Techniques for Formulating a Financial Program

Various techniques, in principle, may be used to formulate a financial program. If adequate data are available, as well as computing facilities and time, a large-scale econometric model could be built; and if the model is sufficiently reliable (that is, the statistical tests were satisfactory and simulation showed that the model “tracked” quite well over the sample period), it could be used to prepare a financial program. The procedure would be to fix the targets to be achieved in a specified period of time and, after inserting the forecast values for the exogenous variables, the required values of the policy instruments could then be calculated either by solving or by simulating the model.

The computed values of the policy instruments would be subject to various errors associated with this type of analysis—namely, errors in the statistical data used, in the specification of the model, in the estimation procedure, and in forecasting exogenous variables. Furthermore, the stability of the behavioral relationships that are the linkages between variables in the model cannot be taken for granted outside the sample period; this is especially true for a developing economy undergoing rapid structural change. Hence, in the ultimate analysis, judgmental considerations would influence the final decision on the precise values of the policy instruments. Some of the problems associated with prediction on the basis of an econometric model are discussed in the Introduction to Workshops (Chapter 1).

The desirability of having a comprehensive econometric model arises, in part, because a simple model may not accurately portray the structure of the economy and, in part, because the authorities of a country may be concerned with more objectives than the simple model can handle. Even in financial programs where the major objective is a reduction in the balance of payments deficit, the measures aimed at achieving it (such as credit restriction, reduction of the budget deficit, and a change in the exchange rate) usually involve costs in terms of disposable real income that may severely affect certain groups or sectors. The authorities may, therefore, use other policy instruments to minimize these costs—that is, they may utilize multipie policy instruments to achieve multiple targets simultaneously. A comprehensive econometric model will permit the investigation of the effects on all relevant variables of the policy measures that may be used.

When the construction of a comprehensive econometric model is not feasible, it may be necessary to adopt a more pragmatic approach. Nevertheless, the approach must be one that permits judgment of the likely effects of proposed policy actions. On the basis of this pragmatic approach, the authorities should be able to decide on a mix of politically acceptable policy actions that permit the attainment of the primary objectives. One of the various possible methods, which is presented only as an illustration, is described below.

Steps in the Financial Programming Exercise

As a starting point, the values of the exogenous variables needed for the preparation of a financial program may be estimated for the program period—say, the next 12 months. These variables are those over which the current economic policy of the country has relatively little influence during that period, such as the foreign demand for its exports. The next step is to fix tentatively the values of the target variables and to “envisage” the policy actions that may be necessary to achieve such targets, given the values of the exogenous variables. At the outset, a decision must be made whether an adjustment in the exchange rate (a key ingredient in the envisaged policy “mix”) is required in the light of recent, as well as expected, changes in either domestic prices and costs or external factors. If a policy mix is found to be inadequate to achieve the desired targets without an exchange rate adjustment, such an adjustment may have to be envisaged; in this event, a new set of policies consistent with the new exchange rate would be formulated. After this preliminary work, it is necessary to check whether the envisaged policy actions are appropriate to achieve the results expected of the financial program.

A convenient procedure is to estimate the values, for the next 12 months, of the various items appearing in a monetary or financial survey (see Workshop 1), as has been done in Workshop 6: Projection of Monetary Aggregates. These estimates should be made on the basis of the assumed values for the target variables and the exogenous variables. Thus, starting with the monetary survey, “net foreign assets” may be taken as a target variable on the basis of a given exchange rate. This is likely to be the procedure followed in financial programs for countries that have a deficit in the balance of payments and have a low level of international reserves. Accordingly, a value that is desirable in view of the circumstances is assigned to this item.

The next step is to estimate “money.” This is done on the basis of a demand for money function. It is frequently necessary to estimate several different specifications of the demand for money function, including different coverage of the variables in the relationship, in order to find the one that is reasonably satisfactory, i.e., where the relationship is plausible and relatively stable and where the probable magnitude of prediction errors is relatively small. However, in practice, many estimates of the demand for money function contain prediction errors that are uncomfortably large. This leaves room for judgmental considerations to be used in the projection.

If the demand for money is a function of nominal income alone, estimates of the real income and the level of prices over the next 12 months are needed in order to obtain the estimate for money.

The rate of growth of real national income is a policy objective that must be realistic and also be consistent with the other policy objectives. Hence, there is no simple and easy way to estimate the rate of growth of real national income over the next 12 months. It depends on numerous and complex relationships that underlie aggregate supply and demand. On the supply side, perhaps one of the crudest but simplest ways is to investigate the growth of real output over the last few years and then to consider any new factors that are likely to affect real output over the 12-month period. These would include factors affecting agricultural output, particularly in primary producing countries; new plants and equipment coming on stream; measures to increase the rate of capacity utilization, such as changes in import restrictions, particularly on raw materials and semifinished products, and in credit allocation; and changes in the labor force.

On the demand side, it is necessary to consider fiscal, monetary, exchange rate, and incomes policies, as well as economic conditions in the rest of the world that affect the prices and volumes of exports and imports. A simultaneity problem occurs in the estimation of real income. The estimated real income, which is used to estimate the demand for money, is in part determined by the monetary and fiscal policy stances. However, the domestic credit derived from the estimated demand for money (see below), given the amount of net foreign assets, may not be consistent with the monetary and fiscal policy stances envisaged initially. This implies that real income, the demand for money, and the monetary and fiscal policies must be determined simultaneously. Operationally, this difficulty may be circumvented by making general assumptions about the effects of these policies and by checking later to see whether these are borne out by the calculations. Thus, the estimated level of the real national income has to take into account the exogenous factors, as well as the effects of the initially envisaged monetary, fiscal, exchange rate, and incomes policies.

The level of prices over the next 12 months is a target variable. However, as in the case of real national income, the value of this target cannot be set arbitrarily. The prices of imports and exports in foreign currency may be largely outside the sphere of influence of the authorities of the country. The prices of domestic products for the home market may change not only because of events that have already occurred (such as an increase in the wage rate, already granted) or because of likely events over which the authorities have no control, but also because of monetary, fiscal, exchange rate, and incomes policies. The complication of simultaneity again arises—namely, that the level of prices is used to estimate the demand for money, which in turn, together with the supply of money, influences the level of prices. This implies that the demand for money, the supply of money, and the level of prices must be determined simultaneously. A procedure similar to the one described in connection with the estimation of real national income may be used here.

