Kenya: Fourth Reviews Under the Extended Arrangement under the Extended Fund Facility and under the Arrangement under the Extended Credit Facility, and Requests for Augmentation of Access under the Arrangement under the Extended Credit Facility, and Modifications of Quantitative Performance Criteria—Press Release; Staff Report; and Statement by the Executive Director for Kenya

1. Kenya is navigating a turbulent global economic backdrop. The economy remained broadly resilient in the run-up to August 9 elections.1 Real GDP grew by 6 percent y/y in the first half (H1) of 2022 despite a continuing drought, while tax overperformance and a strong commitment to the Fund program helped contain risks ahead of the elections. However, slowing global and regional growth, tighter external financing conditions and a surging U.S. dollar, volatile international commodity prices, and elevated global uncertainties have created a challenging backdrop for policy-making. Markets conditions did not allow previously planned international issuance of US$1.1 billion amid heightened investor risk aversion to frontier market debt and election-related uncertainty.2 High global food, fertilizer, and fuel prices and weak agricultural production have pushed inflation above the CBK’s target band. Food insecurity and malnutrition have risen in the areas impacted by drought across the Horn of Africa (Kenya’s Arid and Semi-Arid Lands (ASAL)). COVID-19 vaccination rates have plateaued.3

Abstract

1. Kenya is navigating a turbulent global economic backdrop. The economy remained broadly resilient in the run-up to August 9 elections.1 Real GDP grew by 6 percent y/y in the first half (H1) of 2022 despite a continuing drought, while tax overperformance and a strong commitment to the Fund program helped contain risks ahead of the elections. However, slowing global and regional growth, tighter external financing conditions and a surging U.S. dollar, volatile international commodity prices, and elevated global uncertainties have created a challenging backdrop for policy-making. Markets conditions did not allow previously planned international issuance of US$1.1 billion amid heightened investor risk aversion to frontier market debt and election-related uncertainty.2 High global food, fertilizer, and fuel prices and weak agricultural production have pushed inflation above the CBK’s target band. Food insecurity and malnutrition have risen in the areas impacted by drought across the Horn of Africa (Kenya’s Arid and Semi-Arid Lands (ASAL)). COVID-19 vaccination rates have plateaued.3

Context

1. Kenya is navigating a turbulent global economic backdrop. The economy remained broadly resilient in the run-up to August 9 elections.1 Real GDP grew by 6 percent y/y in the first half (H1) of 2022 despite a continuing drought, while tax overperformance and a strong commitment to the Fund program helped contain risks ahead of the elections. However, slowing global and regional growth, tighter external financing conditions and a surging U.S. dollar, volatile international commodity prices, and elevated global uncertainties have created a challenging backdrop for policy-making. Markets conditions did not allow previously planned international issuance of US$1.1 billion amid heightened investor risk aversion to frontier market debt and election-related uncertainty.2 High global food, fertilizer, and fuel prices and weak agricultural production have pushed inflation above the CBK’s target band. Food insecurity and malnutrition have risen in the areas impacted by drought across the Horn of Africa (Kenya’s Arid and Semi-Arid Lands (ASAL)). COVID-19 vaccination rates have plateaued.3

2. The new administration has demonstrated its commitment to fiscal consolidation and debt sustainability. William Ruto was sworn in as President on September 13 after the Supreme Court rejected challenges to the official results, completing a peaceful election that demonstrated the growing strength of Kenya’s institutions. Ruto campaigned on a “bottom-up” economic model of supporting small businesses in the informal sector while also raising revenue and reducing the fiscal deficit. In his first week in office, fuel subsidies were sharply reduced and monthly adjustments in passthrough of variable costs to electricity consumers were restored. New fertilizer subsidies (smaller than fuel subsidies) were also announced. Despite pressures from delayed, unbudgeted, and emergency spending, the authorities have publicly committed to stay the course of fiscal consolidation, announcing expenditure cuts and an emphasis on tax revenues.

Recent Economic and Financial Developments

3. Growth momentum has slowed while inflation is above the authorities’ target.

  • After a strong rebound in 2021 (7.5 percent y/y), 2022 saw a normalization, with easing growth supported by robust services, with a continued recovery in the hospitality sector (Text Figure 1). However, agricultural output declined for the third successive quarter on continued drought (Box 1). In 2022Q3, an indicator of manufacturing activity bottomed out (Figure 1).

  • Inflation (9.5 percent y/y in November) has exceeded the CBK’s 2.5–7.5 percent target band since June, driven by food, fuel, and electricity prices (Text Figure 2; Box 2). Nonfood, nonfuel (NFNF) inflation has ticked up to 4.2 percent. Monetary policy rate was tightened by a cumulative 175 basis points in three hikes, beginning in May.

Text Figure 1.
Text Figure 1.

Kenya: Contribution to GDP Growth

(Percentage points)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: Kenya National Bureau of Statistics.
Text Figure 2.
Text Figure 2.

Kenya: Contribution to Overall Inflation

(Percentage points)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenya National Bureau of Statistics; and Central Bank of Kenya
  • Goods exports through August grew by 11.3 percent y/y, but this was outpaced by goods imports (18.8 percent y/y) on a hefty fuel import bill, while non-oil imports grew just 5.3 percent y/y (Figure 4). The current account impact was mitigated by the steady recovery in tourism and robust growth of remittances (10.4 percent y/y in January– September). Official FX reserves are adequate at above 3.5 months of import coverage but lower than expected at the 3rd reviews, primarily because market conditions have not permitted previously-planned external commercial borrowing (Text figure 3).

Text Figure 3.
Text Figure 3.

Kenya: Net International Reserves

(Millions of U.S. dollars, program definition)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Central Bank of Kenya; and IMF staff projections at program approval and the 3rd reviews.
  • Strong tax overperformance provided space to cushion part of the impact of global shocks in FY2021/22 while meeting program targets (Text Table 1, EBS/22/62). However, with external borrowing constrained and terms on domestic issuance deteriorating around the elections, fiscal financing fell short late in FY2021/22, contributing to a much stronger fiscal outturn than intended, with primary spending under-executed by about 1.9 percentage points of GDP (Figures 2 and 3). Of this, about 0.6 percent of FY2022/23 GDP in committed but undisbursed expenditure—mainly related to transfers to counties, fuel subsidies, and SOE support—will carry over into FY2022/23 (Text Table 2).4 The lower deficit left overall public debt 3.6 percentage points of GDP lower at end-June 2022 than expected at the 3rd reviews.

  • In the first quarter of FY2022/23, tax mobilization was in line with expectations amid political uncertainty and continued financing challenges, with domestic financing short of targeted levels.5 At the same time, new unbudgeted expenditure of about 1.3 percent of GDP emerged mainly for subsidy costs, drought and security, and projects (MEFP, ¶13).6 Since September, domestic fuel prices have been adjusted in line with developments in international markets, with petrol subsidies fully eliminated, and modest cross-subsidization to support kerosene and diesel, which are more heavily used by the vulnerable (Box 2). The authorities plan to fully eliminate fuel subsidies by end-year. In November 2022, total amounts accepted in T-bills and T-bond auctions exceeded the offered amounts, a first since February.

Text Table 1.

Kenya: Fiscal Developments

(In Ksh. billions)

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Sources: National Treasury; and IMF, staff calculations.
Text Table 2.

