Rattan J. Bhatia and Saul L. Rothman
The first request for assistance under the extended Fund facility (EFF) was approved by the International Monetary Fund (IMF) in July 1975. This was for the use by Kenya of Fund resources amounting to SDR 67.2 million over the period 1975–78. Previously Kenya had used Fund resources amounting to SDR 60 million.
The EFF was established by an IMF Executive Board Decision on September 13, 1974 and is considered likely to be of particular benefit to developing countries. Its purpose is to give medium-term assistance to IMF member countries in “special circumstances of balance of payments difficulty” where “the solution of the member’s balance of payments problem will require a longer period than the period for which the resources of the Fund are available under existing tranche policies.” These “special circumstances” include: (1) “an economy suffering serious payments imbalance relating to structural maladjustments in production and trade and where prices and cost distortions have been widespread”; and (2) “an economy characterized by slow growth and an inherently weak balance of payments position which prevents pursuit of an active development policy.”
Requests for Fund resources will be approved “in support of comprehensive programs that include policies … required to correct structural imbalances in production, trade, and prices …” with particular attention being given to “policy measures that the member intends to implement in order to mobilize resources and improve the utilization of them and to reduce reliance on external restrictions.” Thus, the content of programs under the EFF, which may, for example, involve policies relating to the sectoral allocation of investment and the mechanisms for determining product and factor prices, is more encompassing than that of programs under the Fund’s regular tranche policies, which are concerned mainly with financial stabilization.
Under the EFF an IMF member, upon approval of its request and satisfactory performance, may draw upon Fund resources over a three-year period, rather than over a maximum of one year under the normal Fund stand-by arrangement policy. The amount available is larger than that under any other single Fund facility financed through the General Account. Drawings under the EFF may reach a maximum of 140 per cent of a member’s quota over the three-year period; this compares with the normal maximum of 25 per cent of quota each year under the Fund Agreement, subject to the normal ceiling on the Fund’s holdings of a member’s currency equivalent to 200 per cent of quota, although these limits may be waived by the Executive Board. Under the EFF the Fund’s holdings of the member’s currency, excluding any connected with the use of the Fund’s oil, compensatory or buffer stock facilities, must not exceed 265 per cent of the member’s quota. Furthermore, whereas countries are expected to make repurchases under normal Fund facilities within a three-year to five-year period, a maximum of four to eight years is provided for repurchases under the EFF, with the proviso that earlier repurchases will be effected if there is an appreciable upturn in balance of payments performance.
The Kenyan situation
Although since 1964, the year following independence, Kenya has achieved an average annual rate of growth in real gross domestic product (GDP) of almost 6.5 per cent, with favorable growth performance in both agricultural and industrial sectors, and has generally recorded overall balance of payments surpluses, the country is presently confronted with the prospect of substantially reduced growth owing to balance of payments pressures. Since 1970 Kenya has experienced two large balance of payments deficits—one of SDR 70 million in 1971 and one of SDR 72 million in 1974; surpluses in 1972 and in the first half of 1973 were made possible by a relatively restrictive monetary policy and the imposition of trade and exchange controls. As a result, Kenya’s gross international reserves, which had amounted to SDR 220 million (equivalent to 6 months’ imports) at the end of 1970, fell to SDR 157 million (equivalent to 2 months’ imports) by the end of 1974.
Kenya’s request under the EFF was considered as falling in the category of “an economy suffering serious payments imbalance relating to structural maladjustments in production and trade and where price and cost distortions have been widespread.” Its balance of payments difficulties are in part a consequence of an emerging resource constraint because, since 1970, the growth in investment has exceeded the growth in domestic savings. These difficulties are attributable also to its industrialization policies, which have been largely based on import substitution for consumer goods for the sizable East African market. Such policies have taken the form of fiscal measures (including tariff protection) and pricing decisions designed to encourage an investment pattern in favor of industry (manufacturing and construction), to the relative neglect of the agricultural sector.
Government development expenditure over the decade 1964 to 1973 increasingly favored industry, whose share rose from less than 1 per cent to about 20 per cent, and infrastructure and services, while the share of agriculture declined from 63 per cent to 16 per cent. The tariff policy accorded substantial protection to the manufacturing sector, with nominal duties ranging from 30 per cent to over 100 per cent. Furthermore, credit facilities for the agricultural sector remained inadequate, and producer prices for agricultural products were kept low. The ratio of agricultural prices to manufacturing prices (as measured by the ratio of GDP sectoral deflators) declined by nearly 25 per cent between 1964 and 1973. While domestic prices of export commodities mainly reflected developments in world markets, producer prices for goods (such as wheat, maize, and livestock) that are largely consumed domestically but also have a substantial export potential were held down through official action. Reflecting these policies, fixed investment in manufacturing and construction increased from 17 per cent of total fixed investment in 1964 to 22 per cent in 1973, while that in the agricultural sector declined from 28 per cent to 14 per cent.
