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Cablegate: Kenya: What a Difference an Election Makes

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PP RUEHWEB

DE RUEHNR #0192/01 0171230
ZNR UUUUU ZZH
P 171230Z JAN 08
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC PRIORITY 4270
INFO RUEHXR/RWANDA COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC
RULSDMK/DOT WASHDC
RUEHC/DEPT OF LABOR WASHDC
RUEKJCS/SECDEF WASHDC

UNCLAS NAIROBI 000192

SIPDIS

SENSITIVE

DEPT FOR AF/E, AF/EPS, EEB/IFD/OMA
DEPT ALSO PASS TO DOT FOR CONNIE HUNTER
DEPT ALSO PASS TO USTR FOR BILL JACKSON
DEPT ALSO PASS TO DOL FOR MICHAEL MURPHY
TREASURY FOR FINCEN
TREASURY FOR VIRGINIA BRANDON

SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EAGR ELAB PGOV EFIN KE
SUBJECT: KENYA: WHAT A DIFFERENCE AN ELECTION MAKES

1. (U) Summary: In a stunning reversal from consensus predictions
that the December 27 general election would not affect Kenya's
growing economy, allegations of vote rigging led to inter-tribal
violence and looting that temporarily paralyzed the country's
transportation system, scared away tourists, and closed businesses.
At a minimum, the unrest led to nearly a billion dollars in
short-term revenue losses, and this doesn't yet count the
destruction of businesses, homes, crops, and infrastructure. The
Government of Kenya (GOK) insists the economy can stay on track and
grow by 7% in 2008, but independent economists believe growth will
drop to between two and five percent. Some foresee a scenario in
which loan defaults and delinquencies will reduce bank liquidity and
lending, all of which could lead to a recession. The GOK could add
fuel to this fire if it chooses or is forced to expand domestic debt
issuance to stimulate the economy and/or simply cover a budget gap
which was already large before the crisis began. Any economic
scenario is possible at this point, but all depend on whether, when
and how the political crisis is resolved. End summary.

Billion Dollars Lost Just in Short-Term
---------------------------------------

2. (U) Facts and figures on the immediate economic losses due to
post-election unrest continue to trickle in through the media, and
from both official sources and anecdotes. The only global figure for
revenue losses came on January 9 from Finance Minister Amos Kimunya,
who estimated at the time that the economy had lost Ksh60 billion
($925 million) in lost production, not counting the destruction and
looting of businesses and infrastructure. This is probably a
conservative estimate given the source, but still amounts to a
substantial chunk of Kenya's annual national income (about 4% if one
uses the World Bank's $21 billion GDP estimate for 2006). Revenue
losses appear spread out across the country and the economy, but two
critical sectors in terms of income and employment have been
especially hard hit.

Tourism: Suddenly Down and Out Again
------------------------------------

3. (U) Tourism is critical to Kenya's short, medium-, and long-term
economic prospects. It is the country's leading foreign exchange
earner and employs 250,000 workers directly and another 550,000
indirectly. Each of these workers is estimated to support 10 family
members on average. The post-election violence has had a dramatic
negative impact on a sector that before the election was booming and
that had nearly recovered from the 1998 U.S. Embassy bombing and
later terrorist attacks on tourist facilities in 2002. A clearly
dejected Kenya Wildlife Service (KWS) Director Julius Kipng'etich
reported to USAID/Kenya on January 14 that:

-- The industry "is down 90% and falling;"
-- KWS is in "dire straits" and is asking the Government for KSh1
billion to cover costs over the next six months because of lost
tourism revenues;
-- The industry will take two years to recover if the political
impasse is not resolved within a few weeks.

4. (U) The Kenya Tourist Board publicly confirmed this dire
assessment, noting that 90% of tourist bookings for January have
been cancelled. KTB has reduced its forecast for the first quarter
of 2008 from 314,000 arrivals to 114,000, and revenues from Sh24
billion ($370 million) to Sh8 billion ($123 million) - and this
assumes the situation does not degenerate further. The Kenya
Association of Tour Operators (KATO) reports that major airlines and
charters flying from Europe to Mombasa have been losing over $1.2
million a week. On January 17, KATO raised to Sh20 billion ($308
million) the estimated loss to the economy in the first quarter of
2008. Hotels on the Coast have gone from 80% or more occupancy to
less than 30%. Nairobi hotels are at only 15-35%. Tourism industry
officials have warned that some overseas tour operators have
cancelled irrevocably for 2008, diverting tourists to other
destinations, and others would follow suit if the unrest continues.

