Chapter

Chapter 2: Kenya: The General Setting

Author(s):
International Monetary Fund
Published Date:
September 1985
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Kenya, which gained independence from the United Kingdom in December 1963, covers a land area of 582,647 sq. km. (225,000 square miles), which extends about 280 miles north and south of the equator and which is almost 560 miles wide along the equator. Kenya shares boundaries with Ethiopia, Somalia, Sudan, Tanzania, and Uganda. Its coastline along the Indian Ocean on the southeast is about 250 miles long. The Rift Valley, which runs the entire length of the country in the west, contains a series of lakes, and a small part of huge Lake Victoria lies within Kenya’s territory. While a narrow fertile belt of tropical vegetation borders the Indian Ocean, more than half of the country is an arid lowland, stretching north and west from the coast and having a natural vegetation of poor grass and scrub. The rest of the country consists mainly of a plateau, with an altitude varying from 2,000 to 9,000 feet. The highest point is Mount Kenya, which rises about 17,000 feet and is centrally located to the northeast of the capital, Nairobi.

The country has a wide range in climate, mainly because of variations in altitude. The climate is tropical in the narrow coastal belt along the Indian Ocean. As the land rises, the climate becomes subtropical and even temperate, with heavier rainfall, improving the vegetation and the prospects for intensive cultivation. The mean temperature at 9,000 feet is about 55 degrees F., in contrast to over 80 degrees F. on the coast. The annual rainfall is about 100 inches around Mount Kenya, decreasing to about 10 inches near the northern frontiers. Over most of the country, rainfall comes in distinct seasons, but it varies greatly from place to place and from year to year in the same area.

In the middle altitudes, the grasslands provide good grazing for game and domestic cattle, while the southwestern quarter of the country, ranging from 5,000 to 9,000 feet, includes some of the best farming land in Africa. Although forests cover only about 3 per cent of the land area, they are valuable for land cover and water retention. Land suitable for intensive farming without irrigation is mainly confined to the coastal belt and to the higher elevations, which commonly receive 35 inches or more of rain a year. Expansion of the cultivated area through irrigation is limited by the availability of water. A number of rivers drain into Lake Victoria; only two rivers, the Tana and the Galana (Sabaki), have sufficient water to reach the ocean throughout the year, while other streams dry up for several months of the year. The greater part of the country can, therefore, support only extensive, rather than intensive, grazing.

Kenya’s population, estimated at 14.34 million in mid-1977, is believed to be increasing at about 3.5 per cent a year. The population density in 1977 was 24 per square kilometer for the overall land area and 139 per square kilometer for the arable land area. Africans constitute over 97 per cent of the population, with the remainder being, in numerical order, Indians, Pakistanis, Europeans, Arabs, and persons of other ethnic origin. Kenya’s African population consists of many ethnic groups, of which the most numerous are Kikuyus, Luo, and Luhya. Although these groups speak many dialects, Swahili is commonly understood. English is used primarily in government and business.

Eight cities in Kenya had over 20,000 residents in 1977. Urban population accounts for about 11.3 per cent of the total population. Nairobi, the capital, is the largest city, with over 700,000 inhabitants; next is Mombasa, the principal port, with a population of over 400,000.

ECONOMIC STRUCTURE

The economy of Kenya is predominantly agricultural, although the relative importance of agriculture has been steadily declining in recent years as a result of the more rapid growth of the industrial sector. In 1977, agriculture, forestry, and fishing accounted for about 29 per cent of the gross domestic product (GDP), compared with over 40 per cent at the time of Kenya’s independence in 1963. The share of manufacturing, mining, and construction in GDP was some 21 per cent in 1977, while government services and commerce accounted for about 18 per cent and 10 per cent, respectively.

