Kenya: Staff Report for the 2003 Article IV Consultation
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International Monetary Fund
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Publication Date:
09 Jul 2003
eISBN:
9781451821079
Language:
English
Keywords:
ISCR; CR; Anticorruption legislation; staff projection; government; legislation; Kenyan authorities; public expenditure; debt service; monetary policy; U.S. dollar; East Africa; central government
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Kenya showed low economic performance owing to governance problems and the slow pace of structural reforms. Executive Directors emphasized the need to lower public debt and tighten fiscal and monetary policies. They commended the anticorruption strategy and advised to improve governance, reform the tax system, and ensure fiscal sustainability. They stressed the need to align the Poverty Reduction Strategy Program (PRSP) to the budget and to strengthen public expenditure policy and banking supervision. They welcomed the decision of implementing the full PRSP and emphasized the need to implement the program without interruption.

Abstract

Kenya showed low economic performance owing to governance problems and the slow pace of structural reforms. Executive Directors emphasized the need to lower public debt and tighten fiscal and monetary policies. They commended the anticorruption strategy and advised to improve governance, reform the tax system, and ensure fiscal sustainability. They stressed the need to align the Poverty Reduction Strategy Program (PRSP) to the budget and to strengthen public expenditure policy and banking supervision. They welcomed the decision of implementing the full PRSP and emphasized the need to implement the program without interruption.

I. Introduction

1. At the conclusion of the last Article IV consultation in March 2002 (SUR/02/33, 3/19/02), Directors commended Kenya for achieving a measure of macroeconomic stability during recent years in difficult circumstances. Directors, however, were concerned that the macroeconomic and financial situation remained fragile, and that investor confidence was low. They stressed the importance of implementing a comprehensive medium-term economic and structural reform program and undertaking measures to address the governance problems that had stalled progress to date. Directors stressed that it was important for Kenya to implement the prior actions needed to resume the Poverty Reduction and Growth Facility (PRGF)-supported program and to help restore confidence.1

2. The 2003 Article IV consultation discussions focused on an assessment of the financial outlook for the remainder of 2002/03 (July-June), with an emphasis on the budgetary implications of universal free primary education. Also, the discussions examined the adequacy of the medium-term reform agenda to decisively address Kenya’s tepid growth, its weak budgetary position and large domestic debt, and its suitability for Fund support under a new PRGF arrangement.

II. Background and Historical Developments

A. Real Economy

3. Kenya’s economic performance during the past 25 years has been well below its potential, reflecting primarily the persistence of pervasive governance problems and the slow pace of structural reform. Specific factors contributing to low economic and employment growth and virtually no productivity growth include the following: low saving and capital formation; weak property rights and an unpredictable judicial system; a weak banking system; intermittent shortages and high costs of power; poor infrastructure; a falling primary education enrollment ratio; labor market rigidities; and a deteriorating security situation. As a result, Kenya’s real per capita GDP was lower in 2002 than it was a decade earlier (Figures 1 and 2), and the number of people living below the poverty line is estimated to have increased from 11.3 million, or 48.4 percent of the population, in 1990, to an estimated 17.1 million, or 55.4 percent of the population, in 2001. Moreover, in recent years, the incidence of the HIV/AIDS pandemic has risen markedly, thereby increasing the social and economic burden.

Figure 1.
Figure 1.

Kenya: Real GDP Per Capita, 1962–2002

(Kenya shillings)

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Sources: Kenyan authorities; and Fund staff estimates.
Figure 2.
Figure 2.

Kenya: GDP Volume Growth, 1963–2002

(Percentage change)

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Sources: Kenyan authorities; and Fund staff estimates.

Kenya; Status of Prior Actions for Negotiating a New Program

Governance

Reflecting the main components of the new strategy developed by the authorities and discussed with the IMF staff, near-term actions and indicators of success that were required to allow the conclusion of the first and second reviews under the PRGF arrangement and the approval of a new program include the following:

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Other issues

In addition to finalization of a full poverty reduction strategy paper that could form the basis for the new program, bringing the PRGF-supported program back on track will also require the following:

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1LEG has provided comments on the draft bills and the authorities have indicated that these will be considered during the parliamentary debates.

4. The economic growth rate has been on a declining trend over the last three decades, according to the official national accounts (Figure 2).2 The annual rate of growth of real GDP, which averaged 7.5 percent during 1971–80, fell to 4.3 percent during 1981–90, and to 1.9 percent during 1991–2000. Real GDP is estimated to have increased by only 1.2 percent in 2001 and 1 percent in 2002. All major industries registered a decline in growth, which was more pronounced in agriculture, construction, and manufacturing (Table 1)—sectors that are important for the livelihoods of the poor.

Table 1.

Kenya: GDP by Industry, 1971–2000

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Source: Kenyan authorities.

5. Weaker growth was accompanied by a fall in savings and investment rates. The ratio of total savings to GDP declined from 20.3 percent in 1985–90 to 11.8 percent in 1996–2000 and to an estimated 9.6 percent in 2002. Similarly, the ratio of gross investment to GDP fell from 24.3 percent in 1985–90 to 18.1 percent in 1996–2000 and to an estimated 13.7 percent in 2002.

B. Fiscal Developments

6. The growth decline was also accompanied by a significant expansion in public sector outlays and public sector debt. This was reflected in a sharp increases in wages and salaries and interest payments, a drain on public resources due to inefficient state enterprises, and a contraction of public outlays on social and economic services. Wages and salaries as a share of central government expenditure rose from about 25 percent in 1990 to almost 38 percent in 1999, significantly above the level in most other African countries (Figure 3). There is a broad consensus in Kenya that the public sector, with few exceptions, is overstaffed. At the end of 2001, the public sector employed almost 40 percent of total formal sector employment. The overall expansion of the public sector peaked in the mid-1990s when total central government expenditures rose to almost 35 percent of GDP from about the 20 percent of GDP recorded in the 1960s and early 1970s. Waste and inefficiency in the public sector reportedly increased in tandem. Inadequate spending on operations and maintenance, and the accompanying deterioration of public infrastructure, contributed to a decline in overall total factor productivity.

Figure 3.
Figure 3.

Selected African Countries: Wages and Salaries in Percent of Total Central Government Expenditures, 1990–2002

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Source: World Economic Outlook.

7. Since the mid-1990s, central government revenues have declined steadily, dropping from the relatively high level of 29 percent of GDP in 1995/96 to 22 percent in 2001/02. The largest contributor to the decline in revenues was the policy-induced shrinkage of receipts from corporate taxes and excise duties. The revenue decline was accompanied by significant deviations of revenue outturns from budget projections, as well as a collapse of donor support, which complicated budget management and contributed to an expansion in the stock of pending bills and stalled projects (see Box 2).3 These factors also led to a significant increase in domestic financing and a corresponding rise in domestic debt and related interest payments. By end-June 2002, central government domestic debt was 22 percent of GDP, while the net present value (NPV) of external debt had declined to 30 percent of GDP from slightly above 60 percent of GDP in 1996. The government’s contingent liabilities in the financial and the nonfinancial public enterprises have also risen sharply.

Kenya: Pending Bills and Stalled Project—Problems and Solutions

Expenditure control in Kenya is generally poor. Existing financial regulations have not been enforced, and the Ministry of Finance has been unable to adequately monitor expenditure. Poor financial compliance and accountability have led to the persistent accumulation of domestic arrears (pending bills). The unrealistic costing of policies has aggravated the problem of poor compliance, giving rise to many irregular within-year additions to spending. Too many capital projects have been included in the development budget, few have been completed, and overall efficiency in government capital spending has been reduced, with a remaining large stock of stalled projects. Debt service and wages, moreover, have crowded out operations and maintenance spending—especially utility payments.

The Kenyan authorities recognize that decisive actions to solve these problems are needed—by formulating more realistic budgets, curtailing and rationalizing government operations, and enforcing fiscal discipline to ensure that the budget is respected. Several attempts have been made in the past to resolve these problems, among others, to investigate the claims and to compile an inventory of stalled projects, but these efforts had limited success. The government has once again confirmed their intentions to solve these problems (and to avoid their re-occurrence). Their current efforts to get a handle on the extent and magnitude of the problems included the investigation of all pending bills, especially in light of allegations that contractors were fraudulently paid just before the December election. An inventory of stalled projects was previously completed and is currently being updated.

These actions by the authorities are encouraging, but further improvements of public expenditure management procedures will be necessary to consolidate the progress made. A more systematic treatment of the present stock of pending bills is required, including the undertaking of an audit and the formulation of a strategy for its payment and final resolution. Measures in this direction should include

  • establishing a cutoff date for old pending bills;

  • establishing a formal mechanism to review and report on overcommitments and pending bill information;

  • undertaking a onetime comprehensive audit of the legitimacy of old pending bills, using an external auditor; and

  • developing a strategy and timeframe for paying off legitimate old pending bills.

To prevent the future accumulation of arrears, control over expenditure commitments is recommended, as well as stricter control of within-year changes to the budget. The following measures could be taken to improve expenditure control:

  • enforce commitment limits in addition to the present limits on exchequer releases;

  • impose sanctions on financial officers who fail to control commitments or allow arrears to accumulate;

  • expand the monthly expenditure returns to incorporate the commitment and expenditure information and overdue pending bills, as well as recent and prospective cash releases, and

  • ensure that monthly returns are of sufficient quality and prepare quarterly reports on progress in improving budget execution procedures.

III. Key Constraints to Growth

8. The Kenyan business community lists poor infrastructure, high crime rates, and corruption as their main constraints (Figure 4). The telecommunications system is inefficient. Internet access is low, and Kenya’s fixed-line telephone system is in a state of disrepair with long waiting times for installation and a small number of telephone main lines. The lack of progress in reforming the power sector in Kenya has led to an inefficient system for power distribution and high costs of electricity. The cost of electricity in Kenya is roughly 8 U.S. cents per kilowatt-hour, compared with about 2 and 2.7 U.S. cents, respectively, in South Africa and Egypt, Kenya’s main competitors. Kenya’s road system, moreover, is a serious impediment to production and export.

