## _cr08339

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### Political context
- Political crisis after the December 2007 elections: over 1,000 people killed and more than 350,000 (about 1 percent of the population) displaced.
- Grand coalition government formed in April 2008 under an internationally intermediated power-sharing agreement; President Kibaki remained in office and Mr. Raila Odinga became Prime Minister.
- Minister of Finance stepped aside in July pending investigation of alleged misconduct; allegations also leveled against the Governor of the Central Bank of Kenya (CBK).

### Economic prospects and short-term outlook
- GDP and growth projections:
  - After a contraction in Q1 2008, an economic rebound is underway.
  - Staff projection: GDP growth of 7.2 percent in 2008/09 (July/June).
  - Authorities’ forecast for 2008/09: 5.8–6.6 percent.
  - Medium-term: authorities’ BSP projects GDP growth to average about 7 percent; staff expects 6½ percent on current policies.
- Risks:
  - Downside: instability of the power-sharing arrangement; reform implementation challenges; further increases in global oil and food prices; higher world interest rates; pronounced global slowdown.
  - Upside: faster rebound in confidence, tourism, and donor support.
- Longer-term constraints: infrastructure bottlenecks, relatively low private saving and investment.

### Inflation and price measurement
- Official headline CPI inflation: 26.5 percent in July (year-on-year).
- IMF staff geometric-mean adjustment suggests corrected inflation around 15 percent in mid-2008.
- Box 1 finding: Kenya’s official CPI uses a chain-linked Carli index imparting upward bias; staff applied the Jevons index and found the overall CPI was overestimated over the past 1½ years by a factor of about 2.
- KNBS planned switch to a formula consistent with international best practices later in 2008, with rebasing and reweighing of the CPI basket.
- Key CPI series (selected): Consumer price index (annual average): 11.1, 10.4, 18.5, 14.5, 5.0, 5.0, 5.0, 5.0. Consumer price index (end of period): 10.9, 11.1, 29.3, 8.0, 5.0, 5.0, 5.0, 5.0.

### External stability and exchange rate
- Real effective appreciation: shilling appreciated by almost 32 percent in real effective terms since end-2004 (based on corrected CPI series).
- Current account and reserves:
  - External current account deficit almost doubled in 2007/08 to 4½ percent of GDP (also cited as 4.6 percent in places).
  - Gross official reserves (end of period, US$ millions, memorandum): 2,353; 2,723; 3,443; 3,670; 4,068; 4,561; 5,134; 5,778.
  - Gross international reserve coverage (months of next year imports): 3.3, 2.9, 3.1, 3.1, 3.1, 3.1, 3.1, 3.2.
- Exports and imports (selected US$ levels and components):
  - Exports, f.o.b. (US$ millions): 3,508; 3,835; 4,701; 5,460; 6,095; 6,881; 7,765; 8,796.
    - Coffee: 134; 155; 160; 162; 173; 183; 195; 216.
    - Tea: 612; 675; 801; 849; 830; 879; 948; 1,060.
    - Horticulture: 472; 559; 699; 827; 921; 1,066; 1,253; 1,447.
  - Imports, f.o.b. (US$ millions): -6,295; -7,461; -9,453; -11,256; -12,153; -13,503; -15,101; -16,847.
    - Oil: -1,545; -1,833; -2,489; -3,244; -3,509; -3,746; -4,027; -4,282.
- Staff and authorities broadly agreed the exchange rate level appeared broadly appropriate; appreciation likely driven by fundamentals.
- Box 2: multiple methodologies do not indicate major risks to external stability, but data and methodological weaknesses warrant caution.

### Fiscal developments, budget composition, and recommendations
- 2007/08 fiscal deficit (including grants): 4.8 percent of GDP—below original budget target but more than twice the deficit of the previous year.
- 2008/09 budget envisages overall deficit of 5.3 percent of GDP and rebalancing of spending toward public investment.
- Staff recommendation for 2008/09 fiscal stance: reduce fiscal deficit to around 4½ percent of GDP to provide resources for infrastructure and social objectives while preserving macro stability.
- Authorities’ rationale for higher spending: address infrastructure bottlenecks and new policy initiatives (e.g., free secondary education); better financing opportunities including access to commercial foreign financing.
- Staff noted lower-than-budgeted foreign-financed investment execution rates could allow a 4½ percent deficit while still supporting about 2 percent real spending growth (versus 5 percent in the budget).
- Fiscal projections (Kenya: Fiscal Scenario, 2007/08 - 2010/11; In percent of GDP):
  - Total revenue: 22.3, 21.4, 21.6, 21.6, 21.6.
  - Grants: 1.2, 1.4, 1.3, 1.3, 1.3.
  - Total expenditure and net lending: 28.3, 28.1, 27.6, 26.7, 26.7.
  - Overall balance (incl. grants): -4.8, -5.3, -4.6, -3.8, -3.8.
  - Memorandum: Total public debt: 38.8, ..., 38.0, 38.6, 38.6. Real GDP growth rate (percent): 3.9, 5.8, 7.2, 6.0, 6.6.
- Revenues and privatization:
  - Strong revenue performance from tax administration improvements and buoyant economy through end-2007; a 0.3 percent of GDP one-off transfer of collected road fees.
  - Privatization receipts increased sharply to almost 4 percent of GDP.
  - Domestic financing declined and public debt fell below 40 percent of GDP.
- Public debt target considerations:
  - Cross-country evidence suggests a public debt-to-GDP ratio of about 35 percent as an appropriate target for Kenya; public debt currently close to 40 percent.
  - Staff suggested anchoring fiscal policy on total public debt (including domestic and external), ideally including contingent liabilities.

### Sovereign borrowing and debt management
- Authorities considering commercial external borrowing and a planned sovereign bond issue (envisaged amount around US$ 500 million; discussions at an early stage).
- Staff recommendations:
  - Concessional funds remain first-best.
  - If commercial funds used, carefully evaluate market conditions, funding costs, maturity, and repayment profile.
  - Size of issue should not exceed what can be absorbed in high-return projects ready for execution.
  - Consider amortizing structures or pre-funding for sovereign bond amortizations to avoid spikes in debt service and rollover risks.
  - Develop a comprehensive medium-term debt management strategy and improve statistics on external financial flows.
- Concern: commercial external borrowing could lead to large year-to-year fluctuations in spending for a given amount of domestic financing; a total public debt anchor could provide better guidance.

