Kenya's near-term fundamental picture looks bleak

The Economist somewhat glumly opined this week that for all its recent progress (the economy has hitherto rebounded close to pre-crisis levels, up 5.6% y/y in 2010, the strongest expansion in the past three years) “Kenya still often feels like a country running to stand still.”  Indeed the near-term future continues to look bearish for both policy rates (the monetary backdrop leans towards tightening despite the central bank's (CBK)  latest 180 on its late June 175bp overnight rate hike) and the currency (USD/KES closed last week at 90.90, -1.0% w/w) as sharply surging headline inflation (+14.5% y/y in June from negligible levels at the end of 2010) on the back of food inflation (+22.5%) caused chiefly by East Africa's worst drought in over 50 years which will likely dampen growth (last week Absa Capital lowered Kenya's overall GDP projection for 2011 from well above 5% to 4.8% while noting that Kenya Power, the country's sole electricity distributor announced rationing measures) while also causing a marked deterioration in C/A balances (above 9% of GDP in 2011 projected from 7.4% in 2010) as high import demand for both food and fuel are exacerbated by weaker rates (buoyed additionally by CBK reserve replenishment)–creating a negative feedback loop of sorts for the country's fundamentals in which the output gap widens despite increased fiscal expenditures as reduced or removed import duties help cushion price rises on one hand but also dent progress being made on the very infrastructure projects needed to sustain growth (and woo foreign capital investment) on the other, bloating fiscal deficits (7% of GDP projected, now 2x that seen in 2008) in the process and returning us to square one.  Meanwhile Kenya's 20-share index is down nearly 25% YTD while the 91-day t-bill yield remained 9% at the latest auction compared with 3% at the end of Q1, a symptom of entrenched negative real rates.  If only such clouds contained rain.