Kenya's manufacturing strategy to benefit a range of segments and producers

Under the auspices of the overarching Vision 2030 economic development plan, industrialisation remains a top priority for the Kenyan government, with the sector recording steady growth in 2015 against a backdrop of falling energy and input prices, lending an optimistic outlook for 2017 and beyond. The food and beverage segment continues to dominate, leading growth in 2015 as a result of surging beverage production. The pharmaceuticals, textiles and automotive segments also remain significant contributors, and offer the country some of the best long-term opportunities for industrial growth. In addition, an ambitious infrastructure agenda is driving expansion in the cement segment, despite low commodities prices and rising competition from low-cost imports, which have had a negative impact on other construction materials.

Industrial stakeholders continue to face hurdles, however, and manufacturing’s contribution to GDP has not kept pace with broader macroeconomic growth. Low-cost imports across nearly all segments of the sector have had a negative impact on many local producers, while overlapping and unclear regulatory frameworks have created uncertainty about the role of the country’s export processing zones (EPZs) against a backdrop of planned new special economic zones (SEZs). Ultimately, though, the growing middle class and rising regional demand continue to offer significant opportunities for new private investment over the long term.

Oversight

Guided by Vision 2030’s industrialisation targets, which include increasing manufacturing’s GDP contribution by at least 10% annually until 2030, in addition to establishing new steel mills and business parks, and providing support for small and medium-sized enterprises (SMEs), the Ministry of Industry, Trade and Cooperatives (MITC) oversees a portfolio of departments responsible for investment, industry, cooperatives and trade. Along with Vision 2030, MITC’s industrialisation strategy finds its near-term focus in the country’s second Medium-Term Plan (MTP) 2013-17, which highlights manufacturing as one of six priority sectors and aims to establish an SEZ network across Mombasa, Lamu and Kisumu. The plan also seeks to launch new industrial parks catering to companies in agro-processing, iron and steel, and human resource development. MTP also targets narrowing the infrastructure gap – something that has historically constrained the ability of manufacturers to distribute and export products – with plans to construct a standard-gauge railway, upgrade port capacity to 50m tonnes, and construct or rehabilitate 5500 km of roads.

MITC’s activities are also guided by its Industrial Transformation Programme, which includes plans to launch flagship, sector-specific projects in agro-processing, textiles, leather and construction materials, among other segments, such as a food-processing hub in Mombasa and an integrated textile cluster in Naivasha. The programme also provides support for SMEs and the creation of an industrial development fund.

Recent Growth

According to the most recent economic survey from the Kenya National Bureau of Statistics (KNBS), the country’s manufacturing sector recorded 3.5% growth in 2015, compared to 3.2% on 2014. Falling input costs, including petroleum products and electricity, contributed to that growth, although producer prices, as measured by the producer price index, rose by 3.9% from 109.17 in 2014 to 113.43 in 2015. The cost of importing raw materials rose in the wake of the shilling’s depreciation against major currencies, including an 11.5% drop against the US dollar over the course of 2015. However, by late 2016 international press were reporting that the shilling was expected to stabilise, and as of early 2017 it was more or less stable.

The sector’s economic output has been on the rise in recent years, although, as is the case in most other major African markets, it has been outstripped by the performance of other sectors of the economy. KNBS reported that manufacturing’s output at current prices rose by 19.4% between 2014 and 2015 from KSh539.39bn ($5.3bn) to KSh644.06bn ($6.3bn), although its contribution to GDP remained fairly stable at 11.4% in 2015. Although it is likely to fall short of government growth targets, the sector is nonetheless benefitting from an increase in both lending and project approval. According to statistics from KNBS, credit to the sector rose to KSh290.1bn ($2.8bn) in 2015, compared to KSh237.42bn ($2.3bn) in 2014. The value of approved manufacturing projects similarly increased, rising by 93.3% to reach KSh1.1bn ($10.7m), up from the KSh569.1m ($5.6m) recorded in 2014.