If the demand for money is a function of other variables besides nominal income, such as the expected rate of inflation or the expected rates of return on competing financial assets, these have to be estimated before the amount of money demanded can be calculated. The expected rate of inflation may be inferred from the already estimated level of prices over the next 12 months. Established techniques for generating expectation, such as adaptive expectation or rational expectation, can be utilized. Similarly, the expected rate of interest may be estimated on the basis of the stance of monetary policy and certain behavioral assumptions concerning expectation.

The next step involves the estimation of “quasi-money.” Generally, quasi-money is explained by the same variables as those operating in the demand for money function, or by closely related variables. However, the interest rates on savings and time deposits tend to influence the demand for money and the demand for quasi-money in opposite directions.

For “other items (net)” in the monetary survey, it is useful to check whether this component changes very much from year to year. If it does, the cause of its variations should be investigated so as to derive some basis for estimating the numerical value of this item 12 months hence.

where DC stands for domestic credit, MO for money, QMO for quasi-money, NOI for other items (net), NFA for net foreign assets, and the subscript t stands for the value of the variable at the end of the 12-month program period.

where DC_t is given by equation (1) and the subscript t−1 stands for the value of the variable at the beginning of the 12-month program period.

If it is believed that the credit expansion can be limited to the amount calculated in equation (2) without upsetting the estimates of the macroeconomic variables, such as real income and prices, used in estimating the items in equation (1), then the calculated overall credit expansion is considered to be consistent with the policies initially envisaged. However, it is only rarely that the amount of credit expansion calculated in equation (2) turns out to be consistent with the policies initially envisaged, as well as with the estimated values of other variables in the economy. Furthermore, the amount of credit expansion yielded by equation (2) does not indicate how the new credit is to be allocated, for example, between the government and private sectors. Therefore, it is useful to continue the work and to project (on the basis of the estimated exogenous variables and the policy actions) government sector revenue and expenditure, private sector income and expenditure, and the major components of the balance of payments, in order to ensure the internal consistency of the financial program.

On the basis of the forecasts of national income and its major components (e.g., consumption, imports, etc.), it may be possible to estimate the bulk of government revenue. Typically, in fact, the major part of government revenue depends on income, consumption, exports, and imports (as illustrated in Workshop 7: Revenue Forecasting), as well as on the tax structure and the envisaged changes in tax laws and in collection procedure. Implicit or explicit assumptions must already have been made about government expenditure in estimating the national income. Any change in the exchange rate would also affect estimates of government revenue as well as expenditure. The resulting budgetary deficit, if any, may or may not be such that it can be financed through government borrowing abroad, which is reflected in net foreign assets in equation (1) or by the expansion of domestic credit calculated on the basis of equation (2). If such financing of the government is feasible, then the exercise can proceed. Account should be taken of the fact that the private sector and the rest of the public sector (see Workshop 2: Government Finance Statistics) also need bank credit to finance their economic and financial activities. Therefore, the entire amount of the calculated credit expansion is not available to finance the government deficit. If the deficit cannot be financed by borrowing from the banking system or abroad, various possibilities are open—such as borrowing from domestic non-bank sources, increase in taxation, or reduction in government expenditure below the level initially envisaged. But if some of these policy actions change the values of the endogenous variables already used to calculate credit expansion (such as net foreign assets, real national income, and prices), the calculated expansion of credit would also change. If this is the case, the initially envisaged policies are obviously not compatible with the objectives and therefore the exercise must be repeated with different policies or objectives. It may require several iterations before a consistent set of values for the relevant variables is obtained.

On the basis of the forecasts of the state of the world economy and of domestic supply and demand, exports and imports may be estimated. For the values of exports and imports in domestic currency, assumptions about exchange rate policies have to be made. In estimating private capital movements in a country where the exchange system is free of restrictions on capital transactions, it is necessary to take into account domestic interest rates in relation to the interest rates in international money and capital markets. For other items of the balance of payments, it is necessary to use the information available and to investigate the relationships in each specific case (see Workshop 8: Balance of Payments Forecasting). If these estimates yield a value for the outturn of the balance of payments that is compatible with the target for net foreign assets fixed in calculating the credit expansion, the exercise can proceed further.

If the outturn in the balance of payments is not the desired one, different policies (including possibly a different exchange rate) will be required and these will inevitably affect the endogenous variables used elsewhere in the calculations. Thus, it would be necessary to start all over again with fresh assumptions about the policies to be undertaken and perhaps new values for the target variables. This process would continue until policy measures are found that are compatible with the values of the target variables, given the estimated exogenous variables.

The next step would be to calculate the expansion of central bank credit that is compatible with the expansion of banking system credit. This step would be necessary in order to give the authorities an instrument that is essential for both the execution and control of a financial program. Some countries, for a variety of reasons, have strong objections to imposing credit ceilings on individual commercial banks and prefer to impose a single ceiling on central bank domestic credit. If the relationships involved in the estimation of the credit multiplier (i.e., the ratio between total bank domestic credit and central bank monetary liabilities) are stable, the imposition of a ceiling on the central bank domestic credit would effectively constrain bank credit, given the assumptions about net foreign assets. This would avoid involvement in the sensitive and difficult task of allocating credit among banks. Besides, the ceiling on the central bank domestic credit can be readily controlled.

The task is therefore to estimate the relationships between the monetary liabilities of the central bank and the principal components of the consolidated balance sheet of the commercial banks, taking into account the interest rates on both bank deposits and loans (if such interest rates play a role in the case investigated). This exercise may also give an indication of how a government deficit or surplus can be financed, that is, whether it can be financed through direct advances from the central bank, or from commercial banks, or both. It may be found that, for institutional or other reasons, the domestic credit of the central bank has to be higher than that derived from the credit multiplier. If this is so, a policy to reduce the size of the multiplier, such as the imposition of higher reserve requirements on banks or other similar policy actions, may be necessary.

