IMF Executive Board Concludes 2004 Article IV Consultation with KenyaPublic Information Notice (PIN) No. 09/75
June 12, 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 December 20, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kenya.1
During 2003/04, notable progress has been made in reversing the lackluster performance of the previous decade. A moderate rebound in economic growth has begun and the recent sharp growth in domestic debt has been arrested. However, inflationary pressures have increased.
The moderate recovery in economic growth that began in 2003/04 is expected to continue, with the real Gross Domestic Product (GDP) growth projected at 2.7 percent in 2004/05 after an estimated 2.1 percent in the previous year. Both the tourism and construction sectors are projected to register strong growth. Reflecting the adverse effects of the drought on food prices and the recent sharp increase in oil prices, headline consumer price inflation has accelerated sharply in recent months and reached 16.6 percent in October 2004.
Monetary policy has been expansionary since 2003/04 to promote economic growth. This has, however, contributed to the recent rise in inflation, and ex post real interest rates were negative over much of the past year. In response to the significant pick up in both headline and underlying inflation, the Central Bank began to tighten monetary policy in September 2004, and three-month Treasury bill rates have increased from 2.75 percent in September to 7.2 percent in late November 2004.
Recent economic developments may have worsened poverty indicators. With real GDP growth broadly in line with the increase in population and the economy suffering from the effects of major negative shocks—the drought and the oil price increase—the poverty rate may have increased in the recent past. Moreover, progress in poverty alleviation has been hampered by AIDS and delays in initiating major poverty reduction programs.
Overall fiscal performance strengthened during 2003/04 mainly on account of strong revenue collection and the steps taken to control recurrent expenditure. Some capital spending was also curtailed on fears that the resulting large domestic borrowing would raise interest rate pressures. As a result, domestic borrowing was much lower than budgeted and the ratio of domestic debt to GDP fell from 24.3 percent at end-June 2003 to 22.2 percent of GDP at end-June 2004.
The current account balance turned from a surplus of 1.2 percent of GDP in 2002/03 to a deficit of 2.0 percent in 2003/04, reflecting primarily a drop in private savings. Private savings were negatively affected by negative real interest rates, but also by the drought and the increase in oil prices. Export volumes grew by 7 percent in 2003/04, as tea, horticultural, and garment exports performed well. With a strong capital account position, foreign reserves rose by about U.S. $140 million, but declined moderately in percent of imports.
Progress in implementing structural reforms has been mixed. Some progress was made in strengthening governance, and there were some delays in implementing reforms in the public expenditure, financial sector, and parastatal areas. New wage-setting mechanisms for public employees have been developed.
Executive Board Assessment
Executive Directors observed the progress that has been made under the PRGF-supported program, which has contributed to a rebound in economic growth and arrested the rise in domestic debt. However, Directors noted that Kenya faces serious challenges. In particular, growth remains too slow for making inroads into poverty, inflation has picked up, and governance remains a critical concern.
Directors emphasized that Kenya’s medium-term economic prospects depended critically on the prompt and effective implementation of broad-based structural reforms as outlined in the authorities’ Poverty Reduction Strategy Paper (PRSP). They stressed the importance of promoting strong economic growth and ensuring that its benefits are translated into poverty reduction and improved living standards for the rural population. Implementation of strong policies and a faster pace of reforms would help achieve increased donor budgetary support, and Kenya would be in a position to begin to make progress toward the Millennium Development Goals.
Directors recognized the efforts that have been made to strengthen governance. They welcomed efforts to build a more robust public financial management system, the establishment of the Kenya Anti-Corruption Commission, and the ongoing strengthening of prosecutorial capacity. Directors observed, however, that important gaps remained in implementing the governance agenda, and they stressed the need for more determined actions. In this connection, Directors emphasized the importance of adequate funding of key anticorruption agencies; full investigation, disclosure, and punishment of those involved in corruption cases; and improved rules for the management of security procurements. There were also calls for continued efforts in the area of asset declarations by senior officials, including ministers, permanent secretaries, and heads of state bodies.