### Debt Sustainability Analysis (DSA) — external and public debt
- Classification and thresholds for a medium performer (CPIA average):
  - NPV of debt-to-GDP ratio: 40 percent.
  - NPV of debt-to-exports ratio: 150 percent.
  - NPV of debt-to-revenue ratio: 250 percent.
  - Debt service-to-exports ratio: 20 percent.
  - Debt service-to-revenue ratio: 30 percent.
- Key DSA baseline assumptions (selection):
  - Real GDP growth: average 6.2 percent for 2008–2013; 6.0 percent from 2014–2028.
  - Alternative scenario: average real growth for 2009–2013 one standard deviation lower → average 4.4 percent for 2009–2013.
  - Average inflation: about 5.6 percent for 2008–2013 (GDP deflator); 4.9 percent for 2014–2028.
  - Revenues constant at 21.6 percent of GDP; domestically financed development spending constant at 4.5 percent of GDP.
  - Sovereign bond issuance assumed: $500 million in 2009; $200 million annually 2010–2013; rising to about $500 million by 2028. Terms: 8 percent interest, bullet amortization in year ten.
- Recent debt stocks:
  - End-2007 public external debt (face value): $6.2 billion (25 percent of GDP).
    - Creditor composition: about 60 percent multilateral (including 47 percent owed to the World Bank), about 39 percent bilateral (largely Paris Club), and 2 percent commercial creditors.
  - End-2007 external arrears: about $91 million to commercial creditors (disputed).
  - Net domestic debt declined to 18.5 percent of GDP at end-June 2008.
  - Contingent liabilities: pay-as-you-go civil service pension claims estimated at Ksh 271 billion (11.4 percent of 2008/09 GDP) from an August 2005 actuarial study.
- External DSA findings:
  - Baseline: low risk of external debt distress; initial debt ratios well below indicative thresholds and decline somewhat through the forecast period.
  - Combined shock (lower growth, weaker exports, lower GDP deflator, fall in non-debt creating flows) impacts:
    - NPV of public external debt as a share of GDP: from 14 to 28 percent (2008–2013 series shown).
    - NPV of debt-to-exports: from 55 to 105 percent (2008–2013 series shown).
    - NPV of debt-to-revenue: from 64 to 126 percent (2008–2013 series shown).
  - Under all alternative scenarios and stress tests, Kenya remains under indicative external debt and debt service thresholds.
- Public (total) debt findings:
  - Baseline: NPV of total public debt-to-GDP: 34 percent in 2008; broadly stable up to 2028.
  - Debt service-to-revenue ratio: 25 percent in 2008; gradually declines thereafter.
  - Alternative scenarios:
    - Two-year growth shock → NPV of debt-to-GDP rising to 57 percent by 2028; NPV of debt-to-revenue just below 250 percent by 2028; debt service-to-revenue rising to over 30 percent by 2012.
    - Permanently lower growth → NPV of debt-to-GDP beyond 40 percent and debt service-to-revenue about 30 percent.
    - NPV of debt-to-GDP breaches 40 percent under scenario with primary balances unchanged from 2008, and under combined two-year growth and primary balance shock.
- Policy implications from DSA:
  - Sustainability depends on macro performance and prudent borrowing strategy.
  - Recommended policies: sustain macro stability; substantial infrastructure investment; regulatory and governance reforms to improve investment climate.
  - Avoid excessive nonconcessional borrowing as external financing access increases.
  - Monitor and incorporate contingent liabilities into future DSA work.

### Monetary and financial sector policy
- Monetary stance and instruments:
  - Monetary policy was fairly accommodative over much of past three years; monetary targets frequently missed; real interest rates on treasury bills often negative.
  - In 2008, CBK accommodated crisis-related liquidity early; monetary conditions tightened considerably thereafter.
  - Central Bank Rate (CBR) raised by ¼ percentage point to 9 percent in early June 2008.
  - Reserve money growth: 19 percent, year-on-year, in July (above level consistent with envisaged decline in inflation during 2008/09).
  - Staff recommended decisive instruments to slow reserve money growth/prevent second-round inflation effects:
    - Term-deposit auctions.
    - FX reserve sales.
    - Introduction of CBK’s own bills.
  - Consideration of moving to inflation targeting over the medium term contingent on resolving CPI methodological issues and better understanding monetary transmission.
- Banking sector:
  - Most indicators suggest a relatively healthy system.
  - CBK intervened to help address liquidity shortfalls in a few smaller banks in H1 2008, including interventions when interbank liquidity dried up in the context of the heavily oversubscribed Safaricom IPO.
- Monetary aggregates (selected):
  - M3 (annual percent change, memorandum): 8.6, 18.0, 16.0, 18.3, 18.1, 20.5, 20.7, 21.8.
  - Reserve money (RM): 94.4, 107.7, 126.5, 151.2, 153.0, 182.1, 168.6, 173.9.
  - Money and quasi money (M3, Ksh billions): 442.4, 522.0, 605.5, 716.4, 745.4, 803.4, 841.1, 872.8.

### Structural reforms and Vision 2030
- Vision 2030 objective: make Kenya a middle-income country by 2030; target accelerate annual GDP growth to 10 percent per year by 2012 and sustain thereafter.
- Required reforms and priorities:
  - Substantial infrastructure investment.
  - Financial sector reforms: finalize a Financial Sector Strategy; comprehensive revision of the Central Bank and the Banking Acts, including mandatory and prompt corrective actions.
  - Public financial management reforms:
    - Reinvigorate five-year PFM reform program.
    - Adoption and implementation of the Public Finance Administration Bill.
    - Expand IFMIS to remaining ministries and all districts.
    - Introduce a single treasury account.
    - Adopt program budgeting (pilot underway).
  - Improve money market efficiency via dematerialization of treasury bill transactions and adoption of the Master Repurchase Agreement.
  - Passage of an anti-money laundering bill (before parliament; passage uncertain).
  - Privatization agenda (including National Bank of Kenya).
  - Develop a solid PPP framework; start with smaller projects; transparently record PPPs and potential public liabilities.
  - Governance: update Governance Action Plan and publish outcomes; shortcomings remain on public access to wealth declarations and verification by Kenya Anti-Corruption Commission.