Figure 4.
Figure 4.

Kenya and Africa; General Constraints on Enterprises1

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Source: Business Climate Survey, 2000, World Bank1 Percent of enterprises rating constraint as moderate or major, as opposed to minor.

A. Corruption

9. Many of the problems associated with the inefficient use of public resources and weak investment and productivity are rooted in corruption and political interference in the functioning of government and legal institutions. Corruption is widely thought to have reached epidemic proportions in the 1990s. The problem was exacerbated by a police and court system that was largely ineffective at investigating and prosecuting corruption cases.

B. Financial System

10. The lack of financial services and access to commercial lending at affordable rates, particularly for small businesses and fanners, has been another serious constraint on growth. Kenya’s banking system has been in a fragile and deteriorating state for some years. Banks have been reluctant to lend, and the spreads between deposit and lending rates have been wide, mainly because of the large share of nonperforming loans (NPLs), politically motivated directed lending, and the extreme difficulties involved in recovering through liquidation of collateral. Two-thirds of total NPLs are concentrated in the six public sector banks, which account for about 28 percent of total bank assets and deposits.

C. The Labor Market

11. Labor market policies and labor market rigidities appear to have hurt growth and formal sector employment, and pushed the lower segment of the labor market into the informal sector4 and unemployment. During 1995–2001, real earnings in the private and public formal sector increased at average annual rates of about 12 percent (Figure 5). The large increases in earnings can be traced partly to collective wage agreements and rapid rises in minimum wages. As a consequence of high wages, taxes, and other regulatory costs, most employment creation occurred in the informal sector. During 1995–2001, formal sector employment increased at an average annual rate of 1.2 percent, compared with 12.8 percent in the informal sector. The implications of the relative shrinkage of the formal sector include reduced external competitiveness and productivity growth, lowered growth prospects, lost fiscal revenues, and a deepening of poverty.

Figure 5.
Figure 5.

Kenya: Formal Sector Real Average Earnings, 1981–2001

(Percentage change)

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Sources: Kenyan authorities.

D. Inflation, Money Growth, Interest Rates, and the Exchange Rate

12. During 1998–2001 and the first half of 2002, the government pursued a tight monetary policy, which succeeded in lowering the inflation rate, the treasury bill interest rates, and the perceived country risk premium. The inflation rate was reduced from 47 percent in 1993 to less than 2 percent in 2002. Following the significant disturbances to the financial system in the early 1990s, moreover, the nominal and real U.S. dollar exchange rates for the Kenya shilling have stabilized. Since late 2000, the exchange rate has remained at about KSh 79 per U.S. dollar. These favorable developments resulted in a significant reduction in the perceived country risk premium, as measured by the difference between the Kenyan and U.S. short-term real treasury bill rates (Figure 6), and allowed the nominal and real treasury bill rates to come down significantly. The nominal 91-day treasury bill rate had dropped to 8.3 percent by end-December 2002 from a peak of 70 percent in 1994, and the real treasury bill rate to 4.3 percent in December 2002 from about 20 percent during most of 1996–98. The risk premium against the U.S. treasury bill rate dropped from an average of 13 percentage points in 1996 to 3.6 percentage points in June 2002, before increasing somewhat in the run-up to the election, in spite of the recent sharp decline in U.S. interest rates in real terms.

Figure 6.
Figure 6.

Kenya and United States: Treasury Bill Interest Rate Spread and the Exchange Rate, 1991–2002

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Sources: U.S. and Kenyan authorities; and Fund staff estimates.1/ An increase in the index denotes an appreciation.

13. Kenya’s real effective exchange rate (REER) has shown considerable volatility in the last two decades (Figure 7). Following a sharp depreciation of approximately 29 percent between 1981 and 1991, the REER has appreciated back toward its 1980 level. This development is broadly reflective of the changes in Kenya’s terms of trade. Large disturbances to the financial system in the early 1990s and high and volatile inflation, however, caused significant volatility around this trend in the first half of the 1990s.5 Developments in the REER and the terms of trade differed significantly between December 1999 and April 2001, with the REER appreciating by 16 percent and the terms of trade remaining broadly unchanged. This development was mainly caused by the significant donor inflows, including the November 2000 Paris club rescheduling. It could also be partly reflecting an increased willingness to hold Kenya shillings in response to the improved monetary management, lower inflation, and increased macroeconomic stability in the latter part of the 1990s. The appreciation of the REER in 2000 most likely contributed to the low economic growth over the last couple of years. Since February 2002, the REER has depreciated by about 9 percent.

Figure 7.
Figure 7.

Kenya: Terms of Trade and Real and Nominal Effective Exchange Rates, January 1980-December 2002 (1990=100)1/

Citation: IMF Staff Country Reports 2003, 199; 10.5089/9781451821079.002.A001

Sources: IMF Information Notice System and World Economic Outlook.1/ An increase in the terms of trade index denotes an improvement and an increase in the exchange rate indices denotes an appreciation.

IV. Recent Economic Developments and Prospects for 2002/036

A. Real

14. Real GDP grew by 1.2 percent in 2001/02, and is projected to edge up to 1.5 percent in 2002/03, supported primarily by a strong performance of manufacturing and agricultural exports. Following a sharp contraction in 2001/02, there are indications of a rebound in private sector investment, with bank credit to the private sector picking up in recent month—between March and December 2002, it increased by 6.1 percent.

15. After a significant drop in inflation to about 2 percent in the first half of 2002, the consumer price index (CPI) has registered a sharp increase in recent months, partly on account of a transitory tightening of the food supplies and the surge in retail prices of petroleum products. The overall CPI increased by 10.1 percent in the 12 months to March 2003, while the overall CPI excluding food and fuel (underlying inflation) increased by 3.8 percent. At the same time, the growth of monetary aggregates has risen, reflecting a rebound in private sector credit and increased cash holdings by the public before the December 2002 elections; meanwhile, the 91-day treasury bill rate dropped to 5.8 percent by mid-March 2003 from around 10 percent a year earlier. These developments have exerted upward pressure on prices and downward pressure on the exchange rate of the Kenya shilling, which has weakened over the past year, along with the U.S. dollar, vis-à-vis other major currencies. The nominal effective exchange rate of the shilling fell by about 9.0 percent during 2002. Since the December 2002 election, however, faced with strong exchange rate appreciation pressures, the authorities increased foreign reserves by around US$170 million, in line with their objective of increasing the reserves coverage to four months of imports. Nevertheless, the shilling has appreciated by 4.4 percent against the U.S. dollar and since the end of January 2003, by 1.6 percent against the Euro.

B. Fiscal

16. In the first six months of 2002/03, revenue performance was slightly weaker than projected, largely due to lower-than-expected economic growth and, to a lesser extent, delays in the introduction of tax administration measures announced in the budget. Total revenue of the central government for the year is now expected to be KSh 212.0 billion, compared to the originally budgeted amount of KSh 218.9 billion, an underperformance of about 0.7 percent of GDP.

17. Expenditures are expected to be substantially higher than budgeted in 2002/03. The main cause is a KSh 5.0 billion increase in housing allowances for teachers that were not provided for in the budget, and the additional expenses associated with providing free primary education (KSh 2.8 billion). This will result in a higher deficit (on a cash basis after grants) of 5.5 percent of GDP compared to the budgeted deficit of 3.2 percent. Moreover, privatization proceeds and net foreign financing are likely to be less than budgeted. The net financing requirement, thus, is expected to rise to KSh 58.7 billion (6.1 percent of GDP compared to 3.3 percent of GDP in the budget) for 2002/03 as a whole, of which 3.4 percent of GDP will have to be sourced during the last two months of the fiscal year. Given the limited scope for higher foreign financing most of this will have to be funded by domestic borrowing. The government has indicated its commitment to fully implement the budget as outlined in the supplementary estimates by year-end—with no additional increase in the stock of pending bills or delays in investment spending as was the practice in the past.7

C. External

18. The external current account deficit deteriorated further in 2002, mainly owing to a reduction in private transfers associated with a drop in drought assistance.8 It is estimated that the deficit (including official grants) widened from 3.5 percent of GDP in 2001 to 4.3 percent of GDP in 2002. Export volume growth slowed somewhat, falling from 11.6 percent in 2001 to approximately 8.3 percent in 2002. Nevertheless, some aspects of export growth in 2002 were encouraging, particularly the growth of nontraditional items, such as horticulture exports to the European Union (EU) and manufactured exports to the African regional market. Available evidence also suggests that the U.S. African Growth and Opportunity Act (AGOA) is having a positive impact, as AGOA exports increased from approximately US$30 million in 2000 to US$140 million in 2002, largely as a result of a significant rise in garment exports. After increasing by 7.3 percent in 2001, import volume declined by 2.1 percent in 2002.

V. Medium-Term Outlook and Risk Assessment

A. Main Elements of the Authorities’ Reform Agenda

19. The authorities’ reform agenda is still under discussion, which will bring together the main elements of the government’s election manifesto, the Economic Recovery Program currently under preparation, as well as the priorities identified during the consultations for the poverty reduction strategy paper (PRSP). Meanwhile, the Ministry of Planning and National Development has prepared a paper on the strategy for economic recovery for discussion among the government, domestic stakeholders, and development partners. The paper aims to address the three challenges of reducing unemployment, increasing the utilization of productive capacity, and eliminating poverty. The planned strategy targets a growth rate of 7 percent per annum in the medium term, and focuses on job creation and the expansion of opportunities for poor farmers, micro and small enterprises, and the economically disadvantaged. It calls for the creation of an interministerial task force to alleviate the constraints facing small enterprises. The authorities are also likely to focus initially on policies to encourage tourism and agriculture and to attract investment in labor-intensive export processing. Following concerns expressed by the World Bank that the Economic Recovery Program focused too narrowly on private sector growth, it was agreed that it would be revised to cover social and environmental sustainability issues which are considered essential elements of a comprehensive growth and poverty-reduction strategy.9

20. The discussion paper argues appropriately for a rapid restoration of public confidence in the core functions of government, in particular efficient and impartial law enforcement and administration of justice, a competent and responsive public administration, and an evenhanded framework of economic regulation. As regards the macroeconomic framework, the objectives are to maintain low inflation and promote economic recovery, by improving public expenditure management and relying on adequate fiscal restraint to increase public savings and retire the domestic public debt. To obtain value for money, cost benchmarks and service delivery targets are expected to be established for all government ministries and other public bodies. The discussion paper calls for the creation of independent task forces to review the competitiveness policy, regulatory frameworks, and pricing structures for credit, electricity, telecommunications, and petroleum products.