Directors expressed concern with the recent upturn in inflation. They urged the authorities to maintain firm control over monetary aggregates as several factors, such as high oil prices, the uncertain food supply situation, and exchange rate developments point to a risk of persistent price pressures. Progress in containing wage costs would be important for reducing inflation and, in turn, for promoting financial intermediation. Directors agreed that the current managed floating exchange rate system has served Kenya well in responding to external shocks, and should be maintained. A few Directors saw scope for increased flexibility in this regard.
Directors supported the authorities’ effort to balance their commitment to fiscal consolidation with the need to support the poverty reduction strategy. They welcomed the lower-than-programmed deficit in 2003/04. However, Directors noted that significant fiscal risks remained, as deficits were projected to remain high and the magnitude of donor support uncertain. Some Directors pointed to the fiscal risks associated with weak public enterprises and the costs of addressing HIV/AIDS. In this connection, Directors welcomed the authorities’ efforts to mobilize increased domestic resources through ongoing reforms of tax administration and steps to improve customs services.
Directors also noted that meeting the fiscal objectives will require effective expenditure monitoring and control. They stressed the importance of building a robust public expenditure management (PEM) system. Directors welcomed the authorities’ efforts to modernize the PEM system, including strengthening the links between the medium-term expenditure framework and the annual budget system, with the support of the World Bank and the Fund. They urged the authorities to strengthen further existing institutions and procedures, with a view to enhancing the poverty orientation of public outlays. In addition, Directors recommended close monitoring of the debt situation, and advised against contracting any new nonconcessional debt.
Directors underscored the importance of accelerating the public enterprise restructuring and privatization program. They urged the authorities to make a strong effort to secure parliamentary enactment of the Privatization Bill and to follow up quickly with its implementation. In this context, they welcomed the authorities’ decision to start, in the near future, a detailed assessment of the financial position of key parastatals.
Directors were encouraged by the authorities’ increased attention to improving competitiveness. They supported the authorities’ broad-based strategy that includes streamlining the regulatory framework, upgrading essential infrastructure, reforming the wage-setting system, and liberalizing trade. However, Directors noted the deteriorating trend in total factor productivity in Kenya, and urged stronger efforts to promote private-sector led growth, including through further trade liberalization, regional integration, and improved governance.
Directors welcomed the actions taken by the authorities to strengthen the financial system, including the recent approval of the amendments to the Central Bank of Kenya and Banking Acts, which transfer bank regulatory functions from the Ministry of Finance to the central bank and remove the provisions for official controls of interest rates. Directors looked forward to the removal of government control over bank charges and fees. Directors observed, however, that the financial system remains fragile. While banking soundness indicators have generally improved, the large nonperforming loans (NPLs) remain a problem. They therefore urged the authorities to address the problem of distressed banks, particularly public banks, which held most of the large NPLs, and to move forward promptly with bank privatizations. Directors pointed to the need to move forward with a strengthening of the framework for Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT).
Directors took note of the challenges posed by capacity constraints for policy implementation. They observed that shortages of skilled personnel and weaknesses in public administration, particularly in key ministries, constrained the implementation of essential poverty programs and the absorption of donor-project support. Directors, therefore, welcomed the restructuring efforts that have been initiated to rebuild capacity in the Ministry of Finance and key line ministries. They also welcomed ongoing efforts to restructure the civil service and develop new wage setting mechanisms for public employees, noting that the realization of the poverty reduction objective depended upon improved delivery of public services.
Directors generally welcomed the steps underway to improve the quality of economic and social statistics. They noted that the government has released a revised set of national accounts data, was taking steps to improve the monitoring of fiscal data and intended to develop a framework for the systematic monitoring and evaluation of productivity changes. However, the quality of statistics for surveillance and program monitoring remains weak, and Directors urged further efforts to improve statistics, with the support of the African Technical Assistance Center (AFRITAC), as appropriate.