Agriculture

The important role of agriculture in the Kenyan economy is highlighted by the fact that almost 85 per cent of the population depends on agriculture for a livelihood, mainly in a self-employment status. Slightly less than half of the value added in agriculture is in the monetary sector, the remainder being in production for home consumption. Since Kenya became independent, the rate of growth in the agricultural sector engaged in production for the market (hereinafter called the market sector of agriculture) has been almost twice that of the agricultural sector producing for home consumption (hereinafter called the subsistence sector of agriculture).

Kenya has a diversified agriculture, producing a variety of both food and cash crops, unlike many developing countries in Africa which cultivate only one or two cash crops. As a result, agricultural exports are rather diversified, reducing the vulnerability of the Kenyan economy to fluctuations in world prices. However, as the area under irrigation is limited, agricultural production is greatly affected by changes in the weather. For example, agricultural output was reduced in 1965 and 1973 as a result of droughts and in 1975 as a result of a drought in one part of the country and excessive rainfall in another part.

The principal food crops are maize, pulses, root crops, fruits and vegetables, wheat, sorghum, millet, and nuts, while the major cash crops are coffee, tea, sugarcane, sisal, pyrethrum extract, cotton, and wattle (for sale as bark). Four of these crops—coffee, tea, maize, and wheat—account for three fourths of the gross value of sales of farm products. Livestock and dairy production are also important agricultural enterprises for both domestic consumption and exports.

Of the principal food crops, maize and wheat are largely consumed domestically. Maize, the most important food crop, is cultivated mainly on small farms, and most of the output is consumed by the subsistence sector. Wheat is grown chiefly on large farms, which have to some extent shifted from maize to wheat production. While the output of maize has steadily increased over the years, wheat production rose strongly until 1970 and then declined sharply until 1973, followed by a recovery. However, the output of wheat in 1977 was still 13 per cent below the peak of 1970. Kenya has recently had small exportable surpluses of maize almost every year, and production of rice, mainly on small farms, has expanded rapidly. The production of other food crops, mainly on small farms, has followed a generally rising trend.

The livestock and dairy industry has slowly recovered during the 1970s after several years of stagnation and even decline. In recent years, the value of the output of livestock and dairy products has represented some 22 per cent of total gross farm revenue, and exports of these products, though relatively minor, have increased steadily during the 1970s.

Exports of agricultural products have accounted for 50–60 per cent of total exports in recent years. Coffee, the leading export crop, has traditionally accounted for some 20 per cent of total export earnings. Owing mainly to the sharp increase in coffee prices, this share rose to 27 per cent in 1976 and to some 40 per cent in 1977. Coffee production, after increasing strongly in the early 1960s, remained relatively stagnant until 1976–77 when the sharp rise in prices stimulated a strong recovery in output. Tea has been a rapidly expanding export crop, displacing sisal in 1964 as the second largest foreign exchange earner. Both tea production and tea exports have increased steadily in recent years and, as a result of higher prices, tea exports represented about 14 per cent of total exports in 1977. Production and exports of sisal and wattle bark have been declining as a result of falling prices in the face of excess world supply and competition from synthetic substitutes. Kenya produces about 70 per cent of the world’s pyrethrum, and both production and exports have been well maintained. Cotton, which was one of Kenya’s major exports before World War II, lost its importance mainly because of the persistence of pests. However, cotton production and exports showed a recovery in the late 1960s, and cotton’s position as a relatively minor export has been maintained during the 1970s. Output of sugarcane, which is largely consumed domestically and is grown mainly on large farms, has expanded steadily.

Manufacturing, Mining, and Construction

As a result of the high rate of growth of manufacturing compared with agriculture (an annual average of 8—9 per cent, compared with 5 per cent) since Kenya became independent, the share of manufacturing rose from about 9 per cent of GDP in 1963 to more than 15 per cent in 1977. Early industrial development was spearheaded by the food, beverage, and tobacco industry, followed by the establishment of other industries based on domestically produced raw materials—such as textiles and clothing, leather and footwear, paper and paper products, cement, and clay and glass products. A more recent evolution has been the establishment of capital-intensive and often import-intensive industries, such as petroleum and chemicals, plastics, rubber, metallurgy, motor assemblies, paper mills, electrical goods, and machine tools.

