## cr18295 ## Source details **Canonical URL:** [cr18295](https://www.imf.org/-/media/files/publications/cr/2018/cr18295.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18295.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18295.pdf.json) --- ### Key Policy Recommendations - Near term: - Deliver on fiscal deficit target of 7.5 percent of GDP in 2017/18 (focusing measures on expenditure). - Deliver on fiscal deficit target of 5.7 percent in 2018/19 (focusing measures on revenue) to bring debt ratios onto a downward path. - Remove or significantly modify interest rate controls and move toward an interest rate corridor soon thereafter. - Medium term: - Maintain planned gradual fiscal consolidation to preserve debt sustainability and reduce fiscal risks. - Focus measures on revenues to maintain space for public investment and social spending. - Continue structural reforms to: - Improve revenue administration. - Strengthen public financial management. - Modernize the monetary policy framework. - Enhance bank prudential frameworks. - Improve the business environment and governance to sustain strong and more inclusive growth. ### Recent Economic Developments - Growth and poverty: - Real GDP growth has averaged about 5½ percent since the 2008 global crisis. - Kenya’s poverty rate fell by over 10 percentage points over 2006–16 (to 36.1 percent). - 2017 performance: - GDP growth fell to 4.9 percent in 2017 (from 5.9 percent in 2016). - Growth drivers included a contraction in agriculture due to a severe drought, extended political uncertainty, and weak credit growth partly due to interest rate controls. - Growth accelerated to 5 percent in the fourth quarter of 2017 (up from 4.7 percent through the first three quarters). - Inflation: - Inflation returned to the authorities’ target band of 5±2.5 percent; headline inflation was 3.4 percent in April (food-driven spike earlier in 2017). - Core inflation has remained below 5 percent since late 2016. - External sector: - Current account deficit increased to 6.8 percent of GDP in 2017 (from 5.2 percent in 2016), driven by higher food and fuel imports. - Public finances and debt: - Public debt projected to reach 60.7 percent of GDP by June 2018 (end of FY 2017/18). - Fiscal deficit in 2016/17 was 9.2 percent of GDP, compared to a program target of 6.9 percent. - Revenue shortfalls in FY2017/18 through end-March 2018 were about 0.5 percent of GDP short of the revised budget target. - Interest payments on public debt rose to nearly one fifth of revenue. - Kenya’s risk of debt distress increased from low to moderate. ### Monetary and Financial Sector Issues - Interest rate controls (introduced in September 2016) have: - Weakened economic performance by contributing to lower credit growth, reduced financial inclusion, weaker bank profitability and tax revenues, higher financial stability risks, and a weakening of the effectiveness of monetary policy. - Staff analysis suggests interest rate controls reduced growth in 2017 by ¼–¾ percentage points. - Staff advice: - Critical to remove or significantly modify interest rate controls and transition toward an interest rate corridor. - Interbank market and policy stance: - Policy rate (CBR) had been unchanged at 10.0 percent until March 2018; in March 2018 CBK cut the CBR by 50 bps. - Weighted average interbank interest rate ranged between 3 and 10 percent during 2017 and early 2018. - Private sector credit growth: 2 percent y/y in March 2018; 4.1 percent at end-2016; 16.0 percent at end-2015. - Recommendations to restore interest-rate based framework: - Abolish or significantly modify interest rate controls; if not possible, delink lending rate cap from the CBR, significantly increase lending rate cap to protect consumers, and abolish floor on time deposit rates. - Introduce a formal interest rate corridor for interbank rates around the policy rate shortly (two to three months) after removal/modification of controls. - Reduce interbank rate volatility by sterilizing liquidity impact of FX interventions as needed; improving liquidity forecasting for large National Treasury operations; strengthening the horizontal repo market. - Consider publishing ex-post information on FX operations (volumes and number of participants). - Exchange rate flexibility: - There is room for greater exchange rate flexibility; CBK FX interventions are typically unsterilized but given credibility and reserve coverage, greater flexibility could act as a shock absorber. ### Economic Outlook and Risks - Baseline projections (Adjustment Scenario): - Real GDP growth: 2017 = 4.9; 2018 = 5.7; 2019 = 6.0; 2020 = 6.2; 2021 = 6.5; 2022 = 6.5. - CPI inflation, average: 2017 = 6.3; 2018 = 8.0; 2019 = 5.0; 2020 = 5.3; 2021 = 5.0; 2022 = 5.0. - Overall fiscal balance (percent of GDP): 2017 = -7.3; 2018 = -9.0; 2019 = -7.5; 2020 = -5.7; 2021 = -4.0; 2022 = -3.5. - Gross international reserves (in billions of US$): 2017 = 7.5; 2018 = 7.1; 2019 = 8.0; 2020 = 9.2; 2021 = 10.2; 2022 = 11.0. - Total public debt (gross, percent of GDP): 2017 = 53.2; 2018 = 58.0; 2019 = 63.2; 2020 = 62.9; 2021 = 60.0; 2022 = 57.5. - Kenya’s real GDP growth projected to average 6.0–6.5 percent per year over the medium term, assuming removal/modification of interest rate controls and implementation of reforms. - Alternative scenario (unchanged policies): - With slower fiscal consolidation and no removal/modification of interest rate controls, staff project lower medium-term growth and higher fiscal deficits and public debt. - Risks (mostly downside): - Failure to remove or significantly modify interest rate controls would reduce medium-term growth and likely increase fiscal deficits and debt. - Other downside risks: new security incidents, protracted weak credit growth, larger-than-expected contractionary impact of fiscal consolidation. - External shocks (capital outflows, tightening global monetary conditions) could weaken growth given limited policy space. ### Fiscal Policy Discussion and Recommendations - Rationale and diagnosis: - Reducing the fiscal deficit over the medium term is essential to contain fiscal risks, support private sector growth, and place debt on a downward path. - Public debt has been increasing rapidly since 2013; slippages before the 2017 elections pushed projected debt to 60.7 percent of GDP by June 2018. - Rising reliance on non-concessional borrowing increased fiscal vulnerabilities. - Historically, overly-optimistic revenue projections have led to end-of-year ad hoc spending freezes and risks of arrears and public investment shortfalls. - The 2016/17 fiscal outcome (deficit of 9.2 percent of GDP vs. program target of 6.9 percent) reflected higher-than-programmed foreign-financed investment, lower tax revenues (notably income taxes), drought and election-related spending, and higher interest bill equivalent to 0.2 percent of GDP. - Policy guidance: - Calibrate composition of financing to balance risks from further non-concessional external borrowing and crowding out domestic private sector. - Implement revenue administration measures (e.g., rollout of the Integrated Custom Management System and installation of scanners at customs ports) to reduce under-declaration and boost revenues in the medium term. - If FY2017/18 revenues fall short as projected, pursue further expenditure cuts to meet the June 2018 fiscal target. - Focus cuts on low-priority domestically-financed capital projects to avoid undue disruption to priority spending. - Contain spending commitments (rather than delaying payments) to meet deficit targets without incurring arrears. ### Fiscal Consolidation, Targets, and Revenue Measures - Authorities’ targets and implied adjustment: - Authorities’ target: reduce the deficit to 7.5 percent of GDP in 2017/18 and further to 5.7 percent in 2018/19. - Implied adjustment: an adjustment in the primary balance of over 3 percent of GDP during 2017/18–2018/19 relative to the 2016/17 outcome. - One-off spending expiration contributions to 2018/19 deficit reduction (text table projected): - Projected reduction in the overall deficit in 2018/19: 1.5 percent of GDP - Expiration of one-off spending: 0.5 percent of GDP - Elections: 0.4 percent of GDP - Drought: 0.2 percent of GDP - Residual consolidation (excl. one-offs): 1.0 percent of GDP - Near-term needs: - Additional spending cuts beyond the supplemental budget are needed to achieve the 2017/18 fiscal target. - Authorities committed to containing spending if revenues disappoint. - Authorities’ planned revenue measures (expected to yield a total of 1.1 percent of GDP): - Removal of the VAT exemption on petroleum imports, set to expire in September: 0.36 percent of GDP - Expanding taxes on betting to cover both operator profits and winnings: 0.41 percent of GDP - Removing various VAT and CIT exemptions: 0.15 percent of GDP - Draft income tax bill (planned for introduction in FY2018/19): - Adds a new personal income tax bracket of 35 percent for upper-income individuals. - Simplifies the corporate tax code along a number of lines. - Expected to increase progressivity and have a positive revenue impact. - Staff assessment of revenue outlook: - Staff view: authorities’ revenue projections are overly optimistic; weak underlying performance of income and other taxes likely to persist. - Staff projection: additional measures of 0.6 percent of GDP will be needed to meet the 2018/19 deficit target. - Contingency: further measures required if yields from planned measures are lower than expected. - Scope for broader tax reforms: - Income tax: close remaining loopholes related to investment allowances and capital gains taxes. - VAT: rationalization of VAT exemptions could yield roughly 2½–3 percent of GDP per year. - Property tax: largely unexploited; needed to support devolution of spending responsibilities to county governments. - International taxation: consider improvements to treaty policy and anti‑abuse measures; adopt domestic anti‑base‑erosion rules (earnings stripping / fixed ratio rule set at 30 percent of EBITDA discussed). ### Fiscal Risks, Social Mitigation, and Governance - Fiscal risks and mitigation: - Monitor and prevent accumulation of arrears. - Carefully evaluate fiscal risks related to PPPs, especially planned Big Four projects in the road sector. - Mitigate impact of fiscal adjustment on most vulnerable groups. - Authorities’ commitments and views: - Agreed with staff on near-term fiscal targets but more optimistic on revenues and less urgent about identifying specific spending reductions. - Committed to freeze spending authorizations if revenues disappoint to meet the target without generating additional arrears. ### Financial Sector Stability and Supervision - Bank profitability and structure: - Interest rate controls reduced bank profitability and net interest income, prompting cost reductions (staff cuts, increased fees). - Impact concentrated on smaller banks; system in aggregate remains sound but prolonged controls pose financial stability risks. - Non-performing loans and liquidity support: - NPLs increased to 12.4 percent in April 2018 from 9.6 percent a year earlier. - Outstanding CBK liquidity support to some small banks remains significant (focused on fewer banks than peak). - Resilience and stress tests: - Large non-financial corporations and banks appear relatively resilient; extreme shocks raise NPLs but do not severely deteriorate capital levels (per Selected Issues Paper). - Supervision and resolution recommendations: - Continue strengthening bank supervision; implement remedial plans for banks non-compliant with capital and liquidity ratios, requiring credible, time-bound restructuring plans. - Progress on resolution of three intervened banks: Chase Bank asset offer accepted; Dubai Bank in liquidation; Imperial Bank in non-binding offer stage with expected finalization by July 2018. - Address shortcomings in bank resolution framework: complex legal regime, lack of planning and coordination delaying decision-making. - Consider amending the KDI Act to allow netting off of repurchase agreements to simplify bank resolution and ensure collateral