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Public Information Notice (PIN) No 03/83
July 9, 2003
Corrected (*): August 22, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with Kenya

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with Kenya is also available.

On May 2, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kenya.1

Background

Kenya's economic performance in recent years has been well below its potential reflecting primarily the persistence of pervasive governance problems and the slow pace of structural reforms. Specific factors that have contributed to low economic and employment growth include low saving and capital formation, a weak banking system, poor infrastructure, weak property rights and an unpredictable judicial system, and labor market rigidities. As a result, Kenya's real per capita GDP was in 2002 lower than it was a decade earlier.

Real GDP growth could edge up from 1.2 percent in 2001/02 to 1.6 percent in 2002/03, supported primarily by a strong performance of manufacturing and agricultural exports. After a significant drop in inflation to about 2 percent in the first half of 2002, the consumer price index has registered a marked increase in recent months partly on account of a transitory tightening in the food supply situation and the surge in the retail prices of petroleum products. At the same time, the growth of monetary aggregates has risen, and the 91-day treasury bill rate has dropped to 6.1 percent by mid-March 2003 from around 10 percent a year earlier. These developments exerted downward pressure on the exchange rate of the Kenya shilling, which weakened over the past year along with the U.S. dollar vis-à-vis other major currencies. The nominal effective exchange rate of the shilling fell by about 9.0 percent during 2002.

The new government has placed its anti-corruption strategy at the top of its agenda and has embarked on a major strengthening of its governance and anti-corruption institutions. It has already embarked on a major strengthening of its anti-corruption apparatus, including the tabling of key governance legislation and has commenced steps to strengthen the judiciary.

Executive Board Assessment

Directors noted that Kenya's economic performance in recent years has been well below its potential, reflecting primarily the persistence of pervasive governance problems and the slow pace of structural reforms. As a result, Kenya's real per capita GDP was lower in 2002 than it had been a decade earlier.

Directors commended the new Kenyan government for placing the anticorruption strategy at the top of its policy agenda. They noted that the government had already embarked on a major strengthening of its anticorruption apparatus, including the recent passage of key governance legislation, and that it had begun to take steps to strengthen the judiciary. Directors considered that these actions, if followed by appropriately firm enforcement of the laws and regulations, should significantly reduce the wastage of public resources, improve the incentives for enterprises, and contribute to increased economic growth and the reduction of poverty.

Directors agreed that the main challenge facing the new government is to implement a comprehensive economic program without interruption. They considered that the tangible results from such a program would help to garner broad public support behind the reforms and mobilize financial assistance from the donor community and also encourage additional investment. A comprehensive medium-term reform strategy would need to include credible actions to continue to improve governance and fiscal transparency; consolidation of the budgetary position to address the domestic debt problem and ensure fiscal sustainability; a credible strategy to reform the tax system and enhance revenue; strengthened public expenditure policy and management, involving a reorientation of expenditures towards priorities of the Poverty Reduction Strategy Paper ( PRSP); improved tracking of spending on poverty programs; a bold privatization program, including the divestiture of the government from ownership of commercial banks; and strengthened banking supervision.

Directors welcomed the authorities' intention to finalize a full PRSP in the near future, which would articulate the reform agenda to be supported by the IMF and the donor community. They stressed the need for the PRSP to set out a clear timetable, for implementing key policy actions that the government intended to take to address poverty and promote strong growth over the medium term. They also stressed the importance of aligning the PRSP to the budget and the medium-term expenditure framework.

Directors suggested that budgetary policies should over the medium term aim at fiscal consolidation to significantly reduce the reliance of the budget on domestic borrowing and to support a prudent monetary policy. To help achieve this, Directors encouraged the authorities to pursue discipline expenditure policy and implement a credible strategy to form the tax system and measures aimed at strengthening revenue performance.

Directors stressed the urgent need to reorient public expenditures in favor of social and economic outlays, and encourage the authorities to develop policies to contain the growth of the wage bill, including changes to the public sector wage-setting arrangements and a deepening of civil service reforms. They emphasized the need for such measures to form a key component of the new program. In the near term, however, Directors recognized that present structure of expenditure would impart a high degree of inflexibility to the budget and greatly complicate the management of fiscal policy, as the benefits of the restructuring effort would be realized over time. Nevertheless, Directors emphasized the need to begin immediately the process of realigning public expenditure with PRSP priorities and the recommendations of the ongoing review of public expenditure. Achievement of the needed restructuring of expenditures will also require its close monitoring and control of expenditure to minimize deviations of budget outcomes from intentions. Directors also underscored the urgency of dealing with the problem of stalled projects and pending bills.