Kenya: Expenditure Carryover to FY2022/23

(In percent of GDP)

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  • The banking sector is sound with adequate capital and liquidity, and strong profitability through 2022Q3, but credit risks remain elevated (Table 5, Figures 67).7 Nonperforming loans (NPLs) declined to 11.4 percent of gross loans as of 2022Q3 but remain elevated, while private sector credit growth has broken into double digits (Text figure 4). By late September, 22 banks accounting for 46.4 percent of sector assets (primarily second- and third-tier banks) had received no-objection certificates from the CBK on their risk-based credit pricing models. Banks’ shares of FX loans, deposits, and liabilities have risen, and their net short FX open position has increased.8 Digital credit providers are now under the CBK’s supervisory purview and ten such providers had received approval as of September 2022.

  • The Shilling depreciated against the U.S. dollar at a faster but somewhat smoother pace than in 2021 and has begun appreciating in real effective terms.9 Difficulty in sourcing U.S. dollars in the local market continues. Liquidity in the interbank FX market has dried up and shifted to the bank-client market where forex transactions are executed at a more depreciated rate (Text Figure 5). Banks report delays in meeting some client orders, and bilateral transactions between some non-financial corporates. Staff is closely monitoring the situation with a view to determining the main factors behind the market distortions.

Text Figure 4.
Text Figure 4.

Kenya: Private Sector Credit

(y/y percent change)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: Central Bank of Kenya
Text Figure 5.
Text Figure 5.

Kenya: Non-Interbank vs. Interbank FX Spot Trading Volumes, All Currencies

(Percent of total interbank and non-interbank trading volumes)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: Central Bank of Kenya.
  • In the first few months of FY2022/23, the government’s domestic borrowing moved toward the short end of the yield curve, which has also flattened, reflecting near-term inflationary and financing pressures, while yields have remained largely range-bound despite hikes in the policy rate. The stock market has witnessed net foreign sales in 2022 thus far.

Program Performance

4. Program quantitative targets are all met, with fiscal targets met by large margins, while the structural agenda saw delays amid uncertainty around elections (MEFP, ¶11). Continuous conditionalities linked to Article VIII of the Fund’s Articles of Agreements are also assessed to be met (MEFP, ¶67).

  • Quantitative performance criteria (QPCs): All end-June 2022 and continuous QPCs were met. Notably, tax collection and the primary balance overperformed by 0.8 and 1.9 percentage points of GDP, respectively.10 The NIR overperformed the adjusted target by US$418 million.

  • Indicative targets (ITs): End-June 2022 targets on priority social expenditure overperformed by 0.2 percent of GDP while no outstanding exchequer requests outstanding for more than 90 days were accumulated.

  • Monetary policy consultation clause (MPCC): The MPCC was met with the three-month average of inflation (7.2 percent) within the target band as of end-June 2022.

  • Structural benchmarks (SBs): Only one of three benchmarks for July–August 2022 was met amid political uncertainty, while outstanding delayed SBs are either implemented or expected to be completed soon.

  • A draft action plan to restore KPLC’s medium-term profitability (end-July 2022 SB) was not met. The action plan was prepared but internal consultations on some key proposals could not take place prior to elections. The updated action plan is now expected to be submitted to the Cabinet sub-committee by end-December 2022 (proposed rephased SB).

  • A circular was issued on August 30 with an action plan for the development of a Medium-Term Revenue Strategy (MTRS) (end-August 2022 SB, met).

  • The review of the fuel pricing mechanism and establishment of a task force to oversee progressive fuel subsidy elimination within the first half of FY2022/23 (end-July 2022 SB) was not met. With steps taken by the new administration toward removing fuel subsidies, remaining actions under the SB are now expected to be implemented by end-December 2022 (proposed rephased SB).

  • Publication of beneficial ownership information of entities awarded public contracts (end-June 2021 SB) commenced in November 2022.

  • Publication of audits of COVID-19 vaccine spending (end-May 2022 SB) has now been implemented with a delay (the audits were completed by July and subsequently published).

Macroeconomic Outlook and Risks

5. The medium-term outlook is positive, but the near-term has weakened modestly (Table 1).

  • While the smooth transition to a new government should support confidence and activity, staff’s growth forecast has been revised down on i) a weaker global and regional outlook; ii) the drought’s impact on 2022 agricultural output, normalizing in 2023; and iii) planned cuts in public investment and anticipated monetary policy tightening (Text Table 3).

  • Staff projects inflation to peak in 2023Q1 but to gradually move back within the central bank’s target band in 2023Q3 on global price developments, recovery in agriculture, anticipated administered price adjustments, and the persistence of domestic inflation dynamics.11 Nonfood, nonfuel inflation is expected to be higher in 2023, peaking in 2023Q2, on a lagged response to food and fuel prices, with the impact mitigated by further anticipated monetary policy tightening.

Text Table 3.

Kenya: Growth and Inflation Projections

(In percent)

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Source: IMF staff projections.
  • The current account (CA) deficit/GDP is projected to widen to 5.7 percent in 2022, as the elevated fuel import bill will be partially offset by improving services balance and higher remittances (Tables 4a and 4b). In 2023, easing energy imports and robust tourism and remittances will see a decline in CA deficit/GDP to 5.4 percent.

Text Table 4.

Kenya: Changes in External Financing Since the 3rd Reviews

(In millions of U.S. dollars)

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Fiscal year data. Data for 2022 reflect FY2021/22 outturn.

Source: IMF staff projections.
  • FX reserves during the program have been revised downward relative to the 3rd reviews projections on US$1.8 billion shortfall in external public commercial (US$1.1 billion) and project borrowing (US$0.7 billion) in FY2021/22, further cuts in foreign-financed projects of close to US$1 billion as part of the tighter fiscal stance in FY2022/23, and revisions in the outlook for net private capital flows reflecting expectations of tight global financial conditions persisting in 2023 (Text Table 4).12 Materialization of upside potential on external fiscal financing would support a higher reserves level than in the current baseline.

  • Over the medium term, growth is projected to converge to about 5.5 percent with inflation averaging around 5 percent. Fiscal consolidation would facilitate adjustment, allowing the CA deficit to stabilize around 5 percent of GDP. While the medium-term FX reserves path has shifted downward, reserves will remain adequate over the medium term, supported by mutually-reinforcing policies and the normalization of global financial market conditions.

6. Risks are tilted toward adverse outcomes in the near term, dominated by external factors. Kenya remains exposed to intensification of global spillovers from the war in Ukraine, commodity price shocks, and faster tightening of monetary policy in major economies.

  • Downside risks (adverse outcomes). A shortfall in rains would worsen food insecurity and malnutrition in impacted areas of the ASAL, slow growth, and push inflation higher. Persistent investor concerns about frontier economies or lack of confidence in Kenya’s fiscal path could exacerbate fiscal financing and balance of payments pressures, depressing reserve coverage. Larger decline in prices of key commodity exports would impact FX supply. Higher public sector contingent liabilities and spending, including for security and drought-related needs, could slow the reduction in public debt if not offset.

  • Upside risks (better outcomes). Better-than-expected rainfall would support a faster recovery in agricultural production, ease food prices and headline inflation, and improve food security. Faster-than-expected easing of global commodity prices would also help contain cost of living and support private consumption. Confidence, investment, and market access could rebound more quickly than expected on resolution of global uncertainty and with Kenya’s demonstrated commitment to fiscal consolidation.