B. Outlook for Growth and Poverty Reduction

21. Since December 2002, the investment climate has improved significantly, and growth may have started to pick up. When account is taken of the deep economic decline during the 1990s, the planned public investment program, and the expected strong rebound in private investment, growth over the medium term is likely to be substantial. Much of this growth is likely to come from an expansion of the manufacturing and construction sectors. There is excess capacity in major industries, some of which can be brought onstream fairly quickly. As the economic hub of east Africa, Kenya is well positioned to increase its penetration in African markets, with exports (mainly manufactured) to these markets already accounting for 50 percent of total exports. Kenya, moreover, has a diversified economic base and is well placed to further benefit from the AGOA initiative.

22. Against this background, the staff together with the authorities developed two medium-term macroeconomic scenarios.10 Both scenarios assume a prudent monetary policy that would limit the increase in the consumer price index (CPI) to an average annual rate of 3.5 percent. The high-case scenario assumes implementation of a strong package of economic reforms to raise the growth rate to about 6 percent by 2006/07 (Table 2). In particular, it assumes the following:

Table 2.

Kenya: Medium Term Macroeconomic Scenarios, June-July Fiscal Year 2000/01–07/08

(In percent of GDP, unless otherwise indicated)

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Sources: Kenyan authorities; and staff estimates and projections.

Fiscal year ending June 30.

Despite the strong adjustment effect assumed under this scenario, donor inflows are projected to average 5.0 percent of GDP, well below the amounts received by economies in the subregion with PRGF-supported programs.

  • A strong implementation of the governance agenda results in a rapid restoration of public confidence in the core functions of government, impartial law enforcement and efficient administration of justice, and a competent and responsive public administration.

  • A significant increase in public savings and strong implementation of infrastructure investment (e.g., in the transport, telecommunications, and power sectors) and privatization programs reduces the costs of doing business in Kenya, and spurs large increases in foreign direct investment and domestic private investments. The privatization of the telecommunication sector, as well as the streamlining of the regulatory framework would lay the ground for a major expansion of private investment.

  • Decisive measures would be taken to substantially broaden the tax base and improve the tax system, in order to increase the revenue-to-GDP ratio from 22.2 percent in 2002/03 to 24.9 percent by 2007/08. Higher economic growth and the restructuring of the financial and corporate sectors should increase corporate profitability and formal sector employment, and thus boost income tax receipts and revenue collection.

  • Far-reaching public sector reforms would facilitate a decline of the wage bill from 9.2 percent of GDP in 2002/03 to 7.2 percent by 2007/08. Expenditures would be restructured to increase the allocations for essential social and economic services, including for education, operations and maintenance, and development (Table 2).

  • A speedy restoration of budget support by donors, to facilitate a rapid retirement of domestic debt. The domestic debt-to-GDP ratio is assumed to decline from 32.0 percent in 2003/04 to 9.4 percent by 2007/08.

  • The banking system would be strengthened, through early actions to resolve the problems of the National Bank of Kenya. Over the medium term, the focus would be on speedy institution and enforcement of international banking supervision standards, and on ensuring that in licensing financial institutions, there is a clear separation of policymaking from policy implementation.

23. Under the high-case scenario, Kenya would make good progress toward achieving the Millennium Development Goal (MDG) of reducing poverty incidence to about 24 percent by 2015, from over 50 percent currently. Gross capital formation could rise from 14 percent of GDP in 2001/02 to 22.6 percent by 2007/08, and there would be good prospects for achieving a real GDP growth in excess of 6 percent a year over the medium term. The external current account deficit (excluding official grants) would widen to about 8.8 percent of GDP in 2005/06 before coming down somewhat, as imports would expand in response to the economic recovery and the increase in public spending for poverty reduction. After an initial decline to 2.3 months import cover in June 2004, gross international reserves would rise steadily to the equivalent of about 4.8 months of the following year’s imports.

24. The base-case scenario assumes a more modest pace of reforms and a more gradual increase in donor assistance, with consequent lower capital formation outcomes. It assumes in particular the following:

  • a slower implementation of the governance agenda;

  • a moderate increase in foreign direct investment and domestic private investments;

  • limited progress in reforming the tax system and tax collections, resulting in essentially no increase in revenues as a share of GDP;

  • a more modest decline of the wage bill to 8.3 percent of GDP by 2007/08;

  • a slower restructuring of the budget with expenditures on operations and maintenance assumed to only increase to 5.5 percent of GDP by 2007/08 and the development expenditures-to-GDP ratio to 4.4 percent; and

  • a slower return of donor support, resulting in only a modest decline in the domestic debt-to-GDP ratio to 25.9 percent by 2007/08.

25. In the base case, real GDP growth peaks at 4.8 percent in 2006/07, or 2.8 percent per capita, which would not be sufficient to achieve the MDGs, although poverty incidence could still be reduced to about 35 to 40 percent.11 The domestic debt would decline only slightly, and the reserves coverage would increase over the medium term to only 3.9 months of imports.

C. Risk Assessment and External Environment

26. The projected economic recovery is fragile. The uncertain world economic outlook and the continued difficult budget and financing situation, as well as potential delays in implementing key reforms, could produce a less favorable outcome than assumed in the base-case scenario (see Appendix Table 14).

27. The crisis in the Middle East poses a major threat to the projected recovery. It has already resulted in a marked increase in the prices of petroleum products and contributed to a pickup in inflation. In the event that (i) oil import prices average about US$40 per barrel over the next six months before returning to the World Economic Outlook (WEO) baseline of US$31 per barrel, (ii) export market growth drops by 1.8 percent from the baseline this year, and (iii) tourist arrivals fall by about 20 percent, the current account deficit would widen by US$140 million, or 1.1 percent of GDP in 2003. This scenario could result in a further expansion in the fiscal deficit as revenues from petroleum taxes would likely fall. The higher deficit could fuel inflationary pressure and have a significant dampening effect on the projected recovery.

28. Over the medium term, it will be difficult to reduce the wage bill, because of the announced salary increases for teachers (spread out over ten years) and members of parliament. The increases in teachers’ salaries may also build up pressure for increases in the salaries of other civil servants. Furthermore, retrenchment efforts in recent years have had limited success in reducing the total wage bill.

29. Budgetary management will continue to be difficult in 2002/03 and 2003/04. Because donor support for the authorities’ reform program will resume only gradually, some new expenditure programs will be initiated, and time will be required to significantly restructure the budget, the domestic financing requirement is likely to rise substantially during the remainder of 2002/03 and stay high during 2003/04. The much-needed restructuring of the banking system, in addition, would likely involve the substitution of some contingent liabilities by government bonds. As a consequence, domestic debt will continue to rise in the near term, and there could be considerable upward pressure on interest rates.

30. To minimize the adverse effects of the large domestic borrowing requirement on macroeconomic stability, the staff discussed with the donor community the prospects for an early disbursement—before the end of the 2002/03 fiscal year—of some aid commitments. Indications are that budgetary assistance amounting to about US$145 million (about 1.1 percent of GDP) could be disbursed by end-June 2003, in the event of satisfactory progress toward a new Fund-supported program. This would still leave a domestic financing requirement of about 5.0 percent of GDP.

31. The expectations of the Kenyan public are high, and the authorities stressed the importance of showing early results, especially regarding governance and institution reforms. Many of the fiscal, labor market, and financial sector reforms that are essential to achieve high GDP and employment growth will be politically challenging and require time to prepare properly. In the discussions, senior officials pointed out that the cabinet system of government had so far been operating smoothly and that the ruling coalition possessed both the cohesion and determination to implement the needed reforms on a sustained basis.

VI. Policy Discussions

32. The discussions focused on the factors underlying the weak economic performance in recent years and the steps the authorities are taking to address the underlying structural problems. As indicated earlier, widespread governance failures contributed to Kenya’s poor economic performance. Corruption was primarily responsible for the emergence and persistence of the pending bills problem, the rise in government spending on unproductive activities, the eventual withdrawal of donor budgetary support, and the consequent decline in public investment spending. It also contributed to the marked deterioration in the asset quality of public banks and the decline in private investment. Accordingly, the actions (Box 5) that the authorities have begun to implement to address corruption represent important initial steps to rebuild the economy. The government recognizes that these actions will, however, need to be reinforced by a multi-faceted reform agenda that is credible and backed by adequate donor support.

33. The discussions also focused on the structural measures needed to address Kenya’s major macroeconomic vulnerabilities. These include (i) the high domestic debt burden and the large outstanding contingent liabilities of the government; (ii) a weak financial system; (iii) a sizable parastatal sector, with a significant potential for bailout; (iv) the large shares of public outlays absorbed by wages and salaries and interest payments; and (v) labor market rigidities. In this connection, the staff agreed with the authorities that the full PRSP should present a coherent medium-term reform agenda aimed at: (i) reducing Kenya’s total public debt as a proportion of GDP; (ii) strengthening expenditure management, reorienting expenditure toward PRSP priorities, and improving the productivity of public outlays; (iii) divesting government from commercial activities, including ownership of commercial banks; (iv) enhancing the supervisory framework for financial institutions and the prudential supervision of these bodies to international levels at an early date; and (v) improving the flexibility of labor markets. These actions will also help to safeguard Kenya’s external competitiveness and ensure that increased capital inflows are used efficiently.