5. (U) As a result of this rapid evaporation of visitors, large
number of jobs are now at risk. The Kenya Tourist Board (KTB) has
said about 20,000 direct jobs have been lost already in tourism, and
that up to 120,000 direct jobs could be lost by March.

Agriculture Also at High Risk
----------------------------

6. 4. (U) Subsistence and commercial agriculture employs as much as
80% of Kenya's workforce and contributes 25% to its GDP every year.
It is the mainstay of the economy, but has been hit badly by the
post-electoral unrest. While it is still too early to know the
cumulative long-term effects, the severe short-term impacts include:


-- Maize: A key staple, maize production has been hit badly,
especially in the Rift Valley, where ethnic violence has been the
most severe and where 60% of Kenya's maize is produced. Thirty
percent of Rift Valley maize, worth KSh 3.4 billion ($52 million),
was lost during the unrest - burned either in fields or in storage.
Another 50% would have been in the supply chain by now, but remains
locked up either un-harvested or in storage due to insecurity on the
roads.

-- Horticulture: This subsector, a key export earner, has lost Ksh
2.5 billion ($39 million) because of road closures and increased
airfreight charges.

-- Dairy: 10 days of production, 3.4 million liters, went to waste
in the Rift Valley, Kenya's dairy center, losing Ksh 678 million
($10.4 million) in household farm income. New Kenya Cooperative
Creameries reported losing Ksh 60 million ($923,000) in sales
because the paralysis in transportation and a lack of furnace oil
forced the temporary closure of eight creameries in the Rift Valley.

-- Tea: The closure of 14 tea factories in Nandi District due to
violent attacks on workers and road closures cost over Sh10 billion
(about $154 million), and losses in Kericho District were reportedly
comparable. The tea auction in Mombasa was cancelled in the first
week of January. That said, the Kenya Tea Development Agency (KTDA)
said about 60% of its producers were unaffected by the violence, and
the Mombasa tea auction reopened on January 7.

Transport: A Vulnerable Lifeline
--------------------------------

7. (U) The immediate revenue losses occurring after the outbreak of
unrest were caused less by destruction than by a breakdown in road
transport around the country. Fearing for the safety of their rigs
and drivers, owners simply withdrew their trucks, especially fuel
tanker trucks, from the roads in the days following the disputed
election. Together with the damage to Rift Valley Railways track
near Nairobi's Kibera slum, this temporarily decimated commerce
within Kenya, and between Kenya and her neighbors, causing
short-term shortages of fuel and other key commodities domestically
and in Uganda, Rwanda, Burundi, and South Sudan. However, as of
mid-January, road transport services had returned to near normal
levels thanks to efforts by the police and military to clear roads
and by the police to provide armed escorts to truck convoys.
However, the experience has shown just how vulnerable the economy is
to a de-facto transport lock-down should violence again flare up.

Impact on Growth: The Jury's Out
--------------------------------

8. (U) Given uncertainties over how long the political crisis will
drag out, predictions on how it will impact growth in 2008 vary
widely and are heavily caveated. In the optimist's camp is Finance
Minister Kimunya, who claims the Kenyan economy will achieve its
projected 7% growth in 2008. Kimunya also claimed the Ksh 20
billion (about $307 million) surplus from the privatization of
Telkom Kenya in late 2007 would cover any lost tax revenues and
avoid the need to increase domestic borrowing.

9. (U) Echoing Kimunya, Central Bank of Kenya (CBK) Governor
Njuguna Ndung'u called the crisis a short disruption that would not
have a major impact on GDP growth, trigger a recession, or change
Kenya's long term positive growth trajectory. He conceded that
supply constraints would trigger inflation in the short term, but
said reconstruction will later compensate and boost growth. The CBK,
he said publicly, will continue its short term tightening of
monetary policy to manage excess liquidity in the economy, but does
not foresee any drastic change in interest rates because the
Government's domestic borrowing operations have been and will remain
minimal in the first half of 2008. Ndung'u said it's too early to
assess whether the crisis will lead to a significant rise in
non-performing loans, but the CBK does not foresee any risk of
either public or private loan defaults because it expects commercial
banks and their private sector customers to develop rescue packages.

