Re-engineering of the industrial base presents growth opportunities

Seven years after publication of the Vision 2030 national development roadmap (V2030), Kenya is moving toward the integrated development of industry involving the upgrade of infrastructure, regulation and skills. Policy is being guided by V2030, the National Industrialisation Policy Framework 2012-30 (NIPF) and the Second Medium-Term Development Plan 2013-17 (MTDP2), in tandem with the East African Community Industrialisation Policy and Strategy 2012-32. Yet there are challenges: value addition and formal employment remain low, the cost of credit is high, infrastructure is substandard and the business environment is difficult.

Nuts & Bolts

Industry in Kenya encompasses manufacturing, construction, and mining and quarrying. Combined, these sectors accounted for 14% of GDP between 2009 and 2012. Adjusted to 2001 constant prices, combined economic output grew by 22% between 2007 and 2012, from $2.02bn to $2.47bn. Manufacturing is the dominant sub-sector, contributing 72% of industry’s economic output. Construction contributes 25% and mining 3%. Manufacturing growth averaged 3.1% from 2008 to 2012, and 4.8% in 2013.

Yet while Kenya’s GDP has risen sizeably in recent years, industry’s contribution shrank from 10.8% in 2008 to 8.9% in 2013. The outlook for construction is more encouraging, with many infrastructure projects on the table (see Construction chapter). There have been efforts to develop exploration and production activities, but mining remains peripheral, with GDP contributions of 0.7% consistent since 2010.

By The Numbers

The sector comprises around 3700 manufacturing units, of which over 50% are small enterprises. Directly and indirectly, it employs 778,000 people, 13% of Kenya’s formal labour force. An estimated 1.6m are employed in the informal sector.

Objectives outlined in V2030 and the NIPF will require improved productivity and competitiveness, market development, infrastructure strengthening, diversification into high value-added sectors, and building an environment conducive to innovation with improved research and development capacities. While the country will rely on established manufacturing industries, recent discoveries of new oil and gas reserves across East Africa and a major subterranean aquifer provide options for diversified industrial activities.

History

Kenya followed a policy of import substitution for much of the 1960s and 1970s, and this had a big impact on agro-industrial activity. While this period delivered industrial growth rates in excess of 8%, low domestic demand combined with state-run monopolies exaggerated market inefficiencies. Structural adjustment programmes that encouraged the use of local resources and liberalisation of imports in the 1980s provided little redress as industry remained inward oriented, import dependent and capital intensive.

The government began dismantling trade barriers – including tariffs as high as 170% and foreign exchange restrictions – in the late 1980s, exposing manufacturers to more rigorous competition and resulting in a dramatic rise in imports, along with sluggish growth and an increase in informal employment. Yet the shift was accompanied by a push towards export promotion, which forms the platform for industrial policy today.

Among the components of this approach are export processing zones (EPZs). Established in 1990 to attract foreign direct investment (FDI) and provide employment with skills transfer opportunities, EPZs offer incentives that include 10-year corporate income and withholding tax exemptions, and duty- and stamp-free imports of machinery, raw materials and inputs. From 2008 to 2012 EPZs attracted $1.5bn in investments, earned $1.8bn in exports and employed 36,000 people.

More recently, devolution – a result of the passage of the 2010 constitution, which transfers select powers, including certain economic development policies, to 47 newly created county governments – has been welcomed as a necessary instrument to diversify and decentralise national industry (see Counties chapter). This is being supported by the construction of 210 Constituency Industrial Development Centres, through the Ministry of Industrialisation and Enterprise Development’s (MoIED’s) economic stimulus scheme.

Base Costs

Manufacturers in a number of Africa’s frontier and emerging markets grapple with high operating costs, due to under-maintained infrastructure. In Nigeria, for example, the lack of accessible grid electricity means factories often rely on expensive diesel generators, which can add up to 30% to overheads.

Kenyan manufacturers face similar challenges. The Kenya Association of Manufacturers (KAM) estimates that power outages and surges cost industry 7% of total sales. Outages average eight to 12 per month, yet the principal factor affecting industry is cost, not supply. “Power stations are operating well below capacity, but the government is paying for higher rates of generation, which are being passed onto the consumer,” said Galeb Gulam, the COO of Industrial Promotion Services. “Without upgrades to national distribution networks, planned increases to Kenya’s generation capacity may increase the cost of electricity, when it needs lower costs to attract heavy industry.”

Kenya aims to add 6400 MW of generating capacity by 2017, primarily through independent power producers. Yet investment in distribution networks will be needed, and at $0.15-0.20 per KWh, current costs compare unfavourably with other regional markets, such as South Africa, at $0.04 per KWh for heavy industry. Logistics costs are also among the highest in the region, at $0.20 per tonne per km. Large investments are under way to improve transport facilities both for domestic distribution and export activities, but in the short-term, the introduction of new county-level tolls and levies is expected to deliver a cost hike. However, there was positive news in late 2014 when it was announced that power bills are to fall by 30% in October and by 50% in early 2015 when more geothermal energy hits the grid, reducing reliance on expensive diesel-powered generators. The initial 140 MW was commissioned in October, with a further 140 MW due soon after.

