On behalf of the Kenyan authorities, we thank staff for their constructive engagement during the first review of the economic program under the 12-month Stand-By Arrangement and an Arrangement under Standby Credit Facility. With the significant progress made in implementation of the program, the authorities look forward to the completion of this review, and the Executive Board support for the request for a modification of performance criteria for end-September 2015, and for waivers for non-observance of the performance criteria on external payments arrears.
1) Recent Economic Developments
Kenya’s economic growth remains resilient. The first quarter of 2015 recorded a 4.9 percent growth compared to 4.7 percent in 2014, supported by the expansion of activities of construction, finance and insurance, information and communication, electricity and water supply, wholesale and retail trade and transport and storage. However, there was contraction in tourism sector, mainly due to low hotel occupancy rates arising from insecurity concerns largely by international visitors.
Inflation has remained within the authorities’ target band, averaging 6.49 percent in the last one year. Inflation declined from 7.03 percent in June 2015 to 5.84 percent in August 2015 mainly due to a decline in several food items as a result of favorable weather. There was however an increase in the category of Housing, Water, Electricity, Gas and other Fuels due to the surge in fuel cost adjustments and foreign exchange charges per KwH of electricity. The central bank has tightened monetary policy since June 2015 to anchor inflation expectations especially with the exchange rate depreciation.
Both the fiscal and external current account deficits have widened compared to the projected program path. The fiscal deficit reflects shortfalls in revenue collections and additional expenditure pressures, especially those related to security spending. The deterioration in current account balance in percent of GDP to 9.6 in July 2015 (12 months cumulative) partly reflects imports of aircraft equipment fully financed by loans from the African Exim Bank. Excluding these imports the current account as a percent of GDP moderates to 7.7 percent of GDP which is within acceptable range for net importer comparator country.
Foreign reserves have declined although they remain within the statutory requirement. By August 27, 2015, the reserves were US$6.392 billion (4.05 months of import cover) from US$7.43 billion (4.85 months of import cover) since the beginning of January 2015. The tapering capital inflows, central bank interventions to smooth the foreign exchange market, and decline in tourism receipts have also seen the exchange rate depreciate and weakening of the balance of payment position.
2) Program performance
The authorities continue to demonstrate their commitment to successful implementation of the program despite the prevailing exogenous shocks. All the end-March 2015 performance criteria were met except for the continuance performance criteria on national government external payment arrears, where temporary delays were experienced in repayment of some of the external obligations, reflecting coordination rigidities among the relevant entities rather than inability to pay. These arrears have since been fully settled and corrective measures adopted to avoid such recurrence. All end-June 2015 indicative targets were met except for the net international reserve (NIR) following tapering capital inflows since April 2015 and central bank interventions to stabilize the foreign exchange market. The target for net domestic assets (NDA) was also missed given the increased domestic financing needs. In this regard, the authorities are requesting for waivers under both Arrangements for the temporary non-observance of end-March continuous performance criterion on external arrears, and modification of the performance criteria for NIR and NDA.
Significant progress was made with implementation of the structural benchmarks although there were delays in completing some of them and others have been reset. Of the seven structural benchmarks for end-March and end-June, three were completed on time, and two with some delays, and the rest were reset for end-September with only one reset for end-December. The authorities are making significant progress towards completing the end-September structural benchmarks. In addition, the authorities completed all the financial sector reforms set for the program although they were not set as structural benchmarks.
3) Prospects and Macroeconomic Policies
With the risks to outlook tilted to the downside, the macroeconomic framework has been revised. The revisions reflect a projected lower GDP growth rate, higher inflation, and weakening balance of payments. These reflects the low oil prices that may impact negatively on FDI inflows for new oil explorations, security risks affecting the tourism sector, international market risks with expected unwinding of the unconventional monetary policy, and regional economic distress.
a) Fiscal policy
The authorities remain committed to preserving fiscal sustainability by maintaining debt at sustainable levels, and attaining the East Africa Monetary Union convergence criteria of fiscal deficit in the medium term. In this regard, on the revenue side, various tax policy and tax administrative measures are being implemented to enhance mobilization of domestic resources. These including the review and modernization of the Income Tax Act, and ensuring the tax procedures for VAT, Excise Duty, and Income Tax are under one law. The passage of the 2015 Finance Bill has seen an introduction of a simplified and modern Excise Duty.