enforceability. ### AML/CFT Reforms and Financial Integrity - Supervisory and FIU actions: - Financial supervisors developing risk-based AML/CFT supervisory tools and enhancing operations and procedures of Kenya’s financial intelligence unit. - Reporting entities encouraged to undertake risk assessments for AML/CFT; Kenya has not yet carried out a national risk assessment. - Authorities working with Fund TA to generate data necessary to assess AML/CFT risks. ### Structural Reforms, The Big Four, and Governance - Business environment and competitiveness: - World Bank Doing Business ranking moved up a combined 33 places to 80 during 2016–18. - WEF competitiveness moved to 91/137 in 2017–18, from 106/144 in 2011–13. - The Big Four program overview and estimated financing: - Program goals: manufacturing, affordable housing, universal affordable health care, and food security. - FY2018/19 estimated allocation for related projects: about US$4–5 billion. - About US$2.1 billion (about 2.3 percent of GDP) coming from the government. - On the government side, most would involve reallocation of existing budgeted funds. - Selected Big Four targets and tools: - Manufacturing: target increase from 9 to 15 percent of GDP by 2022; policies include off-peak power cost reductions, industrial parks and SEZs, enforcement of local contracts. - Housing: consider housing development fund, refinance company issuing bonds to extend long-term loans secured against mortgages; government announced a lower tax rate for developers meeting unit targets. - Health care: pursue universal health care; ultimate cost depends on benefit package generosity; governance reforms for private insurance and more community health facilities. - Food security: focus on large-scale production, improving smallholder productivity, irrigation coordination, access to credit, and redesign of food subsidy model. - Policy guidance: - Design policies to correct market failures, avoid “picking winners,” consider independent assessment of incentives, ensure local content policies align with WTO agreements. ### Debt Sustainability, DSA Findings, and Public Debt Facts - Debt profile and projections: - Gross public debt: 51.4 percent of GDP at end-2015; 53.2 percent at end-2016; about 58.0 percent at end-2017. - Nominal public external debt at end-2017: US$21.4 billion, equivalent to 28.5 percent of GDP. - Gross domestic public debt was KSh2,210 billion (29.5 percent of GDP) at end-2017. - Composition of domestic debt: Treasury bonds 67 percent; Treasury bills 32 percent. - Commercial banks hold 54 percent of domestic debt; nonbanks hold 42 percent. - Average maturity profile of outstanding government domestic debt: 5 years as at end December 2016. - DSA outcomes: - PV of PPG external debt as share of GDP expected to rise to 31.4 percent in 2018 from 25.9 percent in 2017; then gradually decline and remain below the 50 percent indicative threshold. - Debt service-to-exports ratio exceeds its threshold over two years by an average of 0.9 percentage points per year due to syndicated loans and worse-than-expected export performance in 2017. - Under the baseline, total public debt projected to peak in 2018 at 63.2 percent (from 58.0 percent in 2017 and 53.2 percent in 2016). - Under an extreme fiscal policy scenario (primary balance fixed at 2017 level = -4.8 percent of GDP), PV of public debt-to-GDP would breach the 74 percent benchmark in 2022. - Policy imperatives: - Reduce reliance on non-concessional borrowing. - Refinance loans at longer maturity to limit refinancing risks. - Continued commitment to fiscal consolidation to maintain debt sustainability. ### Program Performance, QPCs, MPCC, and TMU Highlights - SBA and program timeline: - SBA/SCF approved March 2016; only the first review completed on January 25, 2017. - SBA extended to September 14, 2018. - Proposal to establish new end-June 2018 and continuous quantitative performance criteria (QPCs), indicative targets, a monetary policy consultation clause (MPCC), and structural benchmarks (SBs) for end-August 2018. - Proposed QPCs and indicative targets (selected figures): - Primary budget balance of the national government (-=deficit, floor): End-Dec Act. -54.4; End-Jun (PC) -259.8. - Stock of central bank net international reserves (floor, US$ million): End-Dec 5,789; End-Jun (PC) 7,710. - Contracting or guaranteeing of new public debt (ceiling, KES billion): 3 5081,220 (table entries preserved as reported). - Monetary policy consultation clause inflation bands: Upper band 7.5; Center inflation target 5.0; Lower band 2.5. - Indicative target: stock of net domestic assets of the central bank (ceiling): -153.1 (End-Dec); -301 (End-Jun). - Priority social expenditures of the national government (floor): 64.78 (End-Dec); 81.5 (End-Jun). - Structural benchmarks proposed for End-August 2018 (selected): - Modify interest rate controls while protecting consumers from predatory lending. - Submit to parliament draft legislation to clarify powers by counties to set taxes/user fees. - Adoption by Cabinet of standardized guidelines for project appraisal and selection. - Automate release of funds from the exchequer account. - Make operational a Centralized Payment System. - TMU highlights and definitions: - Primary balance definition for program purposes includes grants and excludes SGR I executed amounts; measured cumulatively from July 1, 2017. - NIR definition: total gross official international reserves minus official reserve liabilities; NIR monitored in U.S. dollars and computed as daily average for the month when testing date is due. - TMU Table 2 projected budgetary external grants and loans (US$ millions) — 2018 Jun. Program grants 60.55; External commercial debt 2,880.82. - TMU Table 3 program exchange rates as of March 29, 2018 (example): US Dollar KSh per currency unit 100.74; US Dollars per currency unit 1.00. - Continuous performance criterion on external payment arrears applies on a cumulative basis from July 1, 2017. ### Data, Statistics, and Capacity Development - Data improvements and plans: - Gross reserves have risen from US$6.6 billion at end-2015Q3 to US$9.3 billion or 4.8 months of imports as of end-March 2018. - Balance of Payments upgraded in line with BPM6. - Work on the Foreign Investment Survey (FIS) to start in May 2018 and expected to be completed by October 2018. - The first estimate of the International Investment Position (IIP) expected to be finalized by end-2018 covering 2016 and 2017. - Capacity development: - TA program addressing public investment management, revenue administration integrity, and bank supervision framework strengthening. - Future capacity-building focus: medium-term budgeting, public financial management, bank supervisory capacity, and expanding government financial statistics coverage. - Safeguards: - CBK implemented all May 2015 safeguards assessment recommendations; legal framework amended and enacted; CBK Board members appointed per law; Audit Committee reconstituted. ### Selected Key Numeric Figures and Dates (preserved exactly) - 7.5 percent of GDP (deficit target in 2017/18). - 5.7 percent of GDP (deficit target in 2018/19). - 3.0 percent of GDP (EAC convergence criteria target). - Real GDP growth figures: 2017 = 4.9; 2018 = 5.7; 2019 = 6.0; 2020 = 6.2; 2021 = 6.5; 2022 = 6.5. - CPI inflation, average: 2017 = 6.3; 2018 = 8.0; 2019 = 5.0; 2020 = 5.3; 2021 = 5.0; 2022 = 5.0. - Overall fiscal balance (percent of GDP): 2017 = -7.3; 2018 = -9.0; 2019 = -7.5; 2020 = -5.7; 2021 = -4.0; 2022 = -3.5. - Gross international reserves (US$ billions): 2017 = 7.5; 2018 = 7.1; 2019 = 8.0; 2020 = 9.2; 2021 = 10.2; 2022 = 11.0. - Total public debt (gross, percent of GDP): 2017 = 53.2; 2018 = 58.0; 2019 = 63.2; 2020 = 62.9; 2021 = 60.0; 2022 = 57.5. - Public debt projected to reach 60.7 percent of GDP by June 2018. - Fiscal deficit in 2016/17: 9.2 percent of GDP (vs. program target of 6.9 percent). - Revenue shortfalls in FY2017/18 through end-March 2018: about 0.5 percent of GDP. - Interest payments on public debt rose to nearly one fifth of revenue. - NPLs: 12.4 percent in April 2018 (up from 9.6 percent a year earlier). - Private sector credit growth: 2 percent y/y in March 2018; 4.1 percent at end-2016; 16.0 percent at end-2015. - World Bank Doing Business ranking: moved up a combined 33 places to 80 during 2016–18. - WEF competitiveness: 91/137 in 2017–18, compared with 106/144 in 2011–13. - CFTA ratified by Kenya on March 27, 2018. - SBA first review completed on January 25, 2017. - SBA approved March 2016. - Introduction of interest rate controls in September 2016. - Only three of eight structural benchmarks met so far. - SBA extended to September 14, 2018. - Proposed authorities’ end-fiscal year target: overall deficit of 7.5 percent of GDP. - Deficit as a share of GDP had been 7.2 percent in March (final 2017 nominal GDP lower than expected). - Debt ceiling referenced: 50 percent of GDP in NPV terms. - Risk of growth reduction from interest rate controls: about ½ percent per annum in 2018 and beyond. - Deficit target needing additional measures: 5.7 percent of GDP. - Medium-term objective deficit target: 3 percent of GDP. - Staff recommendation: next Article IV consultation be held within 24 months. - Box 1: Overall poverty incidence fell from 46.8 percent to 36.1 percent between 2005/06 and 2015/16. - Exchange rate for program monitoring: On April 18, 2018, the exchange rate was KSh100.4028 =US$1.00. - TMU Table 3 program exchange rate example (as of March 29, 2018): US Dollar KSh per currency unit 100.74; US Dollars per currency unit 1.00. - TMU projected budgetary external grants and loans (US$ millions) — 2018 Jun. Program grants 60.55; External commercial debt 2,880.82. - TMU NIR target (floor, US$ million): End-Dec 5,789; End-Jun (PC) 7,710. - Primary budget balance (national government, floor): End-Dec Act. -54.4; End-Jun (PC) -259.8. - Indicative target NDA of CBK (ceiling): -153.1 (End-Dec); -301 (End-Jun). - Priority social expenditures (floor): 64.78 (End-Dec); 81.5 (End-Jun). - Programmed external commercial debt (US$ million): 106.8 (End-Dec); 2,881 (End-Jun). - Program grants: 2.7 (End-Dec); 6.1 (End-Jun). - Programmed project loans: 39.4 (End-Dec); 138.7 (End-Jun). - Budgeted project loans: 138.7 (End-Jun). *Source: IMF staff report, May 31, 2018. cr18295.