The technical task of preparing a financial program is accomplished when the set of policy measures required to produce the desired targets has been determined.

The technique of financial programming described above has been presented in rather general terms. It should be noted that several iterations may be necessary in order to ensure the overall consistency of the financial program. In actual application of the program to specific cases, suitable modifications may have to be made in the light of the relevant economic circumstances and the availability of data. Furthermore, the order of steps in the financial programming exercise is not sacrosanct; in fact, in the formulation of a hypothetical financial program for Kenya as presented under Exercise and Issues for Discussion, the order of steps differs from that outlined above.

This workshop, which contains an illustration and application of one possible technique of financial programming, provides the elements for preparing a hypothetical financial program for Kenya for the calendar year 1978. The first section discusses the medium-term policy objectives, the annual targets, and the performance criteria incorporated in the International Monetary Fund's extended facility arrangement for Kenya in fiscal years 1976–78. The second section reviews the actual performance of the Kenyan economy and discusses the implementation of government policies during 1975 and 1976. The third section describes and analyzes Kenya's economic situation in 1977. In conclusion, the section on Exercise and Issues for Discussion contains a possible methodology to be utilized for the formulation of a hypothetical financial program for Kenya in 1978. It is assumed that the program is being formulated in early January 1978. The forecasting techniques and other elements of information from previous workshops may be used as ingredients in the preparation of this financial program.

Production, Expenditure, and Prices

The rate of increase in real GDP accelerated from 6.1 per cent in 1976 to an estimated 7.3 per cent in 1977 (Tables 2 and 3).

TABLE 2.

Kenya: Selected National Accounts Data, 1975–77

(In millions of Kenya shillings)

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

TABLE 2.

Kenya: Selected National Accounts Data, 1975–77

(In millions of Kenya shillings)

Item		1975	1976	19771
Resources
	GDP at factor cost (current prices)	20,560	25,257	32,404
	Indirect taxes and subsidies	2,783	3,325	4,249
	GDP at market prices	23,343	28,581	36,653
	Imports of goods and services	8,358	9,436	11,688
Total		31,701	38,017	48,341
Use of resources
	Private fixed investment	2,824	3,390	4,633
	Public fixed investment	2.026	2,450	3,141
	Change in stocks	−275	133	−14
Gross investment		4,576	5,973	7,760
	Private consumption	15,731	17,542	21,338
	Public consumption	4,256	4,943	6,250
Total consumption		19,987	22,485	27,588
	Gross domestic expenditure	24,563	28,457	35,347
	Exports of goods and services	7,138	9,560	12,994
Total		31,701	38,017	48,341
National income
	GDP at factor cost	20,560	25,257	32,404
	Factor incomes received from abroad	428	352	372
	Factor incomes paid abroad	1,256	1,444	1,786
	GNP at factor cost	19,732	24,165	30,990
	Indirect taxes and subsidies	2,783	3,325	4,249
	GNP at market prices	22,515	27,490	35,239

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

View Table

TABLE 2.

Kenya: Selected National Accounts Data, 1975–77

(In millions of Kenya shillings)

Item		1975	1976	19771
Resources
	GDP at factor cost (current prices)	20,560	25,257	32,404
	Indirect taxes and subsidies	2,783	3,325	4,249
	GDP at market prices	23,343	28,581	36,653
	Imports of goods and services	8,358	9,436	11,688
Total		31,701	38,017	48,341
Use of resources
	Private fixed investment	2,824	3,390	4,633
	Public fixed investment	2.026	2,450	3,141
	Change in stocks	−275	133	−14
Gross investment		4,576	5,973	7,760
	Private consumption	15,731	17,542	21,338
	Public consumption	4,256	4,943	6,250
Total consumption		19,987	22,485	27,588
	Gross domestic expenditure	24,563	28,457	35,347
	Exports of goods and services	7,138	9,560	12,994
Total		31,701	38,017	48,341
National income
	GDP at factor cost	20,560	25,257	32,404
	Factor incomes received from abroad	428	352	372
	Factor incomes paid abroad	1,256	1,444	1,786
	GNP at factor cost	19,732	24,165	30,990
	Indirect taxes and subsidies	2,783	3,325	4,249
	GNP at market prices	22,515	27,490	35,239

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

TABLE 3.

Kenya: Sectoral Origin of Gross Domestic Product, 1974–77

(In millions of Kenya shillings)

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

TABLE 3.

Kenya: Sectoral Origin of Gross Domestic Product, 1974–77

(In millions of Kenya shillings)

Sectoral Origin			Current prices				Constant 1972 Prices
			1974	1975	1976	19771	1974	1975	1976	19771
Private sector and public sector enterprises			15,206	17,426	21.679	28,220	11,898	11.887	12,627	13,600
	Semimonetary economy		3,519	4.651	5.202	6.106	2,987	3,019	2,979	3,080
		Agriculture, forestry, and fishing	2,741	3,621	4,000	4,650	2,375	2,388	2,329	2,406
		Other	778	1,030	1,202	1,456	612	631	650	674
	Monetary economy		11,687	12,775	16,477	22,114	8,911	8.668	9,648	10,520
		Agriculture, forestry, and fishing	2,593	2,659	4,567	7,768	2,034	2,036	2,115	2,370
		Mining and quarrying	63	66	83	93	58	60	68	71
		Manufacturing	2,381	2,543	3,348	4,108	1,690	1,886	2,236	2,572
		Building and construction	868	888	924	1,040	640	617	589	624
		Electricity and water	209	264	284	433	202	224	263	285
		Transport, storage, and communications	1,075	1,205	1,383	1,386	839	813	898	847
		Wholesale and retail trade, restaurants, and hotels	2,317	2,437	2,889	3.807	1,433	1,325	1,434	1.588
		Finance, insurance, real estate, and business services	936	1,093	1,361	1,570	768	813	916	964
		Other services	1,239	1,420	1,638	1,909	1,050	1,094	1,129	1,199
Government services			2,700	3,134	3,578	4,184	2,452	2,636	2,778	2,936
Total GDP at factor cost			17,906	20,560	25,257	32,404	14,350	14,523	15,405	16,536

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

View Table

TABLE 3.

