;

The Central Bank of Kenya (CBK) introduced a new interest rate benchmark the Central Bank Rate (CBR) to be based on the inter-bank and repo rate. The CBR will be reviewed every 8 weeks at the meeting of the Monetary Policy Committee (MPC) of the CBK.

More recently on 28 August 2006, the CBK on behalf of the Government issued and listed on the NSE, Kshs. 3.82 billion (US $ 5.22 million) worth of a 12 year discounted fixed rate treasury bond, with a coupon rate of 14% (yield 13.75%).

In order to further lengthen the maturity profile of domestic debt, the Government plans to issue a 15 year treasury bond.

Budgetary Reforms: Increasingly the Treasury has reduced donor support for recurrent

expenditure and in 2006 the Minister did not factor in any donor support for the recurrent expenditure component of the fiscal budget 2006/2007.

The deficit of Kshs. 29.5 billion (US$ 402.47 million) will be financed via domestic borrowing which will continue to boost the domestic bond market.

Tax collection: Use of electronic registers & scanners, the simplification of the tax regime, coupled with buoyant economic growth, has led to enhanced tax compliance & collections for the Kenya Revenue Authority and has reduced government appetite for domestic borrowing;

Fiscal Reforms: As an incentive to encourage more listings at the NSE, the Minister proposed that newly listed companies pay corporation tax at a lower rate of 20%, for a period of 5 years, provided these companies offer at least 40% of their shares to the Kenyan public (2005);

Companies that apply and are listed shall get a tax amnesty on their past omitted income, provided they make a full disclosure of their assets and liabilities and undertake to pay all their future due taxes (2001);

MACRO-ECONOMIC STABILITY Financial and Fiscal Reforms

The Retirement Benefits Authority: The Retirement Benefits Act was passed by Parliament in 1997; The first Board of the Retirement Benefits Authority (RBA) was

appointed in 2000;

The Role and Objectives of the RBA: Regulate and supervise establishment and management of

retirement benefits schemes; Provoke development of new capital market instruments through

the diversification of pension schemes’ investment portfolio; Encourage greater saving for retirement thereby increasing the

country's savings rate from the current 8% to over 25% of GDP leading to capital deepening and therefore accelerate economic growth;

The revised national accounts statistics show Kenya’s domestic savings rate rising from 4.9 % of Gross Domestic Product in 2002 to 8.1 % in 2004;

Spur the expansion of the country's capital markets through prudent professional investment of scheme funds;

MACRO-ECONOMIC STABILITY Pension Sector Reforms

The East Asian tigers achieved their double digit growths as result of increased savings and investment at levels in excess of 30% of their Gross Domestic products, notably Singapore and Taiwan;

It is instructive to note that South Korea per capita income in 1969 was lower than that of Kenya at the time. Today as a result of harnessing domestic resources and mobilizing saving, South Korea is a newly developed country while Kenya is still considered at best to be ‘developing’;

While the classical theory that ‘savings equals investment’ has long been disputed, it is indeed true that in most countries there is a very close correlation between the two and the level of capital markets development.

Pension Funds and the Capital Markets

Continued Pension Sector Reform: Public Sector Pension Scheme: The Civil Service Pension Scheme,

created in 1942, by an Act of parliament purely for employees working within various arms of the government, was non-contributory and non-funded; a typical pay–as-you–go scheme funded from recurrent expenditure.

Cost the government Kshs. 17.2 billion (US$ 234.65 million) annually or Kshs. 1.43 billion (US$ 19.51 million) a month.

The Government has since announced its intention to transform the Civil Service Pension Scheme (civil servants, teachers, armed forces) into a scheme that is contributory. The public sector currently employs over 600,000 Kenyans.

When achieved this will unlock huge pools of investment funds that will definitely boost the capital markets in Kenya and within the region.


Continued Pension Sector Reform: Lock-in of employer contributions for employees changing

employment before attaining retirement age;

The retirement benefits assets under management totaled Kshs 128.0 billion (US$ 1.75 billion) in March 2006, up from Kshs 45 billion (US$ 613.92 million) in December 2001;

● The pensions industry investments constitute about 9.59% of the equity market capitalization of the NSE and about 20% of all listed bonds in issue.

The Minister has exempted from tax the investment income of the pooled funds or other investments of retirement schemes. This has widened the scope of relief as previously exemption applied only to individual registered pension schemes, pension funds and provident funds;

We expect to see increased participation of pension schemes on the NSE.