Policy Discussions

Discussions centered on the program’s main objective of reducing debt risks by putting debt/GDP firmly on a downward trajectory, complemented by a more active role for monetary policy and exchange rate flexibility in addressing current challenges. The mission engaged the new administration on emerging structural reform priorities while seeking progress on addressing weaknesses in state-owned enterprises (SOEs), strengthening governance and anti-corruption efforts, and modernizing the monetary policy framework and protecting financial stability.

A. Reducing Debt Vulnerabilities in the Face of Near-Term Pressures

7. The new government has outlined an ambitious agenda for bottom-up economic development while staying the course on fiscal consolidation. Details of key policy initiatives are being firmed up in the coming months. Scaling up of affordable housing and water supply would be done via public private partnerships rather than the government budget. Establishment of a Financial Inclusion Fund (also known as the “Hustler Fund”), is envisaged to have heavy private sector participation with limited budgetary implications. The anticipated scaling up of contributions to the National Social Security Fund from current low levels to 6 percent each from employee and employer is intended to bolster national savings and strengthen the social safety net, also with limited impact on the government budget.

8. Confronted with significant challenges, the new administration has expressed firm commitment to containing spending pressures and increasing tax revenues to safeguard fiscal discipline. On entering office, in addition to the carryover from FY2021/22 (0.6 percent of GDP, ¶3) policymakers had to contend with pressures from unbudgeted expenditures for about 1.3 percent of GDP (Text Table 5, MEFP, ¶13). These reflected spending authorized by the outgoing administration under the constitutional provision of Article 223 for emergency expenditures (0.4 percent of GDP)13 and additional discretionary spending, including related to subsidies, and needs arising from the ongoing drought emergency and policy priorities of the incoming administration. The authorities plan an ambitious rationalization of non-priority spending (1.7 percentage points of GDP in FY2022/23) to offset most of these pressures, mainly diverting budgeted resources from inactive and/or slow-moving investment projects and introducing additional savings in recurrent administrative spending, while protecting priority social spending (MEFP, ¶14). Together with robust revenue collection, this would allow containing the overall fiscal deficit at 5.8 percent of GDP in FY2022/23––below both the FY2021/22 and budgeted FY2022/23 levels (6.2 and 6.0 percent of GDP, respectively), avoiding a deterioration of the debt situation.

Text Table 5.

Kenya: Budgetary Impact of On-Going Fiscal Initiatives

(In Ksh. billions)

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Sources: National Treasury; and IMF staff calculations and projections.

9. A Supplementary FY2022/23 Budget consistent with program objectives will be submitted to Cabinet by end-January 2023 (proposed new SB). The supplementary would target a primary deficit of 1.1 percent of GDP (stronger than the 1.2 percent under the 3rd reviews, Text Table 6), reflecting determined fiscal consolidation to remain within available resources (Table 2a and 2b, MEFP, ¶14). On the revenue side, collection is expected to slightly overperform, as higher prices boost the yield of tax measures introduced by the 2022 Finance Act and in the Eastern African Countries (EAC) context (EBM/22/67) while non-tax revenues from international transactions also increase. Total public expenditure would remain at 23.3 percent of GDP. Based on current commitments, financing needs would be met via modestly higher domestic financing (including full use of Kenya’s SDR allocation) and the requested program augmentation within normal access limits (¶25).14

Text Table 6.

Kenya: Sources of Improvement in the FY2022/23 Primary Balance Compared to Approved Budget

(In percent of GDP)

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Sources: National Treasury; and IMF staff calculations and projections.

10. Preparations for the FY2023/24 budget have commenced (MEFP, ¶15). The budget proposal is expected to target a primary balance surplus of 0.3 percent of GDP (0.2 percent of GDP at the 3rd reviews) so as to put Kenya’s debt-to-GDP ratio firmly on a downward trajectory. Achieving the primary surplus would require a comprehensive package of new tax measures for 0.9 percent of GDP, the composition of which would reflect the authorities’ priorities drawing from their Medium-Term Revenue Strategy (MTRS, ¶19; MEFP, ¶19). Further improvements in strengthening the efficiency of tax and custom administration would complement these efforts. On the spending side, ongoing reductions in non-priority primary spending would be needed, while protecting priority social spending and fully offsetting planned extraordinary SOE support (MEFP, ¶22–24). A FY2023/24 Budget proposal consistent with program objectives is expected to be submitted to parliament by end-April 2023 (proposed new SB).

11. Beyond FY2023/24, the authorities’ fiscal strategy remains centered on reducing debt vulnerabilities, while protecting high-priority service delivery programs. This will require maintaining the fiscal primary balance above its debt-stabilizing level through continued efforts to further strengthen tax compliance per Kenya’s MTRS and streamline recurrent expenditures— particularly for wages and transfers to public sector entities—while improving public investment management and budgetary controls.

12. Kenya’s debt is sustainable but overall and external ratings for risk of debt distress remain high (DSA). Under the baseline, public debt is expected to peak at 67.6 percent of GDP in FY2022/23 (62 percent of GDP in present value (PV) terms). Debt dynamics will be bolstered by fiscal consolidation under the program, bringing debt to more prudent levels over the medium term. The outlook for PV of external debt-to-exports ratio has improved since the last assessment on the stronger-than-anticipated fiscal outturn in FY2021/22 and planned rationalization of capital spending in FY2022/23, including on externally-financed projects.15 Improvement will remain gradual for the external debt service-to-exports ratio.

Text Figure 6.
Text Figure 6.

Kenya: Primary Balance

(Percent of GDP)1

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities and IMF staff projections.
Text Figure 7.
Text Figure 7.

Kenya: Public Debt

(Percent of GDP)1

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities and IMF staff projections.1 Ratios as share of GDP are impacted by GDP rebasing, which took place between the 1st and 2nd reviews of the EFF/ECF arrangements.

13. The authorities plan further steps to strengthen debt management and reduce debt vulnerabilities (MEFP, ¶26). Key strategic objectives are: (i) reducing refinancing risks by issuance of liquid benchmark domestic government bonds across all maturities and continuing to explore possibilities for market-based, external debt management operations to smoothen the debt service profile; (ii) increasing utilization of committed external concessional financing, while tapping into international financial markets to rollover maturing Eurobonds, and optimize the external debt service profile if market conditions are favorable; (iii) empowering the Public Debt Management Office (PDMO) in management of public debt as envisioned in the Public Financial Management (PFM) Act;16 and (iv) deepening the domestic debt securities market by implementing reforms developed jointly by the National Treasury (NT) and the CBK.17

B. Mutually Reinforcing Monetary and Exchange Rate Policy and a Resilient Banking Sector

14. Achieving and maintaining price stability is the principal objective of monetary policy in Kenya, and spillovers from global shocks present continuing challenges. While the timing of inflation breaching the target band was in line with expectations, the near-term inflation outlook has deteriorated. Staff projects inflation to peak around 10 percent y/y in early 2023Q1 and to remain outside the central bank’s target band in 2023Q2.18 Taking into account the 175 basis points in CBK policy tightening to date in 2022, Kenya’s real policy rate on a one-year-looking basis (using staff’s inflation projection) was marginally positive, while the real interbank rate remained at multi-year lows (Text Figure 8 shows comparison to the five years preceding the pandemic).19 Given the extent of US policy tightening, the differential between CBK policy rate and the Federal Funds rate had also narrowed.20 Banks’ excess reserves have remained on an upward trend during this period (Figure 5).21

Text Figure 8.
Text Figure 8.