Kenya: Sectoral Origin of Gross Domestic Product, 1974–77

(In millions of Kenya shillings)

Sectoral Origin			Current prices				Constant 1972 Prices
			1974	1975	1976	19771	1974	1975	1976	19771
Private sector and public sector enterprises			15,206	17,426	21.679	28,220	11,898	11.887	12,627	13,600
	Semimonetary economy		3,519	4.651	5.202	6.106	2,987	3,019	2,979	3,080
		Agriculture, forestry, and fishing	2,741	3,621	4,000	4,650	2,375	2,388	2,329	2,406
		Other	778	1,030	1,202	1,456	612	631	650	674
	Monetary economy		11,687	12,775	16,477	22,114	8,911	8.668	9,648	10,520
		Agriculture, forestry, and fishing	2,593	2,659	4,567	7,768	2,034	2,036	2,115	2,370
		Mining and quarrying	63	66	83	93	58	60	68	71
		Manufacturing	2,381	2,543	3,348	4,108	1,690	1,886	2,236	2,572
		Building and construction	868	888	924	1,040	640	617	589	624
		Electricity and water	209	264	284	433	202	224	263	285
		Transport, storage, and communications	1,075	1,205	1,383	1,386	839	813	898	847
		Wholesale and retail trade, restaurants, and hotels	2,317	2,437	2,889	3.807	1,433	1,325	1,434	1.588
		Finance, insurance, real estate, and business services	936	1,093	1,361	1,570	768	813	916	964
		Other services	1,239	1,420	1,638	1,909	1,050	1,094	1,129	1,199
Government services			2,700	3,134	3,578	4,184	2,452	2,636	2,778	2,936
Total GDP at factor cost			17,906	20,560	25,257	32,404	14,350	14,523	15,405	16,536

Source: Kenya, Economic Survey, 1978.

¹Provisional figures.

Agricultural production is estimated to have increased by about 12 per cent, attributable mainly to favorable weather conditions and the continued increase in export prices. Production of coffee, tea, and sugarcane increased by 21 per cent, 39 per cent, and 14 per cent, respectively, while other crops and livestock products showed little change. Manufacturing output is estimated to have risen by 15 per cent. The effects on this industry of the expansion of rural output and incomes more than compensated for the disruptive effects of the breakup of the East African Community (EAC) in 1977. The output of building and construction is estimated to have increased by 6 per cent, compared with a decline of 5 per cent in 1976, reflecting a turnaround in private residential building activity and the start of several major government projects (e.g., the Upper Tana Reservoir, Mombasa Water Supply Development Program, and Bura Irrigation Project). Tourism was adversely affected by the closing of the Tanzanian border. Nevertheless, the decline in the number of visitors was offset by an increase in the average length of stay, resulting in a 7 per cent increase in the number of bed-nights for tourists. Output of transport and communications is estimated to have declined by 6 per cent, reflecting mainly the strains experienced by the EAC corporations and the closure of the Tanzanian border. Wholesale and retail trade, distribution, and other sectors of the economy all recorded reasonable rates of increase.

Aggregate domestic demand (as measured by the sum of consumption and investment expenditures) rose by an estimated 24 per cent in nominal terms, compared with 19 per cent in 1976. Gross fixed capital formation as a proportion of GDP rose from 20 per cent in 1976 to 21 per cent in 1977. The ratio of consumption to GDP declined from 79 per cent in 1976 to 75 per cent in 1977. Private sector investment in real terms increased most significantly in agriculture (44 per cent); transport, storage, and communications (30 per cent); and manufacturing (15 per cent). By type of asset, investment in 1977 mainly took the form of machinery and equipment. The decrease in the consumption ratio reflected, in part, the reinvestment of the gross farm revenue and business profits and, in part, the impact of the wage guidelines.

Wage employment rose by 5.3 per cent in 1977, with the most significant expansion occurring in finance, insurance, real estate, and business services (16 per cent); transport and communications (9 per cent); and manufacturing (8 per cent). Wage employment in agriculture also expanded by 4 per cent, compared with a decline of 1 per cent in 1975 and an increase of 1 per cent in 1976. Employment in the public sector went up by 5.6 per cent in 1977, compared with an increase of 4.1 per cent in 1976. While in 1976 growth of public sector employment was largely concentrated in central government employees, in 1977 the rise in public sector employment occurred mainly in the parastatal bodies and other enterprises partly owned by the public sector.

Average wage earnings rose by 8 per cent in 1977, compared with 16 per cent in 1976. The rate of increase of average earnings in the public sector decelerated more than that in the private sector. The 9 per cent increase in average earnings in the private sector was in accordance with the wage guidelines, which allowed an average increase in wage earnings equivalent to two thirds of the increase in the cost of living. The highest increase in average earnings in 1977 occurred in manufacturing (13 per cent); transport and communications (11 per cent); and trade, restaurants, and hotels (9 per cent). Average earnings in agriculture declined by about 1 per cent, compared with an increase of 17 per cent in 1976.

In spite of the increase in domestic supply, inflation emerged as the foremost problem in 1977. The sharp increase in domestic liquidity, together with an upward adjustment of retail prices of foods to correspond with higher producer prices, exerted considerable pressure on consumer prices. Between December 1976 and December 1977 consumer prices for the lower-income group in Nairobi rose by 21.0 per cent. The food index went up by 17.2 per cent while the rent index rose by 31.9 per cent for the lower-income group. In terms of the implicit GDP deflator, inflation was estimated at about 20 per cent in 1977.

Balance of Payments

Kenya's balance of payments recorded an overall surplus of more than KSh 2 billion in 1977 (Table 4). The value of merchandise exports rose by 51 per cent (4 per cent in volume), and that of merchandise imports rose by 31 per cent (21 per cent in volume). The terms of trade improved by about 32 per cent following an improvement of 17 per cent in 1976. The trade deficit declined sharply, while the combined surplus in invisibles and capital accounts remained broadly unchanged. At the end of December 1977, Kenya's gross international reserves were SDR 438 million, or the equivalent of about five months' imports.