On the expenditure side, the authorities have embarked on large public investment projects aimed to close the existing infrastructure gaps in the process of transforming the economy. As such, it is expected that development spending as a share of the total national government spending will increase to 41 percent in the current fiscal year. Rationalizing current spending remains a priority and the recently approved Capacity Assessment and Rationalization of the Public Service implementation plan is expected to facilitate easing the current expenditure pressures.
Further, the national government continues to support building capacity at the county level, especially to improve efficiency in public finance management and service delivery and promote rapid local economic development in the devolution process. The implementation of a framework establishing limits and guidelines for county government borrowing consistent with the PFM Act commenced in June 2015. At the same time, counties can access the central bank overdraft facility but this does not pose a threat to monetary policy operations because they will not access the facility over and above the national government’s overdraft limit. The law sets a limit of 5 percent of recently audited accounts which cannot be exceeded by both the National and County Governments. Furthermore, the PFM regulations which have been gazette and awaiting parliament’s approval stipulate that the overdraft should be retired within the year it was accessed.
Efforts to strengthen the capacity of the Debt Management Office are ongoing. The authorities are taking steps to address staffing and enhance the risks and compliance functions of the office. A technical assistant from US Treasury is on the ground to help strengthen the capacity building process. A work plan has been finalized and is awaiting approval in order to commence implementation. Further, the process of recruiting the Director for the DMO has commenced.
In addition, the authorities have made progress in enhancing government cash management. A sub-account structure of TSA model is being implemented in line with the PFM legal and institutional framework. The preparations toward finalizing the Service Level Agreement between the Treasury and the Central Bank are geared for completion as proposed by end-September 2015.
Furthermore, there is progress towards implementation of the parastatal reforms. A new Code of Governance for State Corporations, “Mwongozo”, was launched by His Excellency the President in April 2015 to address governance and management challenges in parastatals. Further, the Government Owned Entities Bill 2014 which is meant to ensure parastatals adopt a leaner and more efficient management structure has been submitted to Cabinet, while the National Sovereign Wealth Fund Bill 2014 is being reviewed by the Attorney General before being submitted to Cabinet for discussion.
b) Monetary and financial policies
The key objective of monetary policy is to maintain price stability. In this regard, the authorities continue to monitor developments in the market and are prepared to take appropriate actions to anchor inflation expectations. At the same time, while they maintain a floating exchange rate regime, the authorities are committed to intervene only to stabilize excess volatility in the exchange rate market.
Significant progress has been achieved towards modernizing the monetary policy framework. The proposed increase in frequency of submission by National Treasury to Central Bank of the cash flow plans is aimed to further improve liquidity forecasting.
Deepening financial sector reforms is also a priority to safeguarding financial stability. In this regard, the central bank continues to strengthen the prudential oversight framework, including the review and implementation of the prudential guidelines on risk classification of assets and provisioning supervision and regulations of the banking sector. The central bank has also enhanced its ability to conduct stress testing of the banking system and continues to strengthen consolidated supervision.
c) Business environment
Improving business environment to encourage private sector innovation, entrepreneurship and business expansion is viewed as a prerequisite to achieving strong and sustained economic growth and poverty reduction. In this regard, addressing security concerns remains a top priority and more resources have been allocated to this sector to continue with the modernization program and reforms. In addition, to deepen the governance reforms, all ministries, departments and agencies are required to use the e-procurement module of the IFMIS to safeguard loss of public finances through corruption. The National Electronic Single Window System declaration module is now operational. Since July 2015, all importers and exporters are required to process their transactions through the system. The aim is to facilitate international trade by reducing delays while at the same time maintaining the requisite controls and ensuring efficient revenue collection. Further, since March 2015, the authorities have been implementing a Business Regulatory Reform Strategy to raise Kenya’s global ranking under the World Bank’s doing business indicators.
d) Data quality
Improving data quality to support policy making remains a top priority. In addition to the progress made in balance of payments and government financial statistics, the Kenya Integrated Household Budget Survey 2015/16 commenced on September 1 2015, with the results expected to be published end 2016. The authorities plan to subscribe to the Fund’s Special Data Dissemination Standard by 2022.
Despite the prevailing downside risks, the authorities are committed to successful implementation of the two arrangements to achieve the objectives set for the program. They continue to treat these Arrangements as precautionary and will only draw under these Arrangements when an actual balance of payment need materializes. There is strong political ownership of the program and the authorities will continue their engagement with the Fund and other development partners in the process of meeting their development goals.