Challenges

The biggest challenges the sector faced in 2015 were competition from cheap imports, the high cost of capital for local producers and disincentives for export due to delays in value-added tax (VAT) refunds, in addition to depressed global commodities prices. The challenges have led to a string of high-profile exits or cutbacks at industrial companies in Kenya. These include mining firm Fluorspar, which suspended its Kenyan operations in February 2016, and Eveready East Africa, which closed its Nakuru plant in 2014, attributing the decision to competition from low-cost imports. Red tape and transparency remain a concern as well. “While stringent public procurement procedures are in place for government contracts, they still lack transparency,” Sanjay Bhudia, director of Office Dynamics, told OBG. Production volumes moderated in 2015 as a result of these challenges, growing at a slower rate of 3.9% in 2015, against 6.3% in 2014. Although food and beverage activities are set to remain the dominant force in Kenyan manufacturing, the sector is also likely to witness significant growth in its apparel and auto industries. The outlook for its pharmaceuticals and construction materials segments, however, is mixed.

Food & Beverage

The food and beverage industry is by far the largest contributor to manufacturing output. KNBS reported that the manufacture of food, beverages and tobacco accounted for KSh264.09bn ($2.6bn) of the sector’s total GDP contribution in 2015, equivalent to 41% of output at current prices, and a 26.1% increase on KSh209.49bn ($2bn) in 2014. The sizeable profile is a result of shifting consumer patterns towards frozen and processed foods, high household spending rates – KNBS reported in June 2016 that the average Kenyan spends 45% of their salary on food and beverages – and a large array of inputs from the country’s agricultural sector. The MITC estimates that the food industry alone comprises roughly one-third of all manufacturing activities, while beverages recorded some of the most robust growth rates in the entire manufacturing sector in 2015, driven by rising demand for Kenyan products (see Retail overview).

2015 Performance

According to KNBS figures, output of meat and meat products rose by 9.3% in 2015 to 459,400 tonnes, up from 419,100 tonnes in 2014, with the production of sausages and processed chicken up 10.7% and 0.1%, respectively. Combined fruit and vegetable production volumes increased by 2.3% in 2015, after contracting by 15.9% in 2014, and the volumes of prepared and preserved vegetables rose by 12.1%. Fruit production, however, fell by 2.3%.

Animal and vegetable fat manufacturing volumes were up 6.5% in 2015, including a 12.2% increase in vegetable oils, while dairy product production grew by 8.2%, with the total amount of processed milk produced in Kenya rising by 4.3% to 437.5m litres, compared to 419.3m litres in 2014. Milled grain production grew by 7.8% as a result of rising wheat flour processing activities, which drove an 11.1% production increase in 2015 to 1.1m tonnes. Bakery output, meanwhile, recorded a 7.2% increase. Sugar production was also up on the year, rising 6.6% from 592,700 tonnes in 2014 to 632,000 in 2015, largely as a result of better cane supply. Within food and beverages, the largest decline in production volumes was recorded in fish processing, which fell by 21.8%, resulting in a 29% reduction in exports from 15,213 tonnes in 2014 to 10,801 tonnes in 2015.

Liquid Gold

Beverages were the manufacturing sector’s leading growth driver in 2015, despite declines in tea and coffee production, which are considered unclassified food products. Although tea processing eased by 10.3%, and semi-processed coffee production fell by 15.9%, roasted coffee was up 7.8% and beverage output as a whole increased by an impressive 22% in 2015, largely as a result of rising beer and spirits production. The volume of carbonated beverages produced in Kenya simultaneously rose by 8.5% to 496m litres in 2015, while production of bottled water was up 11.7%.

Beer production climbed 28.9% in 2015, while spirits production rose by 27.9%, with KNBS attributing the “remarkable” growth in beer production to a 90% remission of excise duties for beer produced from domestically grown sorghum, millet and cassava. The move is part of a broader trend across the continent to encourage beverage and food producers to source inputs domestically, and dovetails with efforts by many African brewers to provide consumers with more affordable options, such as cassava beer. This has had an extremely positive impact on local producers. East African Breweries, for example, the country’s largest brewer fast-moving consumer goods (FMCG) producer, reported its net profits rose to KSh9.57bn ($93.4m) in 2015, from KSh6.84bn ($66.7m) in 2014, largely as a result of strong demand for spirits and premium beer.

Textiles

In contrast to the broader continental trend of declining textile activity, in Kenya the sector has grown steadily and is expected to see further improvements in the coming years via exports. Following an 8.1% increase in textiles production in 2015, a new bilateral agreement with India is expected to further bolster domestic production after nearly two decades of stagnation. Twine, cordage and rope production were up 25.1% in 2015, according to KNBS, while the manufacture of blankets rose by 11.7%, and production of knitted fabrics and shirts dropped by 7.8% and 2.3%, respectively. At the same time, woven fabrics and knitting wool fell by 0.3% and 8.2%, respectively, although production of apparel rose by 10.8%, driven by a 19% increase in the t-shirt segment.