The principal factor underlying the overall improvement in 1977 was the continued rise in the prices of coffee and tea, Kenya's major exports. While these prices peaked in late spring 1977, their weighted averages for the year were higher than in 1976 by 80 per cent and 91 per cent, respectively. Export volumes of coffee and tea also rose by 22 per cent and 19 per cent, respectively. Kenya's “other” exports, which include some manufactured products, rose slightly (5 per cent) in value despite the virtual loss of the Tanzanian market.

The increase in imports was due, in part, to higher incomes and greater availability of domestic credit and, in part, to greater government imports, including those of new capital equipment required for replacing some EAC corporations by Kenyan corporations and defense-related imports. The average propensity to import was 32 per cent, which was about the same as in 1976 but lower than in 1974 and 1975 when high oil prices raised the import propensity to an average of 39 per cent.

As a result partly of the dissolution of the East African Community, and even more as a result of the closure of the Tanzanian border, Kenya's tourist and other service receipts grew more slowly in 1977, while payments of investment income rose faster, reflecting higher profits of foreign firms, particularly those engaged in production and marketing of Kenya's major exports. Larger inflows of private capital, mostly direct investment, were partly offset by a decline in government capital inflows.

TABLE 4.

Kenya: Balance of Payments Summary, 1976–77

(In millions of Kenya shillings)

Sources: For current account and capital account (except commercial banks), the data are taken from Kenya, Economic Survey, 1978. The data for commercial banks and financing are taken from International Monetary Fund, International Financial Statistics, July 1978, in order to ensure consistency with the monetary accounts for purposes of financial programming. The adjustment for the resulting discrepancy a contained in the residual item, errors and omissions.Note: n.e.s. = not elsewhere specified.

¹Includes foreign banks' deposits with the Central Bank of Kenya and International Monetary Fund deposits.

TABLE 4.

Kenya: Balance of Payments Summary, 1976–77

(In millions of Kenya shillings)

				1976			1977
Item			Source	Use	Balance	Source	Use	Balance
Current account			10,552	11,250	−698	14,186	13,704	482
	Trade balance		6,224	8,158	−1,934	9,418	10,702	−1,284
		Imports, c.i.t.		8,758	−8,758		10,702	−10,702
		Exports, f.o.b.	6,224		6,224	9,418		9,418
	Services		3,688	2,722	966	3,948	2,772	1,176
		Freight and insurance	550	92	458	566	80	486
		Other transportation	7,576	558	958	1,490	354	1,136
		Foreign travel	858	260	598	994	150	344
		International investment income	310	1,262	−952	352	1,542	−1,790
		Government transactions, n.e.s.	170	232	−62	190	344	−154
		Other services	284	318	−34	356	302	54
	Transfers		640	370	270	820	230	590
		Private	144	185	−42	230	160	70
		Government	496	184	312	590	70	520
Capital account			1,677	237	1,440	1,754	−59	1,813
	Private long-term		512	50	462	628	12	616
	Government long-term		702	−8	710	678	14	664
	Government corporations long-term		188	86	102	444	−20	464
	Short-term		275	109	166	4	−65	69
		Government	—	12	−12	—	—	—
		Government corporations	6	8	−2	4	8	−4
		Commercial banks	−35	67	−102	—	−73	73
		Private	304	22	282	—	—	—
Errors and omissions			—	—	34	—	—	−48
Overall balance			—	—	776	—	—	2,247
Financing (increase in assets)			158	934	−776	87	2,334	−2,247
	Gross official reserves		—	870	−870	—	1,973	−1,973
	Use of Fund credit		158	—	158	—	361	−361
	Other liabilities1		—	64	−64	87	—	87

Sources: For current account and capital account (except commercial banks), the data are taken from Kenya, Economic Survey, 1978. The data for commercial banks and financing are taken from International Monetary Fund, International Financial Statistics, July 1978, in order to ensure consistency with the monetary accounts for purposes of financial programming. The adjustment for the resulting discrepancy a contained in the residual item, errors and omissions.Note: n.e.s. = not elsewhere specified.

¹Includes foreign banks' deposits with the Central Bank of Kenya and International Monetary Fund deposits.

View Table

TABLE 4.

Kenya: Balance of Payments Summary, 1976–77

(In millions of Kenya shillings)

				1976			1977
Item			Source	Use	Balance	Source	Use	Balance
Current account			10,552	11,250	−698	14,186	13,704	482
	Trade balance		6,224	8,158	−1,934	9,418	10,702	−1,284
		Imports, c.i.t.		8,758	−8,758		10,702	−10,702
		Exports, f.o.b.	6,224		6,224	9,418		9,418
	Services		3,688	2,722	966	3,948	2,772	1,176
		Freight and insurance	550	92	458	566	80	486
		Other transportation	7,576	558	958	1,490	354	1,136
		Foreign travel	858	260	598	994	150	344
		International investment income	310	1,262	−952	352	1,542	−1,790
		Government transactions, n.e.s.	170	232	−62	190	344	−154
		Other services	284	318	−34	356	302	54
	Transfers		640	370	270	820	230	590
		Private	144	185	−42	230	160	70
		Government	496	184	312	590	70	520
Capital account			1,677	237	1,440	1,754	−59	1,813
	Private long-term		512	50	462	628	12	616
	Government long-term		702	−8	710	678	14	664
	Government corporations long-term		188	86	102	444	−20	464
	Short-term		275	109	166	4	−65	69
		Government	—	12	−12	—	—	—
		Government corporations	6	8	−2	4	8	−4
		Commercial banks	−35	67	−102	—	−73	73
		Private	304	22	282	—	—	—
Errors and omissions			—	—	34	—	—	−48
Overall balance			—	—	776	—	—	2,247
Financing (increase in assets)			158	934	−776	87	2,334	−2,247
	Gross official reserves		—	870	−870	—	1,973	−1,973
	Use of Fund credit		158	—	158	—	361	−361
	Other liabilities1		—	64	−64	87	—	87

Sources: For current account and capital account (except commercial banks), the data are taken from Kenya, Economic Survey, 1978. The data for commercial banks and financing are taken from International Monetary Fund, International Financial Statistics, July 1978, in order to ensure consistency with the monetary accounts for purposes of financial programming. The adjustment for the resulting discrepancy a contained in the residual item, errors and omissions.Note: n.e.s. = not elsewhere specified.