The food, beverage, and tobacco industry continues to be the leading manufacturing sector in size, even though its rate of growth has not been as rapid as some of the newer, more dynamic industries. Together with textiles and leather, this industry accounts for a large part of the exports of manufactures, which have recently amounted to 40–50 per cent of total exports. The establishment in 1967 of the East African Community (EAC), comprising Kenya, Tanzania, and Uganda, was an important factor in stimulating Kenya’s industrial development by offering expanded export opportunities. It is significant that, even with the early de facto breakup of the EAC, Kenyan industry has been able to maintain its share of total exports.

Although Kenya’s industrial development has been accomplished largely through the initiative of the private sector, it has also been assisted by the Government through tariff protection, regional integration (the short-lived EAC), tax incentives, and the provision of development finance.

Mining and construction together accounted for close to 6 per cent of GDP in 1977. While Kenya is believed to have exploitable mineral deposits (copper, gold, silver, iron, and limestone), the development of mining has been hampered by a shortage of capital for exploration and exploitation. The most important mining products have been soda ash, raw materials for cement, salt, limestone products, and copper. Construction activity has maintained a steady growth, based on industrial construction, roadbuilding and other public works projects, and residential construction related to increasing urbanization.

Other Sectors

Kenya’s transport and communications sectors, which serve Tanzania and Uganda as well, constitute about 5 per cent of Kenya’s GDP. Mombasa, which has a fine deep-water harbor, is the chief port of East Africa and handles almost all of the overseas traffic of Kenya and Uganda and part of that from Burundi, Rwanda, eastern Zaire, and southern Sudan. Boat services on Lake Victoria form an important link between Kenya and the other East African countries and provide useful feeder routes to the railways. Kenya’s main railway, reaching about 1,200 miles from Mombasa via Nairobi into Uganda, is the principal means of transportation to and from the coast and carries the overseas traffic of both Kenya and Uganda. Branches extend through the rich farming area of Kenya’s Central Province into Tanzania. Kenya has an extensive road network of about 30,000 miles, but only a small proportion of the road surface is bituminized.

The installed capacity of Kenya’s electric power plants increased at the moderate pace of some 3 per cent a year in the early 1960s, but since 1965 annual growth in the domestic generation of electric power has averaged some 15 per cent, which has been in line with the growth of demand, so that the volume of imported electric power has increased only slightly.1 The domestic generation of electric power amounted to some 1 million kilowatt hours in 1977.

ECONOMIC AND FINANCIAL PERFORMANCE

This section focuses on Kenya’s economic and financial performance prior to 1974. Developments since then are reviewed in detail in the workshops on Projection of Monetary Aggregates (Workshop 6), Revenue Forecasting (Workshop 7), Balance of Payments Forecasting (Workshop 8), and Financial Programming (Workshop 9).

The Period 1964–72

During the first decade of its independence, Kenya was remarkably successful in achieving an economic growth well above average for a country at its stage of development. During the eight-year period 1964–72, GDP at factor cost (constant prices) grew at an average annual rate of about 6.5 per cent, leading to a significant increase in real per capita income, despite one of the highest rates of population growth in the world. This favorable outcome may be attributed to the Government’s success in mobilizing resources for growth, to the creation of conditions conducive to a high level of private investment, and to a consistent and generally sound management of the economy.

Other indicators of performance are equally impressive for this period. The mobilization of domestic savings was remarkably high for a country at such an early stage of development. As the Kenyan authorities generally followed a cautious financial policy, inflation and external debt were kept well within manageable proportions and serious balance of payments problems were avoided. The Central Government was able to turn the deficit in the recurrent budget into a sizable surplus, increase its development expenditures sevenfold, and reduce its relative dependence on foreign aid. At the same time, the Government greatly expanded its provision of basic social services.