### Data provision, statistics, and surveillance
- Data strengths and weaknesses:
  - Weaknesses reflect organizational and skill shortages and inadequate resources.
  - KNBS established in 2007 to replace CBS per new Statistics Law.
  - ROSC (IMF Country Report No. 05/388) findings: methodological soundness uneven; significant improvement required in GFS and national accounts; accuracy/reliability need more attention; accessibility adequate except for balance of payments.
  - Kenya participates in GDDS and GDDS project for Anglophone Africa; metadata and plans posted on DSBB.
  - Kenya has received Fund technical assistance; AFRITAC East adviser assessed capacity needs.
- National accounts:
  - Data quality deteriorated due to budgetary and staff constraints.
  - GDP believed significantly underestimated due to undercoverage of informal sector, nonagriculture subsistence, horticulture, self-employed professionals.
  - Rebasing and publication of national accounts estimates for 1996–2005 (2001 base) undertaken with STA assistance; quarterly national accounts being developed.
- Prices and CPI:
  - CPI (new series from 2002) covers 13 urban towns; weights from 1993-94 HBS; indices for lower and middle/upper income groups.
  - No producer, export, or import price indices produced.
  - March 2008 TA mission identified methodological issues imparting substantial upward bias; KNBS plans to switch formula and rebase/reweigh CPI later in 2008.
- Government finance statistics (GFS):
  - Needed improvements: migration to GFSM 2001; broaden coverage to extrabudgetary and social security funds; reconcile fiscal statistics; improve info on external financing; compile monthly/quarterly budget execution data; train MOF staff.
  - Since FY 2005/06 Kenya followed a new economic classification based on GFSM 2001; reporting delays and reconciliation issues persist.
  - Progress on IFMIS but gaps remain; last data reported to GFS Yearbook were for year ending June 2005 (significant lag).
- Monetary and external sector statistics:
  - Progress on MFSM and SRFs but further steps needed; misclassification issues identified; SACCOs (about 3,800 as of end-March 2007, accounting for about 30 percent of total deposits) present coverage questions.
  - CBK compiles annual BOP in US$ and started quarterly BOP estimates; KNBS compiles annual BOP in Ksh—datasets not fully reconciled.
  - Under-recording concerns for tourism receipts, private-sector investment flows, and transactions settled via accounts held abroad.
  - Large errors and omissions in central bank data since 1994 raise uncertainties about external obligations.
  - Recommended actions: foreign investment survey; enhance FX statistics survey; adopt common methodology between KNBS and CBK.
- Data reporting timelines:
  - Table of common indicators: as of August 19, 2008.
  - Latest observations and reporting frequencies provided for Exchange Rates (8/18/08), International Reserve Assets (8/18/08), Broad Money (6/30/08), Central Bank Balance Sheet (8/18/08), Banking System Balance Sheet (6/30/08), Interest Rates (6/30/08), CPI (6/30/08), Government finance (6/2008), External Current Account (Dec 2007), Gross External Debt (March 2008).

### Financial soundness and banking indicators
- Selected indicators (percent or levels as provided):
  - Regulatory capital to risk-weighted assets: 17.3; 16.6; 16.4; 16.5; 18.0; 19.5; 17.4.
  - Nonperforming loans to gross loans: 34.9; 29.3; 25.6; 21.3; 10.9; 10.5; 9.6.
  - Return on assets: 2.3; 2.1; 2.4; 2.8; 3.0; 3.6; 3.2.
  - Return on equity: 23.2; 22.0; 25.0; 28.6; 27.5; 33.3; 33.7.
  - Liquid assets to total assets: 33.2; 32.4; 33.1; 30.5; 35.1; 36.1; 38.6.
  - Customer deposits to total (non-interbank) loans: 131.6; 135.7; 125.1; 129.0; 138.6; 142.6; 140.2.

### Social and development indicators (selected)
- GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent): 2.2; 2.3; 2.1; 2.1.
- Improved water source (% of population with access): 45; ...; 61.
- Immunization, measles (% of children ages 12-23 months): 78; 83; 75; 69.
- Fertility rate, total (births per woman): 5.8; 5.2; 5.0; 5.0.
- GNI per capita, Atlas method (current US$): 380; 270; 430; 540.
- Population, total (millions): 23.4; 27.2; 30.7; 34.3.

### Staff appraisal — key policy recommendations
- Macroeconomic policy mix:
  - Support a strong recovery while guarding macroeconomic stability through tighter monetary policy, prudent fiscal policy (staff recommends targeting a fiscal deficit of around 4½ percent of GDP in 2008/09), and accelerated structural reforms.
  - Consider making the public debt-to-GDP ratio a medium-term fiscal anchor covering domestic and external debt.
- Monetary policy:
  - Mid-2008 tightening welcomed; further steps urgently needed to prevent second-round effects of food and fuel price increases.
  - Resolve CPI methodological issues quickly; consider broader monetary framework reforms including inflation targeting over the medium term (subject to preconditions).
- Fiscal policy and debt management:
  - Preserve macro stability while reallocating spending to high-return infrastructure and social objectives.
  - Favor concessional financing; if using commercial financing, carefully evaluate size, timing, and modalities (sovereign bond proceeds should finance high-return infrastructure).
  - Develop comprehensive medium-term debt management strategy; incorporate contingent liabilities into monitoring.
- Structural reforms and governance:
  - Accelerate investment climate improvements and financial sector reforms to mobilize domestic resources.
  - Use PPPs cautiously (start with smaller projects) and transparently record potential public liabilities.
  - Continue governance and transparency reforms; address unmet objectives (wealth declarations and verifications); expand IFMIS and ensure efficient use of devolved resources.
- Data and surveillance:
  - Improve macroeconomic statistics—national accounts, GFS, BOP—and reconcile KNBS and CBK datasets; conduct foreign investment survey and enhance FX statistics.

### Executive Board and authorities’ views (summary)
- Directors commended authorities for maintaining economic stability after post-election turmoil and for progress with economic reform; noted downside risks (rising food and fuel prices; weakening global demand).
- Directors supported 2008/09 budget focus on removing growth bottlenecks and improving social cohesion while stressing fiscal restraint and accommodating priorities within a smaller-than-budgeted deficit.
- Directors encouraged a fiscal anchor based on total public debt-to-GDP and careful consideration of an international sovereign bond issue.
- Directors welcomed tightening of monetary policy and urged quick action to address CPI methodological bias.
- Authorities noted real GDP growth of 7 percent in 2007, expected 4 percent in 2007/08, and a rebound to 7.2 percent in 2008/09; authorities agree exchange rate appreciation reflects fundamentals and are implementing CPI methodological reforms and measures to address second-round effects.

*Source: Executive Summary and selected sections, _cr08339._*

### Executive Summary ......................................................................................................