* ### 7.5 percent of GDP, a floor on international reserves, and a ceiling on new contracting or ### 7.5 percent of GDP, a floor on international reserves, and a ceiling on new contracting or guaranteeing of public debt. ### Key Policy Recommendations - Near term: - Deliver on fiscal deficit target of 7.5 percent of GDP in 2017/18 (focusing measures on expenditure). - Deliver on fiscal deficit target of 5.7 percent in 2018/19 (focusing measures on revenue) to bring debt ratios onto a downward path. - Remove or significantly modify interest rate controls and move toward an interest rate corridor soon thereafter. - Medium term: - Maintain planned gradual fiscal consolidation to preserve debt sustainability and reduce fiscal risks. - Focus measures on revenues to maintain space for public investment and social spending. - Continue structural reforms to: - Improve revenue administration. - Strengthen public financial management. - Modernize the monetary policy framework. - Enhance bank prudential frameworks. - Improve the business environment and governance to sustain strong and more inclusive growth. ### Recent Economic Developments - Growth and poverty: - Real GDP growth has averaged about 5½ percent since the 2008 global crisis. - Kenya’s poverty rate fell by over 10 percentage points over 2006–16 (to 36.1 percent). - 2017 performance: - GDP growth fell to 4.9 percent in 2017 (from 5.9 percent in 2016). - Growth drivers included a contraction in agriculture due to a severe drought, extended political uncertainty, and weak credit growth partly due to interest rate controls. - Growth accelerated to 5 percent in the fourth quarter of 2017 (up from 4.7 percent through the first three quarters). - Inflation: - Inflation returned to the authorities’ target band of 5±2.5 percent; headline inflation was 3.4 percent in April (food-driven spike earlier in 2017). - Core inflation has remained below 5 percent since late 2016. - External sector: - Current account deficit increased to 6.8 percent of GDP in 2017 (from 5.2 percent in 2016), driven by higher food and fuel imports. - Public finances and debt: - Public debt projected to reach 60.7 percent of GDP by June 2018 (end of FY 2017/18). - Fiscal deficit in 2016/17 was 9.2 percent of GDP, compared to a program target of 6.9 percent. - Revenue shortfalls in FY2017/18 through end-March 2018 were about 0.5 percent of GDP short of the revised budget target. - Interest payments on public debt rose to nearly one fifth of revenue. - Kenya’s risk of debt distress increased from low to moderate. ### Monetary and Financial Sector Issues - Interest rate controls (introduced in September 2016) have: - Weakened economic performance by contributing to lower credit growth, reduced financial inclusion, weaker bank profitability and tax revenues, higher financial stability risks, and a weakening of the effectiveness of monetary policy. - Staff analysis suggests interest rate controls reduced growth in 2017 by ¼–¾ percentage points. - Staff advice: - Critical to remove or significantly modify interest rate controls and transition toward an interest rate corridor. ### Economic Outlook and Risks - Baseline projections (Adjustment Scenario): - Real GDP growth expected to increase to 5.7 percent in 2018 (from 4.9 percent in 2017). - Kenya’s real GDP growth projected to average 6.0–6.5 percent per year over the medium term, assuming removal/modification of interest rate controls and implementation of reforms. - Medium-term fiscal adjustment envisages strong adjustment over 2018-19, driven largely by revenue measures, with the deficit gradually approaching, but not reaching, the EAC convergence criteria of 3.0 percent of GDP. - Inflation expected to remain within the authorities’ target range in the near term. - Current account deficit projected to decline over the medium term as tea exports and tourism recover. - Selected baseline figures: - Real GDP growth: 2017 = 4.9; 2018 = 5.7; 2019 = 6.0; 2020 = 6.2; 2021 = 6.5; 2022 = 6.5. - CPI inflation, average: 2017 = 6.3; 2018 = 8.0; 2019 = 5.0; 2020 = 5.3; 2021 = 5.0; 2022 = 5.0. - Overall fiscal balance (percent of GDP): 2017 = -7.3; 2018 = -9.0; 2019 = -7.5; 2020 = -5.7; 2021 = -4.0; 2022 = -3.5. - Gross international reserves (in billions of US$): 2017 = 7.5; 2018 = 7.1; 2019 = 8.0; 2020 = 9.2; 2021 = 10.2; 2022 = 11.0. - Total public debt (gross, percent of GDP): 2017 = 53.2; 2018 = 58.0; 2019 = 63.2; 2020 = 62.9; 2021 = 60.0; 2022 = 57.5. - Alternative scenario (unchanged policies): - With slower fiscal consolidation and no removal/modification of interest rate controls, staff project lower medium-term growth and higher fiscal deficits and public debt. - Risks (mostly downside): - Failure to remove or significantly modify interest rate controls would reduce medium-term growth and likely increase fiscal deficits and debt. - Other downside risks: new security incidents, protracted weak credit growth, larger-than-expected contractionary impact of fiscal consolidation. - External shocks (capital outflows, tightening global monetary conditions) could weaken growth given limited policy space. ### Fiscal Policy Discussion and Recommendations - Rationale: - Reducing the fiscal deficit over the medium term is essential to contain fiscal risks, support private sector growth, and place debt on a downward path. - Gradual reduction toward the authorities’ medium-term objective of 3 percent of GDP would reduce financing risks and avoid procyclical tightening during shocks; aligns with East African Monetary Union convergence criteria (3 percent of GDP by 2021). - Diagnosis: - Public debt has been increasing rapidly since 2013; slippages before the 2017 elections pushed projected debt to 60.7 percent of GDP by June 2018. - Rising reliance on non-concessional borrowing increased fiscal vulnerabilities. - Historically, overly-optimistic revenue projections have led to end-of-year ad hoc spending freezes and risks of arrears and public investment shortfalls. - The 2016/17 fiscal outcome (deficit of 9.2 percent of GDP vs. program target of 6.9 percent) reflected higher-than-programmed foreign-financed investment, lower tax revenues (notably income taxes), drought and election-related spending, and higher interest bill equivalent to 0.2 percent of GDP. - Policy guidance: - Calibrate composition of financing to balance risks from further non-concessional external borrowing and crowding out domestic private sector. - Implement revenue administration measures (e.g., rollout of the Integrated Custom Management System and installation of scanners at customs ports) to reduce under-declaration and boost revenues in the medium term. - If FY2017/18 revenues fall short as projected, pursue further expenditure cuts to meet the June 2018 fiscal target. *Source: IMF staff report, May 31, 2018.* ### 15. The authorities’ plan to reduce the deficit to 7.5 percent of GDP in 2017/18—and ### 15. The authorities’ plan to reduce the deficit to 7.5 percent of GDP in 2017/18—and ### Fiscal consolidation and stance - Authorities’ target: reduce the deficit to 7.5 percent of GDP in 2017/18 and further to 5.7 percent in 2018/19. - Implied adjustment: an adjustment in the primary balance of over 3 percent of GDP during 2017/18–2018/19 relative to the 2016/17 outcome. - One-off spending expiration: expiration of one-off spending would help achieve envisaged fiscal consolidation; text table projects: - Projected reduction in the overall deficit in 2018/19: 1.5 percent of GDP - Expiration of one-off spending: 0.5 percent of GDP - Elections: 0.4 percent of GDP - Drought: 0.2 percent of GDP - Residual consolidation (excl. one-offs): 1.0 percent of GDP - Note on nominal target: the nominal fiscal deficit target of Ksh 623 billion is now equivalent to 7.5 percent of GDP (revision following April 2018 national accounts). ### Near-term adjustment needs and spending policy - Additional spending cuts beyond the supplemental budget are needed to achieve the 2017/18 fiscal target. - Authorities’ commitment: if revenues disappoint, they would contain spending for the remainder of 2017/18 as needed to achieve the deficit target. - Staff recommendation on cuts: - Focus cuts on low-priority domestically-financed capital projects to avoid undue disruption to priority spending. - Contain spending commitments (rather than delaying payments) to meet the deficit target without incurring arrears. ### Revenue measures and tax reform (2018/19) - Authorities’ planned revenue measures (expected to yield a total of 1.1 percent of GDP): - Removal of the VAT exemption on petroleum imports, set to expire in September: 0.36 percent of GDP - Expanding taxes on betting to cover both operator profits and winnings: 0.41 percent of GDP - Removing various VAT and CIT exemptions: 0.15 percent of GDP - Draft income tax bill (planned for introduction in FY2018/19): - Adds a new personal income tax bracket of 35 percent for upper-income individuals. - Simplifies the corporate tax code along a number of lines. - Expected to increase progressivity and have a positive revenue impact. ### Staff assessment of revenue outlook and further needs - Staff view: authorities’ revenue projections are overly optimistic; weak underlying performance of income and other taxes likely to persist, partially offsetting planned measures. - Staff projection: additional measures of 0.6 percent of GDP will be needed to meet the 2018/19 deficit target. - Contingency: further measures required if yields from the measures in paragraph 17 are lower than expected. - Staff encouragement: careful costing of any tax benefits planned as part of the government’s “Big Four” development plan. ### Scope for broader tax reforms - Income tax: close remaining loopholes related to investment allowances and capital gains taxes. - VAT: rationalization of VAT exemptions could yield roughly 2½–3 percent of GDP per year. - Property tax: largely unexploited; needed to support devolution of spending responsibilities to county governments. - International taxation: authorities should consider improvements (see Box 3 and Selected Issues Paper referenced in source). ### Fiscal risks and social mitigation - Staff calls to: - Monitor and prevent accumulation of arrears. - Carefully evaluate fiscal risks related to PPPs, especially planned Big Four projects in the road sector. - Mitigate impact of fiscal adjustment on most vulnerable groups. - Staff welcomes authorities’ initiatives: move towards free secondary education, expand access to healthcare, promote housing for low-income groups. ### Authorities’ views on fiscal outlook - Agreed with staff on near-term fiscal targets but more optimistic on revenues and less urgent about identifying specific spending reductions. - Commitment: if revenues disappoint (based on April outturn), they would freeze spending authorizations to meet the target and believed they could slow down spending as needed without generating additional arrears. ### Monetary policy framework and exchange rate - CBR and interest rate controls: - Policy rate (CBR) had been unchanged at 10.0 percent until March 2018. - In March 2018, CBK cut the CBR by 50 bps to signal an accommodative stance. - Staff notes the CBR has lost signaling role due to interest rate controls weakening link to bank lending and deposit rates. - Interbank market volatility: - Weighted average interbank interest rate ranged between 3 and 10 percent during 2017 and early 2018. - Volatility driven by a small number of large banks dominating the market, inefficiencies in processing large government transactions, and unsterilized FX interventions. - Private sector credit growth: - 2 percent y/y in March 2018 - 4.1 percent at end-2016 - 16.0 percent at end-2015 - Policy recommendations to transition to interest-rate based framework: - Abolish or significantly modify interest rate controls; if not possible, delink lending rate cap from the CBR, significantly increase lending rate cap to protect consumers, and abolish floor on time deposit rates. - Introduce a formal interest rate corridor for interbank rates around the policy rate shortly (two to three months) after removal/modification of controls. - Reduce interbank rate volatility by: (1) sterilizing liquidity impact of FX interventions as needed; (2) improving liquidity forecasting for large National Treasury operations; (3) strengthening the horizontal repo market. - Consider publishing ex-post information on FX operations (volumes and number of participants). - Stance of policy: - An accommodative monetary policy seems appropriate given core inflation below the mid-point of the target range, fiscal consolidation in progress, and a negative output gap. - CBK should stand ready to loosen liquidity conditions further if growth and inflation remain subdued. - Exchange rate flexibility: - There is room for greater exchange rate flexibility; CBK FX interventions are typically unsterilized but given credibility and reserve coverage, greater flexibility could act as a shock absorber. ### Authorities’ views on monetary policy - Agreed that interest rate controls and interbank volatility hamper monetary policy but prefer reducing interbank market segmentation first by improving the government securities trading platform to increase liquidity access for more banks. - Did not view sterilizing FX interventions as necessary given relatively low volumes. - Preferred a longer period (six months) after controls are modified before establishing an interest rate corridor to observe financial stability implications. - Underscored adherence to a flexible exchange rate policy; FX interventions aimed at avoiding excessive shilling volatility. ### Financial sector stability and supervision - Bank profitability and structure: - Interest rate controls have reduced bank profitability and net interest income, prompting cost reductions (staff cuts, increased fees). - Impact concentrated on smaller banks; system in