Government Divestiture Privatization Bill: Legal and institutional framework for

privatization of state enterprises and the divestiture of state assets passed by Parliament in August 2005;

Minister for Finance indicated that as much as possible privatizations will be done through the NSE;

As part of the provisions of the bill the Treasury is in the process of creating the Privatization Commission that will continue to oversee privatizations;

The government has also created the Bank Privatization Unit to co-ordinate ownership restructuring of the remaining state-owned financial institutions i.e. Kenya Commercial Bank, National Bank of Kenya, Consolidated Bank of Kenya.

MACRO-ECONOMIC STABILITY Institutional Reforms

Kenya Investment Authority: Created out of the Investment Promotion Centre in 2005 to facilitate investment in the country. Investment Authority is a natural partner for the NSE and discussions have commenced on how both institutions can leverage off their synergies;

Licensing Bureaucracy: Ongoing efforts to identify and scrap licenses that hinder business. The Ministry of Trade and Industry is addressing the issue under the Repeals and Amendments Bill together with the 2006/2007 Finance Bills. There used to be 1347 licenses for conducting business in Kenya;

In June 2005, the Minister for Finance proposed to eliminate 17 and simplify 30. In the 2006/2007 Budget Speech 37 licenses were eliminated;

With the enactment of the 2 bills into law, a total of 73 licenses will be eliminated;

During the current financial year, there are plans to simplify and/or eliminate 700 licenses, these include the 600 licenses issued by Kenya’s 175 local authorities.

MACRO-ECONOMIC STABILITY Trade and Industry

Regional Trade: East African Community (EAC) Customs Union which unified and harmonized tariffs was completed in 2005 – a firm foundation for a common market;

The Customs Union agreement sets a common external tariff and calls for the progressive elimination of internal tariffs within 5 years, but, although it is being implemented, several teething problems have been encountered (in both technical and policy areas).

The East African Securities Exchanges Association (EASEA): As the technical advisory arm of the Capital Markets Development Committee of the EAC continue to pursue a single or merged market by lobbying law makers on a harmonized policy and fiscal incentives for capital markets in the region;

Concrete results include the fact that East African Breweries and Kenya Airways are both listed on all three East African securities exchanges, and Jubilee Holdings is cross listed on the NSE and the Uganda Securities Exchange (USE);

MACRO-ECONOMIC STABILITYRegional Trade


Reforms to Strengthen Governance

Public sector reforms are aimed at downsizing the public sector to make it

more efficient and investor friendly thus promoting private sector growth

and poverty reduction.

Enactment of the Financial Management Act 2005: With the objective of enhancing transparency and accountability of the management of the public finances.

Governance Public Expenditure and Financial

Management Reforms

Ministerial Rationalization: Ministries functions and structures have been reviewed with non-core activities identified for privatization.

Information Technology: Previously this sector was served by two incongruous ministries i.e. Transport and Communications on the one hand and Tourism and Information on the other, now information, communication and technology policy issues are dealt by one Ministry - Ministry for Information and Communication.

Policy has been developed to support e-government.

Given way to numerous opportunities in ICT, that can exploited using the Capital Markets as a source of funds.

– Outsourcing: BPOs and Contact Centres;– Content: Digitization and Databases;– Infrastructure: Fibre Networks and Technology Parks;– Distribution: CDMA, WiFi, Wimax, IPTV etc.;– Other Support Services. i.e. equipment assembly.

Governance Ministerial Rationalization

Results based management was introduced in all Ministries in 2005. Performance contracts for the civil service were concluded in February 2005 and in July 2005 for all state corporations;

Revenues and more importantly net profits for state corporations has soared with many reversing loss positions. This was across the board and included reversed fortunes in all listed state corporations (9 of them);

The objective of reducing overall public expenditure has yet to be achieved.

Governance Public Sector Reforms


Rehabilitation and Expansion of Infrastructure

Unbundling: Restructuring of the energy sector through the unbundling of the KPLC into a separate transmission and distribution company. The unbundling of KPLC is being implemented under the Energy Sector Recovery Project (ESRP) funded by the World Bank and other multilateral agencies.

Management Service Contract: Under the ESRP, the management service contract for KPLC was handed over to Manitoba Hydro International (Manitoba) of Canada. Manitoba will have to adhere to strict conditions including reducing system losses by 4% at the end of the management contract in June 2008, from a 18.8% loss in 2004 and;

Raise the rate of new connections from 70,000 realized in 2005 to 150,000 annually.