### _cr08339 - Executive Summary

### Political context
- Political crisis followed the December 2007 elections: over 1,000 people were killed and more than 350,000 (about 1 percent of the population) displaced.
- Grand coalition government formed in April 2008 under an internationally intermediated power-sharing agreement; President Kibaki remained in office and Mr. Raila Odinga became Prime Minister.
- Government submitted the 2008/09 budget and launched Vision 2030. The Minister of Finance stepped aside in July pending investigation of alleged misconduct; allegations were also leveled against the Governor of the Central Bank of Kenya (CBK).

### Economic prospects and short-term outlook
- After a contraction in the first quarter of 2008, an economic rebound is underway.
- Staff expected that GDP growth would exceed 7 percent in 2008/09 (July/June); staff projection specifically: 7.2 percent in 2008/09.
- Authorities’ forecast for 2008/09: 5.8–6.6 percent (not fully incorporating the larger-than-anticipated Q1 output decline).
- Medium-term growth expectations: authorities’ Budget Strategy Paper (BSP) projects GDP growth to average about 7 percent; staff expects 6½ percent on current policies.
- Risks to projections: downside risks include instability of the power-sharing arrangement, challenges to implement reforms, further increases in global oil and food prices, higher world interest rates, and a more pronounced global slowdown; upside risks include faster rebound in confidence, tourism, and donor support.
- Longer-term constraints noted: infrastructure bottlenecks, relatively low private saving and investment.

### Inflation and price measurement
- Official headline CPI inflation: 26.5 percent in July (year-on-year).
- IMF staff geometric-mean adjustment suggests corrected inflation around 15 percent in mid-2008.
- Box 1 finding: Kenya’s official CPI uses a chain-linked Carli index that imparts an upward bias; staff applied the Jevons index and found the overall CPI was overestimated over the past 1½ years by a factor of about 2.
- KNBS planned to switch to a formula consistent with international best practices later in 2008, with rebasing and reweighing of the CPI basket.

### External stability and exchange rate
- The shilling appreciated by almost 32 percent in real effective terms since end-2004 (based on a corrected CPI series).
- External current account deficit widened: the external current account deficit almost doubled in 2007/08 to 4½ percent of GDP.
- Despite appreciation, exports held up well; export values expanded somewhat faster than global exports; financial and FDI inflows increased; external debt declined and is fairly low; reserves are at historically high levels.
- Staff and authorities broadly agreed that the exchange rate level appeared broadly appropriate; appreciation likely driven by fundamentals (rising tea and coffee prices, a strengthening net foreign asset position, improved productivity).
- Box 2 summary: multiple methodologies (equilibrium REER estimates, macroeconomic balance variant, current-account level to stabilize external debt) do not indicate major risks to external stability, but data and methodological weaknesses warrant caution.

### Fiscal developments and policy
- Fiscal deficit (including grants) for 2007/08 (July/June): 4.8 percent of GDP—below the original budget target but more than twice the deficit of the previous year.
- Fiscal composition and financing:
  - Strong revenue performance from tax administration improvements and buoyant economy through end-2007; a 0.3 percent of GDP one-off transfer of collected road fees.
  - Privatization receipts increased sharply to almost 4 percent of GDP.
  - Domestic financing declined and public debt fell below 40 percent of GDP.
- Staff recommendation for 2008/09 fiscal stance: reduce the fiscal deficit to around 4½ percent of GDP to provide resources for infrastructure and social objectives while preserving macroeconomic stability.
- Authorities’ 2008/09 budget envisaged a higher deficit of about 5⅓ percent of GDP; authorities emphasized infrastructure needs.
- Authorities considering staff proposal to anchor fiscal policy on total public debt (including domestic and external), ideally including contingent liabilities; cross-country evidence suggests a public debt-to-GDP ratio of about 35 percent as an appropriate target for Kenya. Public debt currently close to 40 percent.

### Sovereign borrowing and debt management
- Authorities considering plans for commercial external borrowing and a planned sovereign bond issue; staff and authorities agreed that the size, costs, and maturity profile needed careful evaluation to mitigate potential risks.
- Concern that commercial external borrowing could lead to large year-to-year fluctuations in spending for a given amount of domestic financing; moving to a total public debt anchor could provide better guidance with room for accommodating one-off events (e.g., privatization receipts, drought-related emergencies).

### Monetary and financial sector policy
- Recent measures to tighten monetary policy were judged to be in the right direction given high money growth and inflationary pressures.
- Staff recommended urgent additional steps to prevent second-round effects of higher food and fuel prices.
- CBK interventions in foreign exchange were largely limited to meeting foreign reserve and monetary targets and reducing exchange rate volatility; de facto and de jure exchange rate regimes classified as a managed float.

### Structural reforms and Vision 2030
- Government’s Vision 2030 aims for Kenya to reach middle-income status by 2030.
- For the private sector to play the envisaged lead role, substantial infrastructure investment and structural reforms are required, including reforms in:
  - Financial sector
  - Public financial management
  - Governance
  - Trade policy
- Staff and authorities agreed on the need to step up reforms to address infrastructure bottlenecks that impede trade and to keep the current account deficit sustainable.

### Ex-Post Assessment and staff appraisal
- Authorities agreed with the main findings of the Ex-Post Assessment and suggested steps for a more effective and balanced partnership in the future.
- Overall staff view: policy mix should support a strong recovery while guarding macroeconomic stability through tighter monetary policy, prudent fiscal policy (with potential shift to a total public debt anchor), and accelerated structural reforms.

*Source: Executive Summary, _cr08339.*

### 16.      The 2008/09 budget envisages a deficit of 5.3 percent of GDP and a rebalancing of

### 16.      The 2008/09 budget envisages a deficit of 5.3 percent of GDP and a rebalancing of

### Fiscal outlook and budget composition
- 2008/09 budget envisages an overall deficit of 5.3 percent of GDP and a rebalancing of spending toward public investment.
- Authorities’ rationale for higher spending:
  - Address infrastructure bottlenecks and new policy initiatives (for example, free secondary education) emerging out of the political tensions in early 2008.
  - Better financing opportunities than envisaged earlier, including access to commercial foreign financing.
- Staff view:
  - Supported emphasis on public investment but recommended a lower-than-budgeted deficit (of about 4½ percent of GDP).
  - Noted this deficit was achievable if foreign-financed investment spending were executed in line with rates of the recent past rather than the 100 percent execution rate assumed in the budget.
  - Under this scenario, real spending growth would still allow for some 2 percent real spending growth (versus 5 percent in the budget).