Land

Kenya faces a shortage of available land for industrial development. KAM has identified this as a critical constraint on industrial expansion. It is a priority for the government, which is looking to open access to land held under communal trust – around 70% of the total area – through the Communal Lands Law, but with just 10% of Kenya government owned, industrial investors are largely dependent on private freehold land, which comprises the remaining 20%. This has fuelled private speculative developments, particularly along new strategic transport corridors.

This has benefitted owners of existing industrial land. Over the past decade rents per sq metre per month have risen by 135%, from $7 to $16.50, and industrial rental yields of 12% were the highest of any sector in 2013, outperforming the 11% sub-Saharan Africa average. The industrial real estate market has traditionally been dominated by owner-occupiers but is now shifting toward rental agreements, notably with properties compatible with large-scale warehousing and logistics. In some instances, real estate firms have shifted development focus from residential to industrial.

Agro-Industry

Agro-industrial and processing dominate the manufacturing sector, accounting for around 1200 businesses in 2012, encompassing bakery and grain-milling products, vegetable and animal oils and fats, dairy products, and fruit and vegetable canning. One of the first sectors to receive FDI in the 1960s, agro-industrial production and processing has considerable potential, given Kenya’s large primary sector. While output is dominated by domestic production of tea, maize and wheat, potential investment opportunities lie in beef, fish and vegetable processing, and the manufacture of animal feeds (see Agriculture chapter). This will complement existing target markets, notably Europe and the US. Current agro-industrial capacity is restricted by its dependence on rain-fed production and seasonality, although the discovery of a 250bn-cu-metre aquifer in the Turkana region in the north of the country could provide some relief in the medium- and long-term, and encourage output of by-products, including leather.

Value-added enterprises in the leather and footwear sub-sector are currently negligible, and are a priority focus of the NIPF. Most exports are in unprocessed raw hides and skins, which require qualitative upgrades to the production process to minimise spoiling and defects. The government has also sought to encourage value-added activity through export bans on unprocessed products. In 2010 the government implemented a ban on the export of raw nuts, to stimulate downstream processing domestically, although low extant capacity among domestic processors created a glut, halving low-income farmers’ revenue, according to local press.

Textiles

Rehabilitation of the textiles industry is a priority under V2030 and the NIPF. Textile mills such as Rivertex, Kicomi and United Cotton Mills were also among Kenya’s first FDI recipients. Government-owned mills were closed as a result of trade liberalisation, with much of the current activity concentrated in EPZs. Given its export-oriented nature, the EPZs have helped the sector. Of the $439m of investment that flowed into EPZs in 2012, 27% was in garments, followed by minerals and metals (20%) and agro-processing (16%).

Garment manufacturers also led in outbound sales, contributing 49% of total EPZ sales. Subsequent sales were led by agro-processing (15%), minerals and metals (8%) and electrical manufacture (6%).

The industry was resuscitated in the late 1990s, although it has struggled to cope with a 2007 directive requiring indigenous raw materials, as the cotton value chain is unable to supply the quantity, quality and variety of fabric required. Consequently Kenya lacks a fully integrated textile mill. The duty-free trade of textiles has also enabled Asian exports and second-hand clothing to dominate the local market, providing competition for domestic products on price and quality.

Heavy Industry

Coming years will likely see a jump in hydrocarbons activity. Oil and gas is set for considerable growth, with reserves across northern Kenya alone now estimated at 2.6bn barrels, and several players have entered the market (see Energy chapter).

This has implications for hydrocarbons products and downstream activity. Kenya has committed to the construction of a $2.5bn new oil refinery, for example, in the port of Lamu. Positioned at the terminus of the forthcoming Lamu Port and South Sudan-Ethiopia Transport Corridor, it will serve as South Sudan’s main oil export outlet and replace Kenya’s current refinery in Mombasa, which is reaching the end of its operational lifetime.

Competition from other national refineries in the East African Community notwithstanding, Kenya’s oil and gas find also represents a potential windfall for its production of organic and non-organic chemicals, alongside refined petroleum products.

Steel

Building materials including cement and metals are still going strong, and with many infrastructure projects on the table, domestic demand alone should help sustain growth. The steel industry was boosted by the launch of the Nyayo Pioneer Car project in 1990, part of the objective of which was to help cultivate a domestic steel industry. KAM reports 258 registered steel and metal manufacturers, producing a broad range of products for both domestic and export markets. Although the Common Market for Eastern and Southern Africa is the principal export destination, import tariffs continue to block full market access. Exports reached $172m in 2012, but imports of $645m the same year indicate capacity shortfalls upstream. While Kenya has installed smelting capacity of 180,000 tonnes, the sector is largely dependent on scrap metal, or on imports of intermediate or finished products at 10% and 25% duty, respectively, to manufacture required products.