Government policies also appear to have induced capital-intensive, as opposed to labor-intensive, techniques. During the decade 1964-73, interest rates on loans were generally low, and the average price of capital goods (mostly imported duty free) increased by only some 5 per cent annually. On the other hand, wage earners (employed principally in the urban sector) benefited from the Government’s intervention in inducing employers to expand job opportunities in industry, and wages increased faster than productivity gains; average labor earnings rose by 60 per cent during the decade, compared with an increase in average labor productivity of 45 per cent. There is evidence that employers tended to offset the impact of the cost of large wage increases by substituting capital equipment, particularly since investment allowances favored the use of capital.
Several consequences for the balance of payments followed from these policies. On the investment side, there was a gradual increase in the aggregate incremental fixed capital/output ratio. Moreover, the pattern of investment contributed to a rapid increase in imports of intermediate goods, and the share of imports of capital and intermediate goods in total imports increased from less than half in 1964 to nearly 75 per cent in 1973. On the consumption side, the shifting of income shares in favor of the urban sector tended to strengthen the demand for consumer imports and for domestic products containing imported inputs. The ratio of imports of goods and nonfactor services to GDP increased from 29 per cent in 1964 to 35 per cent in 1971 before it dipped to 28 per cent in 1972-73 following the imposition of import controls. The domestic pressures on Kenya’s balance of payments were compounded in 1974 by a deterioration of 18 per cent in Kenya’s external terms of trade, caused principally by increases in import prices for petroleum and other products.
Medium-term corrective action
The Kenyan authorities have launched a medium-term program covering the three fiscal years 1975/76 to 1977/78 (July-June), in support of which the Fund has approved Kenya’s request for Fund resources under the EFF. The program reflects, in part, extensive discussions by the Kenyan Government with staff members of the Fund and of the World Bank who have made coordinated policy recommendations to the Government. On May 29, 1975 the Bank approved a program loan of US$30 million (to be repaid over a period of 25 years) to help Kenya to adjust to the deterioration in its balance of payments. The loan—in support of plans that contain some of the elements included in Kenya’s EFF program—will finance the import of essential raw materials and capital and intermediate goods and will help Kenya to maintain a reasonable rate of development while long-term changes are made in its structure of growth.
Projections of the levels of export and other foreign exchange receipts suggested that Kenya’s import availability during the period 1975–78, in constant prices, was not likely to be above the 1974 level (see table) and, therefore, in the absence of corrective measures, the average rate of growth in real GDP was not likely to exceed 1 per cent per annum. Under the EFF program, the targets set by the Kenyan Government are to achieve an average annual growth rate of at least 5 per cent in real GDP during the period 1975–78, to keep the rate of domestic price increase significantly below the world rate, and to eliminate the need for balance of payments assistance after five years. Taken in conjunction with Kenya’s projected import availability, reaching the target for GDP implies that over the period 1975–78 the average import propensity will be brought down by 20 per cent from the 1974 level, the gross investment/GDP ratio will be reduced by some 16 per cent, and the ratio of total consumption to GDP will decline by about 1 percentage point a year.
To reach the targets, Kenya’s medium-term program contains a comprehensive set of policies, with emphasis on measures designed to bring about the required structural changes. Growth in private consumption is expected to be kept down to approximately the rate of growth in population (3.5 per cent), and public consumption is to be restrained to a growth rate almost 35 per cent lower than the average rate recorded in the previous five years. Private consumption is being contained through a combination of tax measures, such as sales taxes, which weigh heavily on consumption, and the introduction of a capital gains tax and a tax on urban property. In addition, wage guidelines are being enforced, and incentives to savings, such as a higher rate of interest, will be studied. The Government expects to regulate the growth of public consumption, with the objective of obtaining a current account budgetary surplus that would finance at least one third of its increasing development expenditure.
The reductions in the import/GDP and investment/GDP ratios are intended to be effected essentially by a change in the composition of investment. The Government has adopted a three-year forward budget in which the average proportion of government development expenditure devoted to agriculture, water development, land settlement, and cooperative development will rise to 42 per cent, compared with 29 per cent budgeted for 1974/75. This shift will be achieved largely at the expense of highway and building construction, where most uncommitted major projects will be postponed and where the thrust will be toward access and feeder roads in rural areas and toward essential construction. The anticipated shift in public investment toward historically less capital-intensive agriculture and away from historically more capital-intensive sectors should bring about considerable savings in the use of both capital and imports.
Restructuring private investment
Kenya’s program also contains a strategy to induce a restructuring of private investment. Kenya, together with the other two partner states in the East African Common Market (Tanzania and Uganda), is undertaking a systematic reform of the customs tariff with a view to introducing uniform protective duties on import-competing goods and to levying duties on most capital goods. At present most consumer goods are taxed at rates between 30 per cent and 50 per cent, and, until now, most capital goods and industrial inputs have been permitted to enter duty free, all of which provided a substantial inducement for capital-intensive and import-intensive production. In addition, the private sector will be encouraged to improve repair and maintenance services and to utilize existing productive capacity with a view to reducing imports of capital goods.