### Fiscal projections (Kenya: Fiscal Scenario, 2007/08 - 2010/11; In percent of GDP)
- Total revenue: 22.3, 21.4, 21.6, 21.6, 21.6
- Grants: 1.2, 1.4, 1.3, 1.3, 1.3
- Total expenditure and net lending: 28.3, 28.1, 27.6, 26.7, 26.7
- Overall balance (incl. grants): -4.8, -5.3, -4.6, -3.8, -3.8
- Memorandum items:
  - Total public debt: 38.8, ..., 38.0, 38.6, 38.6
  - Real GDP growth rate (percent): 3.9, 5.8, 7.2, 6.0, 6.6
- Sources: Kenyan authorities; and IMF staff estimates and projections.

### Financing plans and sovereign bond considerations
- Authorities outlined plans to finance some infrastructure spending from a sovereign bond, envisaged amount around US$ 500 million (discussions at an early stage).
- Staff recommendations regarding commercial financing:
  - Concessional funds remain the first-best source.
  - If commercial funds are used, carefully evaluate market conditions, funding costs, maturity, and repayment profile to maximize benefits.
  - Size of the issue should not exceed what can effectively be absorbed in high-return projects ready for execution.
- Authorities indicated they would cut back on domestically financed development spending if the bond issuance were delayed.
- Staff stressed the need for a comprehensive medium-term debt management strategy and encouraged steps to improve statistics on external financial flows.

### Measures to mitigate rising world food prices
- Authorities implemented measures with very limited fiscal costs:
  - Zero-rating of VAT on bread and rice.
  - Reductions in customs duties for wheat.
  - Steps to make fertilizer available at internationally competitive prices.
- Discussions included targeted support to the most vulnerable (for example, expansion of school feeding programs), contingent on future price and supply developments.

### Medium-term fiscal stance and public debt objective
- On unchanged policies, little progress would be made in reducing the public debt ratio.
- The 2008 Budget Strategy Paper envisaged a gradual reduction of the public debt-to-GDP ratio toward 35 percent over the medium-term—an objective supported by staff.
- Authorities indicated overall spending (relative to GDP) would decline over the medium-term while shifting composition toward development spending to address urgent infrastructure needs.
- Specific measures to secure the adjustment still needed to be identified in future budgets.

### Monetary and financial sector policy
- Monetary policy was fairly accommodative over much of the past three years; monetary targets frequently missed, and real interest rates on treasury bills were often negative.
- In 2008, CBK accommodated crisis-related liquidity needs early in the year; monetary conditions tightened considerably thereafter.
- In early June 2008, the Central Bank Rate (CBR) was raised by ¼ percentage point to 9 percent in response to continued inflationary pressures.
- Staff recommended decisive use of instruments to slow reserve money growth and prevent second-round inflation effects, including:
  - Term-deposit auctions.
  - FX reserve sales.
  - Introduction of the CBK’s own bills as a useful instrument.
- Reserve money growth was 19 percent, year-on-year, in July (above the level considered consistent with envisaged decline in inflation during 2008/09).
- Discussions included moving to inflation targeting over the medium term, contingent on resolving CPI methodological issues, better understanding of monetary transmission, and possible institutional arrangements.
- Banking system: most indicators suggest relatively healthy system, but CBK had to help address liquidity shortfalls in a few smaller banks in the first half of 2008, including interventions when interbank liquidity dried up in the context of the heavily oversubscribed Safaricom IPO.

### Vision 2030 and structural reform priorities
- Vision 2030 target: accelerate annual GDP growth to 10 percent per year by 2012 and sustain this growth thereafter to make Kenya a middle-income country by 2030.
- Structural reform priorities:
  - Finalize a Financial Sector Strategy.
  - Comprehensive revision of the Central Bank and the Banking Acts, including mandatory and prompt corrective actions in line with international best practices.
  - Improve efficiency in the money market via dematerialization of treasury bill transactions and adoption of the Master Repurchase Agreement.
  - Passage of an anti-money laundering bill (before parliament, passage uncertain).
  - Privatization of the National Bank of Kenya on the agenda.
- Fiscal-area structural reforms:
  - Reinvigorate five-year public financial management reform program, including:
    - Adoption and implementation of the Public Finance Administration Bill.
    - Expansion of the Integrated Financial Management Information System (IFMIS) to remaining ministries and all districts.
    - Introduction of a single treasury account.
    - Adoption of program budgeting (pilot underway).
  - Ensure mechanisms for coordination and strengthened budget reporting/control if more spending is devolved to subnational levels.
  - Develop a solid PPP framework; recognize PPPs’ potential fiscal and implementation risks and start with smaller projects; transparently record all PPPs and potential public liabilities.
- Governance and transparency:
  - Authorities intend to update the Governance Action Plan and publish outcomes for actions envisaged under the Plan.
  - Progress cited in public procurement and business regulation; shortcomings remained on public access to wealth declarations and ongoing verification of wealth declarations by the Kenya Anti-Corruption Commission.

### Staff appraisal — key conclusions and policy recommendations
- Political stability and initial government measures could facilitate a quick return to strong economic growth if sustained and if the world economy does not weaken beyond current forecasts.
- External stability: despite a larger current account deficit, no major risks identified; appreciation of the real exchange rate appears broadly in line with fundamentals; exchange market interventions should be limited to smoothing short-term volatility and meeting foreign reserve targets.
- Monetary policy: mid-2008 tightening was welcome, but further steps urgently needed to prevent second-round effects of food and fuel price increases; resolve CPI methodological issues quickly; consider broader monetary framework reforms (including inflation targeting) over the medium term.
- Fiscal policy: needs to balance spending for growth and poverty reduction with preserving macroeconomic stability; 2008/09 budget realigns priorities toward infrastructure and social objectives (e.g., free secondary education); staff recommends targeting a reduction in the fiscal deficit to around 4½ percent of GDP to allow reduction in the public debt-to-GDP ratio.
- Public debt anchor: consideration could be given to making the public debt-to-GDP ratio a medium-term anchor for fiscal policy, covering domestic and external debt.
- Sovereign bond: could help finance high-return infrastructure projects where concessional resources are unavailable; important considerations include size, timing, and modalities of issuance.
- Structural reforms: accelerate investment climate improvements and financial sector reforms to mobilize domestic resources; use PPPs cautiously (start with smaller projects); further trade reforms could deliver an important growth impulse.
- Governance and transparency: continue progress and address unmet objectives (wealth declarations and verifications); expand IFMIS and ensure efficient use of devolved public resources.