A. Restructuring the Fiscal Position

34. Fiscal restructuring, including tax and public expenditure reforms, will be key to the achievement of the high-growth scenario. There is a need to restore fiscal sustain ability over the medium term starting with early steps to address the contingent liabilities of the financial sector in the near future. The Kenyan authorities agreed with this view, but stressed that external donor support and rapid economic growth would be important for reducing the domestic debt burden and to establish fiscal sustainability.12

35. The staff argued that it was necessary to reconsider the current tax regime in Kenya, noting that (i) the regime in Kenya was complex, and contained many exemptions; (ii) tax rates were relatively high, especially for excise taxes, direct taxes, and withholding taxes on foreign remittances (see Box 3); (iii) the tax base was narrow; (iv) weak policing and enforcement of tax laws and regulations had led to lower revenue collection; (v) the tax compliance rate was low and tax arrears were prevalent; and (vi) tariff reforms might have a revenue-reducing effect. The authorities recognized that tax measures might be needed to maintain revenues constant as a share of GDP.

Selected Tax Rate Comparisons (East African Region)

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36. The Kenyan representatives indicated that they recognized the urgent need to restructure public expenditure to free resources for poverty reduction. They have therefore initiated work on the identification of policy options, including actions to reduce the wage bill and other benefits. As part of this undertaking, the authorities intend to redesign the mechanisms for setting public sector wages to align them more closely with productivity gains and the availability of resources over time. They also plan to review all existing wage agreements and contracts. The Department of Personnel Management (DPM) is reviewing the role of the government and individual government departments, with a view to focusing government resources on core activities. The authorities will be discussing the implications of this work for the civil service restructuring plans with the staff of the World Bank. The government has also started work on the design of a system to track pro-poor expenditures (see Box 4). The authorities noted, however, that a restructuring of the public sector was not something that could be carried out very quickly, as political commitment needed to be transformed into action plans and timetables.

B. Monetary, Exchange Rate, and International Reserve Issues

37. The monetary authorities’ principal objective is to keep inflation low while providing a stable environment for the financial markets;13 the June 2002 Monetary Policy Statement specified the monetary policy objective principally as one of containing inflation below 5 percent. The CBK indicated that it would continue to use the current monetary policy framework to achieve its policy objectives with broad money (M3X) as the intermediate target and reserve money as the operational target. Open market (REPO and reverse REPO) operations are the main instruments used by the CBK, and interest rates on treasury bills will remain fully market determined. The authorities argued that with the effective use of existing monetary instruments the CBK was successful in achieving low inflation rates.

Kenya: Progress on the Design of an Expenditure-Tracking System for Fro-Poor Expenditures

During the last two years, the government has been monitoring a set of core poverty programs, as requested by the World Bank, on a quarterly basis. These expenditures were chosen on the basis often criteria determining social expenditures as part of the PRSP consultative process. These expenditures, however, represent only a very narrow-based listing of poverty-related expenditure, and the government has in recent months intensified its efforts to expand this listing. As part of the medium-term expenditure framework (MTEF) budget process, spending ministries were requested to provide the Ministry of Planning with an updated list—based on a set of criteria for selecting poverty programs. The criteria include the following:

  • measures to increase the income of the poor (such as access roads, agricultural services, access to credit and financial services);

  • measures that will improve the quality of life of Kenyans (health care, access to clean water, primary education, and the environment);

  • measures to improve security and governance (the protection of human rights, administration of law and justice, reduction of wastage/accountability, security of people and property); and

  • measures that will improve equity and equality (equal opportunity, empowerment, and capability).

The government has undertaken a comprehensive assessment of its public expenditure management system’s capacity to track these pro-poor expenditures, and, it will, with technical assistance from the Fund, the World Bank, and other bilateral donors, design an action plan to strengthen it.

38. Staff welcomed the disinflation that had been achieved, but raised concerns about the relaxation of monetary policy during the latter part of 2002. During that period broad money growth picked up significantly, leading to a decline in treasury bill rates, and a substantial weakening of the Kenya shilling vis-à-vis major currencies. Staff argued that this relaxation of monetary policy could risk reversing the recent hard won gain of reducing inflation below 5 percent. The staff noted that inflation had indeed registered a marked increase in recent months. To consolidate the progress made in reducing inflation, the staff suggested developing a reserve money program aimed at keeping underlying inflation over the medium term under the 5 percent ceiling set out in the Monetary Policy Statement.

39. The staff suggested that, over time, an increase in the foreign reserve coverage to around 5 months of projected imports might be needed to provide a cushion against temporary external shocks and delays in aid disbursements. However, because of the expected large government domestic borrowing requirement for the remainder of 2002/03 and for 2003/04, the reserve build up may have to be backloaded so as not to unduly constrain credit to the private sector within the target range of reserve money growth.

40. Staff also noted the need for greater exchange rate flexibility than has been the case in the recent past. The authorities attributed the stability of the shilling vis-à-vis the U.S. dollar over the last two years to the stance of monetary and fiscal policies, and the weak demand for imports. The staff noted, however, that the remarkable stability of the shilling against the U.S. dollar during 2001 and 2002 suggests that the CBK effectively was shadowing the U.S. dollar. The staff explained the danger of pursuing an unannounced peg for a longer period and stressed the importance of allowing the exchange rate to be fully determined by the market to prevent a misalignment from emerging. In this regard, the greater flexibility of the shilling against the U.S. dollar since the election was welcomed. The authorities noted that they will continue to pursue a flexible exchange rate regime, which they believe to be appropriate for Kenya.

C. Competitiveness Issues

41. The staff discussed with the authorities and representatives of the private sector actions that could be taken to enhance Kenya’s competitiveness. While Kenya’s diversification into nontraditional exports is an indicator of increased competitiveness, the recent slowness in its overall export growth does indicate that there are some valid concerns about international competitiveness. Although data on price determinants of competitiveness in Kenya are scarce, some evidence14 suggests that price factors did have a negative impact on international competitiveness. Information gathered from businesses, however, indicates that nonprice constraints tend to play a more important role in inhibiting business performance in Kenya than specific concerns about the level of the exchange rate.15 For example, policies aimed at enhancing labor market flexibility and containing upward pressures on wages would help to safeguard competitiveness and increase employment opportunities.16 In this regard, efforts to ensure that civil service wage increases are based on improvements in productivity and that a greater degree of wage restraint is exercised in the public sector could help to contain wage pressure in other sectors. Given these considerations, efforts to improve competitiveness will have to focus on price and nonprice factors. As regards the former, the authorities will need to allow greater exchange rate flexibility to ensure that producers face the appropriate structure of economic incentives. The nonprice factors would be addressed through structural reforms (discussed below).

D. Financial Sector and Parastatals

42. Discussions on the financial sector and parastatals focused on the significant contingent liabilities which could lead to a call on the government budget in the near future.17 The very high level of NPLs in the banking system, especially in the public sector banks, has contributed to wide interest rate spreads between lending and deposit rates, which continues to be a matter of serious concern. The authorities noted that the poor condition of many Kenyan banks was the result of past government interference in lending decisions and poor governance. A key objective of the new government is to divest itself from the banking system through privatization, although some banks may need to be restructured to facilitate privatization. In line with recent advice from MAE technical assistance missions, the staff argued for bringing banking supervision up to international standards and better enforcement of already existing prudential regulations. It has been agreed that an FSAP mission will take place in mid-2003.

43. The authorities noted that they would not be in favor of bringing into force the restrictive provisions of the Central Bank of Kenya (Amendment) Act 2000 (the so-called Donde Act), which would place controls on the spread between commercial bank lending and deposit interest rates. The act is not being implemented as its constitutionality has been challenged in the courts. The staff argued that the problem of the spread between lending and deposit rates should be addressed by taking measures to reduce cost pressures in the sector, improving borrower accountability through strengthened commercial courts, making strong efforts to recover the NPLs, and enhancing competition. The government is, nonetheless, very concerned about commercial bank interest rate spreads and public perceptions of malpractice on the part of banks.

44. The privatization program is expected to play a central role in improving the provision of key infrastructure services. In this regard, the government plans to first establish a policy framework for privatization that will be presented to parliament in the near future. This will be followed by a listing of the public enterprises for eventual privatization that would involve sale in the domestic market as well as strategic partnerships with foreign investors.

45. Meanwhile, the government is developing plans, in consultation with the World Bank, for enhancing private sector participation in a number of key parastatals, including Kenya Ports Authority, Kenya Railways, and Kenya Telcom. It is also considering a strategy for divesting its remaining holding in the Kenya Commercial Bank (KCB). It will be important to establish quickly the extent of potential liabilities of the central government associated with the required rationalization of the parastatal sector. In order to be sure that all contingent liabilities have been assessed, staff have also suggested that the authorities undertake a comprehensive audit of the National Social Security Fund, which had invested heavily in land and property, thereby weakening the balance sheet.

E. Governance

46. The new government has placed its anticorruption strategy at the top of its agenda and has embarked on a major strengthening of Kenya’s governance and anticorruption institutions (see Box 5). It has proposed a constitutional amendment to permit the establishment of a fully independent anticorruption agency with investigative and prosecutorial powers, and has gazetted new versions of the Anti-Corruption and Economic Crimes Bill and the Public Service Ethics Bill. While it may be difficult to obtain adequate parliamentary support for a constitutional amendment separately from the wider constitutional review process under way, the government remains committed to establishing an anticorruption authority with independent powers to prosecute, and it is expected that the new constitution will provide for this. The other two governance bills are expected to be passed by parliament by April 2003. Additional steps are under way to strengthen the judiciary, with the assistance of the World Bank and other donors. These actions, if followed by appropriately firm application and enforcement of the rules and regulations, should result in a significant reduction in the wastage of public resources.