10. (U) Others dispute these rosy assessments. Professor Terry
Ryan, a respected local economist and member of the Central Bank's
Monetary Policy Advisory Committee, said a preliminary assessment
shows that the agricultural, financial services and tourism sectors,
representing 31% of GDP, are likely to under-perform, dragging the
2008 growth forecast down from 7% to only 2-4.5%, even if the
situation returns to normal soon. The Institute of Certified
Accountants (ICPAK) likewise doubts Kimunya's claims, citing
declines in key sectors of the economy, especially agriculture.
Absent a fast resolution of the political crisis, the Federation of
Kenya Employers also warned that economic growth could drop to 3.5%
in 2008. Taking a middle-of-the-road position, Standard Chartered
Bank on January 15 reduced its growth estimate for 2008 from 6.5% to
5.0%. Similarly, the IMF cut its 2008 economic growth projections
for Kenya by only 1% to 5-7%, but warned that this depended on
resolving the deadlock within the next two weeks.

Banking and the Budget
----------------------

11. (U) Just as with the wider economy, the impact of the crisis on
the banking sector remains to be seen. Kenyan banks, after several
profitable years, are awash in reserves and liquidity. It's
possible that uncertainty about the economy's prospects could dampen
demand for credit in the short term, leading to lower rates.
Conversely, banks could become skittish and raise rates to account
for greater perceived risk, especially if the farmers and small
businesses victimized by the unrest default on their loans.

A Slippery Slope to Recession?
------------------------------

12. (U) Some analysts fear this latter effect could generate a
recession scenario. The narrative goes like this: The disruption of
incomes and economic activity caused by the political crisis could
lead to a large number of loan delinquencies and defaults,
significantly reducing liquidity in the banking system. Banks will
likely raise rates to reflect greater risk and uncertainty, and be
wary of further lending. If the GOK has to increase borrowing
and/or offer higher interest rates to cover revenue shortfalls or
increased spending for compensation and economic stimulus, banks
will gladly put their funds into risk-free government bonds and
reduce or stop lending to the private sector, especially to small
and medium-sized enterprises (SMEs), a sector which has been a
significant source of growth and job creation over the past several
years. Bottom line, according to this pessimistic-but-plausible
scenario: The economy sinks into a recession.

13. (SBU) A key variable in this analysis is whether and how much
the GOK needs to expand domestic debt issuance. The GOK's budget
for FY 2007-08 already calls for a deficit amounting to 5.3% of GDP.
The GOK had planned to cover this gap through domestic borrowing
and proceeds from privatization, including the sale in early 2008 of
25% of cell phone giant Safaricom on the Nairobi Stock Exchange.
But the much-anticipated Safaricom IPO may be delayed due to the
political crisis and resulting uncertainty. If so, the GOK will
either have to increase domestic borrowing, or cut back on
development spending, neither of which is attractive. In the event
it issues more domestic debt than originally planned, it could push
up interest rates, crowding out credit to the private sector, as per
the analysis above.

International Impact of Crisis
--------------------------------

14. (SBU) The crisis has clearly damaged one of Kenya's most
valuable assets for attracting investment: Its reputation as the
most stable, democratic country in East Africa. It is still far too
early to assess the actual cost of this damage in terms of lost
investment and lost markets overseas (if indeed it can ever be
done), but one tangible signal was the decision of Standard & Poor's
to cut Kenya's long-term local currency credit rating shortly after
the unrest began from BB- to B+. The negative publicity in the
international media generated by the unrest now also threatens the
Government's painstaking efforts to bring to market a landmark
$200-500 million sovereign Eurobond in the first half of 2008.
Appetite for the bond in the U.S. and European bond markets was
reportedly very strong during a September pre-road show staged by
the Ministry of Finance, but it seems very likely that Kenya will
either have to postpone the issuance until international perceptions
of the country's stability return to normal, or else pay a
potentially much higher rate of interest.

Comment and Analysis
--------------------

15. (SBU) The bottom line is that all bets are off and any number of
scenarios could emerge in the coming weeks and months - all
depending on the political scenario that plays out, and how Kenyans
react to it. A genuine political reconciliation between the two
political camps in the coming weeks could regenerate economic
normalcy and confidence, giving the economy a new lease on life and
a shot at maintaining growth in the 6-7% range. Even then, however,
some sectors, notably tourism, will feel the pain for at least
another six months. If things go the other way and there is
prolonged violence and unrest, the recession scenario becomes all
too real, as confidence and certainty give way to fear and economic
retreat. If the political situation remains in an uneasy status
quo, without a breakthrough but also without a great deal of
violence or disruption, then the economy does the same - it just
muddles through. The economy mirrors the state of Kenyan society at
the moment: Teetering between potential breakthrough and potential
collapse. Only a month or two ago, the political and economic
elite, with a chorus of approval from the international community,
were talking about attaining Vision 2030's goal of 10% sustained
annual growth for the next 25 years. What a difference an election
makes.
RANNEBERGER

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