Kenya has experienced a sharp decline in foreign direct investment (FDI), dropping to $335 million in 2024 from a previous high of $710.2 million in 2023. This decline, amounting to a 47.2% drop, highlights the challenges facing one of Africa’s largest economies amid currency depreciation, rising inflation, and regulatory hurdles. According to the East African Community (EAC) Secretariat, the decrease coincided with a 43% reduction in the number of projects implemented by foreign investors, with the project count falling from 209 in 2023 to 146 in 2024. These figures signal growing concerns about Kenya’s investment climate and broader economic stability.

Factors Behind Declining FDI

Economic Challenges

Kenya’s economy has faced multiple challenges in recent years, including a volatile currency, a shortage of foreign exchange, and high inflation. The Kenya Shilling has been under pressure against major currencies, largely due to global economic conditions and increased demand for foreign currency to support imports. Inflation has risen sharply, driven by high fuel and food prices, which have eroded purchasing power and affected local businesses. Additionally, high-interest rates have made borrowing costly, discouraging investment and consumer spending. This complex economic environment has contributed to the FDI decline, as investors seek stability and predictable returns.

Global Investment Trends and Regional Competition

The global investment landscape is increasingly competitive, with emerging economies vying for limited international capital. In East Africa, countries like Tanzania, Rwanda, and Uganda have stepped up efforts to attract FDI, creating competitive tax policies, offering investment incentives, and focusing on sectors like tourism, agriculture, and manufacturing. Tanzania, in particular, has recently seen a surge in FDI due to reforms that simplify the business environment and enhance investor protections, drawing attention away from Kenya.

Key Contributors and Sectors Affected

The report highlighted that while Indian investors had the highest number of projects in Kenya (18), Chinese investments generated the most employment, creating 2,966 jobs. Despite the overall decline, certain sectors continued to attract foreign investment:

1. Manufacturing: Leading the employment landscape, the manufacturing sector created 3,442 of the 7,059 jobs attributed to FDI in 2024. This sector remains crucial for Kenya’s economic growth, with a significant share of investment valued at $126.82 million. Key areas of growth include agri-processing, construction materials, and textiles, which have benefited from both local demand and regional export opportunities.
2. Financial Services: Investments in finance, insurance, and real estate amounted to $62.9 million, demonstrating ongoing interest in Kenya’s financial sector. The financial sector has seen growth in mobile money and digital lending solutions, although rising costs and new taxation measures present potential obstacles for future growth.
3. Energy: Kenya is positioning itself as a leader in renewable energy investment. Over 80% of Kenya’s electricity comes from renewable sources, primarily geothermal and hydroelectric power. The country’s geothermal energy potential is among the highest in Africa, which has attracted interest from investors focused on sustainable development.
4. ICT Sector: Kenya’s information and communication technology (ICT) sector also holds promise. The country reversed its National ICT Policy requiring 30% local ownership in ICT firms, making it easier for international tech giants such as Oracle, Microsoft, and IBM to invest in the sector. This policy shift has boosted the digital ecosystem and may attract further foreign interest in Kenya’s digital economy.

Regulatory Challenges

The National Treasury introduced a series of tax measures through the Finance Act of 2023, aiming to raise Ksh200 billion in additional revenues. These measures, however, have drawn criticism for their impact on the business environment:

1. Increased VAT on Petroleum Products: The Finance Act doubled the VAT on petroleum products (excluding LPG) to 16%, which drove up transportation and production costs. This increase had a ripple effect on various sectors, including manufacturing and logistics, increasing operational expenses and putting further pressure on inflation.
2. Turnover Tax Changes: The Act also reduced the threshold for turnover tax from Ksh50 million to Ksh25 million and raised the rate from 1% to 3%, which expanded the tax base and placed added pressure on small and medium-sized enterprises (SMEs). SMEs form a large part of Kenya’s economy, and the higher tax burden has raised concerns about the sustainability of small businesses in the country.
3. Housing Levy and Increased PAYE Rates: A controversial 1.5% housing levy, applicable to both employees and employers, was introduced to fund affordable housing initiatives. Additionally, two new tax bands for Pay-As-You-Earn (PAYE) were implemented, with rates reaching up to 35% for high-income earners. This tax policy faced significant opposition, particularly among Kenya’s youth, sparking protests and forcing the government to reconsider its approach in the 2024 Finance Bill.

Investment Policy Reforms and Opportunities

In response to these challenges, Kenya’s government has been working to enhance its investment policies and regulatory framework to attract more FDI:

1. Ease of Doing Business: Kenya has continued efforts to simplify business registration processes and reduce bureaucratic hurdles. Recent reforms include digitalizing business registration and licensing processes, making it easier for investors to start and operate businesses in the country.
2. Infrastructure Development: Kenya has prioritized infrastructure projects, including expanding the Standard Gauge Railway, upgrading major ports and airports, and developing road networks. These initiatives aim to boost trade and improve connectivity within East Africa, enhancing Kenya’s appeal as an investment destination.
3. Incentives for Key Sectors: Kenya is focusing on offering tax incentives and streamlined regulations for specific sectors, particularly renewable energy, ICT, and manufacturing. This strategy aligns with Kenya’s Vision 2030, a long-term development blueprint aimed at transforming Kenya into a middle-income, industrialized nation.
4. Increased Focus on Public-Private Partnerships (PPPs): Kenya has been actively promoting PPPs to attract private sector investment into infrastructure projects. The government has identified various projects, including roads, water supply, and power generation, that can benefit from private capital through PPP arrangements. This approach is intended to ease the burden on public funds while improving essential infrastructure for economic growth.

Future Outlook and Investor Sentiment

While challenges persist, there is cautious optimism about Kenya’s economic prospects. Analysts note that the country’s diversified economy, robust private sector, and strategic geographical location give it a competitive edge in East Africa. However, addressing regulatory inconsistencies and stabilizing the economy will be essential to attracting sustained FDI.

Encouraging Signs for Growth

In the face of a challenging 2023, Kenya’s economy grew by 5.6%, up from 4.9% in 2022. The country’s potential to rebound is underscored by its young, skilled workforce and a strong entrepreneurial culture, particularly in sectors such as fintech, agribusiness, and digital services. Fintech, in particular, has been a bright spot in Kenya’s economy, with mobile banking, digital lending, and payment solutions driving financial inclusion.

Risks and Considerations for Investors

Investors remain cautious due to concerns about Kenya’s taxation policy, foreign exchange shortages, and the political environment. With upcoming elections, political stability and policy continuity are key factors that investors will watch closely. Additionally, the persistent shortage of dollars has affected repatriation of profits for foreign companies, leading some investors to reconsider expansion plans.

Conclusion

Kenya’s decline in FDI reflects broader economic and regulatory challenges, but ongoing efforts to improve the business environment may help attract new investment in the coming years. Key growth sectors, such as renewable energy, ICT, and manufacturing, show potential for development and are likely to remain attractive for investors. However, Kenya’s government will need to balance taxation with investor-friendly policies to foster a favorable environment for both domestic and foreign investors.

As Kenya continues to position itself as a regional leader, the country’s ability to stabilize its currency, control inflation, and implement consistent regulations will play a crucial role in determining its attractiveness to international investors. Kenya’s path forward will likely require a combination of economic reforms, strategic investments in infrastructure, and a commitment to fostering a predictable business environment.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

29th October, 2024