Kenya: Real Interest Rates

(In percent; against alternative measures of inflation)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities; Haver Analytics; and IMF, World Economic Outlook database and staff calculations.

15. With the monetary policy stance remaining relatively accommodative by historical standards, the CBK’s stance to further tighten monetary policy is essential to keep inflationary expectations anchored and support external sustainability (MEFP, ¶45). The authorities remain committed to mitigating the second-round effects of higher food and fuel prices. Consistent with its inflation projections, staff’s analysis indicates that real policy rates peaking at a low single digit levels in early 2023––while lower than the 2015–19 average––would support the return of inflation within the CBK’s target in 2023Q3. Related further increases in domestic interest rates could also help underpin market interest as the government seeks to meet domestic financing needs. Monetary policy will also need to remain attentive to external shocks that could undermine achievement of CBK’s FX reserves goals and merit an additional response.

16. The authorities affirmed their commitment to exchange rate flexibility and the shock absorbing role of the exchange rate in helping the economy respond to persistent global dislocations and in supporting reserves. To address structural challenges of pricing and liquidity in the interbank FX market, the authorities are considering issuing additional guidelines aligned with international best practices (the FX Global Code). They also recognized that continuing global strength of the U.S. dollar––and the possibility that inflation could peak relatively sooner in Kenya’s trading partners––might undermine competitiveness by leading to real appreciation of the shilling. Considering the program’s FX reserves goals, the authorities plan to limit FX sales to responding to excessive market volatility while recognizing the role a mutually-consistent policy framework plays in supporting the medium-term buildup in FX reserves. They also acknowledged the role of effective communication of these policy intentions in helping to navigate a period of limited near-term FX liquidity, even as FX reserves remain adequate.

17. The CBK is making progress in modernizing the monetary policy framework along the lines set out in its earlier White Paper (MEFP, ¶47). Related efforts to strengthen forecasting and policy analysis are advancing, including with support from AFRITAC East experts.22 The launch of the Central Securities Depository, which is expected to facilitate collateralized transactions among banks, has been delayed to early 2023 to allow time for further testing.

18. The banking system is sound yet exposed to evolving risks (MEFP, section H). With banks well-capitalized and liquid overall, small and medium-sized banks with greater exposure to riskier lending continue to grapple with resolving NPLs and maintaining adequate provisioning. Improving asset quality remains contingent on the economic recovery, with unpaid government bills, including from local governments, weighing on the sector. The CBK continues to encourage consolidation through takeovers of weaker banks. The CBK has devoted considerable efforts to training loan officers on risk-based pricing and issued no-objection certificates to many institutions, although banks indicate that for reasons of competitiveness, full rollout of their credit pricing models will hinge on sector-wide approvals. The CBK is monitoring the gradually rising share of FX loans and deposits in the banking system to assess vulnerability to currency risks. Kenyan banks have seen strong expansion in the EAC region and are systemic in their host countries, raising the possibility of regional spillovers and spillbacks in financial and economic policy. The central bank continues to closely monitor operational risks from digitalization (including cyber and fraud risks) and risks from corporate exposures across the banking sector.

C. Advancing the Structural Reform Agenda and Emerging Priorities

Modernizing the Fiscal Framework

19. The authorities remain committed to strengthening revenue administration and mobilization to support the ambitious tax revenue goals announced by President Ruto (MEFP,¶19–20). The MTRS aims to modernize Kenya’s tax policy system, improve compliance, and inform critical policy decisions. The action plan issued in August 2022 (met SB) provides specific milestones to identify mutually supportive tax policy and administrative measures to widen the tax base and mobilize domestic revenues. An initial draft of the MTRS is expected to be finalized by end-February 2023 with continuing support of Fund technical assistance (TA). The Kenya Revenue Authority (KRA) is enhancing compliance by strengthening audits and data-driven compliance risk management and reducing abuse—particularly related to VAT and improving taxpayer services.

20. Strengthening PFM systems remains key to improving management of fiscal risks. The NT is pursuing an ambitious agenda aimed at improving budget processes and controls, while strengthening fiscal risk management (MEFP, ¶24). Recognizing the significant challenges from extrabudgetary spending in the first months of FY2022/23 and to evaluate the consistency of spending outcomes with plans and enable parliament to serve its function in approving budgets, the Auditor General is launching a special audit on the mechanism, efficiency, and effectiveness of supplementary budgeting—including under Article 223 of the Constitution––to be published by end-of-September (proposed new SB; MEFP, ¶63). The authorities have also established—with the support of Fund TA—a Fiscal Risk Committee (FRC) to anticipate, monitor, evaluate, manage, and mitigate fiscal risks across the public sector—including related to Public Private Partnerships (PPPs; MEFP,¶27–28).23 Furthermore, to prevent unexpected fiscal costs going forward, they are also in the process of reviewing the fuel pricing mechanism and establishing a taskforce to ensure that fuel pricing decisions are at all times aligned with the available resources (rephased SB proposed for end-December 2022, MEFP,¶25).

Addressing SOEs’ Financial Challenges and Governance

21. While the SOE reform agenda saw limited progress since the third reviews, President Ruto has set out a bold objective to step up privatization as part of efforts to rationalize SOEs. Budget risks from Kenya Airways (KQ) and Kenya Power and Lighting Company (KPLC) remain elevated. The authorities reduced extraordinary SOE support to Ksh.17.5 billion (0.14 percent of GDP) in FY2021/22 from an originally budgeted Ksh.32.3 billion, while the FY2022/23 Supplementary Budget will reflect extraordinary support of Ksh.37.3 billion (0.3 percent of GDP). The bulk of this would go to KQ, while support to KPLC would be reduced.24 Given limited fiscal space, the focus remains on identifying cost-saving reforms at KQ and KPLC.

  • Kenya Airways (MEFP, ¶34–38). KQ remains insolvent with the highest cost base among regional airlines even as it met 75 percent of its targeted cost reduction in FY2021/22. Priorities of its restructuring plan include network optimization, lease negotiation, staff rationalization, and other cost management efforts. The airline has retired sixteen loss-making networks and renegotiated some aircraft leases but faces challenges in rationalizing staff costs.25 Discussions are also ongoing to novate KQ’s guaranteed debt. The authorities aim to provide extraordinary budget support to KQ under safeguards linked to appropriate accountability mechanisms and key performance indicators on KQ’s restructuring commitments.

  • Kenya Power and Lighting Company (MEFP, ¶39–40). The 15 percent base tariff reduction of January 2022 has had a significant negative impact on KPLC’s liquidity position, while the restoration of monthly adjustments in passthrough of variable electricity costs (FX depreciation and inflation adjustments) beginning in September 2022 will help cashflows somewhat. The authorities reported a lower KPLC liquidity gap at Ksh.69 billion as of June 2022 (0.5 percent of GDP, compared to 1 percent of GDP in 2021). However, large sums remain outstanding on payables and receivables, including for government support of the rural electrification scheme, and limited progress has been made on cost-saving measures. Well-identified and achievable cost-saving measures are needed to address KPLC’s liquidity and profitability situations, and tariff decisions are under evaluation. The authorities have committed to submit to Cabinet a draft action plan on addressing KPLC’s liquidity gap and restoring medium-term profitability (rephased SB proposed for end-December 2022).

Text Figure 9.
Text Figure 9.

