Statement by Mr. Mkwezalamba, Executive Director for Kenya and Mr. Sitimawina, Senior Advisor to the Executive Director, January 25, 2017

The Executive Board approved on March 14, 2016 a 24-month Stand-By Arrangement (SBA) and an arrangement under the Standby Credit Facility (SCF), with combined access of SDR 1.063888 billion (196 percent of quota). The first tranche of SDR 542.8 million (100 percent of quota) was made available upon approval of the arrangements, and a further SDR 56.994 million (10.5 percent of quota) will become available upon completion of the first reviews. The authorities intend to continue treating both arrangements as precautionary, and to draw only if exogenous shocks lead to an actual balance of payment need.

Abstract

The Executive Board approved on March 14, 2016 a 24-month Stand-By Arrangement (SBA) and an arrangement under the Standby Credit Facility (SCF), with combined access of SDR 1.063888 billion (196 percent of quota). The first tranche of SDR 542.8 million (100 percent of quota) was made available upon approval of the arrangements, and a further SDR 56.994 million (10.5 percent of quota) will become available upon completion of the first reviews. The authorities intend to continue treating both arrangements as precautionary, and to draw only if exogenous shocks lead to an actual balance of payment need.

Introduction

1. We thank staff for the constructive dialogue with our Kenyan authorities during the recent program review mission. As our authorities pursue the objective of sustaining an investment-driven inclusive growth, they appreciate the candid advice from the Fund. They also find the Stand-By Arrangement (SBA) and the arrangement under the Standby Credit Facility (SCF) instrumental in anchoring the macroeconomic policy framework and backstopping the foreign exchange reserve buffers. Our authorities broadly concur with the staff assessment and conclusions.

2. The Kenyan economy remains strong and has continued to show robust growth supported by strong macroeconomic fundamentals. As a result, our authorities’ performance under the economic program supported by the SBA and SCF arrangements has been satisfactory. With this performance and on the basis of an existing track record of program implementation, our Kenyan authorities request Executive Directors’ support for completion of the first reviews under the 24-month SBA and SCF arrangements. In addition, they request for: (i) waivers of applicability for the end-December 2016 quantitative performance criteria, given the unavailability of data for assessment; (ii) a re-phasing of the second and third reviews under the SBA and SCF arrangements to allow sufficient time for the completion of the reviews; and (iii) a modification of the performance criterion on the primary budget balance for end-December 2016, consistent with the higher fiscal deficit target for 2016/17.

Performance under the SBA and SCF Arrangements

3. The authorities met all continuous and end-June 2016 performance criteria (PCs) and the end-June inflation target under the Monetary Policy Consultation Clause (MPCC). In addition, they met all end-March, end-June, and end-September quantitative indicative targets with the exception of the end-June target on priority social spending, which was missed by a small margin due to delays in disbursement of donor commitments on social cash transfers. Performance on structural benchmarks was slower than expected. However, steps have been taken, including through utilization of additional technical assistance, to ensure completion within the revised timeframe.

Recent Economic Developments and Macroeconomic Outlook

4. Real GDP growth in Kenya remains strong, recording 5.3 percent and 5.6 percent in 2014 and 2015, respectively. It is expected to have grown by around 6 percent in 2016. This growth has largely been driven by a continued strong expansion in the construction sector, in particular public investment in the Standard Gauge Railway linking Mombasa and Nairobi. The favorable weather conditions also boosted agricultural production with record yields in tea and coffee. In addition, there has been some recovery in tourism on the back of improved security. In the period ahead, growth is expected to remain robust, supported by resilient exports, continued infrastructure investments, and benefits from ongoing regional integration efforts.

5. Inflation remains within the authorities’ target range of 5±2.5 percent and therefore within the monetary policy consultation clause. Headline inflation, after falling to a record low of 5 percent in May 2016, trended upwards to 6.7 percent in November 2016 but slowed down to 6.4 percent in December 2016. These developments reflected price increases in food that masked a slowdown in housing, utilities, and transport prices. Overall, inflation is expected to remain within the target range in the near to medium term.

6. The current account deficit has continued to narrow in the past two years, reflecting largely lower international oil prices; improved tea, coffee and horticulture exports; strong remittance inflows; and higher tourism earnings. The improvement of the current account deficit coupled with strong capital inflows have led to a stabilization of the exchange rate and an accumulation of international reserves which stood at 5.3 months of prospective imports at end-December 2016.

