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Unpredictable tax rates hurting Kenya’s FDI inflows-World Bank

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President William Ruto with US President Joe Biden.

Kenya’s low rate of foreign direct investments inflows compared to regional counterparts is being attributed to low predictability of tax rates according to the World Bank.

In its 29th edition of Kenya Economic Update, the World Bank has said this has in turn affected import and export sectors.

Kenya’s FDI inflows are yet to reach pre-Covid-19 levels despite the country strengthening its bilateral trade relations with many countries globally.

“Frequent and unanticipated tax policy shifts create a volatile business climate, erode investor trust and hinder strategic planning,” said the World Bank.

According to the bank, due to the unpredictable tax regime, FDI inflows have been underperforming far beyond the country’s potential to account for 0.3pc of GDP in 2022 compared to Tanzania and Uganda who FDIs accounted for around 1.7pc and 6.5pc of GDP respectively in 2022.

“Such unpredictability, exemplified by abrupt tax rate changes or the introduction of new taxes, directly impacts the cost structures of businesses, especially those in the import-export sector. This instability not only discourages investment but also complicates tax compliance, which could lead to decreased government revenue,” stated the bank in the report.

The World Investment Report 2023 by the United Nations Trade and Development indicates that Kenya’s FDI fell from a high of $1.4 billion in 2017 to $759 million in 2022 despite rising by 64pc from 2021 when inflows were $463 million due to the pandemic.

In contrast, Ethiopia had the highest FDI inflows in the region with $3.7 billion followed by the Democratic Republic of Congo with $1.8 billion, Uganda $1.5 billion and Tanzania $1.1 billion.

Why bilateral trade agreements yet to boost FDI inflows

While Kenya continues to build its position as a regional trade and finance hub by enhancing trade integration, the country is yet to see meaningful growth in inflows despite sealing multibillion dollar trade deals with other countries.

Among bilateral trade agreements the country has concluded included becoming an early signatory of the African Continental Free Trade Area (AfCFTA) and Economic Partnership Agreement (EPA) with the United Kingdom and the European Union.

Others are Kenya-United Arab Emirates Comprehensive Economic Partnership Agreement (CEPA) and Kenya-United States Strategic Trade and Investment Partnership (STIP) whose negotiations are being finalized.

“While trade integration offers a pathway to economic growth and job creation, Kenya’s experience illustrates that realizing these benefits is not automatic. Despite active engagement in trade integration efforts, the country still needs to capitalize on the potential of these initiatives fully,” reads the economic update.

According to the bank, the country’s higher trade costs which are double or triple the price of internationally traded goods over domestic ones also hamper FDI inflows.

“Trade costs with main partners are equivalent to a 100-200 percent tariff and, hence, they double or triple the costs of internationally traded goods over domestic goods. For example, trade with neighboring Ethiopia is more costly than with the U.S. despite the significant geographical distance and these have considerably increased over time, especially agricultural products.”

Leading recipients of FDI inflows to Kenya include finance and insurance which account for one-third of the total inflows, information and communication 16.1pc, wholesale and retail 15.4pc and manufacturing activities 14.8pc.

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