F. External Trade

47. At present, Kenya’s trade regime is moderately restrictive—it is rated 6 on the IMF’s 10-point trade restrictiveness index, with 10 being the most restrictive. External tariffs range from 0 percent-35 percent, with eight bands; the simple average tariff is 17.2 percent. The budget for fiscal year 2002/03, announced measures to stimulate exports, particularly manufacturing exports, including the exemption of duty for all capital equipment.18 There is some confusion, however, about the implementation of the policy, with some exporters claiming that they have not benefited from duty exemption. More generally, the private sector contends that the budgetary measures have not been implemented fully, and that relatively high duty rates are still charged on some imported raw materials and intermediate imports.19 The budget also provided for increased protection for selected industries. For example, the most-favored-nation (MFN) duty on imported steel was raised from 20 percent to 35 percent to protect the local industry from increased foreign competition.20 In addition, Kenya continues the pursuit of a discriminatory policy on wheat and sugar imports from the Common Market for Eastern and Southern Africa (COMESA) trading partners, which is designed to protect local producers from what are described as “unfair trading” practices. These are viewed as temporary measures, pending the resolution of these trade frictions through consultations or the COMESA dispute settlement mechanism.21

Governance Measures Taken or Announced by the New Government

The following measures have been taken or announced by the government:

  • The government has publicly placed the fight against corruption and the completion of the constitutional review process at the top of its agenda.

  • The government has established a Ministry of Justice and Constitutional Affairs, which is spearheading government efforts in the governance area.

  • The government has established a Department of Governance and Ethics in the Office of the President, primarily to oversee the implementation of the proposed Public Officers’ Ethics Bill after it is enacted and to provide guidance to public servants on possible conflict of interest and ethical matters in the execution of their duties. This department is headed by the former head of Transparency International (Kenya), who is experienced in such matters and is widely respected.

  • The government is seeking to make provision for the establishment of an anticorruption agency in the new constitution that is under consideration. This agency will have the powers to conduct investigations into alleged corruption cases and undertake prosecution where necessary independently of the Attorney General.

  • The government has published revised versions of the Anti-Corruption and Economic Crimes Bill and the Public Officers’ Ethics Bill. These are expected to be considered in parliament during April.

  • The government has formed an Economic Reform Implementation and Coordination Task Force to oversee the fulfillment of the prior actions for negotiating a new PRGF arrangement and the outstanding measures under the current IDA credit.

  • All sales of public assets, including housing, have been suspended because of concerns about corruption. The government plans to establish a policy framework for privatization—to be approved by parliament—providing a transparent process to determine which public assets are to be sold and how privatization should be undertaken. A draft bill is to be presented to parliament shortly.

  • All payments of pending bills have been suspended, pending a thorough audit of the outstanding stock, because of concerns about corruption.

  • Task forces have been established by the government—Minister for Finance and Minister for Roads, Public Works and Housing—to review of all contracts relating to jobs undertaken for the government and for which payments are pending.

  • A High Court Judge who while under investigation by the Anti-Corruption Police Unit was presiding over the Goldenberg case has been charged in court for involvement in corrupt activities.

  • All senior public officials under serious investigation for corruption have now been suspended.

  • Seminars and workshops on corruption prevention for civil servants, including at the local level, are being continued.

  • With the assistance of the World Bank and other donor agencies, the government is developing an action program to strengthen the judiciary.

  • A new Chief Justice has been appointed.

48. Taken together, the budgetary measures can be said to represent a slight policy reversal of the strategy of trade liberalization to which Kenya has indicated its commitment. The mission urged the authorities to review the recent protective measures in the context of their efforts to develop a medium-term trade strategy conducive to promoting strong economic growth. The authorities have indicated that an important policy issue they are considering is how to ensure that exporters do not pay duty on imported inputs. It is felt that this can best be done either by zero rating these imports or managing an efficient duty drawback scheme.22

49. Kenya is a member of COMESA and the East African Community (EAC), and both regional groups plan to establish customs unions by 2004.23 The authorities indicated that they saw no inconsistency between the two regional arrangements, as it is expected that the EAC will move toward a tariff structure for the customs union based on the agreed COMESA common external tariff system. They expected the EAC to move to the COMESA common external tariff at a faster pace than other COMESA members. The authorities described the EAC as an “inner grouping” of COMESA that would go on a “fast track” to achieve the COMESA customs union.

G. Statistics and Technical Assistance

50. Kenya’s macroeconomic statistics have deteriorated over the past decade, and weaknesses in key statistics hamper economic analysis and surveillance. The staff expressed concerns about (i) the problems with monitoring budgetary data, in particular domestic arrears and pending bills; (ii) the timeliness of trade data; and (iii) the accuracy of national accounts data. The authorities indicated that they are taking actions, with donor assistance, to improve the quality and timeliness of these data. Kenya is participating in the General Data Dissemination System project for Anglophone Africa, and metadata and detailed plans for improving the data over the short and medium term have been posted on the Fund’s Data Standards Bulletin Board. They are also preparing a statistical master plan and a new statistical act that would improve the independence of the Central Bureau of Statistics (CBS). The CBS commenced in early 2002 compilation and publication on a timely basis of a new national CPI (covering 12 urban areas). A peripatetic STA advisor, moreover, is assisting the authorities in improving their national accounts statistics. A revised set of national accounts data is expected to be released in mid-2003.

51. Representatives from the East Africa Regional Technical Assistance Center (AFRITAC) discussed with the Ministry of Finance officials in December 2002 the need for technical assistance in public expenditure management and the general budgeting framework, and for linking the macroeconomic framework to the budget. Fund staff conducted a joint mission with the World Bank in March 2003, with the participation of some bilateral donors, to assess the public expenditure management system in Kenya. AFRITAC is also providing assistance in the areas of secondary government securities market, foreign exchange reserves management, payment systems, and banking supervision.

H. Safeguards Assessment

52. A Stage-Two safeguards assessment was issued for Kenya in January 2001, and since then a number of measures have been taken by the CBK to deal with the issues raised by the report. Key outstanding issues discussed with the staff relate to (i) the establishment of an appropriately structured audit committee of the Central Bank of Kenya Board, and the need for a timetable to regularize an obligation of KSh 36.9 billion payable by the government to the central bank on which interest has not been charged, so as to bring the CBK’s accounts fully into line with International Accounting Standards. The staff of the CBK noted that an audit committee was expected to be established by April 2003, and that negotiations were under way with the treasury to determine the financial terms for the loan. Staff will continue to monitor safeguards issues and any outstanding issues would be incorporated, as needed, in a new PRGF-supported arrangement.

I. The PRSP Process

53. The authorities conducted a comprehensive PRSP consultative process in 2000. While a PRSP document was published by the previous government in September 2001, it did not include the associated government Action Plan (GAP) that was to set out the specific policies that the government intended to follow to achieve the goals of the PRSP. The new government has indicated that it intends to build on the earlier PRSP consultative process and to establish a new reform agenda. The policies identified as part of the economic recovery plan will complement the earlier work undertaken to complete the full PRSP.

J. External Debt

54. Kenya’s external debt appears to be sustainable by the standards of the Initiative for Heavily Indebted Poor Countries (HIPC) Initiative. In 2002, the net present value (NPV) of debt-to-exports ratio was estimated at about 116 percent; the debt-service ratio was approximately 12 percent and is projected to fall further in the medium term. Bilateral agreements have been concluded with all Paris Club creditors in the context of the November 2000 rescheduling.24 During the discussions, the authorities indicated that Kenya had reached a tentative agreement with its commercial creditors in the London Club.

55. Kenya generally has a good external debt-servicing record. Nonetheless, medium-term macroeconomic projections indicate that, in the absence of a new rescheduling request to its Paris Club creditors, Kenya will need initially to curtail its poverty reduction outlays or borrow locally to service its external debt obligations. In these circumstances, the authorities are considering approaching the Paris Club for a further rescheduling in the second half of 2003,25 following agreement on a new program with the IMF. In this regard, the staff, in collaboration with the World Bank and the authorities, will in May 2003 conduct another debt sustainability analysis (DSA) (using end-2002 external debt data) to analyze the implications for total public debt sustainability of an external debt restructuring on both Naples and Houston terms.

VII. Staff Appraisal

56. Kenya’s economic performance in recent years has been well below its potential, reflecting primarily the persistence of pervasive governance problems and the slow pace of structural reforms. Specific factors that have contributed to low economic and employment growth include corruption, low saving and capital formation, a weak banking system, poor infrastructure, weak property rights and an unpredictable judicial system. The implementation of the structural reform components of past Fund/Bank-supported programs has been disappointing, particularly the delay in the privatization of the public utilities. As a result of these factors, Kenya’s real per capita GDP was in 2002 lower than it had been a decade earlier.

57. The challenge facing the new government is to pursue a comprehensive economic reform program without interruption, so as to begin demonstrating tangible results that will encourage further investment and harness increasing support from the international donor community. In order to further encourage investor confidence, sustained progress will be needed in implementing key structural reforms. In the staff’s view, a comprehensive medium-term reform strategy would need to include (i) firm enforcement of planned governance legislation; (ii) strengthened public expenditure management and a reorientation of expenditures towards PRSP priorities; (iii) divestiture of the government from ownership of commercial banks; (iv) strengthened banking supervision; (v) privatization of key parastatals, including Kenya Telkom; and (vii) a medium-term fiscal strategy that allows for domestic debt to be reduced as a share of GDP.

58. The new government should be commended for placing the anticorruption strategy at the top of its policy agenda. Corruption has been primarily responsible for the rise in unproductive public outlays, the growing stock of pending bills, the marked deterioration in the asset quality of financial institutions, and the rise in informal activities, which have negatively affected public revenues. The government has already embarked on a major strengthening of its anticorruption apparatus, including the tabling of key governance legislation, and has taken steps to strengthen the judiciary. These actions, if followed by appropriately firm application and enforcement of the rules and regulations, should significantly reduce the wastage of public resources, improve the incentives for enterprises, and contribute to increased economic growth.

59. The finalization of a full PRSP and the development of a new three-year reform program that is supported by the IMF and the donor community should facilitate the mobilization of urgently needed donor budget support The government’s discussion paper on its Economic Recovery Program is an encouraging start to addressing the outstanding reform agenda. It will be particularly important, however, that the authorities’ full PRSP set out a clear timetable for implementing key policy actions that the government intends to take to address poverty issues and raise growth in the medium term.