Fiscal Policy and Public Financial Management

7. The authorities are committed to fiscal consolidation over the medium term as well as ensuring that public debt remains sustainable. While the 2015/16 overall fiscal deficit was 0.5 percent of GDP lower than programmed, the 2016/17 budget deficit will be slightly higher than under the program to accommodate one-off election related expenditures. However, consistent with the fiscal consolidation objective, the authorities plan to put in place additional revenue and expenditure measures, including reducing tax expenditures, improving tax administration, and cutting low priority spending, in order to return to the original program target of 3.7 percent of GDP by 2018/19 fiscal year. This pace of fiscal deficit reduction would also bring the country closer to the East African Monetary Union deficit ceiling of 3 percent by 2020/21. In addition, our authorities remain focused on the public debt fiscal anchor set at 45 percent of GDP. In this regard, they will further strengthen the debt management framework, and are taking steps to begin capturing all public debt payments in IFMIS.

8. Additional measures to improve public financial management will also be taken, including stricter selection and monitoring of public investment projects to ensure value for money, establishing a Treasury Single Account (TSA), and improving the monitoring and reporting of government pending bills. With respect to public investment projects, the authorities plan to separate the project approval process from the annual budgeting process by adopting guidelines on the appraisal and monitoring of new investment projects. To further enhance fiscal transparency, the authorities are also taking steps to start publishing consolidated financial statement (CFS) for the entire public sector.

Monetary and Financial Sector Issues

9. The primary monetary policy objective remains to bring headline inflation towards the midpoint of the target range in the context of a floating exchange rate regime. As noted earlier, in 2016, the Central Bank of Kenya (CBK) accumulated foreign reserves and the exchange rate remained relatively stable, thereby positively impacting headline inflation. The current monetary policy stance is broadly appropriate. However, the CBK stands ready to take further action should it become necessary.

10. Effective September 2016, the Kenyan Parliament introduced a new law on interest rate controls aimed at reducing the cost of borrowing and increasing the return on savings. While this law somewhat constrains the conduct of monetary policy, our authorities remain committed to strengthening the monetary policy framework. Consistent with this objective, the monetary authorities reiterate their intention to establish an interest rate corridor when conditions permit. In addition, the CBK is taking action to improve liquidity distribution among banks and to reduce structural rigidities in the government securities market. The latter will entail authorities’ support to ongoing work in the capital markets through the development of an efficient primary and secondary market for government securities, including taking steps to broaden participation and lower transaction costs.

11. Furthermore, to reduce borrowing costs and barriers to competition in the credit markets, the CBK, with technical assistance from the World Bank Group, is strengthening the credit reference system to enhance borrower monitoring, data quality and integrity, and conducting sensitization to promote use of credit reference for credit-risk pricing. It will also adopt, in the course of this year, a single annual percentage rate (APR) methodology that includes all fees and charges in a single rate, and require banks to post APRs for all of their credit facilities.

12. Kenya’s banking sector remains adequately capitalized and profitable. However, in view of the increased complexity of the financial sector, the authorities continue to take steps to further strengthen prudential regulation and supervision with a view to safeguard financial stability. In the course of 2016, the CBK addressed emerging risks to financial stability by resolutely intervening in banks deemed unviable. They also quickly stepped in to provide the necessary liquidity facilities to smaller banks that had been cut off from the highly segmented interbank market. In the period ahead, the implementation of the action plan on banking regulation and supervision will increase the authorities’ capacity to monitor credit and liquidity risks and insider lending. Overall, the CBK is closely monitoring developments and stands ready to take necessary steps as needed to ensure continued financial stability.

Structural Reforms and Data

13. The authorities are continuing with various efforts in structural reforms to improve the business environment and remove any impediments to an investment-led inclusive growth. Consequently, Kenya’s ranking in the World Bank’s Doing Business Report (2016) improved 21 places from the 2015 position and was one of the top 10 reformers across the globe. In the period ahead, ongoing reforms will seek to further strengthen governance in business operations through the introduction of anti-bribery legislation; reduction of transportation and trading costs; and improvement in procurement procedures and frameworks at the national and county levels.

14. The authorities are also making considerable progress in improving macroeconomic statistics. Currently, the Kenya Bureau of National Statistics (KNBS) is conducting a foreign investment survey to collect data for 2014 and 2015 and will be publishing the first estimate of the annual International Investment Position (IIP) within this year.

Conclusion

15. The authorities reiterate their commitment to strengthening macroeconomic stability and enhancing resilience to shocks. In this connection, they will implement an appropriate policy mix aimed at sustaining an inclusive and investment-led growth. They also remain committed to a gradual consolidation of fiscal policy, maintaining low and stable inflation, further improving public financial management, strengthening the financial sector supervision and regulation, and deepening structural reforms aimed at further improving the business environment. Thus, they count on Executive Directors’ support in completing these first reviews and approval of the associated request.

Kenya: First Review Under the Twenty-Four Month Stand-By Arrangement and the Arrangement Under the Standby Credit Facility and Requests for Waivers of Applicability, Rephasing of Disbursements, and Modification of Performance Criterion-Press Release; Staff Report; and Statement by the Executive Director for Kenya
Author: International Monetary Fund. African Dept.