*IMF staff estimates and projections; Government of Kenya, Budget Strategy Paper 2008.*

### 39.      It is recommended that the next Article IV consultation take place on the standard 12-month

### _cr08339 - 39.      It is recommended that the next Article IV consultation take place on the standard 12-month

### Recommendation
- It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

### Macro outlook and projections (selected indicators)
- Real GDP growth (market prices): 6.1, 6.7, 3.9, 7.2, 6.0, 6.6, 6.5, 6.5
- GDP deflator (average): 6.4, 5.5, 12.0, 11.6, 4.8, 5.1, 5.1, 5.1
- Consumer price index (annual average): 11.1, 10.4, 18.5, 14.5, 5.0, 5.0, 5.0, 5.0
- Consumer price index (end of period): 10.9, 11.1, 29.3, 8.0, 5.0, 5.0, 5.0, 5.0
- Export volume, goods and services: 6.4, 4.7, 3.7, 6.3, 10.2, 9.6, 9.7, 9.5
- Import volume, goods and services: 16.7, 15.2, 3.5, 1.1, 7.8, 9.6, 9.8, 9.4
- Terms of trade, goods: -5.8, -3.0, -11.9, -7.6, -2.3, 0.3, 0.3, 1.1
- Ksh per US $ exchange rate (end of period): 69.3, 62.6, 64.6
- Nominal effective exchange rate (- depreciation; end of period): 4.0, 5.9, 3.0
- Real effective exchange rate (- depreciation; end of period): 11.8, 14.2, 7.8

### Money and credit
- M3 (broad money, end of period): 18.0, 16.0, 18.3, 21.8, 17.2, 16.2, 16.2, 16.1
- M3X (broad money and foreign currency deposits, end period): 14.9, 18.9, 19.4, 17.3, 16.0, 15.2, 15.2, 15.2
- Reserve money (end of period): 14.0, 17.5, 19.6, 15.0, 14.6, 14.1, 14.1, 14.1

### Investment and saving (percent of GDP)
- Investment: 18.0, 19.1, 20.0, 22.0, 22.1, 22.4, 23.1, 23.6
- Gross national saving: 16.0, 16.7, 15.4, 15.3, 16.6, 17.2, 17.9, 18.3

### Central government fiscal operations (selected levels and ratios)
- Total revenue (billions of Ksh): 311.3, 373.0, 427.2, 442.2, 512.7, 513.7, 569.3, 637.6, 715.8, 801.5
- Total expenditure and net lending (billions of Ksh): 382.8, 419.5, 557.3, 562.0, 673.0, 654.5, 705.6, 790.5, 903.4, 1,019.6
- Overall balance (commitment basis) excluding grants (percent of GDP): -4.7, -2.7, -6.0, -5.9, -5.2, -5.2, -5.7, -5.9
- Overall balance (commitment basis) including grants (percent of GDP): -3.4, -1.8, -4.8, -4.6, -3.8, -3.8, -4.2, -4.3
- Net domestic borrowing (billions of Ksh): 1.9, 2.0, 1.1, 2.2, 2.5, 2.5, 2.6, 2.7
- Total donor support (grants & loans, billions of Ksh): 1.9, 1.5, 2.5, 2.6, 2.8, 2.9, 3.3, 3.3

- Revenue (percent of GDP): 20.5, 21.7, 22.3, 21.6, 21.6, 21.6, 21.6, 21.6, 21.6, 21.6
- Expenditure and net lending (percent of GDP): 25.2, 24.4, 28.3, 27.6, 26.7, 26.7, 27.3, 27.5
- Balance (commitment basis, excluding grants, percent of GDP): -4.7, -2.7, -6.3, -6.0, -6.7, -5.9, -5.2, -5.2, -5.7, -5.9
- Balance (commitment basis, including grants, percent of GDP): -3.4, -1.8, -4.8, -4.8, -5.3, -4.6, -3.8, -3.8, -4.2, -4.3
- Net domestic borrowing (percent of GDP): 1.9, 2.0, 1.6, 1.1, 2.3, 2.2, 2.5, 2.5, 2.6, 2.7

### Financing and public debt (selected)
- Financing (billions of Ksh): 35.0, 35.5, 99.0, 99.2, 126.9, 110.4, 101.3, 113.4, 139.3, 159.8
- Net foreign financing (billions of Ksh): -0.2, -3.1, 29.0, 9.9, 58.8, 43.4, 34.1, 40.7, 53.8, 58.2
- Net domestic financing (billions of Ksh): 28.3, 34.7, 34.0, 21.8, 54.5, 53.3, 67.2, 72.7, 85.5, 101.7
- Nominal GDP (billions of Ksh): 1,519.4, 1,717.5, 2,077.8, 1,983.3, 2,393.2, 2,373.8, 2,637.9, 2,955.5, 3,308.6, 3,703.1
- Primary budget balance (billions of Ksh): 4.0, 13.2, -49.3, -47.4, -70.2, -53.4, -39.6, -41.4, -51.9, -61.0
- Stock of domestic debt, net (end of period, billions of Ksh): 280.1, 334.7, 381.3, 366.5, 421.0, 419.8, 487.0, 559.6, 645.1, 746.8
- NPV of total public debt: 576.0, 611.9, ..., 643.7, ..., 756.4, 864.9, 972.6, 1,097.5, 1,257.7
- Total public debt: 686.0, 725.8, ..., 768.9, ..., 901.0, 1,018.6, 1,140.3, 1,281.1, 1,465.4

### Balance of payments and external sector
- Exports value, goods and services (percent of GDP): 26.6, 25.5, 24.9, 25.2, 25.1, 25.2, 25.4, 26.9
- Imports value, goods and services (percent of GDP): 35.9, 35.2, 36.6, 39.2, 37.6, 37.1, 36.9, 38.6
- Current external balance, including official transfers (percent of GDP): -2.0, -2.4, -4.6, -6.7, -5.4, -5.2, -5.2, -5.3
- Gross international reserve coverage in months of next year imports (end of period): 3.3, 2.9, 3.1, 3.1, 3.1, 3.1, 3.1, 3.2
- Gross official reserves (end of period, US$ millions, memorandum): 2,353; 2,723; 3,443; 3,670; 4,068; 4,561; 5,134; 5,778

