Front Matter Page

© 2008 International Monetary Fund

October 2008

IMF Country Report No. 08/3 53

Kenya, Uganda, and United Republic of Tanzania: Selected Issues

This Selected Issues paper for Kenya, Uganda, and United Republic of Tanzania was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member countries. It is based on the information available at the time it was completed on December 1, 2006. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the governments of Kenya, Uganda, and United Republic of Tanzania or the Executive Board of the IMF.

The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information.

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Front Matter Page

INTERNATIONAL MONETARY FUND

KENYA, UGANDA, AND UNITED REPUBLIC OF TANZANIA

Selected Issues

Prepared by Kevin Cheng, Greetje Everaert, Jiri Jonas, Axel Palmason, Richard Podpiera, and Yuri Sobolev

Approved by the African Department

December 1, 2006

Contents

• Introduction

• I. Investment Incentives Harmonization in the East African Community

  • I. Introduction

  • II. Tax and Investment Incentives Harmonization

  • III. Investment Incentives: Theory and Evidence

  • IV. Moving Ahead: A Cooperative Approach

  • V. Conclusions

  • References

• Boxes:

• I.1 Investment Incentives

• Figures:

• I.1 FDI Inflows in EAC Countries

• Tables

• I.1 EAC countries: Tax systems, FY 2006/07 Budget

• I.2 EAC countries: EPZs: Investment Incentives and Other Features

Introduction

This selected issues paper—prepared within the framework of coordinated Article IV consultations—focuses on critical aspects of economic growth and development in three members of the East African Community (EAC): Kenya, Tanzania, and Uganda. The paper analyzes harmonization of investment incentives, promotion of credit to the private sector, and trade liberalization.

Chapter I argues that a coordinated approach to providing investment incentives—possibly through a Code of Conduct—would be in the interest of all EAC members. The Code would specify what incentives the EAC countries could offer and would provide a framework for consultation and coordination. It would be advisable to set up a transparent rules-based system of investment incentives, which would limit the room for discretion and thus the scope for misuse. Moreover, the policy on incentives should be guided by a realistic assessment of costs and benefits, to avoid undermining other policy objectives. Failure to agree on a common approach could lead to a “race to the bottom” and entail significant costs to all countries in terms of budget revenue loss and a weaker fiscal position. It needs to be recognized, however, that harmonization of tax and investment incentives is not a panacea and that other conditions—such as adequate infrastructure and good business climate—must be in place to promote strong investment and economic growth.

Chapter II recommends a strategy to augment credit to the private sector. Even though the EAC members have stabilized and strengthened their banking systems, credit to the private sector remains low. In such an environment, the first steps are to improve financial intermediation through the removal of obstacles to lending and to support competition in the banking system. Improvements in financial intermediation need to be sustainable and thus cannot be forced by direct government intervention.

Chapter III concludes that the EAC members stand to gain through unilateral trade liberalization by lowering their Common External Tariff. This would lead to trade creation, improved efficiency of resource allocation, and welfare gains. The tariff reform, however, is a long-term undertaking. As such, it needs to be complemented by measures alleviating both non-tariff impediments to trade and the supply response constraints, as well as by measures offsetting the potential loss of revenue associated with tariff reduction.

Contents

• II. Promoting Private Sector Credit in the East African Community: Issues Challenges, and Reform Strategies

  • I. Introduction

  • II. Issues and Challenges

    • A. Background

    • B. Characteristics of Private Sector Credit in EAC

    • C. Factors that Deter Private Sector Lending

  • III. Recent Policies and Reform Strategy Going Forward

    • A. Recent Policies to Improve the Availability of Private Sector Credit

    • B. Strategy for Further Reform

  • IV. Conclusion

  • References

  • Boxes:

  • II.1 Historical Context of Banking Sector Reforms

  • II.2 Successful Turnaround Efforts in Rural and Agricultural Banks

  • Figures:

  • II.1 EAC and Comparator Countries: M2/GDP and Deposit/GDP, percent

  • II.2 EAC and Comparator Groups: Private Sector Credit

  • II.3 EAC: Distribution of Loans, Most Recent Available Data

  • II.4 EAC and Comparator Group: Real Lending Rate and Lending-Deposit Spread, percent

  • II.5 EAC and Comparator Groups: Private Lending and Economic Developments, 2004

  • II.6 EAC and Comparator Groups: Deposits and Private Sector Credit

  • II.7 EAC and Comparator Groups: Banking Sector Claims on Government

  • II.8 Government Debt and Private Sector Credit (Percent of GDP)

  • II.9 Government Debt (percent of GDP) and Real Lending Rate (percent)

  • II.10 Macroeconomic Factors and Private Lending, Deviations from the Means

  • II.11 Private Sector Credit (Percent of GDP)

  • II.12 Spread and Loan to Deposit Ratio, 2003 (Difference from Sample Mean)

  • Tables

  • II.1 EAC and Comparator Groups and Countries: General Economic Indicators, 2004

  • II.2 EAC and Comparator Groups and Countries: Concentration and Efficiency of the Banking Industry—International Comparison, 2003 (In percent)

  • II.3 EAC and Comparator Groups and Countries: Nonperforming loans (in percent of total loans), average of 2000-2004

  • II.4 EAC and Comparator Groups and Countries: Banking Branch Density in International Comparison

  • II.5 EAC and Comparator Groups and Countries: Main Implements to Financing

  • II.6 EAC and Comparator Groups and Countries: Bankruptcy Procedures

  • II.7 EAC and Comparator Groups and Countries: Collateral Requirements

• III. EAC Customs Union: Benefits of Further Trade Liberalization

  • I. Introduction

  • II. Current Structure of Trade in the EAC

  • III. Further Integration

    • A. The Case for Lowering the CET

    • B. Reduction of the CET—Model Simulation Results

    • C. Revenue Impact

    • D. Model Limitations and Potential Dynamic Effects

  • IV. Barriers to Further Integration

    • A. Overlapping Memberships

    • B. Economic Partnership Agreements Negotiations

    • C. Other Measures to Promote Further Integration

  • V. Conclusions

  • References

  • Figures:

  • III.1 Major Regional Trade Arrangements in Eastern and Southern Africa

  • Tables

  • III.1 EAC Main Trading Partners

  • III.2 Direction of EAC Intraregional Trade (percent of GDP

  • III.3 Tanzania and Uganda: Exports to and Imports from Kenya by Product Category, 2004

  • III.4 EAC Countries: Simple Average Statutory Tariffs (percent)

  • III.5 Tariffs, Trade Volumes, and Aid Dependency (percent)

  • III.6 Distribution of Imports by MFN Tariff Band (percent of total imports)

  • III.7 Regional Comparison of Simple Average Tariffs and Tariff Dispersions, 2005

  • III.8 EAC Countries: Simulation Results of Reduction in Maximum Applied Tariffs