AFRICA STRATEGY 3 August 2010

EAST AFRICA: TRIP NOTES

We visited East Africa recently and met with various stakeholders, including the Ridle Markus
finance ministries, central banks, multilaterals and the private sector. The economic +27 (0)11 895 5374
growth outlook for the region is promising, driven largely by infrastructure ridle.markus@absacapital.com

investments and policy support. However, the fiscal situation remains challenging
Dumisani Ngwenya
due to expansionary fiscal stances to support economic growth. Furthermore, the
+27 (0)11 895 5346
political landscape, particularly in Uganda and Kenya, is clouded with uncertainty.
dumisani.ngwenya@absacapital.com
„ Kenya’s economic recovery is strengthening while those of Tanzania and Uganda remain
solid as the region recovers from the impact of the global slowdown. www.barcap.com

„ Governments have focused on reducing substantial infrastructure gaps (specifically

electricity and transport), cutting the cost of doing business and engaging the
private sector to speed up economic development.

„ The commencement of the East Africa Community’s Common Market on 1 July

promises substantial long-term benefits although its implementation is marred by
teething problems.

„ Uganda’s positive oil story is somewhat dampened by the news that commercial oil
flows may only take place in 4-5 years’ time.

„ We expect Tanzanian elections in October 2010 to go smoothly but we are more

cautious on the political outlook in Uganda (elections in 2011) and Kenya (2012).

„ Fiscal conditions remain challenging. Though all three governments have discussed
potential Eurobond issuances, we believe it is unlikely during 2010.

„ Market opportunities in domestic fixed-income assets are limited as East African

markets have seen downward shifts in their yield curves since 2009.

Figure 1: Fiscal situation showing strain (deficits, % GDP)