¹Includes foreign banks' deposits with the Central Bank of Kenya and International Monetary Fund deposits.

Public Finance

Kenya's budgetary position improved considerably in fiscal year 1977, as the overall deficit declined by 22 per cent to KSh 1.3 billion (Table 5). Current revenue increased by 20 per cent as a result of a general economic recovery, while total expenditure increased by 17 per cent. External financing fell short of the budgeted level, but the Government succeeded in mobilizing funds from the domestic non-bank sector. Thus, the recourse to the banking system decreased.

TABLE 5.

Kenya: Summary of Central Government Budgetary Operations, Fiscal Years 1976–78

(In millions of Kenya shillings; year ending June 30)

Sources: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 2 (1978) and International Financial Statistics, various issues; Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; Kenya, Estimates of Revenue, 1977/78, Estimates of Recurrent Expenditure, 1977/78, and Development Estimates, 1977/78.

¹Budget estimates.

²Includes operating revenue of departmental enterprises.

³Includes operating expenditure of departmental enterprises.

TABLE 5.

Kenya: Summary of Central Government Budgetary Operations, Fiscal Years 1976–78

(In millions of Kenya shillings; year ending June 30)

	Item	1976	1977	19781
1	Current revenue	5,123	6,149	7,375
1.1	Tax	4,571	5,297	6,401
1.2	Nontax	552	852	9752
2	Capital revenue	—	—	—
3	Total revenue (1 + 2)	5,123	6,149	7,3752
4	Grants	201	234	440
4.1	Current	61	24	…
4.2	Capital	140	210	…
5	Total revenue and grants (3 + 4)	5,325	6,383	7,615
6	Current expenditure	4,904	5,580	…
7	Capital expenditure	1,259	1,660	…
3	Total expenditure {6 + 7)	6,164	7,240	9,4163
9	Lending minus repayments	870	470	783
10	Expenditure and lending minus repayments (8 + 9)	7,034	7,710	10,1993
11	Current account surplus or saving (without grants) (1 − 6)	219	569	…
12	Gross fixed capital formation	1,059	1,388	…
13	Gross capital formation	1,059	1,388	…
14	Overall deficit/surplus (5 − 10)	−1,709	−1,327	−2,384
15	Financing (= 14)	1,709	1,327	2,384
15.1	Abroad	639	464	686
15.2	Domestic	1,070	863	1,698
15.2.1	Nonbank	670	868	498
15.2.2	: Deposit money banks	350
15.2.3	Central Bank	50	−689	1,200

Sources: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 2 (1978) and International Financial Statistics, various issues; Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; Kenya, Estimates of Revenue, 1977/78, Estimates of Recurrent Expenditure, 1977/78, and Development Estimates, 1977/78.

¹Budget estimates.

²Includes operating revenue of departmental enterprises.

³Includes operating expenditure of departmental enterprises.

View Table

TABLE 5.

Kenya: Summary of Central Government Budgetary Operations, Fiscal Years 1976–78

(In millions of Kenya shillings; year ending June 30)

	Item	1976	1977	19781
1	Current revenue	5,123	6,149	7,375
1.1	Tax	4,571	5,297	6,401
1.2	Nontax	552	852	9752
2	Capital revenue	—	—	—
3	Total revenue (1 + 2)	5,123	6,149	7,3752
4	Grants	201	234	440
4.1	Current	61	24	…
4.2	Capital	140	210	…
5	Total revenue and grants (3 + 4)	5,325	6,383	7,615
6	Current expenditure	4,904	5,580	…
7	Capital expenditure	1,259	1,660	…
3	Total expenditure {6 + 7)	6,164	7,240	9,4163
9	Lending minus repayments	870	470	783
10	Expenditure and lending minus repayments (8 + 9)	7,034	7,710	10,1993
11	Current account surplus or saving (without grants) (1 − 6)	219	569	…
12	Gross fixed capital formation	1,059	1,388	…
13	Gross capital formation	1,059	1,388	…
14	Overall deficit/surplus (5 − 10)	−1,709	−1,327	−2,384
15	Financing (= 14)	1,709	1,327	2,384
15.1	Abroad	639	464	686
15.2	Domestic	1,070	863	1,698
15.2.1	Nonbank	670	868	498
15.2.2	: Deposit money banks	350	View Expanded
15.2.3	Central Bank	50	−689	1,200

Sources: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 2 (1978) and International Financial Statistics, various issues; Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; Kenya, Estimates of Revenue, 1977/78, Estimates of Recurrent Expenditure, 1977/78, and Development Estimates, 1977/78.

¹Budget estimates.

²Includes operating revenue of departmental enterprises.

³Includes operating expenditure of departmental enterprises.

The budget for fiscal year 1978 was formulated against the background of the forecast of a record high balance of payments surplus. Although realizing the danger of renewed acceleration of inflation, the Government felt that there was a need to step up development effort. Budget estimates aimed at increasing the current account surplus by restraining the growth of current expenditure to below that of current revenue. New tax measures, including an export tax on coffee and tea, were estimated to generate KSh 500 million of revenue. Capital expenditure and lending minus repayments were projected to rise sharply, and the overall budget deficit was estimated at KSh 2.4 billion. About half of the deficit was expected to be financed by borrowing from the banking system, including financing by the Cereals and Sugar Finance Corporation.

