IMF Concludes 2006 Article IV Consultation with KenyaPublic Information Notice (PIN) No. 09/60
May 15, 2009
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 April 11, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kenya.1
Kenya’s macroeconomic performance has improved markedly since the conclusion of the last Article IV consultation in December 2004. After more than a decade of slow growth and declines in per capita income, real GDP growth began to accelerate in 2004 and reached 6.0 percent in 2006, the highest in two decades. Economic growth benefited from prudent macroeconomic policies, structural reforms and strong regional and global growth, with exports (including tourism) and investment expanding strongly.
Food shortages following a drought in 2005 and a weak internal distribution system resulted in higher food prices and headline inflation in 2006. Headline inflation dropped sharply over the past three months, to 5.9 percent in March 2007, as a result of a slowdown in the increase in food prices. Nonfood inflation has been hovering around 6 percent.
The fiscal deficit (3.3 percent of GDP, including grants) and government domestic borrowing (1.8 percent of GDP) in 2005/06 were both lower than expected, as shortfalls in revenue and external support were more than offset by expenditure restraint in non-priority areas. Nevertheless, the fiscal stance in 2005/06 was expansionary after a tightening in 2004/05, owing in part to drought-related spending as well as to weaker-than-expected revenue performance. Despite the increase in domestic borrowing relative to 2004/05, the domestic debt-to-GDP ratio declined slightly in 2005/06 and there was no upward pressure on interest rates.
Notwithstanding continued strong growth in exports (including tourism receipts), the external current account deficit (excluding grants) widened over the past two years, to 3.9 percent of GDP in 2005/06. However, international reserves increased, to an equivalent of 3.3 months of imports, and the Kenyan shilling appreciated in both nominal and real terms as capital inflows increased.
On the structural reform front, progress has been made in public financial management and public enterprise reform, including privatization and the introduction of performance contracts in public commercial enterprises. The formation of the East African Community Customs Union in 2005 reduced import tariffs and helped boost Kenya’s trade with neighboring countries. In mid-2006, the authorities launched a new three-year National Anti-Corruption Plan that benefited from substantial stakeholder input, and have recently adopted a Governance Action Plan for Building a Prosperous Kenya, 2006/07 to be implemented through the end of 2007. The authorities have also begun web-posting procurement contracts.
The IMF completed the second review under the PRGF arrangement on April 11, 2007.
Executive Board Assessment
Executive Directors commended the authorities’ sound macroeconomic management, which, together with progress on structural reforms and a favorable external environment, has supported Kenya’s recent strong and broad based economic growth. They considered, however, that sustaining high growth would require a reorientation of public expenditure, including toward infrastructure, and further important structural and governance reforms.
Directors noted that macroeconomic stability has supported the recent rebound in economic growth. They commended the authorities for the important progress made in containing domestic debt, rebuilding international reserves, and strengthening supervision of the financial sector. To reduce emerging inflationary pressures, most Directors underscored the need to tighten monetary policy through appropriate steps to meet the reserve money targets, and to resist election-related spending pressures.
Directors supported the authorities’ objective of further reducing the domestic debt-to-GDP ratio over the medium term. They noted that while infrastructure spending is a priority, its financing should rely mainly on untapped external concessional resources, given the limited scope for additional domestic borrowing. Directors noted the authorities’ plan to float a benchmark sovereign bond, but cautioned that the benefit of additional financing should be weighed against its cost and the potential consequences for aid flows and debt sustainability. Moreover, they suggested the authorities to put in place an appropriate legal and institutional framework for public-private partnerships to minimize related fiscal risks.
Directors supported the authorities’ plans to create fiscal space for priority expenditures on infrastructure and poverty reduction, while calling for increased efficiency of public spending and a cutback in non-priority spending. They advised that this policy be supported by continuing efforts to enhance revenue performance, strengthen capacity in spending ministries, and improve public financial management. Directors encouraged the authorities to continue improving the budget process, make the Procurement Oversight Authority operational, and implement the Integrated Financial Management Information System in key ministries. Directors argued against granting further tax exemptions.
While welcoming important reforms, Directors noted that progress on governance has been slower than envisaged earlier, and stressed the need to address decisively the remaining challenges particularly understaffing and limited capacity in the law enforcement agencies. They noted that reforms had strengthened institutions and increased transparency, including in the procurement process. Directors considered that implementation of the Governance Action Plan for Building a Prosperous Kenya would be a litmus test for the authorities’ strategy to improve governance and reduce corruption, which are critical for sustaining higher economic growth. Directors stressed the importance of completing the legislative agenda on governance and moving forward with investigation and prosecution of corruption cases.
Directors observed that further reforms are needed to accelerate financial sector development and stability. They welcomed the recent enactment of the Banking Amendment Bill that strengthens the supervisory power of the central bank, since the volume of non-performing loans remains high. Directors were also encouraged by the authorities’ plan to expedite the passage of amendments to the Banking Act aimed at aligning the legal and regulatory framework with best international practices, and to divest state shareholdings in state-influenced financial institutions, develop a comprehensive financial sector reform strategy, and complete a diagnostic audit of the National Social Security Fund.
Directors agreed that Kenya’s managed floating exchange rate regime has served the country well, and that the recent real appreciation of the shilling did not appear to have undermined competitiveness. They supported the authorities’ plan to limit interventions to meeting the foreign reserve targets and to smoothing short-term fluctuations unrelated to economic fundamentals. In this regard, they underscored that maintaining competitiveness will require efficiency-enhancing structural reforms and infrastructure improvements.
Directors welcomed the recent steps to improve the business environment for increased private sector participation. They commended moves to streamline Kenya’s business licensing system and increase private sector participation in public enterprises. Directors emphasized that further efforts are needed, especially in concessioning of inefficient port facilities, and addressing contingent liabilities in public enterprises. They noted that in order to build a globally competitive export sector and attract more foreign direct investment, further trade reform and coordination of regional investment incentives are needed.