Kenya: Consumer Electricity Charges

(Cost per KWH)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: https://www.stimatracker.com/.1 Variable charges include adjustments for fuel energy cost for thermal plants, foreign exchange fluctuation, and inflation, and some levies.

22. The new administration is prioritizing rationalization of state corporations (SCs), and the authorities remain committed to strengthening SC governance and oversight (MEFP, ¶41– 42). The authorities have made progress in developing and operationalizing a Government Investment Management Information System (GIMIS) and plan to further develop its capabilities for assessing fiscal risks from SCs. They also are reviewing the earlier reform strategy (Blueprint) to align it with the administration’s new policy priorities and sequencing reform measures. A draft Ownership Policy for SCs, which will describe a new governance architecture and legal ecosystem to improve performance and transparency, will now be submitted to Cabinet by end-June 2023. The authorities are also beginning work, with Fund TA, on the legal reforms necessary to anchor the new ownership arrangements and other measures outlined in the Blueprint.

Strengthening Governance and Fighting Corruption

23. Strengthening Kenya’s anti-corruption legal framework, enhancing transparency, and effective follow up on audit findings remain a priority.

  • The authorities have resolved outstanding operational issues and started publication of beneficial ownership information of successful bidders of new procurements that were reported into the Public Procurement Information Portal (PPIP) since mind-November 2022 (prior action; MEFP, ¶58).26 This follows issuance of revised bidding documents in April 2022, which enabled collection of beneficial ownership information. The Public Procurement Regulatory Authority aims to prioritize enhancing data analysis capabilities of procurement-related information to reinforce the fight against corruption (MEFP, ¶59).

  • The authorities intend to strengthen follow-up on audit findings of the Auditor-General by promoting greater coordination among state bodies, including law enforcement agencies, strengthening monitoring capabilities, and enhancing public reporting (MEFP, ¶60). The rapid production and publishing of multiple audits of COVID-19-related spending, including the most recent audits of COVID-19 vaccination spending and delivery, have identified numerous structural and transactional issues, initiated investigations of suspicious transactions, while highlighting the broader need for more systematic follow-up of findings and recommendations.

  • The recently published Kenya 2022 Mutual Evaluation Report by the Eastern and Southern Africa Anti-Money Laundering Group (ESAAMLG), the FATF-style regional body, highlighted major deficiencies in Kenya’s AML/CFT regime. To help prevent laundering of illicit proceeds from corruption, the authorities plan by end-June 2023 to submit to the National Assembly, draft amendments to the Proceeds of Crime and Anti-Money Laundering Act and Regulations to address gaps in the AML/CFT legal framework, including requirements on politically exposed persons (PEPs), in line with FATF standards (proposed new SB; MEFP, ¶64). To this end, the authorities also aim to prioritize ensuring compliance by banks with enhanced due diligence measures for higher risk customers, including PEPs, through AML/CFT risk-based supervision.

  • Stakeholder and public consultations on the draft Access to Information Regulations and the draft Conflict of Interest Bill were finalized, and the authorities plan to, respectively, publish and submit the documents to Parliament before end-2022 (MEFP, ¶57 and 61). However, weaknesses remain in the current draft Conflict of Interest Law relating to the underlying system for asset declaration (scope of coverage, publication of asset declaration information, and mechanisms for validating accuracy of submissions), creating a risk that adoption of new regulations in their current form fails to improve accountability and integrity.

Emerging Priorities

24. Efforts to operationalize new reform initiatives have intensified, although details are not yet available (MEFP, ¶43). These include: i) a Financial Inclusion Fund (Hustler Fund) to expand access to credit with a built-in savings (pension) component for those outside the formal workforce, supported by partial contributions from the government capped at a limit; ii) raising minimum contributions to the National Social Security Fund; iii) targeted interventions to expand affordable housing; and iv) privatization of SOEs and needed amendments to existing legal framework to facilitate it. Provision will be made in the forthcoming FY2022/23 Supplementary budget for anticipated costs related to the Financial Inclusion Fund of 0.1 percent of GDP. As these policies are further developed, staff will assess their impact in future program reviews, including any fiscal risks.

25. Kenya is highly vulnerable to climate change, especially droughts and floods (Box 3). Kenya has made important strides toward a green economy.27 Climate-sensitive sectors (i.e., agriculture, tourism, and trade) comprise over a third of domestic production. Building on a strong track record in implementing climate adaptation and mitigation policies, efforts are ongoing to strengthen institutions to deliver and monitor Kenya’s ambitious climate objectives and to mobilize green financing from development partners and the private sector. The CBK’s 2021 Guidance on Climate-Related Risk Management to the banking sector is expected to help banks integrate climate-related risks into their governance, strategy, risk management and disclosure frameworks, and enable them to leverage on business opportunities from efforts to mitigate and adapt to climate change (MEFP, ¶53). Other priorities include building resilience to large and protracted climate shocks, integrating climate-change considerations in the allocation of government resources, and improving transparency and accountability in their use.28 The authorities have expressed interest in accessing the Resilience and Sustainability Trust (RST).

Program Issues and Risks

26. The authorities request augmentation of access under the ECF arrangement by 30 percent of quota (SDR 162.84 million or about US$215 million; Table 7). This would be made available in full to the CBK upon completion of the 4th ECF/EFF reviews, who will provide it as budget support to the government in local currency.29 The proposed augmentation will help ease pressures on official FX reserves (actual balance of payments need) and ensure continuity in budget financing, including to respond to the ongoing drought and food security needs, by partially offsetting the impact of the shortfalls in external financing and potentially catalyzing additional support by Kenya’s development partners (see footnote 15). It would bring cumulative GRA and PRGT access net of repurchases (including the 2021 Rapid Credit Facility) to 435 percent of quota (about US$3.2 billion) by 2024, remaining within normal cumulative access limits (Table 8). The residual external financing gap, which also reflects more conservative assumptions on private capital flows (¶5), will be absorbed by reserves drawdown, lowering the import coverage to 3.7 months by end-2022 and to 3 months by end-2023 (3rd reviews: 3.9 months and 4.2 months, respectively). There is an upside potential for reserve coverage from stepped-up support by development partners.30

27. The program is fully financed, with firm commitments over the next twelve months and good prospects for the remainder of the program (Table 6). In addition to support from the Fund, Kenya’s external budget financing needs would be met by a mix of official and commercial loans that prioritizes concessional financing:

  • External commercial financing. The authorities are well advanced in securing the budgeted US$900 million external commercial borrowing for FY2022/23 (full disbursement anticipated by early 2023) by tapping medium-term loan facilities from international banks (MEFP, ¶26).31

  • Official concessional financing. Concessional program financing is provided by the World Bank (WB) and the African Development Bank (AfDB), with the AfDB support already disbursed. Discussions are underway on a successor arrangement in FY2022/23 to the US$750 million WB Development Policy Operation (DPO) disbursed in FY2021/22.32 Underutilization of the WB loan targeting acceleration of COVID-19 vaccination in FY2021/22 is also expected to be compensated over the next two fiscal years.

28. The program continues to face significant risks (¶6). These risks are mitigated by the authorities’ strong performance to date and demonstrated commitment to adopting contingency measures as needed to achieve program objectives, including evolving challenges presented by the global environment for monetary policymaking, close engagement with donors and creditors, and a tailored capacity development strategy to support the implementation of structural reforms, including plans to develop a MTRS.