Some aspects of this performance, however, were less satisfactory and created problems for economic management in the period after 1972. First, the benefits of development were not distributed as widely as the Government had intended, leading to the twin problems of growing unemployment and continuing poverty of the “working poor,”2 particularly in the rural areas. Thus, there persisted the core of the distribution problem—the low productivity and with it the poverty of the mass of the Kenyan people.3 Second, the Government’s policy of encouraging import substitution through protection and other incentives resulted in the establishment of a number of capital-intensive and import-intensive industries, contributing to some of the balance of payments problems.

Growth of GDP during the period 1964–72 was distributed unevenly among the economic sectors. While the average annual rate of growth of manufacturing, mining, and construction was over 8 per cent and that of government services almost 10 per cent in real terms, the agricultural sector as a whole grew at an average annual rate of 5 per cent. It is significant that the market sector of agriculture showed an average real growth of 6.5 per cent, which is very satisfactory in comparison with most countries. However, the subsistence sector of agriculture, whose production is for home consumption and where the bulk of the population is employed, grew at an average rate of only 3.7 per cent in real terms, roughly equal to the rate of population increase.

Although a high degree of price stability prevailed during the period 1964–72, with the increases in the consumer price index being less than 2 per cent in most years, rather large price increases took place in 1965 (6 per cent) and 1971 (7.5 per cent) as a result of the drought and of food shortages.

Relative price stability, coupled with sustained efforts by the Government in the fiscal and development fields, contributed to an impressive savings performance in aggregate terms during the period 1964–72. Gross domestic savings as a proportion of GDP were about 19–20 per cent in most of these years—an achievement matched by few developing countries. Household savings (including unincorporated business savings) amounted to about 10 per cent of personal disposable incomes, representing the major item of domestic savings, although their relative share fell as corporate savings accounted for an increasing part of total savings in the expanding economy. Depreciation allowances alone contributed about 30 per cent of total savings during this period.4

The Central Government’s efforts in generating public savings, and thus indirectly influencing the growth of household and business savings, were a striking aspect of Kenya’s development after its independence. In fiscal year 1964 (year ending June 30), the Government had a sizable recurrent budget deficit and had to rely on foreign aid and borrowing to fill this gap as well as to meet all of its slender development budget. Over the next eight years (1964–72), the situation changed dramatically. As a result of a creditable tax effort by the Government, recurrent revenue showed an average annual increase of over 14 per cent during this period. By the end of this period, government revenues accounted for 23 per cent of GDP, an exceptionally high ratio for a developing country, and government savings amounted to more than 20 per cent of total domestic savings. While recurrent expenditures increased by 11 per cent a year, the good revenue performance enabled the Government not only to meet its expanding recurrent budget expenditures but to make a substantial contribution—an average of 28 per cent over this period—to development expenditures, which increased nearly sevenfold during this time. The Government was able to finance its overall deficit largely by noninflationary borrowing on the domestic market and by borrowing on concessional terms from abroad. Over the entire eight-year period, the Government financed 80 per cent of its total (recurrent and development) budget out of recurrent revenue, 10 per cent from net domestic borrowing, and the remaining 10 per cent from net foreign borrowing. Prior to fiscal year 1971, the Government did not have recourse to borrowing from the central bank but rather had a positive outstanding balance with the central bank. However, in the last two fiscal years of this period (1972 and 1973), the momentum of increases in revenues slackened significantly and the Government resorted to some net borrowing from the central bank, while maintaining the rate of growth of government investment.

During the period 1964–72, Kenya had overall balance of payments surpluses in every year except 1964, 1967, and 1971. Until quite late in this period, Kenyan authorities were not particularly worried by a foreign exchange constraint. The growing domestic resource gap was certainly reflected in a widening current account deficit. But, although Kenya was increasingly dependent on a free flow of imported goods and services, the country did not experience any great difficulty in obtaining the foreign exchange necessary to finance these imports through exports and a large inflow of foreign capital. Kenya traditionally has had a deficit in the merchandise trade account, which gradually widened as domestic resources came under pressure. The trade deficit grew quite slowly during the 1960s, when imports increased a little faster than GDP and exports a little more slowly. Most of the trade deficit was covered by Kenya’s net receipts from “invisibles,” particularly the sale of services to Uganda and Tanzania and expanded earnings from the tourist industry. Thus, until the end of the 1960s, the current account was either in surplus or showed a moderate deficit that could easily be met by private and official capital inflows.