60. The need to fund the teachers’ salary increases and the move to universal free primary education, which is essential for tackling poverty, could complicate the management of macroeconomic policies in 2003/04 and beyond. The necessary restructuring of the banking system, moreover, will likely involve the substitution of some nonperforming assets by government bonds. Increased budgetary allocations will also be required to expand the delivery of social services and enhance the productivity of the agricultural sector—key elements of the poverty reduction strategy. To implement successfully the above initiatives will require increased donor assistance, including a new rescheduling of Kenya’s external debt under the Paris Club.

61. The government has recognized the urgent need to restructure public expenditures and has begun to develop policy options, including modalities for rationalizing the structure of salaries, wages, and other benefits, to reduce the wage bill as a share of GDP over the medium term. Measures to address these issues will need to form a key component of the authorities’ new reform program. In the near term, however, these problems will impart a high degree of inflexibility to the budget and will greatly complicate the management of fiscal policy, as the benefits of the remedial measures are expected to be realized after a time lag. Moreover, in order to maintain the credibility of the PRSP process and to reduce poverty in Kenya, budget execution should begin to reflect the priorities identified in the PRSP process, and the public expenditure review that is currently under way. Achievement of the needed restructuring of expenditure will also require that the fiscal implications of new major initiatives be fully costed and funding implications worked out before they are included in the budget. In the meantime, close monitoring and control of expenditure will be essential to minimize deviations of budget outcomes from intentions. Finally, the government should also urgently deal with the problem of stalled projects and pending bills and prevent their recurrence.

62. Over the medium term, fiscal policies should also aim at strengthening macroeconomic stability by lowering domestic public debt and supporting a prudent monetary policy. To strengthen the public finances, the Kenya Revenue Authority (KRA) should at least keep the revenue-to-GDP ratio at the level of recent years; over the longer run, there is some scope for streamlining the tax system, broadening the tax base, and removing disincentives to economic activity, while increasing the revenue-to-GDP ratio.

63. Monetary policy should continue to aim at keeping inflation low while providing a stable environment for financial markets. To this end, the authorities should avoid central bank financing of the government, preserve the CBK’s independence in conducting monetary policy, and continue to allow bank interest rates to be market determined. Concerns about the wide spread between bank lending and deposit rates should be addressed by tackling the underlying problems in the banking system. In particular, there is an urgent need to establish a clear plan to deal with the nonperforming loans, including through enhanced loan recovery efforts. In addition, divestiture of the government’s ownership interests in the publicly owned banks is necessary in order to reduce the risk of political interference in lending decisions, as well as to improve the collection of bad loans and the enforcement of prudential and regulatory standards.

64. In the period ahead it will be necessary to allow greater exchange rate flexibility than has been the case in the past two years. While the exchange rate does not appear to have been a major impediment to export expansion, there is a need to closely monitor exchange rate developments as a continuation of the recent appreciation would likely be distortionary, with adverse implications for export and output growth. Over the medium term, action will be needed to raise productivity and reduce production costs to offset any appreciation pressures and safeguard competitiveness. In this regard, improvements in the governance regime and public expenditure on upgrading infrastructure should help to reduce operating costs. These measures will need to be complemented by policies aimed at increasing labor market flexibility, improving the efficiency of the financial institutions and expanding financial services, streamlining the current tax regime, and reforming the trade regime so as to lower protection rates.

65. Kenya’s economy faces considerable risks. First, the past mixed record of performance and the uncertainties regarding the timetable for completing the constitutional review, which will have a major impact on the governance framework, may continue to undermine the confidence of some potential investors. Second, the level of nonperforming loans in the banking system and the contingent government liabilities in the financial and parastatal sectors represent a serious risk to financial stability. Third, with a new coalition government in power, it will be important for the coalition to remain united in supporting the difficult decisions that will be required for restructuring the public finances. Finally, the geopolitical uncertainties in the region and the conflict in the Middle East mean that the external environment remains highly uncertain. It will thus be important to maintain financial discipline in the immediate period ahead and to resist any pressures for implementing expansionary policies that would undermine the sustainability of the fiscal position over the medium term.

66. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Table 3.

Kenya: Macroeconomic High Case Scenario, June-July Fiscal Year 2000/01–07/08

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Sources: Kenyan authorities; and staff estimates and projections.

March 20, 2003.

12-month period ended December 2002.

Table 4.

Kenya Central Government Financial Operations, High Case Scenario, 1999/2000–2007/08 1/

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Sources: Kenyan authorities, and Fund staff estimates and projections.

Fiscal year ending June 30

In 2002/03 an amount of Khs 2.0 billion was received for UN peacekeeping duties

The fiscal accounts are on a cash basis (with the exception of foreign interest due) Adding accumulation of pending bills and subtracting cash repayment of them adjusts to a commitment basis

Table 5.

Kenya: Balance of Payments, High Cass Scenario, 1999–2008

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Kenyan authorities: and staff estimates and projections

Includes under recorded tourism earnings.

In months of projected imports of goods and nonfactor services

Includes defense-related imports, impairs of maize, sugar, and airplanes, and imports related to rehabilitation of the energy sector.

After November 2000 Paris Club rescheduling and assumed rescheduling, under comparable terms, by commercial and non-Paris Club bilateral creditors

In percent of exports of goods and services

Table 6.

Kenya: External Debt Indicators, High Case Scenario, 2000–2008 1/

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Kenyan authorities; and staff estimates and projections.

This reflects an outcome where the program is brought back on track by 2002: Q2 (foreign program financing is received).

Does not include arrears,

After Paris Club rescheduling in November 2000, and assuming comparable treatment by non-Paris Club and commercial creditors.

Includes commercial banks’ and suppliers’ credit; includes stock and repayment of arrears according to the terms agreed with commercial banks.

Refers to the present value of debt service calculated by using the currency-specific commercial interest reference rate (CIRR) as the discount rats.

Three-year backward-looking average.

Central government revenue, excluding grants.

The stocks of arrears at end-2000 and end-2001 are largely composed of arrears to commercial creditors that are assumed to be cleared when Kenya reaches a rescheduling agreement with these creditors.

The figures for debt service in this table differ from those presented in the balance of payments table, as the balance of payments table presents debt service before rescheduling (and rescheduling is presented as financing below the line).

Table 7.

Kenya: Monetary Survey, High Case Scenario, 2001–2008 1/

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Sources: Central Rank of Kenya Note:

Constant Ksh/US$ exchange rate prevailing on September 30, 2001

Table 8.

Kenya: Macroeconomic Scenario, Base Case Scenario, June-July Fiscal Year 2000/01–07/08

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Sources: Kenyan authorities; and staff estimates and projections.

March 20, 2003.

12-month period ended December 2002.

Table 9.

Kenya. Central Government Financial Operations, Base Case Scenario, 1999/2000–2007/08 1/

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Sources: Kenyan authorities, and Fund staff estimates and projections

Fiscal year ending June 30.

In 2002/03 an amount of Khs 2.0 billion was received for UN peacekeeping duties

The fiscal accounts are on a cash basis (with the exception of foreign interest due). Adding accumulation of pending bills and subtracting cash repayment of them adjusts to a commitment basis

Table 10.

Kenya: Balance of Payments, Base Case Scenario. 1999–2008

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Kenyan authorities; and staff estimates and projections.

Includes underrecorded tourism earnings.

In months of projected imports of goods and nonfactor services.

Includes defense-related imports, imports of marze, sugar, and airplanes, and imports related to rehabilitation of the energy sector

After November 2000 Paris Club rescheduling and assumed rescheduling, under comparable terms, by commercial and non-Paris Club bilateral creditors.

In percent of exports of goods and services.

Table 11.

Kenya: External Debt Indicators. Base Case Scenario, 2000–2008 1/

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Kenyan authorities, and staff estimates and projections.

This reflects an outcome where the program is brought back on track by 2002: Q2 (foreign program financing is received).

Does not include arrears.

After Paris Club rescheduling in November 2000, and assuming comparable treatment by non-Paris Club and commercial creditors.

Includes commercial banks’ and suppliers’ credit; includes stock and repayment of arrears according to the terms agreed with commercial banks.

Refers to the present value of debt service calculated by using the currency-specific commercial interest reference rate (CIRR) as the discount rate.

Three-year backward-looking average.

Central government revenue, excluding grants.

The stocks of arrears at end-2000 and end-2001 are largely composed of arrears to commercial creditors that are assumed to be cleared when Kenya reaches a rescheduling agreement with these creditors.

The figures for debt service in this table differ from those presented in the balance of payments table, as the balance of payments table presents debt service before rescheduling (and rescheduling is presented as financing below the line).

Table 12.

Kenya-Monetary Survey, Base Case Scenario, 2001–2008 1/

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Sources: Central Bank of Kenya Note:

Constant Ksh/US$ exchange rate prevailing on september 30, 2001

APPENDIX I: Kenya: Relations with the Fund

(As of February 28, 2003)

I. Membership Status: Joined February 3, 1964; Article VIII.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans

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V. Financial Arrangements:

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VI. Projected Obligations to Fund

(SDR million; based on existing use of resources and present holdings of SDRs):

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VII. Exchange Rate Arrangement

The currency of Kenya is the Kenya shilling. Kenya has adopted a unitary exchange rate structure where the exchange rate is determined in the interbank market. The official exchange rate, which is set at the previous day’s average market rate, applies only to government and government-guaranteed external debt-service payments and to government imports for which there is a specific budget allocation. The exchange rate regime is a managed float, in which the U.S. dollar is the principal intervention currency. Kenya maintains an exchange arrangement that is free of exchange restrictions and multiple currency practices. On December 31, 2002, the exchange rate was KSh 77.1=US$1.

VIII. Article IV Consultations

Kenya is on the 12-month cycle for Article IV consultations. The 2001 Article IV consultation was concluded on March 15, 2002 (SM/02/60 and SM/02/72).

IX. Technical Assistance

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X. Resident Representative

The Fund has had a resident representative in Kenya since December 1993. Mr. Samuel Itam is the current Senior Resident Representative.