29. Kenya’s capacity to repay the Fund is adequate but is subject to risks (Table 8).

  • At end-2021, the share of Kenya’s multilateral debt was less than half of its total external public debt and is projected to remain below 50 percent over the medium term under the baseline (Table 10). There is no collateralized, public and publicly-guaranteed external debt.

  • The total amount of outstanding credit to the Fund (including the proposed augmentation) is projected at SDR 2,361.2 million, or 435 percent of quota in 2024, equivalent to 2.4 percent of GDP, and 40 percent of gross international reserves in 2023, with the latter exceeding the 75th percentile of past Fund UCT-quality arrangements for LICs (Figure 8). External adjustment will be supported by the authorities’ ambitious fiscal consolidation and mutually-reinforcing monetary and foreign exchange policies which will sustain FX reserves over the medium term and support Kenya’s capacity-to-repay the Fund. Total debt service to the Fund would peak by 2028 at 2.3 percent of exports of goods and services, well above the top quartile of past Fund UCT-quality arrangements for LICs, and 1.8 percent of fiscal revenue, the latter just below the top quartile of the comparator group. These relatively elevated levels of scheduled debt service to the Fund may pose risks to capacity to repay over the medium term. In the near term, the materialization of downside risks, such as a continued lack of market access for frontier issuers and delays in reform implementation could increase pressure on Kenya’s capacity-to-repay the Fund. However, these risks are mitigated by Kenya’s continued access to concessional financing, expected normalization of international market access toward the end of the program, and Kenya’s strong track record of servicing debts to the Fund and other creditors. Risks are further mitigated by the multi-year fiscal consolidation that anchors the program, supported by tax policy measures to boost revenues, and the authorities’ commitment to maintain exchange rate flexibility.

  • One of the key objectives of the program is to undertake growth-friendly fiscal consolidation, achieving the debt stabilizing primary balance during the program to put the public debt/GDP ratio on a downward path. The four external debt indicators are also on a downward path, with near-term breaches relative to the five LIC-DSA thresholds declining over the medium term.

30. The authorities are requesting the following modifications to program conditionality (MEFP, Tables 1 and 2):

  • new QPCs for all relevant indicators for the end-December 2023 test date;

  • modifications of QPCs on primary balance and tax revenue for the end-June 2023 test date (stronger fiscal objectives) and of net international reserves for the end-December 2022 and end-June 2023 test dates;

  • resetting the timeline for the delayed end-July 2022 SBs (KPLC action plan and review of the fuel pricing mechanism) to end-December 2022; and

  • establishment of four new SBs: submissions of FY2022/23 supplementary budget and FY2023/24 budget, both consistent with the program’s objectives and targets; special audit of the mechanism, efficiency, and effectiveness of supplementary budgets, including under Article 223 of the Constitution, to improve budget control; and submitting draft amendments to the National Assembly to support anti-corruption efforts in line with FATF standards, including requirements on politically-exposed persons.

Staff Appraisal

31. Kenya is navigating through a turbulent global backdrop. The recent political transition demonstrated growing strength of Kenyan institutions, and the economy exhibited resilience in the run up to the elections, growing at a 6 percent y/y rate during the first half of 2022. However, the outlook has weakened somewhat and inflation has risen amid a worsening international economic outlook, tighter global financial conditions, and heightened volatility. An expected normalization of rainfall next year should support a recovery in agricultural production, helping ease food and headline inflation, and improving food security and nutrition among vulnerable groups in the ASAL regions. Risks to the near-term outlook are tilted to adverse outcomes. While the medium-term outlook remains positive, it is subject to climate-related shocks.

32. The quantitative targets under the program are all met, but the structural reform agenda has seen delays amid election-related uncertainty. Fiscal targets for end-June 2022 recorded notable overperformance amid challenges in securing planned financing. The program design and the authorities’ consistent fiscal performance has provided a strong policy anchor to ensure that debt vulnerabilities are reduced over the medium term and public debt/GDP is put on a downward path before the end of the program. Timely implementation of delayed SOE and governance reforms will remain important going forward, including to reduce fiscal risks.

33. Further efforts are needed to deliver a mutually reinforcing macroeconomic policy mix, with monetary and exchange rate policies playing a more active role given evolving challenges. Fiscal consolidation is supporting external adjustment. However, amid higher inflation, persistent terms of trade shocks from the war in Ukraine and tighter global financing conditions, monetary policy will need to be proactive and exchange rate flexibility will have an increasing role to play in helping the economy to absorb external shocks. The anticipated rise in domestic interest rates remains manageable from the perspective of debt vulnerabilities and would facilitate securing financing from local capital markets while avoiding a shortening of maturities. In this regard, the authorities’ earlier dedicated efforts to extend the domestic yield curve have provided an important margin of flexibility to navigate the challenging period around elections.

34. The new administration has taken a firm stance on reducing debt risks, backed by strong actions to preserve fiscal discipline in a difficult environment. In September, shortly after taking office, they eliminated petrol subsidies and reduced other fuel subsidies following delays in adjusting domestic fuel prices in July and August. Confronted with significant spending pressures (1.9 percent of GDP)—mainly related to the carryover from FY2021/22 and additional unbudgeted spending around the August elections—the new administration has identified expenditure savings for about 1.7 percent of GDP to contain the overall fiscal balance within available margins. The Supplementary FY2022/23 Budget will thus target a primary deficit of 1.1 percent of GDP—a slight improvement over the approved FY2022/23 Budget—also reflecting the prospect for higher-than-previously-anticipated revenue collection. In FY2023/24, the adoption of a tax package of 0.9 percent of GDP will be critical to further reduce fiscal imbalances and broaden the tax base to make room for needed social and development spending. In subsequent years, further improvements in strengthening spending efficiency and improving tax policy and revenue administration will remain essential.

35. Kenya’s public debt is sustainable but remains at high risk of distress. With a lower realized deficit last fiscal year, public debt is expected to peak below the level anticipated at the 3rd reviews at 67.6 percent of GDP in FY2022/23 (62 percent of GDP in present value (PV) terms). Debt dynamics will be bolstered by the fiscal consolidation under the program, stabilizing debt/GDP and bringing it to more prudent levels over the medium term while securing resources to support social spending. Improvement in the external debt service-to-exports ratio will remain gradual. Staff also welcomes the authorities’ comprehensive strategy to strengthen debt management.

36. Monetary policy should be tightened further to anchor inflationary expectations and guide inflation back within the CBK’s target band in 2023 while also supporting external sustainability. The authorities have raised the policy rate by a combined 175 basis points in 2022. Staff projections show inflation peaking in 2023Q1, supported by a deceleration in food inflation. Against this backdrop, staff recommends further tightening of monetary policy and sees a rise in the real policy rate (based on prospective inflation) to low single-digit levels as consistent with inflation moving back inside the target band in 2023Q3. Central bank liquidity operations should align the interbank overnight rate and commercial banks’ excess reserves with the stance of the monetary policy. Higher real rates should also support external sustainability and FX reserves goals while helping to meet the government’s domestic financing needs. Considering the reduced external buffers, mutually-reinforcing policies to support external adjustment and strengthen adequacy of FX reserves are also important to underpin capacity to repay the Fund. Given elevated uncertainties, the CBK should continue to closely monitor domestic and global developments and stand ready to respond as needed.