aggregate remains sound but prolonged controls pose financial stability risks. - Non-performing loans and liquidity support: - NPLs increased to 12.4 percent in April 2018 from 9.6 percent a year earlier. - Outstanding CBK liquidity support to some small banks remains significant (focused on fewer banks than peak). - Resilience and stress tests: - Large non-financial corporations and banks appear relatively resilient to corporate sector shocks; even extreme shocks raise NPLs but do not severely deteriorate capital levels (per Selected Issues Paper). - Supervision and resolution recommendations: - Continue strengthening bank supervision; implement remedial plans for banks non-compliant with capital and liquidity ratios, requiring credible, time-bound restructuring plans. - Progress noted on resolution of three intervened banks: Chase Bank asset offer accepted; Dubai Bank in liquidation; Imperial Bank in non-binding offer stage with expected finalization by July 2018. - Address shortcomings in bank resolution framework: complex legal regime, lack of planning and coordination delaying decision-making. - Consider amending the KDI Act to allow netting off of repurchase agreements to simplify bank resolution and ensure collateral enforceability. *Source: cr18295* ### 36. The authorities are also making progress with Anti-Money Laundering/Combatting ### cr18295 - 36. The authorities are also making progress with Anti-Money Laundering/Combatting ### AML/CFT reforms and financial integrity - Kenya’s financial supervisors are developing risk-based AML/CFT supervisory tools and enhancing the operations and procedures of Kenya’s financial intelligence unit to help strengthen anti-corruption efforts. - Reporting entities are being encouraged to undertake risk assessments for AML/CFT, but Kenya has not yet carried out a national risk assessment, which would help better understand AML/CFT risks. - Authorities are working (with Fund TA) to generate the data necessary to assess AML/CFT risks in the sector. ### Banking supervision, interest rate controls, and authorities’ views - Authorities agree on the need to continue strengthening banking supervision and support the recapitalization plans of the two government-owned banks. - Work underway includes improving the regulatory and supervisory framework to support continuous surveillance of regulated entities and conducting vulnerability assessments of banks. - On interest rate controls, authorities highlighted CBK engagement with banks to: - review business models based on customer needs, - strengthen information sharing on credit and transparency of pricing, - strengthen banking sector consumer protection, legal, and regulatory framework. ### Structural reforms: promoting inclusive growth and improving governance - Progress and gaps: - Kenya improved its World Bank Doing Business ranking by a combined 33 places to 80 during 2016–18, with notable gains in starting a business, protecting minority investors, and resolving insolvency. - WEF competitiveness moved to 91/137 in 2017–18, from 106/144 in 2011–13. - Performance on corruption indicators (Transparency International and World Bank) suggests continued challenges. - Policy recommendations (staff): - Further regional and multilateral integration: implementation of the Africa Continental Free Trade Area (CFTA), ratified by Kenya on March 27, 2018, and the Comesa-EAC-SADC Tripartite FTA (TFTA); staff encourages signing the Economic Partnership Agreement (EPA) with the European Union. - PFM reforms (structural benchmarks under the program include): - clarification of counties’ power to set taxes/user fees to increase county-level revenue; - standardization of guidelines for project appraisal and selection to improve public investment efficiency; - automation of the release of funds through the exchequer account to prevent accumulation of pending bills; - operationalization of a centralized payment system to ensure better control of public expenditure. - Provide a medium-term budgeting focus, including setting expenditure ceilings consistent with medium term fiscal targets and realistic revenue projections. - Clarify fiscal rules: specify whether the ceiling for the present value of public debt applies to gross or net (of government deposits) basis; describe procedures and correction mechanisms if the 50 percent of GDP NPV debt ceiling is breached. - Strengthen macroeconomic statistics: improve balance of payments statistics (IIP and financial account data), disseminate IIP data, and revise historical financial account data with latest available data. ### Program performance, SBA extension, and new program instruments - Timeline and performance: - SBA/SCF approved March 2016; only the first review completed on January 25, 2017. - Performance criteria on the primary balance for end-December 2016 and end-June 2017 were missed due to revenue shortfalls and spending pressures; latter partly due to drought. - Introduction of interest rate controls in September 2016 weakened program performance. - Structural benchmark implementation partial: only three of eight SBs met so far, partly due to prolonged electoral cycle in 2017. - SBA extension and proposals: - SBA extended to September 14, 2018. - Proposal to establish new end-June 2018 and continuous quantitative performance criteria (QPCs), indicative targets, a monetary policy consultation clause (MPCC), and structural benchmarks (SBs) for end-August 2018. - Proposed QPCs include a floor on the primary deficit in line with the authorities’ end-fiscal year target of an overall deficit of 7.5 percent of GDP. - QPCs also include a floor on net international reserves, a ceiling on the government’s external payment arrears, and a ceiling on new debt contracted or guaranteed by the national government and the CBK. - MPCC triggered should inflation go outside the CBK’s target band. - Proposed SBs include significantly amending interest rate controls to avoid adverse impacts and several PFM reforms. ### Debt sustainability, capacity to repay, and downside risks - Kenya’s capacity to repay the Fund remains strong, supported by: - expected continued export recovery (tourism, regional and continental integration), - envisaged fiscal consolidation, - adequate international reserve coverage. - Risks that would negatively affect the assessment: - failure to fully implement envisaged fiscal adjustment, - repeal or significant modification of interest rate controls, - external shock increasing financing pressures or spurring capital outflows. - Downside risks to the program: - delayed or partial fiscal consolidation, - failure to eliminate or amend interest rate controls, - external shocks and tightening global monetary conditions increasing gross external financing requirements. - Impact of interest rate controls: - Failure to modify controls could reduce growth by about ½ percent per annum in 2018 and beyond. - Policy responses if downside risks materialize: - Allow flexibility in the exchange rate combined with use of FX reserves to minimize volatility and provide space for fiscal adjustment. - Note: failure to remove or significantly modify interest rate controls would limit authorities’ response capacity. ### Capacity development and statistics - Capacity development: - Tailored TA program addressing public investment management, revenue administration integrity, and bank supervision framework strengthening. - Future capacity-building focus: medium-term budgeting, public financial management, bank supervisory capacity, and expanding government financial statistics coverage. - Macroeconomic statistics: - Improvements in quality, timeliness, and coverage noted, but staffing and capacity constraints remain. - Recommended actions: extend government financial statistics coverage to public corporations, improve public debt reporting, disseminate IIP data, and improve trade statistics. - Authorities encouraged to implement the enhanced General Data Dissemination Standards by launching a National Summary Data Page without further delay. ### Safeguards, appraisal, and key policy recommendations - CBK safeguards: - CBK implemented all May 2015 safeguards assessment recommendations; legal framework amended and enacted; CBK Board members appointed per law; Audit Committee reconstituted. - Staff appraisal — key points and recommendations: - Kenya achieved macroeconomic stability and healthy economic growth supported by infrastructure, business environment improvements, and financial inclusion expansion. - Immediate priorities to safeguard gains: - timely action to reduce government budget deficits; - eliminate or significantly modify interest rate controls. - Fiscal policy: - additional measures needed beyond supplemental budget for FY2017/18 and draft FY2018/19 budget to reach deficit target of 5.7 percent of GDP and medium-term objective of 3 percent of GDP; - cutting expenditure is necessary for 2017/18 given limited time for adjustment; - additional revenue measures should include ambitious reform of remaining exemptions in corporate income tax and value added tax. - Budget transparency: - more realistic revenue projections essential to improve transparency and reduce ad-hoc late fiscal cuts and arrears risk; - focus on medium-term budgeting and expenditure ceilings consistent with medium-term fiscal targets. - Interest rate controls: - should be removed; if not possible, modifications must fully address adverse effects: - delink lending rate cap from the CBR; - significantly increase the lending rate cap to protect consumers from predatory lending; - abolish the floor on time deposit rates. - Monetary policy: - revitalize efforts to modernize the inflation-targeting framework to reestablish CBR’s signaling role; - establish an interest rate corridor around the CBR once controls are removed or modified; - smooth interbank market volatility and allow greater shilling flexibility in response to external shocks. - Financial sector supervision: - CBK should maintain efforts to strengthen banking supervision and ensure all banks comply with prudential capital and liquidity ratios. - Business environment and governance: - staff welcomes progress on the business environment; removal of interest rate controls and PFM improvements will further raise potential growth and improve medium-term prospects. - Data dissemination and monitoring: - continued improvements in macroeconomic statistics and dissemination urged; address gaps in government finance and balance of payments statistics. - Program support: - staff supports establishment of new QPCs and an MPCC under the SBA and recommends next Article IV consultation within 24 months. ### Selected key numeric figures and dates (preserved exactly) - World Bank Doing Business ranking: moved up a combined 33 places to 80 during 2016–18. - WEF competitiveness: 91/137 in 2017–18, compared with 106/144 in 2011–13. - CFTA ratified by Kenya on March 27, 2018. - SBA first review completed on January 25, 2017. - SBA approved March 2016. - Introduction of interest rate controls in September 2016. - Only three of eight structural benchmarks met so far. - SBA extended to September 14, 2018. - Proposed authorities’ end-fiscal year target: overall deficit of 7.5 percent of GDP. - Deficit as a share of GDP had been 7.2 percent in March (final 2017 nominal GDP lower than expected). - Debt ceiling referenced: 50 percent of GDP in NPV terms. - Risk of growth reduction from interest rate controls: about ½ percent per annum in 2018 and beyond. - Deficit target needing additional measures: 5.7 percent of GDP. - Medium-term objective deficit target: 3 percent of GDP. - Staff recommendation: next Article IV consultation be held within 24 months. ### Box 1 — Poverty, Inequality, and Employment developments (selected figures) - 2015/16 Household Budget Survey published March 22, 2018. - Overall poverty incidence fell from 46.8 percent to 36.1 percent between 2005/06 and 2015/16. *IMF staff report content (cr18295) excerpt.