APPENDIX II: Kenya: Relations with the World Bank

(as of March 24, 2003)

1. As of March 24, 2003, the World Bank had committed to Kenya about US$3.9 billion (net of cancellations), of which US$3.6 billion had been fully disbursed. The total undisbursed balance as of March 24, 2003 is about US$310 million. IDA disbursements in FY02 were US$85.4 million.

Agriculture

2. The Bank’s activities in the sector support the government’s development strategy, which aims at realigning the policy framework and the incentive structure, redefining the role and core functions of the government in the sector, and encouraging a more competitive marketing system with increased participation by the private sector. The government’s development strategy also envisages support for the core programs of research and extension. The Bank currently has three ongoing projects in the agriculture and environmental areas, including a Second National Agricultural Research Project, which would set the stage for developing a sustainable agricultural research program.

3. On environmental/natural resource management, the Bank financed the preparation of the National Environmental Action Plan. The Bank also approved in December 1995 an Arid Lands Resource Management Project, which seeks to ameliorate economic and environmental conditions in the more fragile arid areas. This is scheduled to close in June 2003, and a second phase (Arid Lands II) is expected to be approved by the Bank’s Board in June 2003 for US$60 million. The project’s overall objective is to enhance food security and promote sustainable livelihoods through implementing effective systems and structures which reduce vulnerability. In addition, the Bank approved in July 1996 a Lake Victoria Environmental Management Project, which will support efforts by the Kenyan, Ugandan, and Tanzanian governments to improve management of the lake’s ecosystem. Although the IDA credit has closed, the GEF component has been extended for two years to complete the regionally-oriented components and activities of the project.

Infrastructure development

4. A major impediment to private sector development is inadequately maintained and inefficiently operated physical infrastructure. Public enterprise inefficiency is at the heart of many of these problems. Addressing these deficiencies requires an appropriate role for the private sector. Bank activity in this sector has aimed at financing critical infrastructure needs while putting in place policy and budgetary reforms to increase long-term sustainability through greater private sector participation.

5. The Bank has three ongoing infrastructure projects. In January 1996, the Bank approved two infrastructure projects: an Urban Transport Project (currently under suspension), which finances new and expanded road links, intersections, and public transport facilities in urban areas, and a Nairobi-Mombasa Road Rehabilitation Project, which supports rehabilitation of Kenya’s chief transport corridor. The Bank also approved an Energy Sector Reform and Power Development Project in June 1997, which is expected to increase generation capacity, reform energy pricing, and encourage private sector participation in the sector. An Emergency Infrastructure Rehabilitation Project to assist the country in coping with the damage done by the “El Niño” floods was approved by the Board in July 1998, providing US$40 million of new support and redirecting US$37 million of existing commitments toward rehabilitation. In addition, an emergency power supply credit for US$72 million was approved in October 2000 to assist the government in implementing emergency measures to address the ongoing power supply crisis. Both emergency credits closed at the end of December 2001. Preparation is underway for a Transport Project which is currently planned for Board delivery in FY04.

Education and health

6. In these two sectors, the Bank’s emphasis has been on enhancing financing and management capacity to increase the effectiveness and sustainability of public sector expenditures. In education, the emphasis is on (i) improving the quality of primary and secondary education through curriculum reform; (ii) restructuring key sectoral institutions and policies to enhance the efficiency of service delivery; and (iii) shifting public expenditure to improve access to quality basic education, especially in rural areas. In health, the emphasis is on (i) the development of prevention programs for sexually transmitted diseases, including AIDS; (ii) a shift in resources from curative to efficient primary care, including reproductive services; and (iii) a clarification of the respective roles of the private and public sectors.

7. The Bank has three ongoing human resource operations. In April 1997, the Bank approved an Early Child Development Project, which aims at reinforcing existing institutions and improving the quality of services offered to children of preschool age. In September 2000, the Bank approved a US$50 million HIV/AIDS Disaster Response Project to reduce the spread of HIV/AIDS, to mitigate the socio-economic impact of the disease, and to increase the access to care and support for people infected or affected by the HIV/AIDS epidemic in Kenya. In December 2000, the Bank approved a US$50 million Decentralized Reproductive Health and HIV/AIDS Project aimed at improving mother and child health by promoting delivery of comprehensive reproductive health services. Moreover, in response to the Government’s policy of universal free primary education, the Bank is rapidly preparing a quick-disbursing operation for US$50 million which is expected to be presented to the Board in June 2003. The project will focus primarily on providing textbooks along with a small capacity building component. This will be followed up by a larger program of assistance in FY04, with a broader focus on secondary as well as primary education.

Public sector management

8. A Public Sector Management Technical Assistance Credit for US$15 million was approved in July 2001 with the principal objective of improving governance by putting in place systems and human resource capacity that are necessary conditions for achieving greater fiduciary responsibility and reducing corruption in the public service.

Private sector development

9. In April 2001, the Bank approved a Regional Trade Facilitation Project (US$25 million) aimed at poverty alleviation through private sector led growth in participating countries by improving access to financing for productive transactions and cross-border trade. The Bank is also discussing with the government a technical assistance project to support Kenya’s privatization program.

Adjustment lending

10. In June 1996, IDA approved a structural adjustment credit (SAC) of US$126.8 million, including US$36.8 million in IDA reflows. The first tranche of US$79.8 million was released in June 1996. The second tranche of about US$47 million, together with about US$26.6 million in fiscal-year (FY) 1997 IDA reflows and US$17.5 million additional reflows approved in December 1997, was not released because of the government’s failure to meet fully all second tranche release conditions. The SAC was closed in June 1998, and US$87 million was cancelled.

11. In September 1998, the Bank’s Board endorsed a new Country Assistance Strategy (CAS) for Kenya which put the Bank’s lending program for Kenya in the “low case,” with a projected lending program of up to US$150 million over the next three years. Subsequently, the government undertook a series of governance and public sector reforms, paving the way for the resumption of a base case lending program in August 2000.

12. With a major initiative of public sector reform under way in Kenya, on August 1, 2000, the Bank approved the Economic and Public Sector Reform Credit of US$150 million, to be disbursed in three tranches: an effectiveness tranche, and two floating tranches. The first tranche was released in late August 2000. In November 2000, the Bank approved a supplemental credit of US$3.4 million in IDA reflows, which has been fully disbursed. The two additional tranches of SDR 37.7 million each and another IDA reflows allocation for 2001 amounting to SDR 1.15 million were expected to be released during 2000/01 on the basis of performance relative to agreed monitorable indicators. The tranches have yet to be released. Following a request from the Government, the closing date of the EPSRC was extended for one year - from June 30, 2002 to June 30, 2003 on the basis of an agreed Action Plan. We hope to release the second tranche by the end of this fiscal year.

13. A $2.6 million Learning Innovation Loan in support of a Development Learning Centre Project is expected to be presented to the Bank’s Board in June 2003.

APPENDIX III: Kenya: Statistical Issues

1. Weaknesses in key macroeconomic statistics hamper economic analysis and surveillance. Kenya’s macroeconomic statistics have deteriorated significantly over the past decade, reflecting primarily managerial and organizational weaknesses, and inadequate resources at the Central Bureau of Statistics (CBS). During the 2002 Article IV consultation discussions, the staff emphasized the need to improve the timeliness and quality of these statistics, and encouraged the authorities to promptly implement the recommendations of past technical assistance missions from the STA.

2. The authorities are taking actions, with donor assistance, to improve the quality and timeliness of the data. Kenya is participating in the General Data Dissemination System project for Anglophone Africa that is funded by the Department for International Development (DFID) of the UK, and metadata and detailed plans for improving the data over the short and medium term have been posted on the Fund’s Data Standards Bulletin Board. Kenya received Fund technical assistance in the context of this project, and further assessment of the need for capacity building has been undertaken by the AFRITAC East Statistical Advisor. The authorities, moreover, are preparing a statistical master plan and a new statistical act that would improve the independence of the CBS.

3. A multisector STA mission to Kenya in 1998 undertook a comprehensive review of the major statistical areas and prepared a work program providing a broad time frame for implementing the principal recommendations, which address most of the statistical problems discussed below. A peripatetic STA advisor assisted the authorities in improving the balance of payments statistics in the course of 1999 and 2000, and a peripatetic STA advisor is currently assisting the authorities in improving their national accounts statistics. A revised set of national accounts data is expected to be released in mid-2003.

4. Monetary, exchange rate, and some external data are published on a monthly and biannual basis by the Central Bank of Kenya (CBK) in its Monthly Economic Review. Core financial data are also made available to the Fund on a regular basis. A detailed account of various sectoral activities and the corresponding statistical data are published annually by the CBS in its Economic Survey.

National accounts

5. Data quality, which was previously reported as good, has deteriorated significantly because of budgetary and staff constraints at the CBS. GDP is believed to be significantly underestimated, as important and increasing parts of the economy, such as the informal sector, nonagriculture subsistence, horticulture, and self-employed professionals are not properly covered. Moreover, the constant-price base year is seriously outdated (1982). The authorities urgently need to revise their annual national accounts statistics and strengthen their institutional capacity to improve the quality of data. The latest available official national accounts data are for 2001.

Prices and production

6. The CBS commenced publication in early 2002 of a new national CPI (covering 12 urban areas), with 1997=100 and weights based on the 1992–93 HBS. The index is compiled and published on a timely basis. There is no producer price index, or any short-term export and import price indices produced.

Government finance statistics

7. The 1998 multisector statistics mission found several statistical problems with the cumulative year-to-date monthly and quarterly fiscal data that the Ministry of Finance (MoF) compile and report to the AFR for budget-monitoring purposes. These data, which do not conform to the Fund’s government finance statistics (GFS) methodology, do not adequately facilitate economic analysis, mainly because of inappropriate classification of expenditure data. The MoF has not developed a system to adequately monitor expenditure commitments, or domestic arrears, and relies mainly on monitoring cash movements in government accounts at the CBK. The recording of external financing and expenditure directly financed from abroad also remains an area for improvement. The 1998 mission made several recommendations for improving the data, most of which have not been implemented.