37. Staff welcomes the authorities’ intention to support reactivation of Kenya’s interbank foreign exchange market, which, combined with exchange rate flexibility, should help in navigating global shocks. Following the war in Ukraine, Kenya has experienced a period of tight forex demand, accompanied by reduced liquidity in the interbank foreign exchange market and a relatively smooth depreciation of the bilateral exchange rate against the U.S. dollar. However, the Shilling has risen against Kenya’s other trading partners following the strong surge of the U.S. dollar on a global basis. Such flexibility should help the exchange rate function as a shock absorber, mitigating the pressures from global shocks, supporting competitiveness, and protecting FX reserves buffers, even as global shocks have impacted projections for capital flows over the medium term. Relatedly, dedicated efforts to reactivate efficient functioning and price discovery in the interbank FX market should help address reported pressures in sourcing foreign exchange and mitigate the trend toward increasing FX exposures (assets, liabilities) in the banking sector. Official interventions in the FX market (FX sales) should be limited to addressing excessive market volatility and consistent with the program’s FX reserves goals. While foreign reserves remain adequate, effective communication of the CBK’s policy intentions will be important in navigating a period of elevated global uncertainty.

38. Banks are well-capitalized and liquid overall, and the authorities should continue to closely monitor risks. Resolution of NPLs and continued adequate provisioning should be priorities, while the CBK’s approach to consolidating weaker banks is welcome. Staff also welcomes the CBK’s increased engagement with banks on their risk-based loan pricing, where faster issuance of no-objection certificates could help unlock MSME credit. Continued attention to risks from banks’ FX positions—now closely monitored from a capital adequacy perspective alongside the underwriting of FX loans—should be a priority. The CBK should continue to closely monitor spillovers and spillbacks from local banks’ regional expansion and operational risks from digitalization.

39. The new Administration’s focus on minimizing the drain on fiscal resources from SOEs is welcome and should be accompanied by decisive steps to tackle vulnerabilities at KQ and KPLC and improved SOE governance and oversight. KQ and KPLC continue to receive extraordinary budget support, albeit at a lower level than initially budgeted, while progress on fundamentally addressing their financial vulnerabilities has remained limited. Steadfast implementation of KQ’s restructuring plan to cut costs, with exchequer support linked to clear accountability—even as needs for servicing KQ’s guaranteed debt are being addressed via a process of novation—remains critical to limit fiscal risks. On KPLC, while steps in September to reinstitute passthrough of variable costs are welcome, making progress on an action plan to address KPLC’s liquidity gap and medium-term profitability remain critical to limit fiscal risks. Further progress is also needed in improving the governance framework for SOE oversight, including on the SOE Blueprint, even as the new administration sets a course toward achieving the bold privatization objective set out by President Ruto.

40. Strengthening the anti-corruption legal framework, enhancing transparency and effective follow up on audit findings should remain priorities. Staff welcomes recent publication of beneficial ownership information of winning bidders through the Public Procurement Information Portal, which delivers on a longstanding commitment, and encourages strengthening of data analysis capabilities on procurement-related information. The planned special audit on supplementary budget spending, including under Article 223 of the Constitution, will provide needed transparency and accountability and should help to ensure going forward that spending outcomes are consistent with plans. The authorities should take timely actions to address the strategic deficiencies identified in the Kenya 2022 Mutual Evaluation Report by ESAAMLG to safeguard financial and macroeconomic stability. Amendments to address gaps in the AML/CFT legal framework in line with FATF standards, including requirements on politically-exposed persons, will help support anti-corruption efforts. To this end, the authorities should conduct AML/CFT risk-based supervision to ensure banks’ compliance. Government progress in preparing the draft Conflict of Interest Law is noted, but substantial changes are needed in order to align the draft law with principles of good practice, especially relating to asset declarations. Staff encourages the authorities to act rapidly to introduce necessary modifications regarding collection and publication of asset declarations prior to submission of the draft bill to Parliament.

41. Staff supports the authorities’ requests for completion of the 4th ECF/EFF reviews with an augmentation of access of 30 percent of quota under the ECF arrangement within the normal cumulative access limit, and modifications of QPCs for end-December 2022 and end-June 2023, given the performance under the arrangements and the commitment toward meeting the program’s objectives.

Drought in Kenya

A large-scale, climate-induced, humanitarian crisis is unfolding across the Horn of Africa including in parts of Kenya. Following below-average rainfall for four successive seasons, the country is currently experiencing one of the longest droughts in the last 40 years in the Arid and Semi-Arid regions (ASAL).1 The Predictive Livestock Early Warning System (PLEWs) in Kenya is forecasting that October-December 2022 short rains are likely to underperform with the drought situation not expected to improve before June 2023. The Government of Kenya (GoK) declared a national emergency in September 2021.

The exceptional series of disappointing rainfall seasons are having a devastating impact on agricultural production and water availability in impacted regions, causing a sharp increase in malnourishment and food insecurity while eroding livelihoods. Food availability and access in the ASAL regions saw a sharp decrease as food production shortages increased, which, in addition to a very high pass-through of global staple food price increase to domestic prices in Kenya (estimated to be 97 percent), caused a spike in staple food and water prices.2 Moreover, malnutrition increased markedly, with data by UNICEF/GoK in July 2022 indicating that 884,464 children under 5 and 115,725 pregnant and breastfeeding women were malnourished and in need of treatment.3 Similarly, food insecurity escalated with Kenya’s National Drought Management Authorities estimating the number of food insecure people to have increased from 3.5 million at end-2021 to 4.5 million by end-October 2022.4 To help mitigate elevated food insecurity, the FY2022/23 Supplementary Budget is projected to allocate KSh.10.2 billion (0.07 percent of GDP) in drought-related spending, of which nearly 60 percent is intended to finance food provision. Unfavorable weather conditions have also eroded livelihoods and increased social tensions and inter-communal conflicts.

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1 Food Security and Nutrition Working Group, Special Report, July 29, 2022.2 IMF, Climate Change and Chronic Food Insecurity in Sub-Saharan Africa (September 2022)3 Food and Agricultural Organization (FAO): Predictive Livestock Early Warning Information System (PLEWS)4 Kenya Food Security Steering Group (KFSSG) Long Rains Assessment/IPC, July 2022

Recent Inflation Developments

The rise in inflation has been driven by unfavorable weather conditions and spillovers from the war in Ukraine, which, coupled with COVID-19 related supply chain disruptions, increased transportation costs. In the first eleven months of 2022, inflation accelerated from 5.4 percent y/y in January to 9.5 percent in November, breaching the upper bound of the CBK’s 2.5–7.5 percent target range for the sixth consecutive month. This acceleration mainly reflected the pass-through of global shocks and poor agricultural performance feeding into food prices, which increased from 8.9 percent to 15.4 percent over the same period. Contribution of some key commodities (namely wheat, maize, milk, and edible oils) increased markedly, from 1.2 percentage points in January 2022 to 3.1 percentage points in October 2022, with overall food inflation contributing nearly 80 percent of the average price increase over the same period.1

Inflationary pressures from elevated global oil prices were contained by the authorities’ decision to gradually adjust retail fuel prices and lower electricity tariffs earlier in the year. Following the onset of the war in Ukraine, the authorities resumed gradual adjustments in domestic retail fuel prices in March after having kept them unchanged over October 2021 to February 2022. However, adjustments were paused in July and August around the elections.2 On September 14, the authorities resumed the monthly fuel price adjustments and announced the largest increase of the year (15.6 percent, averaged across products), eliminating the subsidy for petrol and sharply reducing the subsidy for diesel and kerosene. The 15 percent reduction in the retail electricity tariff in January provided some counterweight to inflationary pressures this year, even as it created cashflow challenges at Kenya Power and Lighting Company. With September’s move to restore adjustments in variable charges in electricity bills, overall fuel inflation jumped to 13.8 percent in November. Non-food, non-fuel inflation has moved up from 1.9 percent in January 2022 to 4.2 percent in November.