* ### 32.0 percent and 8.6 percent, respectively. ### cr18295 - 32.0 percent and 8.6 percent, respectively. ### Poverty trends and geographic distribution - Overall poverty rate reduction driven by rural areas, where about two-thirds of Kenya’s population lives. - Rural poverty rate fell from 52.5 to 40.1 percent. - Urban poverty rate fell by a much smaller margin; urban poverty rate is 29.4 percent. - Graphic source noted: Source: Country authorities. ### Labor market developments - Employment ratio (those with employment as a share of the working age population) improved from 69.3 to 71.6 percent between 2009 and 2016. - Employment ratio increases by area: - Rural: increased to 73.2 percent. - Urban: increased to 69.4 percent. - Youth employment remains particularly low: - Age brackets 15–19 and 20–24 saw falling employment rates. - Youth employment is 27.6 percent. ### Inequality and gender disparities - Top income quintile accounts for 59.4 percent of consumption expenditure; inequality is even more pronounced in urban and semi-urban areas. - Female-headed households are somewhat poorer than male-headed households: - Female-headed households: 30.2 percent. - Male-headed households: 26.0 percent. - Labor force participation and unemployment by gender: - Men: labor force participation 79.2 percent; unemployment 5.2 percent. - Women: labor force participation 75.6 percent; unemployment 9.6 percent. - Women comprise nearly two-thirds of Kenya’s unemployed. ### The Big Four (program overview, estimated financing, and policy directions) - Program goals: manufacturing sector, affordable housing, universal affordable health care, and food security. - FY2018/19 estimated allocation for related projects: about US$4–5 billion. - About US$2.1 billion (about 2.3 percent of GDP) coming from the government. - On the government side, most would involve reallocation of existing budgeted funds. - Responsibilities for each policy area assigned to relevant ministries; specific policies and financing needs still being identified. - Manufacturing (objective and potential policies) - Target: increase manufacturing’s share of GDP from 9 to 15 percent by 2022. - Policies under consideration: reduction in the cost of off-peak power for heavy industries; creation of industrial parks and SEZs; enforcement of local contracts for government projects and procurement. - Housing (tools under consideration) - Consider creating a housing development fund to use publicly-owned land to encourage construction of low-cost housing. - Consider creating a refinance company that would issue bonds in the local capital market and extend long-term loans to financial institutions secured against mortgages to help create a market for longer-maturity mortgages. - Government announced a lower tax rate for developers who build a certain number of housing units per year. - Health care (objectives and uncertainties) - Government seeks to provide universal health care; ultimate cost depends on the generosity of the benefits package. - Government would look to reform governance of private insurance companies and increase the number of community health facilities. - Food security (policy focus) - Focus on large-scale production, improving smallholder productivity, and reducing the cost of food. - Measures under consideration: expanding land under production via PPPs, better coordination of irrigation services, improving access to credit for the agriculture sector, and redesigning Kenya’s food subsidy model to better target farmers’ needs. ### Policy guidance and implementation considerations - Development efforts targeting the Big Four are welcome, but authorities should carefully consider design of policies to achieve objectives. - Manufacturing-support policies should seek to correct market failures or negative externalities and apply to industries as a whole. - Authorities should seek to avoid “picking winners” and ideally leave implementation and assessment of incentives to an independent body to ensure a level playing field. - Authorities should ensure that any local content policies are in line with existing WTO agreements. *INTERNATIONAL MONETARY FUND* ### Box 3. Strengthening International Corporate Taxation in Kenya ### Box 3. Strengthening International Corporate Taxation in Kenya ### Assessment of current international tax regime - The overall parameters of Kenya’s current international tax regime are described as "quite sound". - The regime faces a likely increase in leakage from the tax base due to increasing cross-border inbound investment and from constraints on cross border taxation arising from a widening tax treaty network. - Many of Kenya’s treaties do not include the necessary provisions to make effective the relatively recent additions to the ITA designed to permit taxation of indirect offshore transfers of interest in Kenyan immovable assets. ### Treaty policy and anti‑abuse measures - A transparent treaty policy that uses cost‑benefit analysis to assess the need for a treaty is essential to preserve the integrity of Kenya’s treaty network. - To restrict revenue leakage through payment of inter‑group technical, management and professional service fees, future treaties should include a separate technical services article (following the Seychelles Treaty Article 13 model). - To limit incentives for treaty shopping, a limitation of benefits (LOB) provision restricting use of a DTT to entities that have a sufficient economic nexus to justify the source country tax concessions given up by Kenya should be included. - If Kenya were to adopt the Multilateral Legal Instrument an LOB provision would be added to existing treaties. ### Domestic anti‑base‑erosion rule: earnings stripping / thin capitalization - An "earnings stripping" rule is proposed to augment the current thin‑capitalization rule to limit earnings stripping via interest payment. - The recommended approach is implementing a “fixed ratio” rule that limits net interest deductions claimed by a company to a fixed percentage of earnings before interest, taxes and depreciation (EBITDA). - The ratio is most typically set at (a generous) 30 percent of applicable EBITDA. - Advantages cited: this type of rule avoids problems such as the need to define what constitutes debt or to combat the charging of an excessively high interest rate on related party debt. ### Transfer pricing policy and enforcement - Several improvements in transfer pricing policy could be revenue enhancing. - Start with using risk‑based analysis to identify cases that are targets for enforcement. - The draft income tax bill has addressed some issues, for example by introducing the profit split method in the Eighth Schedule. - More improvements are needed in the longer term and would need to be implemented outside the scope of the income tax bill. *Source: Selected IMF staff text in Box 3, "Strengthening International Corporate Taxation in Kenya."* ### Annex I. Implementation of Past Fund Advice ### Annex I. Implementation of Past Fund Advice ### Foreign exchange reserves and exchange rate - Recommendation: Maintain a strong foreign exchange reserves position with a flexible exchange rate to cushion the impact of potential shocks. - Outcome and facts: - Gross reserves have risen from US$6.6 billion at end-2015Q3 to US$9.3 billion or 4.8 months of imports as of end-March 2018. - Reflecting limited movement of the shilling relative to the US$, MCM’s 2018 report on exchange rate arrangement to be published in February 2018 will reclassify Kenya’s shilling from “floating” to “other managed arrangement.” ### Fiscal stance and expenditure composition - Recommendation: Maintain a prudent fiscal stance consistent with Kenya’s medium-term debt target while pursuing a shift in the composition of expenditure towards development priorities; control the wage bill; improve quality and efficiency of public spending; mobilize tax revenue. - Implementation and developments: - The government has increased the share of spending allocated to public investment (albeit less than originally targeted). - The government has announced a revision of the salary scales for public servants in line with recommendations from the Salary and Remunerations Commission. - Steps are being taken to improve tax administration. ### Devolution and fiscal risk mitigation - Recommendation: Effectively implement devolution to promote inclusive growth and improve social conditions, and mitigate the associated fiscal risks. - Actions and outcomes: - Disadvantaged counties have experienced a significant increase in government spending and service delivery. - The 2015 amendments to PFM regulations established: - limits on both the stock of gross debt and debt service for counties (up to 20 percent and 15 percent of each county’s last audited revenues, respectively); - a requirement for annual publication of county financial accounts; - specified financial and criminal penalties for violation of the PFM regulations. ### Cash management and public financial systems - Recommendation: Improve cash management; develop a Treasury Single Account (TSA). - Implementation and timeline: - Improvements in cash management will allow for the introduction of a centralized payment unit in July 2018. - The capabilities of the Integrated Financial Management and Information System (IFMIS) will be more effectively exploited. ### Management of oil and gas resources - Recommendation: Put in place effective management of newly-discovered oil and gas. - Implementation: - The government is working with the World Bank and FAD in implementing the framework for natural resource management. - Capacity building is being rolled out in the context of the Kenya Petroleum Technical Assistance Project. ### Bank supervision and financial sector oversight - Recommendation: Enhance bank supervision. - Recent steps taken: - (i) Stricter enforcement of transparency guidelines requiring banks to disclose their main shareholders and the volume of lending to insiders (directors, board members and employees). - (ii) Enhanced monitoring of capital adequacy levels through the initiation of the internal capital adequacy assessment process (ICAAP). - (iii) Hiring of additional staff in the area of compliance to support supervisory capacity. - (iv) Stricter enforcement of regulations regarding the classification of non-performing loans. - Remaining concerns: - Some small banks have been in non-compliance with prudential ratios for an extended period of time. - Progress in resolving three banks intervened in recent years has been slow. ### Regional integration - Recommendation: Accelerate regional integration. - Progress: - Kenya has continued making progress in implementing EAC agreements, with compliance reaching 90 percent on recognition of certificates of origin (second to Burundi), an important non-tariff barrier expected to be removed in the transition to a common market (well above Rwanda, Tanzania, and Uganda). ### Data quality and statistics - Recommendation: Improve data quality. - Implementation and timeline: - The Balance of Payments has been upgraded in line with the BPM6. - The work on the Foreign Investment Survey (FIS) will start in May 2018, and is expected to be completed by October 2018. - The first estimate of the International Investment Position (IIP) can be started after that, and is expected to be finalized by end-2018. - Both the FIS and the IIP will cover 2016 and 2017. *International Monetary Fund—Annex I. Implementation of Past Fund Advice* ### 3. We propose a set of quantitative performance criteria, an Monetary Policy Consultation ### 3. We propose a set of quantitative performance criteria, an Monetary Policy Consultation ### Proposed actions and timing - Propose a set of quantitative performance criteria, a Monetary Policy Consultation Clause, and indicative targets for end-June 2018 (Table 3). - Reset some structural benchmarks for end-August 2018 (Table 4). - These will serve as a basis for completing delayed reviews under the precautionary SBA, together with a macroeconomic framework and conservative revenue projections for 2018/19 and over the medium term to be agreed with Fund staff. - A follow-up letter of intent will be presented to the Executive Board before the expiration of the SBA program on September 14, 2018. - Authorization for publication of the letter of intent, the attached technical memorandum of understanding (TMU), and the related staff report. ### Quantitative performance criteria and indicative targets (key figures from Table 3) - Fiscal target - Primary budget balance of the national government (-=deficit, floor): End-Dec Act. -54.4; End-Jun (PC) -259.8. - Monetary target (NIR) - Stock of central bank net international reserves (floor, US$ million): End-Dec 5,789; End-Jun (PC) 7,710. - Public debt target - National government external payment arrears (ceiling, millions of US$): 0 0. - Contracting or guaranteeing of new public debt (ceiling, KES billion): 3 5081,220 - Monetary policy consultation clause (inflation bands) - Upper band: ... 