The situation changed dramatically in 1971, when a large overall deficit was registered. The value of imports increased by 62 per cent, largely due to higher world prices, while exports increased by only 34 per cent. At the same time, as the trade deficit widened, the net earnings from invisibles also leveled off because of a disruption in Kenya’s service trade with Tanzania and Uganda, some slackening in tourist inflow, and increasing repatriation of dividends. The overall payments position reverted in 1972 to a surplus, although a small one, largely as a result of reduction in imports in response to corrective measures, while export earnings improved slightly.

The Years 1973 and 1974

Some deterioration in fiscal performance and in the balance of payments position had begun to be noticeable in the last two years of the period 1964–72. The economic environment was adversely affected by a number of factors. Worldwide inflation became pronounced from 1972 on, and a sharp increase in petroleum prices occurred at the end of 1973. Domestically, the situation was further exacerbated by the effects of a severe drought in 1973.

Given these adverse developments, Kenya’s overall economic performance in 1973 could be considered rather satisfactory, but there was a strong upsurge in prices. While economic growth continued at a high rate, with a rise of 6.5 per cent in GDP in real terms, similar to that of 1972, the rate of inflation accelerated to 15 per cent, compared with 3 per cent in 1972. The overall economic growth rate was maintained despite the drought, which reduced the rate of growth of the market sector of agriculture from 7.6 per cent in 1972 to 5 per cent in 1973, mainly as a result of an increase of 11 per cent in the output of the manufacturing sector. Real gross fixed investment rose by 4.7 per cent in 1973, compared with a decline of 4 per cent in 1972. This increase in fixed investment occurred entirely in the public sector. About 95 per cent of total investment was financed by domestic savings, which reached a record high of 27 per cent of the GDP in 1973. In addition, in fiscal year 1974, the Government was able to reverse the unfavorable budgetary trend of 1972 and 1973, reducing the overall deficit by half and practically eliminating government borrowing from the banking system. The main factor in this fiscal improvement was a 25 per cent increase in recurrent revenues, largely due to new tax measures. Only a small overall balance of payments surplus was registered in 1973 (even smaller than in 1972), in spite of a 30 per cent increase in the value of exports, because of a rise in imports of 6 per cent over the low level of 1972 as restrictive credit measures were relaxed and because of a reduction in net income from services and transfers.

Economic developments in 1974 were not favorable, reflecting the impact of the adverse factors mentioned earlier, particularly the rise in petroleum prices. There was a slowdown in economic growth, with real GDP increasing by only 3.6 per cent, about half the average rate of the previous ten years, and barely matching the rate of population increase. The main factors were a minimal increase (1 per cent) in the output of the market sector of agriculture, largely due to continued dry weather and a smaller rise (7.5 per cent) in manufacturing output than in 1973. There were declines in real fixed investment and in the ratio of domestic savings to GDP. Inflation continued at the high rate of 1973, with an increase of 16 per cent in the consumer price index. The budgetary position deteriorated sharply in fiscal year 1975, with an increase over fiscal year 1974 of 86 per cent in the overall deficit which, for the first time in recent years, reached a level of 6 per cent of GDP. About half the deficit was financed from the banking system. While recurrent revenues increased by 20 per cent as a result of additional tax measures, both recurrent and development expenditures recorded much larger increases, substantially exceeding budget estimates. The balance of payments registered a large overall deficit in 1974 because of a dramatic deterioration in the terms of trade, led by the rise in petroleum prices.