Since the inception of the budget for fiscal year 1978, two developments have assumed increasing importance. First, the dissolution of the East African Community has necessitated additional expenditure to set up Kenyan replacements for various EAC corporations. Second, defense expenditure increased more than anticipated. The budgetary outturn during the first half of fiscal year 1978 showed an overall budget deficit of KSh 1.3 billion. Current revenue was increasing significantly faster than current expenditure. Capital expenditure was running below the budgeted rate, primarily because deliveries of equipment were later than expected. During this period, the budget deficit was financed almost equally by nonbank domestic borrowing (KSh 565 million) and by bank borrowing (KSh 537 million). The latter included KSh 232 million of financing from the Cereals and Sugar Finance Corporation.

Money and Credit

The growth in money and quasi-money accelerated sharply in Kenya from 25 per cent in 1976 to 47 per cent in 1977 (Table 6). Both the increase in net foreign assets and the increase in domestic credit contributed to the monetary expansion. Domestic credit increased by 24 per cent in 1977, as the 34 per cent increase in credit to the private sector was only partially offset by a decline of KSh 98 million in net credit to the Government. The expansion in private sector credit occurred in response to rising economic activity and to higher prices, as well as to a relaxation of the limits on domestic borrowing by foreign companies. Beginning in April 1977, foreign-controlled companies engaged in direct agricultural production and manufacturing and tourism industries were allowed to borrow locally up to 100 per cent of their investment while previously such borrowing had been limited to between 20 and 60 per cent.

In terms of the sectoral distribution, credit to all sectors, except building and construction, expanded sharply. Credit to the priority sectors of agriculture, manufacturing, and African small-scale enterprises rose by 34 per cent, 33 per cent, and 39 per cent, respectively. Because of the large expansion of deposits, credit to the agricultural sector in 1977 averaged only about 12 per cent of commercial bank deposits, considerably below the 17 per cent requirement set by the Central Bank.

The decline in net credit to the Government reflected a considerable improvement in the budgetary position, particularly during the first half of 1977. With a view to reducing the creation of primary liquidity, the Government shifted its bank borrowing from the Central Bank to commercial banks. Thus, the Government's position with the Central Bank changed from a net debtor position of KSh 778 million at the end of 1976 to a net creditor position of KSh 35 million by the end of 1977. At the same time, net credit from commercial banks to the Government rose by KSh 715 million.

Commercial banks were highly liquid throughout the year. Their liquidity ratios averaged 32 per cent, compared with the legal requirement of 18 per cent. In mid-1977, the Central Bank announced that, effective January 1, 1978, the liquidity ratio requirement would be raised to 20 per cent. In September 1977 the Central Bank announced a redefinition of liquid assets to net out interbank borrowing, which became effective January 1, 1978.

TABLE 6.

Kenya: Monetary Survey, 1973–77

(In millions of Kenya shillings)

Sources: Central Bank of Kenya, Annual Report lor the Financial year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Foreign liabilities include use of Fund credit.

²Foreign exchange holdings.

³Includes Cereals and Sugar Finance Corporation and Agricultural Finance Corporation.

⁴Adjusted for “uncleared effects.”

⁵The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

TABLE 6.

Kenya: Monetary Survey, 1973–77

(In millions of Kenya shillings)

			December	June	December	June	December	June	December	June	December
Item			1973	1974		1975		1976		1977
Net foreign assets			1,559	1,434	969	854	591	1,189	1.459	3,776	3,633
	Central Bank1		1,584	1,494	1,061	933	681	1,192	1,449	3,717	3,689
	Government2		25	31	4	—	8	9	16	13	23
	Commercial banks		−51	−91	−96	−79	−108	−12	−6	46	−79
Domestic credit			3,859	4,399	4,968	5,297	6.414	6.563	7,475	7,798	9,255
	Government (net)		479	466	930	1,100	1,767	1,500	1,898	1,495	1,800
		Claims	1,019	1,008	1.036	1,183	1,789	2,279	2,043	2,787	3,206
		Deposits	540	542	106	83	22	779	145	1,292	1,406
	Nongovernment		3,380	3,923	4,036	4,197	4,647	5,063	5,577	6,303	7,455
		Official entities	237	176	223	221	303	250	215	205	259
		Private sector3	3.143	3,747	3,813	3,976	4,344	4,813	5,362	6,098	7,796
Other items (net)			−69	−19	−18	−59	180	321	479	622	475
Money and quasi-money			5,356	5,708	5,619	6,077	6,814	7,432	9,454	10,952	12,413
	Money		3.862	4,063	4,016	4,052	4,540	4,966	5,674	7,496	8,427
		Currency outside banks	982	1,015	1,086	1,022	1,234	1,194	1,625	1,765	2,181
		Demand deposits4	2,880	3,068	2,930	3,030	3,306	3,772	4,049	5,731	6,246
	Quasi-money		1,494	1.625	1,803	2,025	2,274	2,466	2,780	3,456	3.986
SDR allocations			130	134	134	134	—5	—	—	—	—

Sources: Central Bank of Kenya, Annual Report lor the Financial year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Foreign liabilities include use of Fund credit.

²Foreign exchange holdings.

³Includes Cereals and Sugar Finance Corporation and Agricultural Finance Corporation.

⁴Adjusted for “uncleared effects.”

⁵The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

View Table

TABLE 6.

Kenya: Monetary Survey, 1973–77

(In millions of Kenya shillings)

			December	June	December	June	December	June	December	June	December
Item			1973	1974		1975		1976		1977
Net foreign assets			1,559	1,434	969	854	591	1,189	1.459	3,776	3,633
	Central Bank1		1,584	1,494	1,061	933	681	1,192	1,449	3,717	3,689
	Government2		25	31	4	—	8	9	16	13	23
	Commercial banks		−51	−91	−96	−79	−108	−12	−6	46	−79
Domestic credit			3,859	4,399	4,968	5,297	6.414	6.563	7,475	7,798	9,255
	Government (net)		479	466	930	1,100	1,767	1,500	1,898	1,495	1,800
		Claims	1,019	1,008	1.036	1,183	1,789	2,279	2,043	2,787	3,206
		Deposits	540	542	106	83	22	779	145	1,292	1,406
	Nongovernment		3,380	3,923	4,036	4,197	4,647	5,063	5,577	6,303	7,455
		Official entities	237	176	223	221	303	250	215	205	259
		Private sector3	3.143	3,747	3,813	3,976	4,344	4,813	5,362	6,098	7,796
Other items (net)			−69	−19	−18	−59	180	321	479	622	475
Money and quasi-money			5,356	5,708	5,619	6,077	6,814	7,432	9,454	10,952	12,413
	Money		3.862	4,063	4,016	4,052	4,540	4,966	5,674	7,496	8,427
		Currency outside banks	982	1,015	1,086	1,022	1,234	1,194	1,625	1,765	2,181
		Demand deposits4	2,880	3,068	2,930	3,030	3,306	3,772	4,049	5,731	6,246
	Quasi-money		1,494	1.625	1,803	2,025	2,274	2,466	2,780	3,456	3.986
SDR allocations			130	134	134	134	—5	—	—	—	—

