Statement by Chileshe Mpundu Kapwepwe, Executive Director for Kenya and Rose Ngugi, Senior Advisor, February 2, 2015

Following the approval of a new constitution in 2010, the authorities have embarked on important reforms including fiscal devolution, VAT reform, and the overhaul of the expenditure management framework. Supported by a three-year ECF, which expired in December 2013 with all six reviews completed, Kenya has consolidated macroeconomic stability. Growth has been robust, inflation contained, debt remained sustainable and reserve buffers increased (Tables 1a and 1b and Figures 1 and 2). This progress in a market-friendly environment has continued to attract the interest of foreign investors. As a result, Kenya is recognized as a frontier market increasingly integrated in global financial markets. A Eurobond debut issue of US$2 billion (the largest in SSA so far) took place successfully in June followed by a $750 million re-tap in December.

Abstract

Following the approval of a new constitution in 2010, the authorities have embarked on important reforms including fiscal devolution, VAT reform, and the overhaul of the expenditure management framework. Supported by a three-year ECF, which expired in December 2013 with all six reviews completed, Kenya has consolidated macroeconomic stability. Growth has been robust, inflation contained, debt remained sustainable and reserve buffers increased (Tables 1a and 1b and Figures 1 and 2). This progress in a market-friendly environment has continued to attract the interest of foreign investors. As a result, Kenya is recognized as a frontier market increasingly integrated in global financial markets. A Eurobond debut issue of US$2 billion (the largest in SSA so far) took place successfully in June followed by a $750 million re-tap in December.

On behalf of the Kenyan authorities we thank staff for their constructive engagement during the negotiation of the proposed program for Kenya.

The Kenyan authorities are requesting for a precautionary program under SBA-SCF arrangements to provide a buffer against exogenous shocks, and a policy anchor for their institutional and economic reforms. They are implementing an ambitious economic transformation agenda aimed at raising the efficiency and productivity of the economy. With sustained commitment to prudent macroeconomic policies and reform agenda, the economy has maintained macroeconomic stability and growth is resilient. However, the economy remains vulnerable to external and domestic shocks, which have the potential to reverse the gains made thus far, and derail the implementation of the transformation agenda. The proposed program therefore aims to strengthen macroeconomic stability, deepen structural and governance reforms, improve security, and support devolution process. The authorities are committed to address these vulnerabilities and unless a balance of payment financing need actualizes, they are not planning to draw on the arrangements.

Economic performance and prospects

GDP growth is resilient but the risks to the outlook are tilted to the downside. Growth is projected to be slower in 2014 as compared to 2013 due to poor rains which have affected agricultural activity, and the yet to recover tourism sector due to issuance of travel advisories. The economy is projected to grow by 6.9 percent in 2015 assuming normal weather prevails. In the medium term growth is expected to reach 7 percent as the authorities continue to address the prevailing constraints to growth. This includes; accelerating infrastructure development, reducing cost of energy through increased geothermal generation and development of the oil and gas sector, improving security situation, supporting regional integration, enhancing access to finance, and providing opportunities for the SMEs.

Macroeconomic stability prevails. Inflation on average has remained within the government target range of (5±2.5 percent) in the last 12 months. Recent declines in inflation are attributed to lower oil and electricity prices, and the stability of the shilling against major foreign currencies. Foreign reserves have on average remained above 4.5 months of import cover since December 2014, supported by foreign exchange inflows through remittances, increased foreign investors participation in the Nairobi Securities Exchange market, and the successful issuance and reopening of the sovereign bond. However, the current account deficit is high given the widening merchandise account due to increased capital goods imports. Bank lending rates have on average declined since the Kenya Banks Reference Rate (KBRR) became effective in July, 2014. The recent downward revision of KBRR from 9.13 percent to 8.54 percent on January 14th 2015 is expected to support this trend.