Along with helping the country revive its textiles and apparel industries, growing trade ties with India should spur greater investment in value-added manufacturing. In July 2016 the Indian government announced it would lend Kenya $45m to help develop a textile factory and other smaller industries. Local media reported that $30m of the funding was allocated to the revival of the Rift Valley Textiles Factory, which was shuttered in 2000 as domestic cotton production collapsed. The sector’s long-term growth trajectory remains positive, with the country expected to start producing shoes for the US market under a renewed quota-and tax-free access agreement, the African Growth Opportunity Act (AGOA). KNBS’s report showed that apparel exports under AGOA rose by 14.4% in 2015 to KSh34.6bn ($337.6m), while capital investment under the act soared from KSh6.86bn ($66.9m) in 2010 to KSh14.48bn ($141.3m) in 2015.

Pharmaceuticals

The pharmaceuticals industry was another strong performer in 2015. Output recorded an impressive 23.9% increase, with production of syrup, tablets and capsules rising by 26.4%, 24.7% and 20.4%, respectively. However, local producers may be impacted by government efforts to improve consumer access to drugs, after the industry’s regulatory agency, the Pharmacy and Poisons Board (PPB), announced in July 2016 that it had proposed a framework that would allow international pharmaceutical firms to import cheaper versions of medicines into the country. This is expected to significantly re-align the country’s pharmaceutical manufacturing base.

Anthony Toroitich, head of trade affairs at PPB, told local media that Kenya does not currently have a regulatory framework in place for parallel imports of drugs, and has not set price controls for essential medicines. “We cannot continue with the protection of business interests at the expense of the legitimate interests of patients. Therefore, the board is setting up a regulatory framework that will allow local firms to import drugs from areas where they are sold most cheaply,” Toroitich said in July 2016, adding that parallel imports do not necessarily mean importing generic medicines, but rather original branded drugs already sold in Kenya.

Although this will undoubtedly benefit health indicators in the country, the move is expected to bring local importers into direct competition with the licensed agents of multinational firms, which currently hold a monopoly on the industry. It is also expected to force price point adjustments and renewed efficiency measures among local manufacturers.

Other Industries

Materials production, including plastics, rubber and metals, is also facing an uncertain 2017 due to rising pressure for low-cost imports. Although rubber and plastic production increased by 5.7% in 2015, motor vehicle tyre production fell by 17.9%, its second consecutive year of decline, which KNBS attributes to import competition. Basic metals production also eased in 2015, by 5.1%, as production of corrugated iron sheets contracted from 284,500 tonnes in 2014 to 256,900 tonnes.

Imports were again blamed for this decline, with KNBS reporting that corrugated iron sheet imports were up 27.9% over the year at 1.5m tonnes, driven upward by the introduction of new roofing materials, including stone-coated steel roofing sheets and asphalt shingles, to the Kenyan market.

Similarly, fabricated steel production fell by 9.5% in 2015 as steel structure manufacturing recorded a 7.1% contraction, and aluminium circles and nails fell by 20.3% and 3.8%, respectively. Alarmingly for metals manufacturers, imports of structures and parts of structures leapt by 43.2% in 2015 to 95,100 tonnes, according to statistics from KNBS.

Rising imports are not solely the result of low-cost competition, but also reflect the volume of activity in the public works and construction sectors. The government has set aggressive targets for improving infrastructure and housing, with demand increasing significantly as a result. High demand for construction materials in Kenya also offers benefits to local industry, with KNBS reporting that domestic cement production rose by 8% in 2015 to 6.35m tonnes. Consumption and stocks also increased, up 9.8% to 5.71m tonnes over the year on rising demand in the construction sector. Cement exports decreased to 681,700 tonnes in 2015, while imports were up marginally at 37,600 tonnes.

Automotive

Growth of the middle class and rising purchasing power (see Retail chapter) have painted a brighter outlook for the automotive industry. The Kenya Motor Industry Association reported in 2016 that despite the shilling’s depreciation, new car sales surged by 12.8% in 2015 to 19,524 new vehicles. General Motors remained a market leader in the country, selling 6575 units via its best-selling Isuzi brand, which comprised 6321 of the total. Simba Colt, the licensed local dealer for Mitsubishi, recorded sales of 3153 units, up from 2774 in 2014, while DT Dobie, which holds distributor rights for Mercedes-Benz in Kenya, saw its sales rise by 75% to 598 units in 2015.