Rehabilitating Infrastructure Energy Sector

Transport: Public transport was reorganized in 2004 leading to increased investment in the area and improved safety conditions;

Transport is now one of the leading sectors in the economy and despite the poor road network in the country, it contributed about 8% and 6% to GDP in 2004 and 2005 respectively.

Railways: In another major development for the privatisation process, and certainly for transport infrastructure, Kenya and Uganda in mid October 2005 finally chose a concessionaire to run their joint 2,350 km railways.

Rehabilitating Infrastructure Transport Sector

Interest income accruing to all listed bonds used to raise funds for infrastructure and, which have a maturity of at least 3 years, is exempt from withholding and income tax (2006);

Securitization based on bankable assets and ability to generate cash has become a viable alternative in most emerging markets, particularly for institutions providing infrastructural services to raise long term capital.

In this regard, the Minister proposed to exempt investment income of Special Purpose Vehicles (SPVs) from income tax. This is to encourage institutions providing infrastructural services to set up SPVs for purposes of issuing asset backed securities (2005);

Rehabilitating Infrastructure Policy Incentives


Social Reforms

Budgetary allocation to the social sectors continues to rise consistent with

government’s commitment to invest in initiatives that will build human capital

and reduce poverty.

Education; Free primary education was introduced in 2003 and grants for infrastructure development for primary schools introduced.

In 2006/2007 budget 27% of total expenditure :Kshs 99 billion (US$ 1.35 billion)) was allocated to education;

Healthcare has increased from 8.6% of total expenditure: Kshs 30 billion (US$ 409.28 million) to 9.4% of total expenditure: Kshs 43 billion (US$ 586.63 million) in 2008/09;

Social Reforms

Social Reforms Policy and Tax Incentives

Interest income accruing to all listed bonds used to raise funds for social services, and which have a maturity of at least 3 years, is exempt from withholding and income tax (2006);


Impact of the Reforms on the Economy

GDP Growth 2000-05

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2000 2001 2002 2003 2004 2005

Economic Performance Highlights

Accelerated growth since 2003, first three year expansion since the mid 70s. Key drivers:

Monetary stimulus 2003 Trade led recovery in 2004 Shift to investment led expansion in 2005 and the NSE is

no exception Robust agricultural sector recovery in 2005 Other sectors: tourism, communications (cellular

phones) Robust performance in spite of adverse shocks: oil prices,

drought, aid shortfall

Economic Growth 1968-05

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1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004

• Inflation: The CBK expects inflation to decline further due to the expected decline in food prices and the implementation of prudent monetary policy by the CBK. Currently Overall Average Annual 10.99% and Underlying Average Annual 4.24%

• Exchange Rates: The Kenya shilling has been relatively stable, more recently, it has strengthened against the major currencies;

• Interest Rates: • 91 day T Bill (6.511%); and 182 day T Bill (7.533%);• The declining short term interest rates are a reflection of the

liquidity in the money market;• Continued high liquidity in the Kenyan economy will translate

into sustained demand for listed securities.• The Central Bank Rate (CBR) was raised by 25 basis points to

10% in August.

Macroeconomic Indicators

Short Term Outlook

Robust growth expected to be sustained in 2006-7 (5 – 7 % range). Factors:

Sustained agricultural recovery due to favourable weather and effect of reforms/rehabilitation;

buoyant tourism sector and public infrastructure spending;

buoyant global and regional growth outlook. Risks:

continued strengthening of the shilling will have adverse effects on export sectors (horticulture, EPZs, tourism);

Weak regional market due to electricity shortages in Uganda and Tanzania;

Infrastructure capacity constraints: railway, pipeline, electricity generation.

Standard & Poors assigns Kenya a Credit Rating of B+

On 8 Sept 2006, Standard & Poors assigned the Republic of Kenya a long term foreign currency sovereign credit rating of B+ with a stable outlook; a long term local currency sovereign credit rating of BB- and a short term foreign and local currency rating as B;

According to S&P the ratings are supported the government's continued progress in implementing economic reform and by the strengthening of macroeconomic and political stability;

S&P said the landslide victory of President Mwai Kibaki in the 2002 general election is providing the basis for economic growth, raising confidence which is being reflected in declining domestic interest rates and strong inflows of remittances from the Kenyan diaspora;

The partisan nature of Kenyan politics has not stopped the government making some economic reforms.

Standard & Poors assigns Kenya a Credit Rating of B+

The ratings on Kenya are also constrained by a high level of infrastructure and development needs, S&P said.