0
-1
-2
-3
-4
-5
-6
-7
-8
2006/07 2007/08 2008/09 2009/10 2010/11

Kenya Tanzania Uganda

Source: IMF, National agencies, Absa Capital

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 9

Absa Capital is a division of Absa Bank Limited

Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
Common market ushers in
higher level of integration with
long-term benefits
Common market has 127mn
people and a total GDP
of close to USD80bn
Kenya well positioned to take
advantage of single market
Infrastructure projects have
become the priority for East
African governments
3 August 2010
Promising but challenging time ahead
During our visit, much of the discussion centred on the recent formation of the East Africa
Community (EAC) Common Market, infrastructure backlogs, Uganda’s oil plans and the
upcoming elections in the region. The formation of the common market, which commenced
on 1 July, and the potential impact on the region was a major point of discussion. The EAC’s
key objective is to widen and deepen cooperation among its partner states, Burundi,
Rwanda, Kenya, Tanzania and Uganda, in political, economic and social fields. It is also
working towards becoming a fully-fledged customs union. The establishment of a common
market is taking it closer to achieving this goal as it allows for freer movement of people,
services, capital, labour and goods in the EAC countries although it may still take some time
for it to be fully implemented. Included in the objectives of the common market are the
acceleration of growth and development of partner states and the strengthening,
coordination and regulation of economic and trade relations among the EAC partners.
With a population of 127mn and a combined GDP of nearly USD80bn, the common market
hopes that the benefit of free movement of all production factors will result in a more
efficient allocation of factors of production, increasing productivity further. However, there
are still many teething problems that need to be addressed as not all the laws of member
countries have been aligned. EAC originated goods are supposed to be traded freely but
taxes are still being charged. While EAC originated goods, which need an EAC certificate of
origination, are exempted from import duties, taxes such as VAT, excise duties and
withholding taxes, where applicable, are still payable. Moreover, non-tariff barriers are seen
as a major obstacle in allowing the smooth flow of trade. Labour movement is still not free
as individual states’ immigration laws remain in place. Infrastructure problems in the region
also mean that the smooth movement of goods is still problematic, while not all border
posts are ready to adopt common market procedures. Despite these problems, the
implementation of the common market protocol will be progressive and the benefits will
therefore only be seen in the long run. The EAC countries are working towards the
establishment of a monetary union in 2012 and ultimately the formation of a political
federation. Although the East African Monetary Union (EAMU) is envisaged by 2012,
indications following joint ministerial meetings in March this year and during our visit were
that the establishment of the union is likely to be delayed.
Despite the expected benefits of the single market for its partner states, it appeared to us
that of the three larger countries in the region, Kenya is best prepared and placed to take
advantage. Kenya also appears to be more excited about the benefits of the new common
market than the other countries. Tanzania seems less equipped and less competitive than
its stronger neighbour (Kenya). During our discussions, it was viewed that productivity and
innovation was highest in Kenya, while Tanzania was lagging the region somewhat in these
aspects. However, it is hoped that the increased competition will lift productivity across the
region, create jobs and spur more investment opportunities.
Continuing investment in infrastructure projects, started during the boom periods, has been
a key aspect in supporting growth during the global economic crisis. East Africa, like the rest
of the continent, has significant physical infrastructure gaps spanning different spheres -
electricity, transport, water, and social infrastructure such as education and health. To
unlock growth and reduce the high cost of business, east African governments have made
infrastructure projects their priority and have encouraged the private sector to assist
through Private Public Partnerships (PPPs). Tanzania has recently enacted the PPP Bill,
which will govern the cooperation and relationship between the public and private sector.
2
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
Energy crisis acute means
there are many opportunities
for investment
Uganda’s positive oil story
dampened by the news that oil
windfalls will only be seen in 4-5
years’ time
Kenya’s constitutional
referendum is being held
on 4 August
3 August 2010
Kenya already has a PPP law in place, while Uganda’s President Museveni earlier this year
instructed parliament to come up with a policy on PPPs.
The acute electricity shortage means that the expansion of electricity capacity has been the
priority area for development and one that has many interesting opportunities for
investment. Electricity shortages in East Africa, which relies heavily on hydroelectric power,
are at critical levels and are having a severe impact on overall economic activity and
competitiveness. As a result, the Uganda government plans to accelerate rural electrification
and a number of small projects (hydropower plants like Buseruka and Ishaha) are near
completion, while larger projects such as Bujagali (250MW) are being constructed. The
Karuma Falls project (potential of 700MW) will also be developed soon. Uganda has
liberalised the electricity sector as it needs substantial financing and has started to privatise
generation and distribution businesses. Kenya has been restructuring its electricity sector
and has indicated that the total cost of investment in additional capacity may be as much as
USD5bn. Kenya, like other countries in the region, is in the process of diversifying into
geothermal energy, mini-hydropower and other new techniques and a number of projects
are in the pipeline (Sangoro, Lake Turkana Wind Power project, etc). Similarly, in Tanzania,
several large projects are being planned in order to meet electricity demand.
In Uganda, there was a lot of excitement about the country’s positive long-term outlook
following the discovery of oil. Vast oil reservoirs (estimated at 2.5bn barrels and a 20-25-
year lifespan) have been found by exploration companies in the past four years and there is
substantial upside potential, according to these companies. Since the discovery of oil in
2006, the process towards commercial production has been slow and fraught with delays.
The Early Oil Production Scheme (EPS) is expected to start towards the end of 2010 or 2011
