IMF Executive Board Concludes 2018 Article IV Consultation and Establishes Performance Criteria for the Second Review Under the Stand-By Arrangement with Kenya
October 23, 2018
On June 13, 2018 the Executive Board of the International Monetary Fund (IMF) concluded the 2018 Article IV consultation [1] and established performance criteria for the second review under the Stand-By Arrangement with Kenya.
Kenya has maintained strong growth in recent years and external imbalances have narrowed, strengthening resilience to shocks. The business environment continues to improve, supporting private investment. However, a severe drought, an extended presidential election, and weak bank lending—due in part to interest rate controls—slowed growth in 2017. In addition, public debt has risen as revenue shortfalls have not been matched by spending cuts. Moreover, interest rate controls continue to hamper lending (especially to small- and medium-size enterprises), growth, and monetary policy.
The Executive Board approved a six-month extension of Kenya’s SBA until September 14, 2018 (its SCF expired on March 13, 2018). Since the performance criteria (PCs) for the second review (end-June 2017) are now outdated, new PCs for end-June 2018, a monetary policy consultation clause, and new structural benchmarks were established. The authorities plan to continue treating the SBA as precautionary.
Kenya’s medium-term growth prospects are favorable, supported by infrastructure investment and an improving business environment. However, continued strong growth and macroeconomic stability hinge on the implementation of reforms. In addition, headwinds from fiscal consolidation and weak credit growth will weigh on economic activity in the near term. Kenya also remains vulnerable to a deterioration of security conditions, and to external shocks that could spur capital outflows, such as a pullback on investors from emerging markets or tightening global monetary conditions.
Executive Board Assessment [2]
Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities for maintaining macroeconomic stability and sustained economic growth in recent years, together with gains in financial inclusion and poverty reduction. While domestic shocks reduced the pace of expansion in 2017, the economy is recovering and medium‑term growth prospects remain favorable. To safeguard the gains achieved, Directors encouraged further reduction of fiscal deficits to preserve debt sustainability; the repeal or significant modification of interest rate controls; and measures to strengthen the financial sector and business environment. The six‑month extension of the Stand‑By Arrangement will give the authorities more time to undertake these critical reforms.
Directors encouraged the authorities to take substantive steps to reduce the fiscal deficit to address Kenya’s rising public debt. They commended the authorities on their ambitious plans for fiscal adjustment in 2017/18 and 2018/19 and agreed that the size of the adjustment would help put the public debt ratio on a downward path. Adjustment efforts should focus on both expenditures and revenues to preserve space for planned growth‑enhancing public investment and key social programs, including the authorities’ Big Four agenda. Directors welcomed the authorities’ planned revenue measures while emphasizing the need for additional steps to meet the deficit targets for both 2017/18 and 2018/19. They stressed the importance of realistic revenue projections to increase fiscal transparency and to avoid ad hoc cuts in public investment and other high‑priority expenditures.
Directors encouraged the authorities to repeal or significantly modify interest rate controls, noting that the controls have slowed growth, reduced access to finance, and hampered the effectiveness of monetary policy. They emphasized that any modification should include the removal of the link between the lending rate cap and the central bank policy rate, the removal of a floor on deposit rates, and an increase of the lending cap to a level that protects consumers from predatory practices.
Directors saw merit in modernizing the monetary policy framework. They recommended that, following the reform of interest rate controls, the Central Bank of Kenya move to establish an interest rate corridor. This would help align the policy rate with the interbank market rate, thus improving the policy rate’s signaling role and strengthening the effectiveness of monetary policy.
Directors commended the authorities for the progress made in strengthening the banking supervision framework, and encouraged continued efforts in this area. At the same time, they saw merit in further measures to develop the bank resolution framework and risk‑based AML/CFT supervisory tools.
Directors welcomed the improvements made in strengthening competitiveness and the business environment in recent years and encouraged the authorities to build on the progress made. In particular, they emphasized the importance of implementing public financial management reforms to strengthen governance and anti‑corruption efforts.
It is expected that the next Article IV consultation with Kenya will be held within 24 months, in accordance with the Executive Board decision on consultation cycles for members with Fund arrangements.
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PRESS OFFICER: Lucie Mboto
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