7.5 - Center inflation target: 5.0 5.0 - Lower band: ... 2.5 - Indicative targets - Stock of net domestic assets of the central bank (ceiling): -153.1 (End-Dec); -301 (End-Jun). - Priority social expenditures of the national government (floor): 64.78 (End-Dec); 81.5 (End-Jun). - Stock of all guarantees issued by the national government (ceiling): ...... (no number provided). - Memorandum items (selected) - Programmed external commercial debt (US$ million): 106.8 (End-Dec); 2,881 (End-Jun). - Program grants: 2.7 (End-Dec); 6.1 (End-Jun). - Programmed project loans: 39.4 (End-Dec); 138.7 (End-Jun). - Budgeted project loans: 138.7 (End-Jun). ### Performance against earlier quantitative PCs and indicative targets (selected figures from Table 1) - Primary budget balance of the national government (-=deficit, floor) - 2016 End-Dec Prog.Adj. -111.2; Prog.Act. -131.1; Met/Not Met: Not met. - 2016 End-Jun Prog.Adj. -100.0; Prog.Act. -111.2; Met/Not Met: Not met. - 2017 End-Dec Prog.Adj. -211.5; Prog.Prel. -240.6; Met/Not Met: Not met. - Stock of central bank net international reserves (floor, in millions of US$) - 2016 End-Dec Prog.Adj. 6,283; Prog.Act. 5,633; Met/Not Met: Met (table shows mixed cells; preserve numeric values). - Monetary policy consultation clause (center inflation target) - 2016/2017 center targets and results include: 5.0, 5.0, 6.5 (Met/Not Met entries preserved in table where indicated). - Indicative target (stock of net domestic assets of the central bank, ceiling) - Example entries: -165, -99, -279 (Met); -193, -232, -355 (Met); -289, -321, -391 (Met). ### Structural benchmarks (Table 4: proposed for End-August 2018) - Modify interest rate controls while protecting consumers from predatory lending. - Target date: End-August 2018. - Macro criticality: To enable banks to resume providing credit to the economy and support growth, and to improve the effectiveness of monetary policy. - Submit to parliament draft legislation to clarify powers by counties to set taxes/user fees, aimed at increasing revenue at the county level, while maintaining a business-friendly tax system. - Target date: End-August 2018. - Macro criticality: To reduce pressures on transfers to counties while maintaining a business-friendly tax system. - Adoption by Cabinet of standardized guidelines for project appraisal and selection. - Target date: End-August 2018. - Macro criticality: To improve the efficiency of public investments. - Automate the release of funds from the exchequer account, first through the current system of MDA accounts. - Target date: End-August 2018. - Macro criticality: To prevent the accumulation of pending bills. - Make operational a Centralized Payment System to ensure better control of public expenditure. - Target date: End-August 2018. - Macro criticality: To strengthen expenditure control. ### Technical Memorandum of Understanding (TMU): definitions, measurement, and adjustors (selected points) - Scope and purpose - Memorandum sets out understandings between Kenyan authorities and the IMF regarding definitions of quantitative PCs and ITs, their adjusters, and data reporting requirements for the Stand-By Arrangement. - National Government of Kenya for program purposes = budgetary central government (national executive, legislative, judicial powers covered by the National Budget), including parliament, presidential office, national judiciary, Ministries, Departments, Agencies, and Constitutional Commissions and Independent Offices. - Quantitative PCs established for June 30, 2018 (TMU ¶3) - Primary balance of the national government including grants, and excluding spending related to SGR I (SGR I = first phase of the Standard Gauge Railway project connecting Mombasa to Nairobi), cash basis (floor). - Net official international reserves (NIR) of the Central Bank of Kenya (CBK) (floor). - National government medium- and long-term external public debt arrears (continuous ceiling). - Contracting or guaranteeing of new debt by the national government and the CBK (ceiling). - Monetary policy consultation clause (band). - Indicative targets (TMU ¶4) - Net domestic assets (NDA) of the CBK (ceiling). - Change in the stock of national government domestic bills pending for 90 days or longer (ceiling). - Priority social spending of the national government (floor). - Stock of guarantees issued by the national government (ceiling). - Primary balance measurement (TMU ¶5–7) - National government primary balance on cash basis = national government revenues and grants minus expenditures and net lending, plus due interest payments, and spending related to SGR I, adjusted for cash basis. - For program purposes, measured from the financing side as sum of: (a) negative of net domestic financing; (b) negative of net external financing excluding executed amounts related to SGR I; (c) domestic and external interest payments. Measured cumulatively from July 1, 2017. - Net domestic financing components: net domestic bank financing; net domestic nonbank financing; proceeds from privatization. - Net external financing components: disbursements of external project loans (including securitization and excluding SGR I executed amounts); disbursements of budget support loans; negative of principal repayments due on all external loans; net proceeds from issuance of external debt; exceptional financing; net changes in short-term external debt; any change in external arrears including interest payments. - Adjustors to primary balance target: (i) adjusted downward by shortfall in program grants (AMISOM refunds) as specified in TMU Table 1; (ii) adjusted downward by excess in project loans (excluding SGR I) relative to programmed amounts, up to maximums specified in MEFP Table 3. - TMU Table 1: AMISOM Grant Schedule (Billions of Kenyan Shillings) — 2018 Jun. Program Amount 1 6.1. - NIR definition, measurement, and adjustors (TMU ¶8–9) - NIR (stock) = total gross official international reserves minus official reserve liabilities. - Gross official international reserves include: CBK holdings of monetary gold (excluding amounts pledged as collateral); holdings of SDRs; CBK holdings of convertible currencies in cash or in nonresident financial institutions (deposits, securities, or other financial instruments); Kenya's reserve tranche position with the IMF. - Exclusions from gross official international reserves: pledged, swapped, or encumbered reserve assets; deposits with Crown agents; precious metals other than gold; assets in nonconvertible currencies; illiquid foreign assets. - Gross official reserve liabilities include: total outstanding liabilities of the CBK to the IMF (excluding SDR allocations); convertible currency liabilities of the CBK to nonresidents with original maturity up to and including one year; commitments to sell foreign exchange arising from derivatives. - NIR adjustors: - If budgetary external program grants and external commercial debt exceed programmed amounts in TMU Table 2, NIR target adjusted upward by half of the difference. - If budgetary external program grants and external commercial debt fall short of programmed amounts in TMU Table 2, NIR target adjusted downward by the difference. - TMU Table 2. Projected Budgetary External Grants and Loans (US$ millions) — 2018 Jun. Program grants 60.55; External commercial debt 2,880.82. - NIR monitoring: monitored in U.S. dollars; assets and liabilities in other currencies converted using exchange rates in TMU Table 3; NIR computed as daily average for the month when testing date is due. - TMU Table 3. Program Exchange Rates (Rates as of March 29, 2018) - US Dollar: Kenyan Shillings per currency unit 100.74; US Dollars per currency unit 1.00 - STG Pound: 142.15; 1.41 - Japanese Yen: 0.95; 106.3 - Canadian Dollars: 78.17; 1.29 - Euro: 124.60; 1.24 - Swiss Franc: 105.53; 0.95 - Swedish Kronor: 12.12; 8.32 - Danish Kronor: 16.69; 6.04 - Chinese Yuan: 15.99; 6.30 - Australian Dollars: 77.32; 1.30 - SDR: 146.84; 0.69 - Continuous performance criterion on external payment arrears (TMU ¶10–11) - National government external payment arrears to official and private external creditors = overdue payments (principal or interest) not made by contract due date nor during applicable grace period. - Guaranteed external debt payment arrears defined as overdue payments beyond 30 days after original contract due date to allow time for processing after debtor notifies inability to pay. - Excludes arrears relating to debt subject to renegotiation (dispute) or rescheduling. - Performance criterion on external payment arrears is a cumulative flow in gross terms from July 1, 2017 and applies on a continuous basis. *Attachment: Technical Memorandum of Understanding, Nairobi, Kenya, May 25, 2018.* ### 12. A performance criterion (ceiling) applies to the nominal value of new debt (external and ### cr18295 - 12. A performance criterion (ceiling) applies to the nominal value of new debt (external and ### Performance criterion on new debt - A performance criterion (ceiling) applies to the nominal value of new debt (external and domestic) contracted or guaranteed by the national government and the CBK. - For debt with original maturity of one year or less, new debt is measured as the change in the outstanding stock over the specified period. - Exclusions from the ceiling: the use of Fund resources, operations related to external debt restructuring, and normal import related credits. - Public debt issued in foreign currency shall be valued in local currency using the program exchange rates. ### Definition of debt (per Guidelines on Public Debt Conditionality, Executive Board’s Decision No.15688-(14/107)) - Debt is defined as a current, i.e., not contingent, liability created under a contractual arrangement through the provision of value in the form of financial and nonfinancial assets (including currency) or services, which requires the obligor to make one or more payments in the form of assets (including currency) or services at some future point(s) in time. - Primary forms of debt: - (i) loans: advances of money to the obligor by the lender (including deposits, bonds, debentures, commercial loans and buyers’ credits), and temporary exchanges equivalent to fully collateralized loans (such as repurchase agreements and official swap arrangements). - (ii) suppliers’ credits: contracts permitting the obligor to defer payments until after delivery of goods or services. - (iii) leases: arrangements where the lessee has the right to use property for specified periods; for the guideline, debt equals the present value (at lease inception) of all lease payments expected during the agreement excluding payments that cover operation, repair, or maintenance. - Under this definition, arrears, penalties, and judicially awarded damages arising from failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt. ### Monetary policy consultation clause (Inflation consultation band) - Quarterly bands around the projected 12-month CPI inflation (headline CPI published by KNBS) are specified for the test date. - If the observed average for the latest three months of the 12-month CPI inflation falls outside the lower or upper bands specified for the end-June 2018 test date, the authorities will complete a consultation with the IMF Executive Board focusing on: - (i) the stance of monetary policy and whether the Fund-supported program remains on track; - (ii) the reasons for program deviations, taking into account compensating factors; and - (iii) proposed remedial actions if deemed necessary. - When the consultation is triggered, access to Fund resources will be interrupted until the consultation takes place. - TMU Table 4. Inflation Consultation Band (2018 Apr.