Sources: Central Bank of Kenya, Annual Report lor the Financial year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Foreign liabilities include use of Fund credit.

²Foreign exchange holdings.

³Includes Cereals and Sugar Finance Corporation and Agricultural Finance Corporation.

⁴Adjusted for “uncleared effects.”

⁵The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

TABLE 7.

Kenya: Summary Accounts of the Monetary Authorities, 1973–77

(In millions of Kenya shillings)

Source: Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Includes balances with banks abroad and foreign securities.

²Includes use of Fund credit.

³Includes revaluation account, uncleared effects, and other unclassified assets and liabilities.

⁴The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

TABLE 7.

Kenya: Summary Accounts of the Monetary Authorities, 1973–77

(In millions of Kenya shillings)

Item				1973	1974		1975		1976		1977
	December				June	December	June	December	June	December	June	December
Net foreign assets				1,609	1,525	1,065	933	689	1,201	1,465	3,730	3,712
	Foreign assets			1,615	1,559	1,354	1,380	1,439	1.867	2,309	4,477	4,282
		Foreign exchange1		1,371	1,305	1,333	1,340	1,403	1,862	2,282	4,432	4,143
		SDRs		142	148	16	40	36	5	27	45	139
		Reserve position in the Fund		102	106	—	—	—	—	—	—	—
	Foreign liabilities2			6	34	289	447	750	666	844	747	570
Domestic credit				−88	−31	726	872	1,205	678	787	−53	−17
	Government (net)			−95	−33	490	586	1,171	636	778	−53	−35
		Claims		369	399	526	575	1,112	1,295	851	1,100	1,243
			Advances	200	200	200	339	543	288	200	200	200
			Treasury bills	60	22	146	87	284	164	20	—	133
			Government securities	109	171	177	149	150	709	497	741	726
			SDR allocations used by Government	—	—	—	—	134	134	734	134	134
			Trust Fund loans	—	—	—	—	—	—	—	25	50
		Deposits		464	432	36	−11	−59	659	73	1,153	1,278
	Official entities			7	—	—	—	—	—	—	—	—
	Commercial banks			—	2	236	286	34	42	9	—	18
Other items (net)3				−4	−40	−132	138	281	145	251	287	462
Reserve money				1,395	1,400	1,789	1,533	1,613	1,734	2,001	3,390	3,233
	Currency outside banks			982	1,015	1,086	1,022	1,234	1.194	1,625	1,765	2.182
	Currency in commercial banks			137	117	253	161	174	189	205	217	241
	Banks' deposits			221	261	381	313	131	311	133	1,268	730
	Official entities' deposits			55	6	69	37	74	40	38	139	80
SDR allocations				130	134	134	134	—4	—	—	—	—

Source: Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Includes balances with banks abroad and foreign securities.

²Includes use of Fund credit.

³Includes revaluation account, uncleared effects, and other unclassified assets and liabilities.

⁴The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

View Table

TABLE 7.

Kenya: Summary Accounts of the Monetary Authorities, 1973–77

(In millions of Kenya shillings)

Item				1973	1974		1975		1976		1977
	December				June	December	June	December	June	December	June	December
Net foreign assets				1,609	1,525	1,065	933	689	1,201	1,465	3,730	3,712
	Foreign assets			1,615	1,559	1,354	1,380	1,439	1.867	2,309	4,477	4,282
		Foreign exchange1		1,371	1,305	1,333	1,340	1,403	1,862	2,282	4,432	4,143
		SDRs		142	148	16	40	36	5	27	45	139
		Reserve position in the Fund		102	106	—	—	—	—	—	—	—
	Foreign liabilities2			6	34	289	447	750	666	844	747	570
Domestic credit				−88	−31	726	872	1,205	678	787	−53	−17
	Government (net)			−95	−33	490	586	1,171	636	778	−53	−35
		Claims		369	399	526	575	1,112	1,295	851	1,100	1,243
			Advances	200	200	200	339	543	288	200	200	200
			Treasury bills	60	22	146	87	284	164	20	—	133
			Government securities	109	171	177	149	150	709	497	741	726
			SDR allocations used by Government	—	—	—	—	134	134	734	134	134
			Trust Fund loans	—	—	—	—	—	—	—	25	50
		Deposits		464	432	36	−11	−59	659	73	1,153	1,278
	Official entities			7	—	—	—	—	—	—	—	—
	Commercial banks			—	2	236	286	34	42	9	—	18
Other items (net)3				−4	−40	−132	138	281	145	251	287	462
Reserve money				1,395	1,400	1,789	1,533	1,613	1,734	2,001	3,390	3,233
	Currency outside banks			982	1,015	1,086	1,022	1,234	1.194	1,625	1,765	2.182
	Currency in commercial banks			137	117	253	161	174	189	205	217	241
	Banks' deposits			221	261	381	313	131	311	133	1,268	730
	Official entities' deposits			55	6	69	37	74	40	38	139	80
SDR allocations				130	134	134	134	—4	—	—	—	—

Source: Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

¹Includes balances with banks abroad and foreign securities.

²Includes use of Fund credit.

³Includes revaluation account, uncleared effects, and other unclassified assets and liabilities.

⁴The domestic counterpart of Kenya's SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.