IMF Executive Board Concludes 2011 Article IV Consultation with KenyaPublic Information Notice (PIN) No. 12/1
January 17, 2012
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 9, 2011 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kenya.1
Kenya’s economy has continued to expand, but high inflation and exchange rate pressures have come to threaten the growth outlook. GDP growth has shown little sign of slowing down so far and is estimated at 5.3 percent in 2010/11. Private investment has remained dynamic and has supported growth of above 5 percent across all non-agricultural sectors. Agricultural sector has begun to recover from the downturn in the first quarter of 2011.
Inflation reached 19.7 percent in November, well above the Central Bank of Kenya (CBK) target range. Food and fuel inflation have remained higher than anticipated, and exchange rate depreciation has led to higher inflation expectations and an acceleration of core inflation. In response, the CBK has raised its policy rate (CBR) by 11 percentage points since October to contain demand pressures and rein in inflationary expectations.
Fiscal policy has moved towards consolidation. The primary deficit declined from 3.8 percent of GDP in FY 2009/10 to 1.5 percent of GDP in FY 2010/11 as a result of delays in domestically financed investment, restraint in current spending, and strong tax revenue performance.
Higher drought-related food and energy imports coupled with higher international prices, and strong domestic demand, swelled the external current account deficit to an estimated 9½ percent of GDP in 2010/11 from 5½ percent the previous year. The combined impact of these shocks has led Kenya to request an augmentation of access under the Extended Credit Facility (ECF) arrangement.
The nominal effective exchange rate depreciated by 15 percent this year through September 2011, reflecting Balance of Payments (BOP) pressures and high inflation. The CBK’s intervention in the foreign exchange market has been limited, and this has allowed the exchange rate to adjust to absorb the external shocks. Since mid-October, the exchange has stabilized on the back of CBK policy rate hike.
The implementation of structural reforms under the program has progressed. A new value-added tax (VAT) bill is almost ready to be sent to parliament, and a Public Finance Management (PFM) bill has been submitted to the Commission for the Implementation of the Constitution.
Executive Board Assessment
Executive Directors commended Kenya’s strong economic growth and satisfactory program implementation despite challenges posed by the severe drought in the Horn of Africa and higher than expected food and fuel prices. However, the combination of external shocks and strong domestic demand, fueled by rapidly expanding credit, has led to a sharp increase in inflation, a widening current account deficit, and currency depreciation. Directors welcomed the authorities’ firm commitment to address these imbalances, stressing the need for continued steadfast implementation of their economic program.
Directors welcomed the recent decisive steps taken to rein in inflation and noted that further tightening of monetary policy should anchor inflation expectations. They commended the Central Bank of Kenya for raising its policy rate to help absorb liquidity and discourage excessive credit growth and demand for foreign exchange. A gradual accumulation of international reserves and maintaining the existing floating exchange rate regime will mitigate the impact of external shocks.
Directors agreed that fiscal policy should continue to focus on medium-term consolidation and complement monetary policy to curb domestic demand. Noting the progress made in reducing the primary deficit, they welcomed the authorities’ plans to adopt a more ambitious medium-term target by rationalizing nonpriority expenditure and front-loading adjustment. Directors underscored the importance of protecting key outlays, in particular emergency food relief for the population, targeted transfers to the poor, implementation of the new constitution, and high-priority investments.
Directors observed that Kenya’s financial system remains sound. They supported the efforts to monitor credit risks more closely and to strengthen the supervision of intergroup transactions. They also looked forward to the capital markets reform which will allow small and medium-sized enterprises to expand their access to new sources of financing. Directors urged the authorities to address deficiencies in the AML/CFT framework.
Directors noted the progress in structural reforms. They stressed that prompt implementation of the new legislation on public finance management and the draft VAT law will be important to ensure sound expenditure management in the context of fiscal decentralization and to strengthen revenue mobilization. Directors underscored that additional reforms to improve the business environment and adopt long-term solutions to the recurring droughts, including investment in infrastructure, will enhance Kenya’s prospects for growth and poverty reduction.