- Jun. Target): - Upper band: 7.5 - Center point: 5.0 - Lower band: 2.5 ### Indicative target on Net Domestic Assets (NDA) of the Central Bank of Kenya - NDA defined as reserve money minus NIR converted in shillings at the accounting exchange rate specified in TMU Table 3, plus medium- and long-term liabilities (maturity of one year or more) of the CBK; minus the value in shillings of encumbered reserves converted at the accounting exchange rate specified in TMU Table 3. - NDA components: - net CBK credit to the national government; - outstanding net credit to domestic banks by the CBK (including overdrafts); - other items net. - Reserve money = currency in circulation + required and excess reserves. - Adjustors to the NDA target: - if budgetary support (external grants and loans) and external commercial debt exceed the programmed amounts, the target for NDA will be adjusted downward by half of the difference; - if budgetary support (external grants and loans) and external commercial debt fall short of the programmed amounts, the target for NDA will be adjusted upward by the difference. - NDA are monitored in shillings, computed as the daily average for the month when the testing date is due. ### Indicative target on national government domestic pending bills - Defined as outstanding invoices for which requisitions for payment have been received in IFMIS but no corresponding release of funds from the exchequer account has taken place. - Indicative Target (ceiling) applies to the change in the total stock of bills that have been pending for 90 days or more. ### Indicative target on priority social spending - Priority social spending of the national government is defined as the sum of: - cash transfers to orphans and vulnerable children; - cash transfers to elderly; - free primary education expenditure; - free secondary education expenditure. ### Indicative target on guarantees issued by the national government - Guarantees include all guarantees extended by the national government to counties, public enterprises and all parastatal entities. - All indicative targets are cumulative from July 1, 2016. ### Data reporting (summary of obligations and deadlines) - The National Treasury (NT) and the CBK will provide information at the frequency and within the reporting deadlines specified in TMU Table 5. - Selected reporting items and deadlines (responsible entity in parentheses): - Net domestic bank financing; Net CBK credit to national government — Monthly; Within 20 days after the end of the month. (CBK) - Net nonbank financing of the national government — Monthly; Within 20 days after the end of the month. (NT) - Proceeds from privatization — Monthly; Within 20 days after the end of the month. (NT) - Interest due and paid on domestic debt — Monthly; Within 20 days after the end of the month. (CBK) - Interest due and paid on external debt — Quarterly; Within 4 weeks after the end of the quarter. (CBK) - Disbursements of external concessional and non-concessional project loans, including securitization — Quarterly; Within 45 days after the end of the quarter. (NT) - Disbursements of budget support loans — Quarterly; Within 45 days after the end of the quarter. (NT) - Principal repayments due and paid on all external loans — Quarterly; Within 20 days after the end of the month. (CBK) - Net proceeds from issuance of external debt — Monthly; Within 20 days after the end of the month. (CBK) - Any exceptional financing (including rescheduled principal and interest) — Monthly; Within 20 days after the end of the month. (NT) - Net changes in the stock of short-term external debt — Quarterly; Within 45 days after the end of the quarter. (NT) - Net change in external arrears, including interest and principal, and penalties — Monthly; Within 45 days after the end of the quarter. (NT) - Additional reporting items (public debt, reserves, official reserve liabilities, NDA components, other indicators) are listed in TMU Table 5 with specified frequencies and reporting deadlines to CBK and/or NT as applicable. - Other indicators include: 12-month CPI inflation — Monthly; Within 15 days after the end of the month. (KNBS) ### Debt dynamics, DSA findings, and public debt facts - Kenya’s risk of external debt distress: Moderate. - Drivers and context: - Kenya’s risk increased from low to moderate due to breaches of three external debt indicators—external debt service-to-export ratio, external debt service-to-revenue ratio, and the present value of external debt to export ratio—for an extended period under the most extreme shock. - The external debt service-to-export ratio is also breached under the baseline scenario (temporary and marginal), related to a bullet Eurobond repayment. - Public debt has risen in recent years but public–sector debt dynamics continue to be sustainable; most new debt finances infrastructure to address bottlenecks and boost sustainable growth. - Policy imperatives highlighted: - Reduce the fiscal deficit over the medium term. - Restrict borrowing to finance projects with high social and economic returns. - Lengthen the maturity of non-concessional borrowing to limit and eventually reverse the rise in public debt ratios and reduce refinancing risks. - Manage composition of fiscal financing between domestic and foreign sources to contain risks from export shocks while avoiding crowding out domestic bank credit to the private sector. ### Key public and external debt statistics (as reported) - Gross public debt: - 51.4 percent of GDP at end-2015. - 53.2 percent of GDP at end-2016. - about 58.0 percent of GDP at end-2017. - About half of Kenya’s public debt is owed to external creditors. - Nominal public external debt at end-2017: US$21.4 billion, equivalent to 28.5 percent of GDP. - Gross domestic public debt was KSh2,210 billion (29.5 percent of GDP) at end-2017. - Composition of domestic debt: - Treasury bonds: 67 percent of domestic debt. - Treasury bills: 32 percent of domestic debt. - Commercial banks hold 54 percent of domestic debt; nonbanks hold 42 percent. - Average maturity profile of outstanding government domestic debt: 5 years as at end December 2016. ### Composition and recent history of commercial external financing - 2014 sovereign bond issuances: - June 2014: two tranches — a five-year $500 million bond at a yield of 5.875 percent, and a 10-year $1.5 billion bond at 6.875 percent. - December 2014: added $250 million to the five-year tranche at a 5.0 percent yield and $500 million to the 10-year tranche at 5.9 percent. - Total raised in 2014: $2 billion in June and $750 million in December. - October 2015: contracted a two-year US$750 million syndicated loan at LIBOR plus 570 basis points (equivalent to an effective yield of 8 percent). Payment for nearly 90 percent of this syndicated loan was extended to April 2018; maturity later extended to seven years. - February 2018: raised an additional US$2 billion in a new sovereign bond issue; issued in two equal tranches: - 10 years at a coupon of 7.25 percent; - 30 years at a coupon of 8.25 percent. ### Underlying macroeconomic assumptions and projections (selected) - Real GDP growth in the baseline: weaker in 2017 relative to 2016 due to severe drought, a prolonged presidential election, and sluggish private sector credit growth (partly due to the interest rate cap). Growth expected to recover in the medium to long term as weather and political uncertainty dissipate, global economy strengthens, and flagship infrastructure projects complete. - Primary fiscal deficit: 5.6 percent in FY2016/17; projected to be brought down in the medium to longer term consistent with the EAC Monetary Union criteria of an overall fiscal deficit (including grants) of 3 percent of GDP. - Fiscal consolidation expected to be underpinned by expenditure and revenue measures, including slowing growth of development expenditures as flagship projects complete and crowding-in private capital via PPPs, plus revenue measures (rationalizing exemptions, new income tax bill, electronic tracking of cargo) and a projected pickup in GDP growth. - Current account deficit: estimated to have widened to 6.8 percent of GDP in 2017. Staff projects the current account deficit to start declining in 2018, supported by a rebound in exports and a slowdown in import growth as the pace of development expenditure slows. *Prepared by staffs of the International Monetary Fund and the International Development Association; May 31, 2018.* ### 6. External solvency debt indicators remain below their policy-dependent debt burden ### 6. External solvency debt indicators remain below their policy-dependent debt burden ### External solvency baseline outcomes - The present value (PV) of public and publicly guaranteed (PPG) external debt as a share of GDP is expected to rise to 31.4 percent in 2018 from 25.9 percent in 2017. - The PV of PPG external debt then gradually declines over time, remaining well below the 50 percent indicative threshold. - The PV of external debt-to-exports and debt-to-revenue both remain below the indicative thresholds of 200 percent and 300 percent, respectively, over the entire projection period. ### Liquidity indicators and baseline breaches - Debt service-to-exports ratio: - Exceeds its threshold over two years by an average of 0.9 percentage points per year. - This reflects contracting of syndicated loans in the second half of FY2017/18 and worse-than-expected export performance in 2017. - Debt service-to-revenue ratio: - Touches its threshold in one year. ### Stress-test outcomes - Under standard stress tests there are longer breaches in: - PV of debt-to-exports ratio, - Debt service-to-exports ratio, - Debt service-to-revenue ratio. - Under the most extreme stress scenario: - The PV of debt-to-exports breaches the threshold for 10 years by an average of more than 53 percentage points. - The most extreme stress scenarios of the debt service-to-exports and debt service-to-revenue ratios also exceed the indicative thresholds. ### Change in external debt distress rating and immediate policy implications - Staff has increased the risk of external debt distress from low to moderate. - Rationale: breach of three external debt indicators — external debt service-to-export ratio, external debt service-to-revenue ratio, and the PV of external debt to export ratio. - The baseline breach of the external debt service-to-export ratio is short and marginal and related to a bullet Eurobond repayment, against the background of Kenya’s continued access to international markets and a comfortable level of official foreign reserves. - Policy recommendations: - Reduce reliance on non-concessional borrowing to keep financing costs low. - Refinance loans at longer maturity to limit refinancing risks. - Continued commitment to fiscal consolidation to maintain debt sustainability. ### Public debt baseline and benchmarks - Total public debt as a share of GDP: - Projected to peak in 2018 at 63.2 percent (from 58.0 percent in 2017 and 53.2 percent in 2016) due to ramping up of infrastructure projects. - Under the baseline, the primary deficit is expected to be 2.6 percent of GDP in 2018 and to decline to about zero in 2020–22. - Result: debt declines to 56.3 percent of GDP in 2022. - PV measures: - PV public debt peaks at 60.6 percent of GDP in 2018 and falls thereafter. - PV of public debt-to-revenue ratio: 299.6 percent in 2018, easing to 261.5 percent in 2022. - Comparison to LIC benchmark: - Total public debt remains well below the low-income DSA public debt benchmark of 74 percent of GDP in PV terms. - Note: public debt in Kenya excludes legacy debts of pre-devolution county governments (modest) and non-guaranteed debt of state-owned enterprises. ### Alternative and extreme scenarios - Fiscal policy scenario (primary balance fixed at 2017 level): - Keeping the primary balance unchanged from its 2017 level (corresponding to -4.8 percent of GDP) throughout the projection period (20 years) leads to: - PV of public debt-to-GDP remaining on a steady upwards trajectory and breaching the 74 percent benchmark in 2022. - Debt-to-revenue ratio rising above 400 percent in 2027. - Extreme exchange rate shock scenario: - A one-time depreciation of 30 percent taking place in 2018: - PV of debt-to-GDP would remain below its threshold. - Such a shock would bring overall public debt only about 1 percentage point of GDP away from its benchmark. - Highlights vulnerability of public debt to a severe exchange rate shock. ### Main findings and strategic conclusions - Kenya’s risk of external debt distress has increased from low to moderate due to rising refinancing risks and narrower safety margins. - There are significant and prolonged breaches of several external debt indicators under extreme shocks, though baseline breaches are limited in magnitude and duration. - Authorities are strengthening debt management capacity to manage and prepare for large repayments on commercial borrowing, including plans to refinance loans to longer maturities over the next year. - Concessional borrowing should continue to play an important role because of lower cost and longer maturities; non-concessional borrowing should be limited to projects with high social and economic returns. - Continued investment in infrastructure is critical to raise growth and export potential, supporting external debt sustainability. *Source: IMF staff estimates.