### Monetary survey and banking sector aggregates (selected)
- Central Bank of Kenya net foreign assets (US$ millions): 1,212; 2,159; 2,357; 2,896; 3,067; 3,078; 3,089; 3,192
- Reserve money (RM): 94.4, 107.7, 126.5, 151.2, 153.0, 182.1, 168.6, 173.9
- Money and quasi money (M3, Ksh billions): 442.4, 522.0, 605.5, 716.4, 745.4, 803.4, 841.1, 872.8
- M3 (annual percent change, memorandum): 8.6, 18.0, 16.0, 18.3, 18.1, 20.5, 20.7, 21.8
- Multiplier (M3/RM): 5.7, 5.6, 5.7, 5.7, 5.7, 5.1, 5.8, 5.8
- Velocity (GDP/M3): 2.6, 2.5, 2.5, 2.4, 2.4, 2.4, 2.4, 2.4

### Financial soundness indicators (selected, percent)
- Regulatory capital to risk-weighted assets: 17.3; 16.6; 16.4; 16.5; 18.0; 19.5; 17.4
- Nonperforming loans to gross loans: 34.9; 29.3; 25.6; 21.3; 10.9; 10.5; 9.6
- Return on assets: 2.3; 2.1; 2.4; 2.8; 3.0; 3.6; 3.2
- Return on equity: 23.2; 22.0; 25.0; 28.6; 27.5; 33.3; 33.7
- Liquid assets to total assets: 33.2; 32.4; 33.1; 30.5; 35.1; 36.1; 38.6
- Customer deposits to total (non-interbank) loans: 131.6; 135.7; 125.1; 129.0; 138.6; 142.6; 140.2

### Social and development indicators (selected)
- GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent): 2.2; 2.3; 2.1; 2.1
- Improved water source (% of population with access): 45; ...; 61
- Immunization, measles (% of children ages 12-23 months): 78; 83; 75; 69
- Fertility rate, total (births per woman): 5.8; 5.2; 5.0; 5.0
- GNI per capita, Atlas method (current US$): 380; 270; 430; 540
- Population, total (millions): 23.4; 27.2; 30.7; 34.3

### Joint Debt Sustainability Analysis (DSA) summary
- The Joint IMF/World Bank Debt Sustainability Analysis notes that the DSA was prepared following the standardized methodology for low-income countries.
- Findings indicate: "the risk of external debt distress is low."
- The DSA also notes: "Risks are somewhat greater for public debt, particularly in the event of lower growth."

*Sources: Kenyan authorities; Central Bank of Kenya; IMF staff estimates and projections; Joint IMF/World Bank staff analysis.*

### 1.      Debt sustainability is assessed in relation to policy-dependent debt burden

### _cr08339 - 1.      Debt sustainability is assessed in relation to policy-dependent debt burden thresholds

### Assessment framework and classification
- Kenya is classified as a medium performer in terms of the quality of its policies and institutions as measured by a three-year average of Kenya’s score on the World Bank’s Country Policy and Institutional Assessment (CPIA) index.
- Indicative thresholds for a medium performer:
  - NPV of debt-to-GDP ratio: 40 percent
  - NPV of debt-to-exports ratio: 150 percent
  - NPV of debt-to-revenue ratio: 250 percent
  - Debt service-to-exports ratio: 20 percent
  - Debt service-to-revenue ratio: 30 percent
- The DSA uses non-reconciled debt data and a single discount rate.
- The DSA consists of two parts:
  - External DSA: covers borrowing by the central government (including parastatal borrowing with a government guarantee) and the central bank; includes estimates for private sector borrowing.
  - Fiscal DSA: assesses sustainability of total debt—external and domestic—incurred or guaranteed by the central government.

### Key assumptions (consistent with the 2008 Article IV Staff Report)
- Growth and macro:
  - Average annual real GDP growth of 6.2 percent for 2008 through 2013; 6.0 percent from 2014 through 2028.
  - Alternative scenario: average real growth for 2009-2013 one standard deviation lower (average real growth for 2009-2013 in this scenario would be 4.4 percent).
  - Average inflation about 5.6 percent for 2008-2013 (GDP deflator); 4.9 percent for 2014-2028.
  - Constant real exchange rate through 2013, followed by some real appreciation thereafter; WEO exchange rate projections used.
- Exports and current account:
  - Annual goods and services export growth in U.S. dollar terms of about 12-13 percent; goods and services exports share of GDP rising from about 25 percent to 31 percent over the forecast period.
  - Non-interest external current account deficit rises to about 6.3 percent of GDP in 2008 before falling to an average of 3.3 percent of GDP over 2014-2028.
- Fiscal:
  - Revenues constant as a share of GDP at 21.6 percent.
  - Domestically financed development spending constant at 4.5 percent of GDP.
  - Constant wage bill of 6.6 percent of GDP.
  - Other recurrent spending declines from 7.2 percent of GDP to 7.0 percent of GDP.
  - Primary fiscal deficit: 2.5 percent of GDP in 2008 narrowing to 1.5 percent by 2013 and remaining near that level thereafter.
  - Interest assumptions: short-term public domestic debt at 8 percent; medium- and long-term debt at about 10.5 percent.
- Borrowing and instruments:
  - New external borrowing rises from about 2 percent of GDP in 2007 to 3.2 percent in 2009, then declines to just under 2 percent of GDP by end of forecast period.
  - NPV of domestic debt assumed equal to face value.
  - Sovereign bond issuance assumed: $500 million in 2009; $200 million annually from 2010 through 2013; annual external sovereign bond issuance rises gradually beginning in 2014 to about $500 million by 2028. Terms assumed include an 8 percent interest rate and a bullet amortization in year ten (implying a nine year grace period on principal payments).
  - Only debt relief assumed is an existing swap agreement with Italy cancelling about Euro 44 million in external obligations.
  - Continued eligibility for concessional borrowing from IDA is assumed.

### Recent developments and debt stock profile
- End-2007 public external debt (face value): $6.2 billion (25 percent of GDP).
  - Creditor composition: about 60 percent multilateral (including 47 percent owed to the World Bank), about 39 percent bilateral (largely Paris Club), and 2 percent commercial creditors (some disputed and in arrears).
- Kenya’s end-2007 external arrears: about $91 million to commercial creditors; these arrears are disputed (security-related contracts, often referred to as the “Anglo-Leasing” scandal).
  - Authorities disputing validity, obtained external audit, intend to renegotiate amounts and expect eventual refinancing through new nonconcessional external debt or sovereign bond proceeds.
- Net domestic debt declined to 18.5 percent of GDP at end-June 2008.
  - Domestic debt trends reflect strong growth, prudent fiscal policies, and lower interest rates since end-June 2003.
  - Contingent liabilities: government launched a study of contingent liabilities in 24 parastatals and the National Social Security Fund; pay-as-you-go civil service pension claims estimated at Ksh 271 billion (11.4 percent of 2008/09 GDP) from an August 2005 actuarial study.
  - About 70 percent of Kenya’s domestic debt is longer-term borrowing with maturities up to 20 years.