and will produce just 5,000bpd, all of which is expected to be used to boost thermal
electricity generation and reduce the substantial electricity shortages the country is
currently experiencing. As oil production is gradually ramped up (maximum output is
expected to be around 200,000bpd), the government plans to focus on refining the crude
oil for local and regional markets and will be exporting the surplus crude oil. The planning
process for the building of refineries and the transportation of the oil is underway, and the
government expects the development of the first refinery to start in 2011. Uganda’s
government has decided that more value can be gained from exporting refined fuel instead
of crude oil, which means revenues from oil production can only be expected once the
refineries are completed in 4-5 years’ time. Disappointingly, details on revenue sharing and
fiscal planning are not available. As such, with first oil flows only expected by 2014/15,
Uganda cannot be seen as another “Ghana”.
Upcoming elections and referendums in East Africa mean that the region needs closer
monitoring over the next few months. Tanzania’s elections are being held on 31 October
2010, while Uganda and Kenya’s elections are scheduled for February/March 2011 and
2012, respectively. Kenya, however, is planning a referendum on 4 August on the adoption
of the new constitution. The key changes proposed by the new constitution include the
reintroduction of regional governments, curtailment of presidential powers and the creation
of the position of prime minister. The new constitution is aimed at limiting presidential
authority in an effort to reduce the possibility of abusing these powers and also enshrines
separation of power and checks and balances which is aimed at reducing corruption. The
referendum in itself holds few political risks provided the new constitution is accepted.
Currently, the main disagreements centre on the peripheral issues on abortion, Muslim
courts and land reforms and the ‘Reds’ (those favouring a ‘no’ vote) are campaigning hard
to have the new constitution blocked. A rejection of the new constitution by voters,
however, would be a huge blow to reforms in the country although our sense was that the
3
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
Uganda’s elections may see
some volatility; however, we
expect the ruling NRM
to retain power
Tanzania’s elections are
likely to go smoothly
Economic growth solid, driven by
infrastructure investment and
policy support
3 August 2010
population may accept the constitution. Recent opinion polls (allAfrica, 16 July) indicated
that 62% of Kenyans are likely to vote ‘yes’ with 20% stating that they will reject the
proposed constitution.
In Uganda, the situation ahead of the 2011 elections is more worrying. The recent militant
attacks in Kampala, which appear unrelated to next year’s elections, does have the potential
to divide the country ahead of the elections and also pose a long-term threat. However, with
nearly 80% of the population Christians, we do not expect these attacks or the long-
standing instability in the north of the country to have a major impact on medium-term
stability or the election outcome. Instead, we expect two other issues to become topical
ahead of the elections. Attempts by the Buganda tribe to become more autonomous may
have some impact on support for President Museveni, while opposition parties’ refusal to
accept the electoral committee may cause some volatility closer to elections. Yet, despite
these issues, the dominance of the ruling National Revolutionary Movement (NRM) means
that the party will remain in power in 2011, in our view.
Tanzania’s elections are likely to go smoothly, in our view. The ruling CCM is the dominant
party and given its access to resources for campaigning and the weak opposition, we expect
the party to win the October 2010 elections comfortably. Though Zanzibar has traditionally
been a political hotspot around election time, the referendum on 31 July in which voters
adopted (66% in favour) the proposal to change Zanzibar’s constitution to allow for a unity
government, has raised hope that the political problems of the island are in the past. This
will substantially reduce political risk on the island and pave the way for a peaceful run-up
to the October elections.
Economic growth solid
East Africa’s economic growth has been solid despite global economic difficulties. Although
the region escaped the initial impact of the financial crisis, the decline in trade and capital
inflows dampened economic activity. Policymakers eased monetary policy, continued with
infrastructure programmes started before the crisis and engaged multilaterals for support in
an effort to cushion the economy from the full impact of the global crisis. The worst-hit
economy during the past three years was Kenya, which suffered a double whammy as the
Figure 2: East Africa GDP growth outlook upbeat
12
10
0
2006 2007 2008 2009 2010F 2011F
Kenya Tanzania Uganda
Source: Central banks, Absa Capital
4
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
We remain positive on growth
despite structural impediments
Lower food inflation has driven
overall inflation lower
Accommodative monetary policy
to remain until at least 2011
3 August 2010
global crisis hit shortly after the post-election violence had already affected the economy.
However, following growth of 1.6% in 2008, Kenya’s economy grew 2.6% in 2009. Ugandan
and Tanzanian economic growth, in contrast, remained solid in 2009 (5% and 6%,
respectively) although growth moderated from pre-crisis highs. Similar to Kenya,
governments in these two countries supported growth by relaxing monetary policy and
continuing with large infrastructure programmes. The Bank of Uganda continued its
accommodative monetary policy stance to support demand amid a fall in credit demand,
while improved exports also boosted growth from Q2 09. Uganda’s long-term economic
outlook has improved significantly with the discovery of vast oil reservoirs (holding up to
2.5bn barrels of oil) although the benefits may only be seen in 4-5 years’ time.
Despite structural impediments, we remain positive on the region’s growth prospects as
investment in infrastructure will be supportive of growth. Furthermore, a stronger agricultural
sector, improved export and tourism revenues and continuing policy support should further
support growth. Oil-related investment will be positive for Uganda’s growth prospects.
Benign inflation environment
Inflation has fallen sharply in the three large east African countries in recent months.
Following a change in inflation methodology and a reweighting of the basket, Kenya’s
inflation fell from 5.3% y/y in December 2009 to 3.6% in July 2010, while Uganda’s inflation
rate declined from 11% to 3.2%. Tanzania’s inflation also eased from 12.2% y/y in
December 2009 to 7.2% in June. Improved agriculture conditions this year and improved
food supplies resulted in substantially lower food inflation, falling from the high teens to