Demographic trends are also driving domestic vehicle manufacturing activities. KNBS reported that motor vehicle, trailers and semi-trailer production rose by 6.8% in 2015, led by a 7% increase in motor vehicle manufacturing from 9514 to 10,081 units over the period. Trailer and semi-trailer production was up 13.2%, while motor vehicle bodies manufacturing rose by 1.3%.

Looking ahead, the government is hoping to better develop this segment. In January 2017 Germany’s Volkswagen opened a car assembly plant in Thika, just outside of Nairobi. The new plant receives parts from the firm’s South African Uitenhage facility for final assembly and will initially produce 1000 units per year, though it plans to increase this to 5000 units.

Epzs

The EPZ programme, established in 1990 under the EPZ Act, is intended to promote export-oriented development. Today, the country’s EPZ network comprises 50 zones, including 20 in Mombasa, 10 in Kajiado, nine in Nairobi and four in Kilifi. EPZs offers investors tax holidays; duty exemptions on machinery, raw materials and intermediate inputs; and the removal of restrictions on foreign capital repatriation.

In addition, non-commercial tenants in EPZs benefit from a 10-year corporate tax holiday and a 25% corporate tax rate for 10 years after, as well as a 10-year withholding tax holiday on non-resident remittances. All tenants are offered permanent duty and VAT exemptions for raw materials, construction materials and machinery, stamp duty exemption and a 100% investment deduction on capital expenditure within 20 years. KNBS reported that companies operating within its EPZ network have recorded increases in employment, exports, imports, and expenditure on local goods and services. Total EPZ sales rose by 12.1% to KSh64.1bn ($625.4m) in 2015, of which KSh60.33bn ($599.6m) were exports. Capital investment in EPZs also recorded gains, rising by 7% to KSh47.3bn ($461.5m), while employment in the sector was up 8.7% at 50,523 people, of whom 41,548 are employed in the garment and textiles industry. However, domestic sales fell by 34.8% to hit KSh3.79bn ($37m), even as exports rose by 17.4% and imports rose by 4.2% over the year.

In The Zone

In September 2015 President Uhuru Kenyatta signed a new piece of legislation, the SEZ Act of 2015. The act is expected to bolster industrialisation through the establishment of SEZs, which offer a number of incentives to investors, including exemptions from VAT, income tax, stamp duty, Customs and excise duties, and quotas for work permits.

Under the act, SEZs can include regional headquarters, business process outsourcing centres, management consulting and advisory services, and other associated services, while the types of SEZs established under the act range from business service parks and free port zones, to free trade zones, industrial parks and ICT parks, among others.

While SEZs are mostly planned for Mombasa, Lamu and Kisumu, the act also grants the secretary of the MICT the power to declare any area in Kenya an SEZ based on a recommendation from the newly established SEZ Authority, which will also be responsible for the establishment, operation and regulation of SEZs. The secretary has also created regulations that cover the criteria for designation and gazetting of SEZs; the application process; investment rules; fees; and other conditions, terms and procedures. The SEZ Authority will become the second such body established for the purpose of developing incentivised industrial space, following the launch of the EPZ Authority under the EPZ Act of 1990. However, according to a 2015 report by EY, the crucial difference between the two authorities was described as the EPZ Authority’s aim being to attract investment in export-oriented manufacturing, while the SEZ Authority’s is broader and could offer incentives for investors intending to keep production and sale of its goods within the country.

Outlook

Although rising imports, shilling depreciation and unclear legal reforms will continue to challenge Kenyan industrial producers, the sector’s growth outlook for 2017 is positive. The government’s far-reaching infrastructure development agenda should keep investment in new construction materials production expanding, while its mainstay food and beverages segment will continue to benefit from a growing middle class that prioritises spending on Kenyan-branded FMCG products. Moreover, with electricity and fuel costs still relatively low, and ongoing government investment in new electricity capacity, particularly in the renewables segment, the sector is expected to remain attractive.

 

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The Report: Kenya 2017

Industry & Retail chapter from The Report: Kenya 2017

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