* ### 15. Overall public-sector debt dynamics continue to be sustainable, although delivering on the ### 15. Overall public-sector debt dynamics continue to be sustainable, although delivering on the ### Summary assessment of debt dynamics - Overall public-sector debt dynamics are assessed as sustainable under the program baseline. - The overall fiscal balance in 2016/17 was larger than projected in the previous DSA in December 2016, in part due to higher execution of foreign-financed investment projects expected to raise growth in output and exports in the longer term. - The baseline public debt path remains consistent with the EAC convergence criteria for debt. - Debt indicators are below the relevant public debt benchmark in the baseline and in stress scenarios presented for 2017–37. - Standard stress-testing scenarios show that if the primary deficit were to remain at current levels, public debt would remain on an upward path—highlighting the need to follow through on the intended medium-term fiscal consolidation. - The authorities are urged to remain committed to medium-term plans of gradual fiscal adjustment to reduce risks. ### Indicators and stress-test evidence (scope and horizons) - Figures and scenarios cover 2017–37 and present baseline, historical scenario, and most extreme stress shock (where the most extreme shock is the test that yields the highest ratio on or before 2027). - Stress scenarios referenced include: One-time depreciation shock; Exports shock; combination shocks (e.g., Exports shock and One-time depreciation shock). - Key indicator series in figures and tables include: Debt accumulation, Rate of Debt Accumulation, Grant-equivalent financing (% of GDP), Grant element of new borrowing (% right scale), PV of debt-to-GDP ratio, PV of debt-to-exports ratio, PV of debt-to-revenue ratio, Debt service-to-exports ratio, Debt service-to-revenue ratio, and Debt service-to-revenue ratio (PPG). ### Quantitative context and selected projections (2017–37) - Projections and historical context are presented across multiple tables and figures for 2014–37 and 2017–37 horizons. - Historical and projection assumptions explicitly reported include: - Real GDP growth (in percent): 5.4, 5.7, 5.9, 5.2, 2.2, 4.9, 5.7, 6.0, 6.2, 6.5, 6.5, 6.0, 6.0, 6.0, 6.0 (series as reported in tables). - Effective interest rate (percent) (key series reported): 5.3, 4.1, 4.0, 3.2, 1.2, 4.2, 4.5, 5.0, 4.8, 4.7, 4.6, 4.6, 4.6, 4.8, 4.6 (series as reported in tables). - Grant-equivalent financing (in percent of GDP) series reported for projection years (examples given in tables): 1.0, 0.9, 1.1, 1.1, 1.0, 0.9, 0.8, 0.6, 0.7 (as reported). - Exchange rate noted for program monitoring: On April 18, 2018, the exchange rate was KSh100.4028 =US$1.00. - The DSA includes extensive sensitivity analyses (tables) for PV of debt-to-GDP ratio, PV of debt-to-exports ratio, PV of debt-to-revenue ratio, and debt-service ratios under alternative scenarios and bound tests (including historical averages, less favorable loan terms, real GDP growth shocks, export shocks, US dollar GDP deflator shocks, net non-debt creating flows shocks, combinations, and a one-time 30 percent nominal depreciation). ### Policy implications and recommendations - Delivering on the fiscal consolidation envisaged under the program is essential to reduce downside risks to public debt dynamics. - If the primary deficit is not reduced (i.e., remains at current levels), stress tests indicate public debt would trend upward—underscoring the importance of following through on intended medium-term fiscal consolidation. - Continued commitment by authorities to their medium-term plans of gradual adjustment is necessary to maintain sustainability and to preserve compliance with the EAC convergence criteria for debt. *Prepared by IMF staff; figures, tables, and projections drawn from the Kenya DSA and accompanying analytical annex covering 2014–37 and 2017–37.* ### 1. Assessment of key infrastructure projects and ### 1. Assessment of key infrastructure projects and ### Context and objectives - Arrangement: Stand-By Arrangement (SBA) extended to September 14, 2018; extension necessitated new end-June 2018 quantitative performance criteria (QPCs), indicative targets, a monetary policy consultation clause (MPCC), and structural benchmarks (SBs) for end-August 2018. - Policy focus: The Big Four Plan — manufacturing, provision of affordable housing, universal affordable health care, and food security — building on the Economic Transformation Agenda (since 2014). - Fiscal strategy: Commitment to a sustainable fiscal policy path aiming to enhance domestic revenue mobilization, rationalize expenditures, and reverse the recent upward debt trajectory. - Private sector engagement: Leverage partnerships with the private sector and strengthen evaluation of Public Private Partnership (PPP) proposals. ### Recent economic performance and outlook - Growth: - Average real GDP growth: 5.5 percent for nearly a decade. - 2016 growth: 5.9 percent. - 2017 growth: 4.9 percent (slowed due to drought, extended election period, weak credit growth). - 2018 projected growth: 5.7 percent. - Medium-term projection: exceed 6 percent. - Inflation: - Target range: 5 ± 2.5 percent. - Peak: 11.7 percent in May 2017 (sharp rise due to drought). - April 2018: 3.7 percent. - Since December 2017: inflation below the mid-point of the target; expected to remain within target range in near to medium-term. - External sector: - Current account deficit: widened to 6.8 percent of GDP in 2017 from 5.2 percent in 2016 (driven by higher food and fuel imports and rising global oil prices). - Medium-term outlook: current account deficit projected to narrow owing to high tea, coffee, and horticulture exports, strong remittance inflows, and higher tourism earnings. - Key growth drivers expected: favorable weather boosting agriculture, supply effects from the completed Standard Gauge Railway linking Mombasa and Nairobi, expansion in construction and electricity sectors, and recovery in tourism. ### Fiscal policy and public financial management (PFM) - Fiscal targets and outcomes: - 2016/17 fiscal deficit: 2.3 percent of GDP higher than program target. - 2017/18 fiscal deficit target: within 7.5 percent of GDP. - 2018/19 fiscal year target: 5.7 percent. - Medium-term objective: move closer to East African Monetary Union deficit ceiling of 3 percent of GDP by 2020/21. - Revenue and expenditure measures: - Planned measures expected to yield more than 1 percent of GDP in additional revenues. - Specific revenue measures: removal of the VAT exemption on petroleum imports; removal of various VAT and CIT exemptions; expanding taxes on betting to cover both operator profits and winnings; impending income tax bill expected to boost revenue collection and enhance tax administration. - Expenditure measures: cut low priority spending including domestically financed development projects; preserve priority social spending (free primary and secondary education); allocate for expansion of access to healthcare and promote housing for low income groups. - PFM reforms and controls: - Automation of the release of funds through the exchequer account to prevent accumulation of pending bills. - Operationalization of a centralized payment system for better control of public expenditure. - Clarify fiscal rules and standardize guidelines for project appraisal and selection to improve public investment efficiency. - Debt management: - Authorities determined to ensure public debt returns on a downward trajectory. - Strengthen capacity in debt management and evaluation of PPP proposals. ### Monetary policy, exchange rate, and financial sector stability - Monetary and exchange rate stance: - Central Bank of Kenya (CBK) committed to price stability and aims to keep headline inflation around the midpoint of the target range. - Adherence to a flexible exchange rate regime; limit foreign exchange interventions to addressing volatility. - Plan to establish an interest rate corridor after interest rate controls have been modified. - Interest rate controls: - Controls introduced September 2016 aimed at reducing borrowing costs and increasing return on savings. - Authorities acknowledge controls have constrained monetary policy conduct and weakened link between CBR and commercial bank lending and deposit rates. - Significant modification of interest rate controls seen as key for transitioning to an interest-rate based monetary policy framework. - Financial sector indicators and actions: - Non-performing loans (NPLs): increased from 9.6 percent in April 2017 to 12.4 percent in April 2018. - Actions: strengthen supervisory framework; enhance specialized on-site inspections of banks’ ICT systems; ensure implementation of International Financial Reporting Standards (IFRS) 9; implement remedial plans for banks not compliant with capital and liquidity ratios; support recapitalization plans of the two government-owned banks. - AML/CFT progress: - Develop risk-based AML/CFT supervisory tools and enhance operations and procedures of the financial intelligence unit to strengthen anti-corruption efforts. ### Structural reforms and data - Business environment improvements: - World Bank Doing Business ranking improved by a combined 33 places to 80 in 2016–18. - Notable improvements: starting a business, protecting minority investors, resolving insolvency, and overall competitiveness. - Statistics and capacity: - Progress in improving macroeconomic statistics, including government finance and balance of payments. - Ongoing efforts to address staffing challenges and overall capacity constraints. ### Conclusion and policy commitments - Fiscal consolidation: pursue gradual fiscal consolidation to bring public debt on a downward trajectory while preserving space for growth-friendly public investment, including The Big Four. - Monetary reform: modify interest rate controls to improve monetary policy effectiveness, boost lending to the private sector, and support inclusive growth. - Price and financial stability: sustain efforts to maintain low and stable inflation and further strengthen financial sector supervision and regulation. - Structural agenda: continue deepening structural reforms to improve the business environment and support investment-led inclusive growth. *Statement by the Executive Director, Mr. Maxwell M. Mkwezalamba, and by the Senior Advisor of the Executive Director Mr. Ted Sitima-wina on Kenya June 13, 2018* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18295.pdf_