* Pretax profit up 10 pct in 2016, raises dividend
* Hyperinflation in South Sudan causes loss
* CEO says closing 5-7 outlets in South Sudan
* Kenya rate cap cuts net interest margin (Recasts with 2017 outlook)
By Duncan Miriri
NAIROBI, March 9 (Reuters) - A government cap on commercial lending rates is likely to cut KCB Group's pretax profit by 2 percent this year and will mean fewer loans to small and medium sized firms, Kenya's biggest lender by assets said on Thursday.
The limit, which caps rates at 4 percentage points above the central bank rate, now at 10 percent, had cut KCB's net interest margin by 2 percentage points to 9 percent, Joshua Oigara, the group's chief executive, said.
Kenyan bank shares have slumped since the cap was imposed in September, with the average valuation dropping by half to 0.9 times book value.
The government said the cap was justified since Kenyan lenders had some of the highest returns on equity on the continent, yet customers were charged high rates.
Francis Mwangi, a bank analyst at Nairobi-based Standard Investment Bank, said he expected KCB's profit to fall by more than 2 percent this year.
"We believe the impact of the rate cap will be more significant than that," he said.
KCB Group, which also operates in neighbouring Uganda, Tanzania, Rwanda, Burundi and South Sudan, said its pretax profit rose 10 percent last year to 29.09 billion shillings ($284 million), curbed by hyperinflation in South Sudan.
It booked a 3.46 billion shillings loss from the South Sudan business after it revalued its assets there.
"It is a double whammy," Lawrence Kimathi, the group's chief financial officer told investors, saying the revaluation of South Sudan assets did not have a tax benefit.
South Sudan, which is facing famine in some parts due to years of fighting and drought, saw its cumulative three year inflation exceed 100 percent last year and Oigara said KCB was cutting back there to reduce risk.
"This year we will shut down an additional 5-7 branches so we remain with a few branches in Juba," he told Reuters.
KCB would continue to invest in government securities following the imposition of the cap, which also sets a minimum interest rate for customer deposits in banks, while increasing lending to selected customers, in sectors that were still profitable, he added
"Of course some areas will suffer," the chief executive said, singling out lending to small and medium firms, which were now deemed risky.
Oigara said the bank was reviewing staffing needs, to contain costs, but denied recent reports it was targeting a reduction of 500 jobs.
KCB raised its dividend 50 percent to 3 shillings per share saying it had enough capital to distribute more earnings to shareholders. ($1 = 102.4700 Kenyan shillings) (Editing by Alexander Smith)