single digits. Coupled with lower fuel inflation, it dragged overall inflation across the region
lower. The medium-term outlook for inflation remains favourable and we expect inflation
for Kenya, Uganda and Tanzania to end the year at 5.1%, 4.3% and 4.8% y/y, respectively.
Figure 3: Medium-term inflation outlook is benign
35
30
25
20
15
10
0
Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10
Kenya Tanzania Uganda
Source: Statistics offices, Absa Capital
The region’s central banks have generally maintained accommodative monetary policies
throughout the crisis and after. While Tanzania and Uganda use open-market operations to
conduct monetary policy (Uganda is working towards adopting an inflation-targeting
regime though its implementation is still some way off), Kenya has reduced its benchmark
policy rate considerably. Over the past 18 months, the Central Bank of Kenya (CBK) has
reduced the policy rate by 300bp to 6%. We expect central banks from all three countries to
5
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
Private sector credit lending
slowing in Uganda and
Tanzania; recovering in Kenya
External accounts have improved
in 2009 but likely to deteriorate
in 2010 as imports pick up
Longer-term currency outlook
still upbeat despite
recent depreciation
3 August 2010
continue with their accommodative monetary policy stance until at least 2011 in an effort
to boost credit lending and demand. With the economic recovery well underway, we do not
expect the CBK to lower its policy rate further after a very aggressive 75bp cut on 28 July.
However, despite the accommodative stances, commercial banks have generally failed to
materially reduce their lending rates and both the Kenyan and Ugandan central banks have
already indicated that they will continue to engage with commercial banks to lower lending
rates. Should they succeed, it will further support credit lending and overall demand.
Private sector credit lending in Uganda slowed from 40% y/y in May 2009 to 21% in May
2010, while in Tanzania, it eased from 32.2% to 13.7% over the same period. However, in
Kenya, private sector credit extension is recovering steadily, having risen from 12.2% y/y in
April 2009 to 17.7% in April 2010 (30% in mid-2008). The CBK, at its 28 July MPC meeting,
reiterated that commercial lending rates are still too high as it wants credit lending to grow
further to boost private sector investment.
Currencies have some upside potential
Since the second quarter of 2009, Ugandan exports showed some improvement while those
for Kenya and Tanzania showed no real increase despite higher commodity prices.
Positively, imports remained weak as a result of domestic economic difficulties, resulting in
improved trade balances in the region. Overall, current accounts improved in 2009 from the
previous year largely as a result of improved trade balances. Q1 10 data from Kenya and
Tanzania point to a worsening in trade balances as a result of higher imports. As such, we
expect current account balances to widen somewhat in 2010 on higher imports. That said
recent weaker currencies support external balances.
After strengthening considerably in H2 09, East African currencies have been under
pressure so far this year as a result of the strong USD. The KES depreciated 7% YTD against
the USD, followed by the TZS (-10%) and the UGX (16%) with most of the depreciation
occurring in May. That said these currencies continued to perform well against other major
currencies such as the euro. Looking ahead, we expect currencies to strengthen marginally
on improved capital flows when risk appetite returns, as well as on our expectation of a
marginally weaker USD and firm export and tourism revenues.
Figure 4: Currencies have been under pressure in H1 10
125
120
115
110
105
100
95
Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10
USD/KES USD/TZS USD/UGX
Note: Exchange rates indexed to January 2010 = 100. Source: Reuters, Absa Capital
6
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes
Uganda’s fiscal deficit expected
to widen in 2010/11;
disappointingly, no oil inflows for
next 4-5 years
Kenya planning to go ahead with
sovereign bond issuance
in 2010/11
Upcoming elections pose upside
risk to spending
3 August 2010
Fiscal positions under strain
East African countries presented their respective budgets during June with the focus firmly
on infrastructural investment. Hence, generally expansionary budgetary stances have been
maintained, resulting in somewhat larger fiscal deficits in Tanzania and Uganda, while Kenya
saw a small narrowing. Uganda is projecting a deficit of 3.5% of GDP (3% in 2009/10) in
2010/11 and has a medium- to long-term fiscal deficit target of 5%. The discovery of oil has
raised our expectations that the fiscus may benefit from oil inflows very soon, but during
our visit it became clear that actual oil revenues may still be 4-5 years away. As such, fiscal
challenges will remain in the interim. Uganda’s government has also indicated that it will
continue to finance the fiscal gap through foreign and domestic financing and is not
planning to issue a sovereign bond any time soon. Likewise, Tanzania’s government has
also been silent on earlier plans to issue a sovereign bond despite plans to increase its
borrowing to around to 4% of GDP in 2010/11 from a budgeted 3.5% in 2009/10.
Tanzania’s budget remains very dependent on foreign assistance, whether in the form of
loans or grants. In the current fiscal year, 28% of expenditures will be financed from loans
and grants, down from 33% in the previous fiscal year. Tanzania plans to borrow a total of
USD0.9bn (around 4% of GDP) from domestic and foreign sources to finance priority
infrastructure projects.
Kenya is projecting a fiscal deficit equivalent to 6.8% of GDP in 2010/11 (estimated at 7% in
2009/10) and the government remains positive that tax revenues will be in line with
expectations, which will allow infrastructure projects to continue uninterrupted. Kenya,
which operates the region’s largest bond market, plans to reduce its domestic borrowing to
3.8% of GDP from 5.1% of GDP in 2009/10. The government still plans to go ahead with a
USD500mn sovereign bond during the current fiscal year (July 2010-June 2011).
We believe that improved revenue flows from increased economic activity and stronger
exports will improve domestic revenues in east African countries. In our discussion, the
various governments noted that they expect improved fiscal positions over the next few
years despite upcoming elections as they do not see elections having a negative impact on
spending. The expansionary fiscal stances have resulted in external debt creeping higher
post debt relief.
Figure 5: External debt creeping higher (% GDP)
70
60
50
40
30
20
10
0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10
Kenya Tanzania Uganda
Source: Official offices, Absa Capital
7
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes

Figure 6: Macroeconomic forecasts of selected countries in east Africa

Kenya Tanzania Uganda

2009 2010F 2011F 2009 2010F 2011F 2009 2010F 2011F

Real GDP (% y/y) 2.6 3.9 5.1 6.0 6.4 6.8 5.2 6.1 7.5
CA (% GDP) -5.5 -6.6 -6.1 -7.8 -9.6 -9.8 -2.6 -4.9 -3.8
FX reserves (eop) 3.9 3.6 … 3.2 3.2 … 2.8 2.7 …
External debt (%
23.9 24.3 23.2 33.9 34.1 … 12.7 13.3 …
GDP)1
Overall fiscal balance
-3.7 -7.0 -6.8 -4.8 -5.7 -6.5 -1.7 -3.0 -3.5
(% GDP)1
CPI (% y/y, eop) 5.3 5.1 9.3 12.2 4.8 10.9 11.0 4.3 9.5
Currency per USD
75.85 79.10 76.50 1339 1399 1300 1900 2000 1850
(eop)
Benchmark policy
7.00 6.00 7.50 n/a n/a n/a n/a n/a n/a
rate (%, eop)
Note: 1Fiscal year ending. Source: BoG, IMF, Reuters, Absa Capital

3 August 2010 8
Absa Capital, affiliated with Barclays Capital East Africa: Trip Notes

Emerging EMEA Research Analysts

ABSA CAPITAL
Jeff Gable Ian Marsberg Jeffrey Schultz Divya Vasant
Head of Research Macro Strategist Macro Strategist Credit Analyst
ABSA Capital +27 11 895 5374 +27 11 895 5349 + 27 11 895 5345
+27 (0) 11 895 5368 ian.marsberg@absacapital.com jeffrey.schultz@absacapital.com divya.vasant@absacapital.com
jeff.gable@absacapital.com
Ridle Markus Dumisani Ngwenya Judy Padayachee Bulent Badsha
Africa Strategist Africa Strategist Technical Strategist Rates Strategist
+27 11 895 5374 +27 11 895 5346 +27 11 895 5350 +27 11 895 5323
ridle.markus@absacapital.com dumisani.ngwenya@absacapital.com judy.padayachee@absacapital.com bulent.badsha@absacapital.com
BARCLAYS CAPITAL
Piero Ghezzi Matthew Vogel Koon Chow Christian Keller
Head of Economics and Emerging Head of Emerging EMEA Research Senior FX Strategist Chief Economist - Emerging Europe
Markets Research +44 (0)20 7773 2833 +44 (0)20 777 37572 +44 (0)20 777 32031
+44 (0)20 313 42190 matthew.vogel@barcap.com koon.chow@barcap.com christian.keller@barcap.com
piero.ghezzi@barcap.com
Alia Moubayed Arko Sen George Christou Donato Guarino
Senior Economist – Middle East & Rates Strategist EM Strategist Credit Strategist
North Africa +44 (0)20 3134 2839 +44 (0)20 777 31472 +1 212 412 5564
+44 (0)20 313 41120 arko.sen@barcap.com george.christou@barcap.com donato.guarino@barcap.com
alia.moubayed@barcap.com
Andreas Kolbe Daniel Hewitt
Credit Strategist EMEA Economist
+44 (0)20 313 43134 +44 (0)20 313 43522
andreas.kolbe@barcap.com daniel.hewitt@barcap.com

3 August 2010 9
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any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly
related to the specific recommendations or views expressed in this research report.

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