Directors considered that monetary policy should continue to aim at keeping inflation low while providing a stable environment for financial markets. To this end, they stressed the need for bold actions to significantly reduce the reliance of the budget on domestic financing, which would also help to preserve the independence of the Central Bank of Kenya in the conduct of monetary policy, and to ease interest rate pressures. Directors suggested that the authorities' concerns about the wide spreads between bank lending and deposit rates should be addressed by tackling the underlying structural problems in the banking system, including a clear plan to deal with the large nonperforming loans. In addition, Directors urged the government to divest itself from the ownership of banks, which tended to complicate the prudential supervision of the sector. Directors considered that a flexible exchange rate system continued to be appropriate for Kenya. They therefore encouraged the authorities to take steps to improve the functioning of the system.

Directors considered that a flexible exchange rate system continues to be appropriate for Kenya. They therefore encouraged the authorities to take steps to improve the functioning of the system. They noted that, while the exchange rate did not appear to have been a major impediment to export performance, there was a need to closely monitor exchange rate developments as a continuation of the recent appreciation could have adverse implications for export and output growth. In this context, Directors stressed the importance of actions to raise productivity and reduce production costs to safeguard competitiveness over the medium term. They pointed out that measures to improve the governance regime, upgrade infrastructure, and enhance the flexibility of the labor market were essential.



Kenya: Selected Economic Indicators, 1997-2002


 

1997

1998

1999

2000

2001

2002

 
           

Estimate 1/


(Annual percentage change, unless otherwise indicated)

 

National accounts and prices

             

GDP volume

2.4

1.8

1.4

-0.2

1.2

1.2

 

GDP volume per capita

0.1

-0.4

-0.7

-2.4

-0.8

-0.6

 

Consumer prices (annual average)

11.9

6.7

5.8

10.0

5.8

2.0

 

Terms of trade, goods (- deterioration)

2.0

-5.0

-1.3

-0.7

-2.6

-5.0

 

Exchange rate (Kenya Shillings per U.S. dollar, period average)

58.0

61.8

70.4

76.3

78.6

78.6

 

Real effective exchange rate (- depreciation; end of period)

-1.9

-6.6

0.1

12.0

2.9

4.3

 
               

(In percent of GDP, unless otherwise indicated)

 

Investment and saving

             

Investment

18.5

17.4

16.2

15.4

14.5

13.5

 

Central government

4.4

4.0

2.9

3.0

3.1

3.0

 

Other

14.1

13.4

13.3

12.4

11.3

10.5

 

Gross national saving

14.3

12.5

14.0

12.7

11.0

9.3

 

Central government

2.1

3.6

3.5

1.9

0.3

-1.1

 

Other

12.2

8.9

10.5

10.7

10.7

10.4

 
               

Macroeconomic policy variables

             

Total central government revenue 2/

27.2

26.8

23.1

22.6

21.6

22.2

 

Total central government expenditure and net lending 2/

29.5

27.6

23.0

27.4

25.0

27.7

 

Overall central government balance (commitment basis)

             

excluding grants 2/

-2.3

-0.7

0.2

-4.8

-3.4

-5.5

 

Overall central government balance (commitment basis)

             

including grants 2/

-1.5

0.0

0.7

-2.0

-2.2

-4.6

 

Government domestic debt, net (end of period) 2/

20.7

20.5

21.2

19.4

22.3

26.2

 

Money and quasi money (M3. End year, percent change)

9.8

3.3

2.7

0.8

2.5

8.8

 

Interest rate (90-day treasury bill; end of period)

26.3

11.1

20.5

13.5

10.8

8.4

 

(In million of U.S. dollars, unless otherwise indicated)

 

External sector

             

Current external balance, excluding official transfers

-549

-233

-375

-486

-497

-857

 

(in percent of GDP)

-4.4

-4.9

-2.2

-3.6

-4.3

-4.2

 

Overall balance of payments

-37

66

-20

-8

21

38

 

Net present value of external public debt

             

(in percent of exports of goods and services) 3/ 4/

156

145

140

143

126

115

 

Scheduled external debt service, including the Fund 4/

             

(in percent of export of goods and services)

22.4

23.6

27.3

19.1

15.6

11.3

 

Gross international reserves (end of year)

788

783

791

897

1,064

1,067

 

(in months of next year imports)

2.5

2.8

2.5

2.7

3.1

2.7

 

Sources: Kenyan authorities; and staff estimates.

               

1/ Actual data for prices, exchange rates, money and interest rates.

2/ Data are on July-June fiscal-year basis.

3/ Three year backward looking average of exports.

4/ After 2000 Paris Club rescheduling and assumed rescheduling by commercial and non-Paris Club creditors.

1/ Actual data for prices and exchange rates.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.

(*)Correction to the Executive Board Assessment.




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