Public Information Notice: IMF Concludes Article IV Consultation with Kenya
January 5, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On December 16, 1999, the Executive Board concluded the Article IV consultation with Kenya.1
Kenya's economic performance weakened over the last decade because of the failure to sustain prudent macroeconomic policies, the slow pace of structural reform, and the persistence of governance problems. The often lax fiscal policy led to a rapid build up of short-term government debt which, in combination with declines in the saving rate, translated into lending rates in excess of twenty percent in real terms. This, together with other high costs of doing business in Kenya—because of corruption, a deteriorating infrastructure, and an inefficient parastatal sector (e.g., utilities, and transportation services)—depressed investment and its effectiveness, and as a consequence economic growth. Since early 1998 Kenya's economic performance was mixed. It has achieved fiscal adjustment against the difficult backdrop of a worsening terms of trade, a dearth of external financing, and adverse weather conditions. At the same time, the rescue of a major bank in late 1998 strained fiscal policy and temporarily weakened monetary policy. In this context, investor confidence has remained weak, and growth has continued to decline.
Following a relaxation in 1996/97 and in the first half of 1997/98, fiscal policy was tightened in the second half of 1997/98 and further in 1998/99. As a result, the overall deficit was reduced from 3.9 percent of GDP in 1996/97 to 2.5 percent in 1997/98 and to 0.7 percent of GDP in 1998/99, compared with a targeted overall balance of zero. The higher deficit in 1998/99 relative to the target reflected unanticipated outlays of 0.9 percent of GDP related to the rescue of the state-owned National Bank of Kenya (NBK). A task force instituted by the government concluded in April 1999 that the stock of domestic arrears was much larger than originally thought and that its accumulation reflected weaknesses in expenditure control and circumvention of relevant financial regulations.
Monetary policy was cautious throughout most of 1998, but it was relaxed in late 1998 in the context of the rescue of the NBK because the liquidity injection was not fully sterilized. Following a sharp decline in interest rates, a 20 percent depreciation of the shilling, and a considerable loss of official reserves, monetary policy was tightened in mid-1999 partly reversing those developments. The external current account deficit (excluding official grants) widened to about 5 percent of GDP in 1998, reflecting a poor export performance and a worsening in the terms of trade, but an increase in the capital account surplus led to a shift in the overall balance of payments from a deficit of US$13 million in 1997 to a surplus of US$74 million in 1998. Gross official reserves remained virtually unchanged, amounting to US$783 million (2.4 months of imports cover) at end-1998. External arrears, which were reduced by US$95 million to US$23 million at end-1998, are estimated to have increased to US$133 million by early November 1999.
Inflation remained subdued in 1998 and in the first half of 1999. But it increased in the third quarter of 1999 mainly owing to increases in fuel and food prices as well as the lagged effects of the depreciation of the shilling. Real GDP growth slowed from 2.3 percent in 1997 to 1.8 percent in 1998, and it is expected to slow further in 1999, and unemployment continued to increase.
Executive Board Assessment
Directors commended Kenya for pursuing generally cautious macroeconomic policies since early 1998, but noted that weak economic growth had persisted over this period, partly on account of slow progress in the areas of governance and structural reform. They observed that this had had adverse effects on investor and donor confidence, and had resulted in increased poverty and deteriorating social indicators. Directors noted that this trend needed to be reversed urgently. Directors, therefore, stressed that the implementation of a comprehensive set of measures to address wide-ranging problems of governance, the pursuit of prudent macroeconomic policies, and the acceleration of structural reforms were critical to restoring confidence, and in fostering sustainable high economic growth.
Directors considered that the measures being implemented to improve governance are part of a systematic and comprehensive approach that seeks to enhance accountability; strengthen control bodies by increasing their resources, independence, jurisdiction, and competence; strengthen budget planning and execution; and remove rent-seeking opportunities and incentives for corruption. Directors considered that the measures taken in these areas in recent months were substantial and could lead to a material improvement in governance. However, they emphasized the need to maintain the momentum of this reform effort in order to produce a decisive improvement in the area of governance, and thereby strengthen the credibility of the authorities' commitment in this regard. Accordingly, Directors urged the authorities to reinforce recent measures by implementing an ambitious and comprehensive work plan of further measures to enhance governance.