(In billions of Kenya shillings at constant 1974 prices)
|GDP at factor cost||16.7||17.6||18.5||19.4||20.4|
|+ Indirect taxes||2.4||2.2||2.4||2.6||2.8|
|= GDP at market prices||19.0||19.7||20.8||21.9||23.1|
|+ Imports of goods and services||8.3||7.7||7.9||7.9||8.1|
|− Exports of goods and services||6.6||6.9||7.1||7.5||7.9|
|= Import surplus||1.7||0.8||0.8||0.4||0.2|
|Total resources available for domestic investment and consumption||20.7||20.5||21.6||22.3||23.3|
|Public fixed capital formation||1.8||1.9||2.0||2.1||2.2|
|Total public expenditure||5.2||5.6||5.8||6.1||6.4|
|Private fixed capital formation||2.0||3.2||3.6||3.6||3.7|
|Increase in stocks||2.1|
|Total private expenditure||15.5||14.9||15.8||16.2||16.9|
|Total use of resources||20.7||20.5||21.6||22.3||23.3|
|Annual percentage change in GDP at factor cost||3.6||5.4||5.1||4.9||5.2|
|Imports as percentage of GDP at factor cost||50||44||43||41||40|
|Gross investment as percentage of GDP at market prices||31||26||27||26||26|
|Total consumption as percentage of GDP at market prices||78||78||77||76||75|
The overall consumption and investment strategy is being complemented by a credit policy designed to moderate demand, especially for imports, in the medium term to a level consistent with Kenya’s annual balance of payments targets. At the same time, the planned rates of growth for credit and money plus quasi-money have been set so as to be adequate for reaching the GDP growth target.
Policies to restructure investment and control demand are expected to release resources for exports. The Kenyan Government is also examining its present policy so as to provide incentives for exports, and it intends to maintain producer prices at levels that would provide adequate profit to agricultural producers and to set consumer prices at levels consistent with producer prices. Additional credit will be provided to the agricultural sector, especially to the small-holder and for seasonal purposes, and in this regard two major financial institutions engaged in the agricultural sector—the Agricultural Finance Corporation and the Cooperative Bank—are expected to be strengthened.
First-year targets set
The Fund decision establishing the EFF requires that a member making a request for an extended arrangement must, in addition to presenting a program “setting forth the objectives and policies for the whole [medium-term] period …” present “a detailed statement of the policies and measures for the first twelve months … of the program.”
Kenya’s major targets during the fiscal year 1975/76 are to achieve growth in real GDP slightly in excess of 5 per cent and to limit the loss in foreign reserves to about SDR 20 million. In 1974/75 growth in real GDP was less than 4 per cent, and the loss of foreign reserves exceeded SDR 30 million. The Kenyan Government has formulated a program for 1975/76, the major elements of which were announced in connection with the presentation of the budget in June 1975. Prior to that, wage guidelines had been issued limiting full compensation for cost of living increases to only the lowest paid workers, with compensation for higher paid groups tapering off gradually. Objectives for total domestic credit as well as separately for the Government and the private sector have been set. Consistent with Kenya’s medium-term program, the 1975/76 budget provides for a current surplus equivalent to one third of development expenditure, which is budgeted to rise by some 40 per cent. As part of the reform of the customs tariff, a 10 per cent duty has been imposed on the importation of most raw materials and capital goods. Also, an investment allowance of 20 per cent permitted hitherto has been withdrawn except for investment undertaken outside the two main cities—Nairobi and Mombasa. Sales taxes on luxuries and labor-saving items have been increased from 10 per cent to 20 per cent, and a capital gains tax has been imposed on certain properties and shares.
With regard to the agricultural sector, in early 1975 the Government decreed increases of between 10 per cent and 48 per cent in producer prices for wheat, maize, sugarcane, and livestock; comparable increases in consumer prices were announced for bread, maize meal, sugar, and beef. Furthermore, the Agricultural Finance Corporation is expanding its operations and expects to double the number of small-scale farmers receiving credit.
Review of progress
The Fund will review progress being made in implementing the EFF program with the Kenyan Government at the end of each six-month period. Furthermore, in accordance with the decision establishing the EFF, Kenya “for each subsequent twelve-month period [after the first year] … will present to the Fund a detailed statement of the progress made, and the policies and measures … that will be followed, to further the realization of the objectives of the program ….”
Being the first case under the EFF, Kenya’s approved program—in terms of both targets and policies—has a somewhat experimental character. Experience during each of the first two years of the program may indicate the need for modifications in Kenya’s targets and policies for the succeeding period—provision for which has been made in the decision establishing the EFF. More generally, however, developments under Kenya’s program will have relevance not only for Kenya but also for other similar operations with Fund member countries.