While all households across Kenya will be affected by the rising food inflation, the poorer households have suffered the most. This is due to even higher significance of food products in their consumption basket than the national average. As of November, official data show that for lower income households living in Nairobi, inflation rate was at 10.4 percent as compared to 6.9–7.8 percent for the higher income groups.3 As a result, the surge seen in inflation is expected to erode living standards, already pressured by elevated levels of food insecurity, and raise poverty rates.

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1 This is despite several types of interventions, including: i) waiver of import duty on 540,000 metric tons of white maize imported into the country before August 22, 2022 (subsequently extended to September 30, 2022); ii) fertilizer subsidy provided during the April planting season (in amount of Ksh.3 billion) and during October for the forthcoming planting season (Ksh.2.2 billion); iii) waiver of the Railway Development Levy and Import Declaration Fee on the imports of the gazetted white maize on July 14, 2022; and iv) temporarily subsidizing sifted maize in the month of July to keep the retail price of 2kg of maize at Ksh.100.2 In June, the authorities publicly communicated that fuel subsidies were unsustainable given Kenya’s limited fiscal space, and the authorities have committed under the program to remove these subsidies by end-2022.3 Kenya National Bureau of Statistics.

Climate Change Goals and Financing in Kenya

Kenya is highly vulnerable to consequences of climate change, especially droughts and floods. The 2020 ND-GAIN Country Index ranks Kenya as the 39th most vulnerable country to climate change and 154th in terms of readiness to improve resilience out of 181 countries.1 As a lower-middle income country depending heavily on rain-fed agriculture, climate change is expected to reduce Kenya’s economic activity on average by 2–2.8 percent of GDP every year.2 The World Bank estimates that climate change has increased the frequency of drought-induced food insecurity episodes from every 20 years (in the 1980s) to every 2–3 years.3

The impact of climate change could significantly impact household income and welfare (text figure)4, in addition to increasing food insecurity and poverty levels. The climate-related impact is expected to lower labor productivity due to an increased incidence of climate-sensitive illnesses and greater food insecurity, which is currently impacting 4.5 million people (8 percent of total population) assessed to be facing severe food insecurity at end-October 2022. Climate change is also likely to worsen poverty, with some estimates suggesting that a 1-degree increase in average temperatures can result in a 2.1 percent increase in the poverty headcount rate.5

The Government of Kenya is committed to addressing climate change as an integral part of its development agenda. This includes adoption of the National Climate Change Action Plan 2018–22 aimed at maintaining a low carbon development trajectory. As of end-2021, more than 90 percent of electricity production was generated from renewable sources. The country is on track to achieve its target of universal access to clean cooking by 2028, universal use of clean energy by 2030, and 10 percent forest cover by 2030.6 Moreover, Kenya has committed to reducing 32 percent of its GHG emissions by 2030 and adapt to climate risks as part of its Nationally Determined Contributions (NDCs) under the 2015 Paris Agreement. The Government of Kenya estimated the cost of achieving its NDCs at USD 62 billion and committed to mobilize resources to meet 13 percent of the total cost.7

To meet elevated climate investment needs, the authorities are focused on enhancing the country’s capacity to attract climate-related finance. Private sector investments are expected to be vital for climate-smart growth in Kenya considering the current fiscally constrained environment. The authorities have already taken decisive steps to stimulate nascent green finance industry, including by issuing a sovereign green bond framework.8 They have also issued a Guidance on Climate-Related Risk Management to the banking sector aimed at enabling banks to integrate climate-related risks into their governance, strategy, risk management and disclosure frameworks. This is expected to facilitate banks’ leverage on business opportunities from efforts to mitigate and adapt to climate change.9

1 University of Notre Dame Global Adaptation Index.2 The National Treasury and Planning, 2021. The Landscape of Climate Finance in Kenya.3 World Bank, Country Partnership Framework (July 2022).4 Asafu-Adjaye, Ndung’u, and Shimeles, 2022. Macroeconomic consequences of climate change in Africa and policy implications.5 Dang, H. & Trinh, T, 2022. Does Hotter Temperature Increase Poverty? Global Evidence from Subnational Data Analysis.6 Ministry of Environment and Forestry, 2022. National REDD+ Strategy.7 UNFCCC, 2020. Kenya’s Updated Nationally Determined Contributions.8 The National Treasury and Planning, 2021. Kenya Sovereign Green Bond Framework.9 Central Bank of Kenya, 2021. Guidance on Climate-related Risk Management.

Figure 1.
Figure 1.

Kenya: Real Sector Developments

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities; Markit Economics; World Bank; and IMF staff calculations and projections.

Figure 2.
Figure 2.

Kenya: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities; and IMF staff calculations and projections.

Figure 3.
Figure 3.

Kenya: Financing

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities; Bloomberg L.P; and IMF staff calculations and projections.

Figure 4.
Figure 4.

Kenya: External Sector Developments

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authorities; and IMF staff estimates and projections.1 Negative values represent net inflows associated with an increase in net external liabilities.

Figure 5.
Figure 5.

Kenya: Monetary and Exchange Rate Developments

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Sources: Kenyan authoritie; and IMF staff calculations.

Figure 6.
Figure 6.

Kenya: Financial Sector Structure

(2022Q3 or latest available)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: Central Bank of Kenya.

Figure 7.
Figure 7.

Kenya: Financial Sector Developments

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Source: Central Bank of Kenya; Financial disclosures of Kenyan banks; and IMF staff calculations.1 Pre-tax profits pertain to Q3 of the year.2 Based on IMF FSI.

Figure 8.
Figure 8.

Kenya: Capacity to Repay Indicators Compared to UCT Arrangements for PRGT Countries

(In percent of indicated variable)

Citation: IMF Staff Country Reports 2022, 382; 10.5089/9798400226045.002.A001

Notes:1) T = date of arrangement approval. PPG = public and publicly guaranteed.2) Red lines/bars indicate the CtR indicator for the arrangement of interest.3) The median, interquartile range, and comparator bars reflect all UCT arrangements (including blends) approved for PRGT countries between 2010 and 2020.4) PRGT countries in the control group with multiple arrangements are entered as separate events in the database.5) Comparator series is for PRGT arrangements only and runs up to T+10.6) Debt service obligations to the Fund reflect prospective payments, including for the current year.

Table 1.

Kenya: Selected Economic Indicators, 2020–25

article image
Sources: Kenyan authorities; and IMF staff estimates and projections.

Ratios as share of GDP are impacted by GDP rebasing, which took place between the 1st and 2nd reviews of the EFF/ECF arrangements.

Fiscal year basis. Fiscal year runs from July 1 – June 30 (e.g., FY22-23 runs from July 1, 2022 to June 30, 2023).

Table 2a.

Kenya: Central Government Financial Operations 2020/21–2024/251

(Billions of Kenyan Shilling)

article image
Sources: Kenyan authorities; and IMF staff estimates and projections.

Fiscal year runs from July to June.

As approved in early June 2022.