S&P expects annual GDP growth to remain in the 5.5 % area over the medium term while a general government deficit of 3.3 % of GDP in 2006 is expected to narrow to 2.4 % of GDP by 2009.


Impact of the reforms on the performance of the NSE

2nd Quarter 2006 Performance Overview & Full Year 2002

Market Indicators:Mkt. indicator 31 Dec. 2002 30 June 2006 % Change

NSE 20 Share Index

1362.85 4,260.49 212.62

Mkt Cap.(Kshs./US$ Bn)

112.05/1.53 623.20/8.50 456.18

2nd Quarter 2006 Performance Overview & Full Year 2002

Market Indicators:Mkt. indicator 12 months

ending 31 Dec. 2002

6 months ending 30 June 2006

% Change

No. of Shares Traded (Mn)

148.836 382.756 157.17

Equity Turnover(Kshs./US$ Mn)

2921.18/39.85

22,740.60/310.24

678.47

No. of Deals 25,051 109,532 337.24

Bond Turnover(Kshs./US$ Mn)

33,629.4/458.79

18,913.75/258.03

-43.76

Equity Market Performance

December 2003 – 12 September 2006

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500

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Index

Mkt. Cap.

Equity (Rights Issues and Other Corporate Actions) Kshs. 1.769 billion (US$24.1 million)Debt 18 Government of Kenya treasury bonds with a face value

of Kshs. 74.80 billion (US$1.02 billion); Corporate bonds with a face value of Kshs. 5.8 billion (US$

79 million);

Total Amount Kshs. 82.369 billion (US$1.12 billion) indicates increased

absorption capacity of our market.

Total Capital Raised at the NSE in 2005

Equity (Rights Issues and Other Corporate Actions) Kshs. 8.521 billion/US$ 116.25 million in IPOs

Debt Government of Kenya treasury bonds with a face value of

Kshs. 67.221 billion (US$ 917.06 million);

Total Amount Kshs. 75.742 billion (US$ 1.03 billion) indicates increased

absorption capacity of our market.

Total Capital Raised at the NSE in 2006

Kenya Electricity Generating Company (KenGen) Kenya’s largest IPO to date. KenGen created out of the unbundling of the Kenya Power and Lighting Company (KPLC) produces approximately 80% of the electricity consumed in the country.

The Government of Kenya sold a 30 % stake

The issue was oversubscribed by Kshs 18.2 billion (US$ 248.3 million) or 333%, highlights the absorptive capacity of our markets. Listed on 17th May 2006;

Equity Bank Kenya: On 7th August 2006, the introduction and trading of the entire issued (90,564,550) ord. shares of Equity Bank took place. It is one of Kenya’s fastest growing domestically owned banks targeting small and micro entrepreneurs

Scangroup: On 29th August 2006, Scangroup, the largest media and advertising company in East Africa, listed 43.4 % of its share capital on the NSE. The IPO which raised Kshs. 724.0 million (US$ 9.88 million), was oversubscribed 6 times.

New Issues

Privatization transactions in the pipeline include the sale to the public and subsequent listing of Government stakes in the following:-

– 40% of Kenya Re-insurance Corporation;– 18.4% of Mumias Sugar Company (which is a listed

company and Kenya’s largest and most efficiently run sugar miller);

– 34 % of Telkom Kenya offloaded through the NSE after 26 % has been sold to a strategic investor;

Eveready East Africa Limited; The application to list 30 % of the ordinary shares of Eveready (East Africa’s largest battery manufacturer) in an IPO is under consideration by the Capital Markets Authority and the NSE.

Transactions in the Pipeline


Automation of the Trading System

Automation

The implementation of the Automated Trading System happened on Monday 11 September 2006;

The ATS is sourced from Millennium Information Technologies (MIT) of Colombo, Sri Lanka, who are also the suppliers of the Central Depository System (CDS). MIT have also supplied similar solutions to the Colombo Stock Exchange and the Stock Exchange of Mauritius;

The NSE trading hours have increased from 2 to 3 hours (10:00 am – 1:00 pm). Besides trading equities, the ATS is also fully capable of trading immobilised corporate bonds and treasury bonds.

Opportunity to enhance revenue streams through information vending to our stakeholders.

The implementation of the ATS and achievement of T+3, will bring us a step closer to meeting the Group of 30's (G30) standards on trading and settlement as adopted in 1989.


End

NAIROBI STOCK EXCHANGE THE IMPACT OF POLITICAL REFORMS ON SECURITIES EXCHANGES – KENYA’S...

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