8. The CBS compiles and reports to the STA aggregate annual GFS revenue and expenditure data for budgetary central government based on detailed data in the reports of the Controller and Auditor General, using a methodology established by a 1999 STA GFS mission. Lack of proper computerization prevents the CBS from compiling more detailed GFS data. Considerable differences exist between these data and the data compiled by the MoF and reported to the AFR for monitoring purposes.

Monetary statistics

9. Monetary statistics are compiled from a bank reporting system and are broadly adequate for policy, analytical, and supervisory purposes. A STA technical assistance mission in January 2000 observed that the authorities had implemented virtually all recommendations of the previous STA missions, which had led to a number of improvements in Kenya’s monetary statistics. However, the mission identified and made recommendations to address further problems in monetary data, in particular (a) asymmetrical interbank positions, (b) the statistical implications on the data of numerous bank closures, and (c) the coverage of international reserves. Since then, the authorities have initiated revisions to monetary statistics in line with the recommendations of the mission.

Balance of payments statistics

10. The CBS compiles and reports balance of payments data in Kenya shillings annually on a regular basis to the STA, although with a considerable lag. The CBK, in addition, compiles a complete set of annual balance of payments statistics in U.S. dollars, which are reported to the AFR and used for programming and surveillance purposes. The two sets of balance of payments data are not entirely consistent, and the staff has been strongly encouraging the authorities to reconciling the two sets. Recently, the CBK also started to compile and publish discrete quarterly balance of payments estimates.

11. The quality of the data has deteriorated. Although the overall quality of trade data may be reasonably good, data for other current account and many financial account transactions are rather weak. Following the liberalization of the exchange system in 1993–94, gaps have emerged in the coverage of balance of payments source statistics. The compilation system (other than that used for compiling customs statistics), used since 1994, relies on reports from domestic banks and may result in a substantial underrecording of current earnings, including tourism receipts, as well as a failure to capture transactions that are settled via accounts held abroad. Present estimates of direct and portfolio investment are believed to be substantially understated. The large positive errors and omissions that have emerged in the balance of payments since 1994 raise concerns as to the potential size of external obligations.

12. The MoF compiles data covering Kenya’s public and publicly guaranteed external obligations to official and commercial creditors. This database does not take account of nonresident purchases of the government’s domestic currency-denominated debt securities. The 2001 STA BOP mission noted that, should the results of the benchmark foreign investment survey become available; the CBS can start compiling and disseminating more comprehensive annual external debt data for Kenya.

Kenya: Survey of Reporting of Main Statistical Indicators

(as of January 31, 2003)

article image

D = daily; W = weekly; M = Monthly, Q = quarterly; A = annually.

DR = direct reporting from the Central Bank of Kenya or Ministry of Finance; OP = official publication.

F = facsimile; P = mail; SV = staff visit.

R = restricted use; E = embargoed for a specified period and then unrestricted use.

APPENDIX IV: Kenya: Social Indicators

article image
Source: World Bank, World Development Indicators, 2002; and draft Kenya poverty reduction strategy paper, June 2001.

Low-income countries are those that had a GNI per capita of 755 U.S. dollars or less in 2000.

These data are for 1997. Poverty rates for 1994 are 43.7 percent at the national level, and 29.0 percent and 46.3 percent in urban and rural areas, respectively

Gross national income (GNI) data for Kenya are from 1975, 1985, and 1999; income data for sub-Saharan Africa and low-income countries are for 1999.

These data is for 1998.

These data is for 1999.

Kenya: Low-Case Macroeconomic Scenario, 2002/03–2007/08

(In percentage of GDP, unless otherwise indicated)

article image
Source: IMF staff estimates.

For the domestic debt-to-GDP ratio to stabilize at the projected 2003/04 level, the primary balance during 2003/04–2007/08 would have to be improved from the average of -2.0 percent of GDP to 1 percent of GDP.
1

A status report on the prior actions is presented in Box 1.

2

As a result of the poor data quality, the nominal GDP and real GDP growth rates may be underestimated, particularly so for the last decade. An STA advisor is working with the authorities to improve the data. A revised set of national accounts data is expected by mid-2003.

3

This expanding stock may also reflect a degree of corruption, and the legitimacy of a number of contracts is being reassessed by the new government.

4

The formal sector includes wage employment, as well as self-employed and unpaid family workers; the informal sector pertains to all semiorganized, small-scale and unregulated activities. Although much informal sector production is characterized by low productivity and lack of credit access, some microenterprises and small enterprises are reported by the authorities to be as, or more, productive than formal sector firms.

5

The authorities adopted a floating exchange rate system in 1993.

6

A detailed background analysis of economic developments during the past 25 years is presented in the accompanying document (Kenya—Selected Issues and Statistical Appendix).

7

The Supplementary Budget was tabled in parliament in late March. Staff will provide an update and assessment of the revised estimates in a Supplement to be issued prior to the Board Meeting.

8

This assistance refers to amounts provided by nongovernmental organizations (NGOs).

9

The World Bank program is focused on creating the conditions for growth, increasing employment, reducing the cost of doing business, good governance (including strengthening the judiciary), and improved services to the poor. The Bank currently envisages lending operations for financial sector reform, transport, urban water, energy, and education in fiscal year 2003/04, and expanding the agenda in subsequent years to include rural sector poverty and growth, agriculture, health, and governance and public sector restructuring, including privatization. The Bank’s Economic and Sector Work (ESW) program addresses gaps in knowledge, particularly in the areas of poverty and rural sector growth, as well as on the sources of growth, competitiveness, tourism, and accountability and fiduciary issues which will provide the underpinnings for Poverty Reduction Support Credits (PRSCs), beginning in fiscal year 2004/05.

10

The staff has also developed an alternative scenario (Appendix V), which illustrates the considerably weaker economic outcomes that are likely to result if the economic reforms are delayed or not implemented and donor support is not forthcoming.

11

Allocations for certain key public expenditures and for operations and maintenance, such as health, water and sanitation, as well as for environment protection, might be insufficient to achieve the required reduction in poverty.

12

See SM/02/72 (3/1/02), Section VII, “Fiscal Sustainability and Fiscal Risk in Kenya.”

13

Mandated by the Central Bank Act.

14

See SM/02/72. It was concluded that the incentive for producers to move into the export sector diminished over the 1990s, particularly in the second half.

15

The greater importance of nonprice constraints on business performance was also cited in SM/02/72 (3/1/02).

16

Labor market issues are discussed in the Selected Issues note accompanying this staff report.

17

Fiscal costs of restructuring the banking sector could be equivalent to about 2 percent of GDP.

18

A review of the effective operation of the existing duty drawback scheme for exporters is needed.

19

Some intermediate inputs for manufacturing are classified in the trade regime as finished goods and thus attract the highest rate of duty of 3.5 percent.

20

No time limit has been placed on the increased protection for the steel industry. Some private sector actors are concerned that the increased duty will force them to purchase higher-cost locally produced steel and thus increase their overall costs.

21

At this stage, there is no set deadline for the removal of the discriminatory measures.

22

In many developing countries duty drawback schemes are plagued by extensive delays, frequently exceeding one year, in reimbursing importers for duty paid on imported inputs. In these circumstances, it is probably more efficient to zero rate vital imported inputs.

23

It is expected that the EAC Protocol will be signed by December 2003. The tariff structures in the three EAC members are quite different, with Kenya having a range of 0–35 percent (with eight bands), Tanzania a range of 0–25 percent (with four bands), and Uganda a range of 0–15 percent (with three bands).

24

The November 2000 agreement (detailed in Box 2 of SM/02/60, 2/19/02) resulted in the rescheduling of US$300 million of Paris Club debt, and approximately US$40 million is expected to be rescheduled as a result of the London Club agreement.

25

Preliminary estimates indicate that with a three-year Paris Club deal (2003–05) based on pre-cutoff date debt falling due, Kenya could potentially reschedule up to about US$200 million, resources that could be directed to additional poverty spending.

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Cover IMF Staff Country Reports
Kenya: Staff Report for the 2003 Article IV Consultation
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 199
Publisher:
International Monetary Fund
ISBN:
9781451821079
ISSN:
1934-7685
Pages:
71
DOI:
https://doi.org/10.5089/9781451821079.002
  • Figure 1.
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    Figure 1.

    Kenya: Real GDP Per Capita, 1962–2002

    (Kenya shillings)

  • Figure 2.
    View in gallery
    Figure 2.

    Kenya: GDP Volume Growth, 1963–2002

    (Percentage change)

  • Figure 3.
    View in gallery
    Figure 3.

    Selected African Countries: Wages and Salaries in Percent of Total Central Government Expenditures, 1990–2002

  • Figure 4.
    View in gallery
    Figure 4.

    Kenya and Africa; General Constraints on Enterprises1

  • Figure 5.
    View in gallery
    Figure 5.

    Kenya: Formal Sector Real Average Earnings, 1981–2001

    (Percentage change)

  • Figure 6.
    View in gallery
    Figure 6.

    Kenya and United States: Treasury Bill Interest Rate Spread and the Exchange Rate, 1991–2002

  • Figure 7.
    View in gallery
    Figure 7.

    Kenya: Terms of Trade and Real and Nominal Effective Exchange Rates, January 1980-December 2002 (1990=100)1/

Figure 1.

Kenya: Real GDP Per Capita, 1962–2002

(Kenya shillings)
Figure 2.

Kenya: GDP Volume Growth, 1963–2002

(Percentage change)
Figure 3.

Selected African Countries: Wages and Salaries in Percent of Total Central Government Expenditures, 1990–2002
Figure 4.

Kenya and Africa; General Constraints on Enterprises1
Figure 5.

Kenya: Formal Sector Real Average Earnings, 1981–2001

(Percentage change)
Figure 6.

Kenya and United States: Treasury Bill Interest Rate Spread and the Exchange Rate, 1991–2002
Figure 7.

Kenya: Terms of Trade and Real and Nominal Effective Exchange Rates, January 1980-December 2002 (1990=100)1/