By 1974, it was clear that an adverse trend in the external terms of trade, together with the effects of long-standing policies that contributed to increases in both capital-intensive and import-intensive production, had led to mounting pressures on Kenya’s balance of payments. These developments were viewed by the Kenyan authorities as threatening a reduction in Kenya’s future economic growth to considerably below the average annual rate (6.5 per cent) achieved in the decade prior to 1975. The unfavorable developments in 1974 lent urgency to the need for corrective action. Accordingly, in July 1975, the Government of Kenya undertook a three-year program, supported by the resources of the International Monetary Fund under an extended facility arrangement, seeking the attainment of (1) an annual rate of growth in real GDP of 5 per cent, (2) a rate of increase in domestic prices substantially less than that of import prices, and (3) the elimination of balance of payments assistance after five years. To achieve these objectives, the program included policies relating to demand management and structural policies, such as a shift of public and private investment toward agriculture (for example, through increased development outlays on agriculture, water, and rural development; maintenance of remunerative producer prices; and the provision of adequate agricultural credit facilities); reform of the tariff structure which, in the past, favored imports of capital goods and raw materials; the gradual elimination of fiscal incentives for certain types of investment; and the possible modification of Kenya’s interest rate structure.

Details of the three-year economic and financial program and of developments during the period 1975–77 are presented in the workshop on Financial Programming (Workshop 9). In this workshop, these details serve as background material for the preparation of a financial program for 1978 within the framework of the medium-term objectives incorporated in the program adopted by the Kenyan authorities under the extended facility arrangement concluded with the International Monetary Fund. The workshops on Projection of Monetary Aggregates (Workshop 6), Revenue Forecasting (Workshop 7), and Balance of Payments Forecasting (Workshop 8) provide additional information about fiscal, monetary, and balance of payments developments during the period 1975–77.

References
APPENDIX I

Map of Kenya

Source: International Bank for Reconstruction and Development (World Bank), Kenya: Into the Second Decade (Baltimore: Johns Hopkins University Press, 1975), p. 244.

APPENDIX II
Kenya: Selected Economic Data, 1963–74(In millions of Kenya shillings, unless otherwise indicated)
196319661970197219731974
Output and prices
GDP (at market prices)6,4408,22411,45314,44716,76120,343
Consumer prices
(Index: 1975 = 100)52.457.059.365.071.283.9
Government finance 1
Total revenue and grants7731,0401,6212,7122,8283,696
Total expenditure and lending
minus repayments9831,4441,9783,2783,7304,283
Overall deficit (–) or surplus−210−404−357−566−902−587
Money and credit
Net foreign assets7751,6171,3581,558969
Claims on government (net)−7931346479930
Claims on official entities30108191237223
Claims on private sector8721,0491,7322,4813,1433,813
Money1,3332,4103,0293,8624,016
Quasi-money2945521,0951,2651,4941,803
Balance of payments(In millions of SDRs)
Exports, f.o.b.190.4243.6285.5310.8394.2483.1
Imports, f.o.b.198.5276.8371.8418.4457.0746.6
Current account balance,−10.4−27.2−76.4−89.6−127.6−283.7
excluding officials transfers
(deficit –)
Overall balance (deficit –)8.720.150.727.018.2−73.4
Source: All items: Intarnational Monetary Fund, International Financial Statistics, 1978 Supplement, May 1978. Additional sources for gross domestic product: Kenya, Statistical Abstract, 1976 and Kenya, Economic Survey, 1976, 1977, and 1978; consumer prices: Kenya, Statistical Digest, various issues; government finance: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 1, 1977 and Vol. 2, 1978; and balance of payments: International Monetary Fund, Balance of Payments Yearbook, 1977.

Kenya, Development Plan, 1974–1978, p. 315.

International Labor Office, Employment, Incomes and Equality: A Strategy for Increasing Productive Employment in Kenya, ILO/UNDP Report (Geneva, 1972), pp. 9 and 60–61.

International Bank for Reconstruction and Development (World Bank), Kenya: Into the Second Decade (Baltimore: Johns Hopkins University Press, 1975), p. 5.

Ibid., p. 7.

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