Directors noted the important challenges that Kenya faces in the macroeconomic policy area in fiscal year 1999/2000. They observed that the originally projected large increase in the domestic financing requirement of the government—mainly reflecting a bunching of external debt maturities—posed considerable risks, and they therefore welcomed the authorities' intention to accelerate the privatization process and to adopt corrective fiscal measures. With regard to the latter, Directors welcomed the recent measures to reduce low priority current expenditure and accelerate loan recovery, and urged the authorities to proceed rapidly with the implementation of the remaining measures in this area. In view of the serious problems in public expenditure control, Directors welcomed the authorities' intention to seek technical assistance to strengthen public expenditure management. Directors expressed concern about the potential emergence of revenue shortfalls, given developments in the first five months of the fiscal year, and they urged the authorities to promptly adopt any additional measures that may be needed to contain the domestic financing so as to maintain macroeconomic stability. Directors also emphasized the need to materially advance the work on the medium-term expenditure framework, as much work was needed to prioritize and increase the efficiency of government spending, so that resources could be effectively directed toward investment in human capital and poverty reduction.
Directors expressed concern that the increasing delays in the payment of external obligations hampered Kenya's creditworthiness. They urged the authorities to clear external arrears as early as possible, including by carrying out the planned privatizations without delays.
Directors generally commended the authorities for their cautious monetary policy during most of 1998 and the recent actions taken to absorb excess liquidity. Directors were supportive of the conservative monetary program of the authorities for 1999/2000, and advised that the exchange rate should continue to be market determined, with central bank intervention basically guided by the achievement of the international reserve targets.
Directors welcomed the government's decision to sell the remaining government shares in the Kenya Commercial Bank (KCB), and urged the authorities to proceed rapidly with the sale. Regarding the National Bank of Kenya, Directors generally supported the approach of helping the bank satisfy the minimum capital adequacy ratios and privatizing the bank as soon as the government's share in KCB is sold. Directors noted that, while significant progress had been made in strengthening bank supervision, there was a need to monitor banks more frequently and to strictly enforce the existing regulations.
Some Directors expressed concern at the recent increases in import duties and the proliferation of suspended duties. They urged that these measures be reversed and the existing suspended duties phased out, especially given the incentives for rent-seeking behavior that they created.
Directors welcomed the authorities' recent steps to accelerate structural reforms. Specifically, they commended the decision to offer for sale 49 percent of the capital of TELKOM to a strategic partner and urged the authorities to proceed with that sale as soon as possible. They emphasized that similar steps needed to be taken vis-à-vis the privatization of other parastatals, while ensuring the fairness and transparency of the process. Directors also noted the importance of proceeding rapidly with other structural reforms, including limiting the monopoly powers of the Kenyan Coffee Board and reducing the role of other parastatals, in order to create conditions for high and sustainable growth over the medium term.
Directors welcomed the reduction in the number of ministries as a positive step toward streamlining the government and helping focus on the identification of existing redundancies. They felt that the authorities' intention to formulate a civil service reform strategy and to prepare both cost-effective forms of retrenchment and a more appropriate pay structure deserved strong support.
Directors considered that the progress achieved thus far had created a good basis for the initiation of discussions on a program that could be supported by an arrangement under the Poverty Reduction and Growth Facility. They stressed, however, that significant and sustained efforts will be needed before a comprehensive program that addresses the concerns of the Kenyan population, investors, and donors could be put in place. Directors emphasized that early work on the preparation of a Poverty Reduction Strategy Paper in consultation with the World Bank, the Fund, and the civil society; performance in the implementation of a comprehensive and sustained action plan to enhance governance; and an acceleration of structural reforms in key areas would be essential to rebuilding confidence and strengthening Kenya's relationship with the international community.
Directors were concerned about the deterioration of Kenya's macroeconomic statistics over time. They urged the authorities to provide the Central Bureau of Statistics with adequate resources and to implement the necessary measures to improve macroeconomic statistics.