Fiscal policy and reforms

The authorities are committed to fiscal prudence to ensure debt sustainability as they implement the infrastructure projects to expand the capacity for economic activity. They will continue to enhance resource mobilization by broadening the tax base and deepening tax administration reforms. Further, the authorities aim to improve efficiency, and enhance effectiveness in public resource utilization and budget execution. Their focus is to strengthen public finance management, and reduce fiscal risks from PPPs and the devolution process. Moreover, they intend to adhere to the fiscal responsibility principle which requires 30:70 ratios of development and recurrent expenditures in the total expenditure, respectively, while targeting project implementation performance benchmark of at least 80 percent.

Further, to address the growing wage bill, the authorities are taking measures to have a leaner, efficient and responsive public service covering both the national and county levels of government. The operationalisation of the Treasury Single Account is also underway.

The authorities are preparing to implement the parastatal reforms to strengthen governance, improve accountability, and reduce budgetary transfers for current spending. To facilitate the process, two bills are being prepared for parliamentary debate and enactment. These are; the Government Owned Entities Bill 2014 which is meant to ensure parastatals adopt a leaner and more efficient management structure, and the National Sovereign Wealth Fund Bill 2014 which seeks to establish a wealth fund and the framework for managing the new found oil and mineral wealth that is consistent with the Public Finance Management Act (2012).

A successful devolution process is a priority. Efforts are being made to address the challenges being experienced at these initial stages of implementing a devolved government system. To strengthen public finance system at the county level, the national government will continue to provide necessary support to build capacity of county governments in public finance management and also in improving revenue collection. Likewise, the county governments are expected to adhere to fiscal responsibility principals set out in the PFM Act. In addition, the authorities are committed to adequately staff the Intergovernmental Fiscal Relations Department and make it fully operational, and also complete the audit of outstanding county assets and liabilities.

Monetary and financial policies

To enhance the effectiveness of monetary policy, the authorities are pushing ahead with efforts to modernize the monetary policy framework, and further strengthen central bank operational independence. As we noted in our previous Buff statement, Kenya is serving as a pilot project in the IMF project on “Monetary and Exchange rate policies for LICs” where IMF is collaborating closely with the central bank to modernize the practice of monetary policy. Through the project Central Bank of Kenya (CBK) staff has received training on Forecasting and Policy Analysis System (FPAS) which improves the authorities’ understanding of monetary transmission mechanism and shocks hitting the economy.

Accordingly, CBK is in the process of institutionalizing this framework by setting up an inflation modeling and forecasting unit. Furthermore, there are ongoing efforts to improve liquidity forecasting, by strengthening coordination between the national treasury and central bank, and enhancing flexibility in the use of monetary instruments.

Financial stability and development is a key focus in deepening the financial sector reforms. Accordingly, the authorities aim to strengthen the prudential oversight framework and effectively manage risks associated with rapid credit growth, rising cross-border operations, and expansion of banks activities into holding groups.

Enhancing business environment and competitiveness

Reducing cost of doing business is important to encourage private sector innovation, entrepreneurship and business expansion. In this regard, the authorities are implementing a business regulatory reform agenda focused on improving Kenya’s ranking in the World Bank ease of doing business indicators. In addition, to improve further the security situation, the authorities are building on the on-going security reforms and modernization program. Further, the authorities aim to improve productivity and enhance overall competiveness by investing in transport and logistics network. This will include improving efficiency of air and sea ports; increasing energy production; and widening the coverage of road and rail networks.

Conclusion

The authorities are determined to foster strong inclusive growth in a stable macroeconomic environment as part of the strategy to achieve economic transformation. However, maintaining macroeconomic stability and sustaining the reform agenda is a challenge considering that domestic and external vulnerabilities persist. The request for the precautionary arrangements is thus critical to secure the gains made so far and continue the momentum to implement the reform agenda geared to enhancing strong growth, job creation, and poverty reduction. The authorities value their engagement with the Fund and look forward to continued international community support for their transformation agenda.