Abstract
Precautionary arrangements: The Executive Board approved on February 2, 2015 a Stand-By Arrangement (SBA) and an arrangement under the Standby Credit Facility (SCF), originally for 12 months, with combined access of SDR 488.52 million (90 percent of quota)1. The first reviews, focusing on the policy response to external shocks, were completed on September 16, 2015. On January 26, 2016, these arrangements were extended until March 15, 2016 to provide more time for implementing structural and fiscal measures. The authorities have treated both arrangements as precautionary. Performance under the current program. Although Kenya's macroeconomic performance remains robust, external shocks complicated achievement of some program's macroeconomic objectives. All end-September and continuous performance criteria (PCs) were met. Performance under the structural benchmarks was mixed.
On behalf of the Kenyan authorities, we thank staff for their constructive engagement during the second review of the economic program under the 12-month Stand-By Arrangement and an Arrangement under the Standby Credit Facility, and also during the negotiations for the successor Arrangements. The current arrangements, which have been maintained as precautionary, have served the authorities well in maintaining macroeconomic stability and supporting investment-led growth, allowing for timely policy adjustments and bolstering implementation of key structural reforms. To maintain momentum in the face of elevated external risks, the authorities are requesting for successor Arrangements to continue providing a policy anchor to the reform agenda in strengthening the resilience of the economy. In this regard, they look forward to the Executive Board’s support in the completion of this second review, and the approval of the new Arrangement.
1) Recent Economic Developments and Prospects
Kenya’s economy remains strong despite the headwinds from global economic slowdown. Growth accelerated to 5.6 percent in 2015 from 5.4 percent in 2014, supported by continued investment in quality infrastructure, construction, mining, lower energy prices, and improved agricultural productivity. It is projected that economic growth will increase to 6.0 percent in 2016. Overall inflation declined from 7.8 percent in January 2016 to 6.8 percent in February 2016, as a result of a decline in food and fuel inflation. This has brought back inflation to the target range (5±2.5) after being outside the upper range in the last two months. With prudent monetary policy, the authorities aim to keep inflation in the mid of the target range.
External balance is improving and the fiscal balance is being maintained on the program target. Current account deficit is narrowing with the lowering oil prices, and it is expected to get to 8.0 percent of GDP in 2016. The foreign exchange market is relatively stable while foreign reserves which stand at 4.6 months of import cover provide adequate buffer against short term shocks. The fiscal deficit for 2015/16 is projected at 8.0 percent of GDP. Although implementation of the budget FY2015/16 was initially hampered by sluggish revenue collections and shortfalls in domestic borrowing, the authorities took appropriate and timely mitigating measures to ensure fiscal position is maintained on the program path. Revenue projections were revised downwards, and various expenditure measures, including curbing non priority expenditures and cutting expenditures on slow and delayed projects, were instituted to align the expenditures with the revised resource envelope.
2) Program Performance and Request for a Successor Program
The authorities have successfully implemented the economic program under the 12-month SBA and SCF Arrangements. All the quantitative performance criteria were met and nearly all the structural benchmarks were completed. Significant progress was made in the remaining two structural benchmarks, and the authorities are determined to have them fully completed in due course. For the list of assets and liabilities of counties, the auditing process will start in June 2016, while the inclusion of the debt service payments in IFMIS is one of the structural benchmarks under the new program, expected to be completed in September 2016.
Nevertheless, Kenya remains vulnerable to external shocks which have the potential to create external imbalances and derail the growth momentum. In this context, the authorities are requesting for a new program under a 24-month SBA and SCF to strengthen their buffers against exogenous shocks and provide a policy anchor to the reform agenda. The authorities aim to continue improving fiscal management, strengthening monetary policy operations, and improving business environment to build resilience and allow for a sustained inclusive investment-led growth. They intend to treat the Arrangements as precautionary and only draw should an actual balance of payments problem materialize.
3) Macroeconomic Policies
The economy is facing elevated downside risks with the potential to create imbalances. These include volatility in global financial market, slower global and regional growth, falling commodity prices, adverse weather conditions, and security threats. To maintain macroeconomic stability and continue supporting investment-led growth, the authorities are committed to undertake key policy and structural reforms.
a) Fiscal policy
The authorities aim to maintain a growth-friendly fiscal policy ensuring a sustainable debt level. They are committed to a gradual fiscal consolidation to be achieved through containing growth in recurrent expenditures while protecting public investments and social spending, and strengthening tax administration to boost revenue mobilization. The fiscal consolidation path is also aimed to ensure a smoother transition towards the EAC convergence criteria on deficit to GDP of 3 percent.
Among the proposed measures include, on the expenditure side, reducing tax expenditures, adopting a clear public sector remuneration and benefits policy framework, tightening selection and monitoring procedures of investment projects, and reducing growth in expenditures of goods and services and transfers to parastatals. With a modern and simplified Excise Duty and Tax Procedure Legislation now enacted, the authorities are gearing to review the Income Tax Act. Modernization of tax legislation and administrative reforms are being undertaken to improve customs revenue collection, strengthen revenue collection by counties; and improve collection of large outstanding tax debts.
Fiscal policy is also aimed at supporting the devolved system of government for effective delivery of services. In this regard, the national government is gearing to roll out the 2015 Public Finance Management Regulations to strengthen the intergovernmental fiscal relations as well as public expenditure controls and reporting frameworks.
b) Monetary policy and financial sector
Maintaining price stability remains the principle objective of monetary policy. In this regard, the authorities stand ready to tighten monetary policy should demand pressures arise and second round effects of supply shocks set in. They also remain committed to strengthen the monetary policy framework and are undertaking to improve the transmission mechanism of monetary policy through money and credit markets reforms and establish an interbank interest rate corridor.
Safeguarding financial stability remains a key priority in further deepening the financial sector. In this regard, the authorities are strengthening bank supervision legal and regulatory framework and are in the process of recruiting additional supervisory staff. Following the recent Financial Stability Review undertaken with the help of the Fund, the Central Bank of Kenya will put together an action plan to strengthen the supervision and regulation of the banking system. Further, the authorities are developing a crisis management framework for banks with significant cross-border operations, and implementing a risk-based approach to AML/CFT supervision for all financial institutions under the central bank purview; an IMF mission is already proposed for end March 2016 to support this efforts.
c) Structural reforms and Data Quality
Creating conducive business environment for job creation is core in the economic transformation agenda that the authorities are pursing. In this regard, they continue to improve security by deepening reforms in the security sector; boost infrastructure development to unlock constraints to growth; advance business regulatory reforms; improve the automation and simplification of government services; and improve the framework for registering property.
The authorities remain committed to improve the quality, coverage and timeliness of macroeconomic statistics. They have agreed to participate in the enhanced general data dissemination system and as a step towards improving the balance of payment statistics and production of an international investment position, they have published data for the foreign investment survey for 2012 and 2013.
4) Conclusion
Maintaining macroeconomic stability and supporting strong economic growth are central to the transformation agenda the authorities are implementing as they gear to become a middle income country by 2030. In this context, they remain committed to maintain the momentum to the reform agenda to strengthen the resilience of the economy in achieving the development goals. They highly appreciated the continued engagement with the Fund as this contributes immensely to their economic development.