Yet there are plentiful reserves of raw material. Vast deposits of iron ore exist, as well as limonitic, goethite and pyritic ores. Coal reserves equivalent to 275m tonnes are also deemed adequate to support both power generation and iron and steel production. Kenya’s plentiful reserves of limestone are adequate for both steel and cement production. To strengthen the domestic value chain, the MTDP2 has endorsed development of integrated iron and mini steel mills. South Korean steel manufacturer POSCO has partnered with Kenya Railways’ Numerical Machining Complex to develop the first mini steel mill in Machakos County, near Nairobi.

Cement

A comparable opportunity exists for the cement industry. Between 2007 and 2013 Kenyan production capacity rose by 91% to 5m tonnes per annum (mtpa), of which 85% is consumed domestically. Kenyan demand is expected to surpass 100 kg per person in 2014. Chinese-Kenyan consortium Savannah Cement, which has a presence in Ethiopia, Uganda and South Sudan, controlled 8% of the domestic market in 2013, thanks to production from a $114m, 1.5-mtpa plant. Cemtech Kenya, a subsidiary of India’s Sanghi Group, has also invested $137m in a new two-phase 1.2m-mtpa plant in outlying Pokot. Dangote Cement is the latest entrant, announcing a $400m, 5500-mtpa plant in 2014. While Kenya’s production capacity is expected to more than double and reach 11.1m mtpa by 2018, margins for manufacturers remain some of the lowest in the region at $25 per tonne – in large part due to higher power and transport costs.

The outlook for raw materials is encouraging as well, with sizeable sources of limestone and gypsum. Mandera county’s El Wak announced a $23m reserve of gypsum in 2004, and the local government is still seeking multinational assistance in the resource’s exploitation, alongside that of commercially viable reserves of limestone. These are estimated to be larger than neighbouring Turkana and Pokot counties’ 150m tonnes.

Small Wonders

While Kenya’s big industry is expected to grow further, the MTDP2 is channelling attention to the micro, small and medium-sized enterprises (MSMEs) that dominate the informal sector. The first attempt to harness the potential of MSMEs was the 1992 Small and Medium Scale Enterprises Sector Policy. Today the MoIED’s MSME division oversees the government’s efforts, including the MTDP2. As with many emerging and frontier markets, the sector is largely unaudited. The direct and indirect contribution of the informal sector in Kenya is substantial, contributing an estimated one-third of GDP and around 80% of jobs created in 2013. However, informal enterprises contribute only around 20% to manufacturing GDP.

Some of the challenges that MSMEs face mirror those of their larger, more formalised counterparts. “Kenya’s MSMEs must be competitive with Chinese and Indian imports. This means addressing shortfalls in infrastructure, such as electricity, transport and market access,” Hezekiah Okeyo, senior assistant director of industries in the MSMEs division, told OBG. “Only by addressing these core issues will Kenyan firms be able to develop a market beyond our borders.” Access to finance is also an issue. Accordingly, “the existing government funding instruments are being consolidated into one fund with a portfolio of up to $230m available to MSMEs at accommodative lending terms,” said Okeyo.

The MoIED’s current initiatives build on the legacy of both the 2005 Development of Micro and Small Enterprises for Wealth and Employment policy and the MSE Act of 2012. Public-private partnerships are being pursued, notably through Kenya Industrial Estates, though mentoring programmes have yet to gain traction. Moves to bring MSMEs into the formal economy and create confidence in the market are being supported by the “Buy Kenyan, Build Kenya” policy, which requires 30% of all public procurement to be from MSMEs.

Managing Employment

Job creation in the informal sector is arguably higher due to high costs in the formal sector. “Kenya’s labour costs are typically 50% of production costs,” said Gulam. “It will be difficult to both maintain Kenyan industry’s competitiveness and raise salaries in line with expectations, as monthly wages are around double those of competing Asian markets, at $150.” Incremental increases of 14% in 2013 resulted in retrenchment of employees across industry and the closure of one Nairobi textile factory.

To reduce the impact on competitiveness of wage rises, the government aims to improve vocational training and technical skills to boost value addition capacity. It is upgrading facilities at the Kenya Industrial Research and Development Institute, and to boost industrial productivity it has created a multilateral training scheme for engineers and technicians under the Ministry of East African Affairs, Commerce and Tourism. Such upgrades to the domestic skill base are critical as the government moves to grow industries such as pharmaceuticals, backed by the Kenya National Pharmaceutical Policy. In 2014 GlaxoSmithKline announced a $116m investment in manufacturing capacity in Kenya as part of a $216m expansion of facilities in the region.

Outlook

Although Kenya adapted to export-oriented policies and trade liberalisation recently, it has a number of advantages – including sizeable upstream inputs and a strong transport network – that give it a competitive edge in several industries, including building materials, textiles and agro-industry. The government is keen to improve value addition and reduce informality, which will require tackling structural and regulatory issues, ranging from pricing to import controls. The reform plans on the table have the capacity to do that, and if they are effectively implemented and combined with the rise in public spending and purchasing power, Kenya’s outlook will be very encouraging.

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The Report: Kenya 2014

Industry & Retail chapter from The Report: Kenya 2014

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