### External debt sustainability (findings and scenarios)
- Baseline outcome:
  - Kenya’s external debt indicators show a low risk of debt distress under the baseline. Initial debt ratios are well below indicative thresholds and decline somewhat through the forecast period.
  - External borrowing projected to rise sharply in 2009 to 3.2 percent of GDP, then decline thereafter.
  - Issuance of a sovereign bond with bullet amortization could create a spike in debt service; an amortizing bond or saving in advance could lessen budgetary pressures and rollover risks.
- Alternative scenarios and stress tests:
  - Combined shock (lower GDP growth, weaker exports, lower GDP deflator, fall in non-debt creating flows) impacts:
    - NPV of public external debt as a share of GDP from 14 to 28 percent.
    - NPV of debt-to-exports from 55 to 105 percent.
    - NPV of debt-to-revenue from 64 to 126 percent.
  - Despite initial worsening under shocks, three debt stock measures improve over time and remain somewhat worse than baseline by end of projection period.
  - Kenya remains under indicative debt stock and debt service thresholds under all alternative scenarios and stress tests.
  - Historical scenario (recent performance of key variables) yields debt ratios better than baseline due to a much lower historical current account deficit reducing borrowing needs.

- Selected time-series indicators shown in the source (baseline vs combined shocks):
  - NPV of PPG External Debt (In percent of GDP, threshold=40)
    - Baseline 2008–2013: 13.7, 13.8, 14.2, 13.2, 13.6, 13.5
    - Combined shocks 2008–2013: 13.7, 20.3, 28.1, 25.7, 25.9, 25.3
  - NPV of PPG External Debt (In percent of exports, threshold=150)
    - Baseline 2008–2013: 53.2, 56.2, 54.9, 52.9, 52.0, 50.0
    - Combined shocks 2008–2013: 53.2, 77.3, 105.2, 99.5, 95.8, 90.5
  - PPG External Debt Service (In percent of exports, threshold=20)
    - Baseline 2008–2013: 4.5, 3.9, 4.0, 3.9, 3.7, 3.4
    - Combined shocks 2008–2013: 4.5, 4.1, 5.2, 5.8, 5.4, 5.0

### Public (total) debt sustainability (findings and scenarios)
- Baseline outcome:
  - Inclusion of domestic debt substantially increases the NPV of public debt-to-GDP, but all debt indicators remain within comfortable levels under baseline.
  - NPV of total public debt-to-GDP: 34 percent in 2008; broadly stable up to 2028 as decline in external debt NPV offsets small increase in domestic debt-to-GDP.
  - NPV of debt-to-revenue remains well below 250 percent and broadly unchanged during 2008-2028 at below 150 percent.
  - Debt service-to-revenue ratio: 25 percent in 2008; gradually declines thereafter.
- Alternative scenarios and stress tests:
  - Two-year growth shock leads to:
    - NPV of debt-to-GDP rising to 57 percent by 2028.
    - NPV of debt-to-revenue just below 250 percent by 2028.
    - Debt service-to-revenue ratio rising to over 30 percent by 2012 (indicating some risk of debt distress).
  - Permanently lower growth increases NPV of debt-to-GDP beyond 40 percent and raises debt service-to-revenue to about 30 percent (NPV of debt-to-revenue remains below 250 percent).
  - NPV of debt-to-GDP also breaches 40 percent under a scenario with primary balances unchanged from 2008, and under a combined two-year growth and primary balance shock.
  - Lower growth for 2009-2013 results in medium-term and long-term debt indicators substantially higher than baseline (e.g., NPV of debt-to-GDP would be 52 percent by end of period versus 34 percent in baseline).

### Policy implications and recommendations
- Managing risk and borrowing strategy:
  - Sustainability depends on macroeconomic performance and a prudent borrowing strategy.
  - Policies recommended to achieve baseline growth and export assumptions:
    - Sustain macroeconomic stability.
    - Substantial investment in infrastructure.
    - Regulatory and governance reforms to improve the investment climate.
  - Important to avoid excessive borrowing and to limit nonconcessional borrowing as access to external financing increases.
- Specific fiscal management points:
  - Consider amortizing structures or pre-funding for sovereign bond amortizations to avoid spikes in debt service and rollover risks.
  - Monitor and incorporate contingent liabilities (parastatals, pension claims) into future DSA work given their potential to materially affect public debt sustainability.

### Conclusions
- External debt: low risk of debt distress under the baseline; all external public debt indicators remain below country-specific thresholds; standard stress tests do not breach thresholds during projection period.
- Public (total) debt: greater risk of unfavorable developments, especially under GDP growth shocks. Even temporary lower growth could push NPV of public debt-to-GDP, NPV of debt-to-revenue, and debt service-to-revenue sharply higher.
- Unreported or large contingent liabilities increase risks to public debt sustainability.
- Continued prudent borrowing, avoidance of excessive nonconcessional financing, and policies that sustain higher productive capacity are critical to maintain debt sustainability.

*Source: _cr08339 - 1.      Debt sustainability is assessed in relation to policy-dependent debt burden thresholds*

### 17.      The staffs encourage Kenya to use tools such as the joint Fund-Bank DSA

### _cr08339 - 17.      The staffs encourage Kenya to use tools such as the joint Fund-Bank DSA

### Staff recommendation on debt strategy
- The staffs encourage Kenya to use tools such as the joint Fund-Bank DSA template to develop a prudent borrowing strategy to maintain both external and fiscal debt sustainability.
- Efforts to use the DSA template and to develop a debt management strategy, including through a workshop in 2007, are welcome.
- Such a strategy should consider:
  - the total concessionality and interest costs of Kenya’s borrowing;
  - the return on individual projects and overall growth impact;
  - steps that would help guard against volatility, whether due to shocks such as droughts or to fluctuations in external assistance.
- Strategies to guard against shocks could include some further build-up in international reserves.
- A better understanding of holdings of shilling-denominated debt by non-residents would also help guide efforts to assess and potentially reduce vulnerabilities.

### Key baseline indicators and projections (selected)
- External debt (nominal): 31.3, 26.8, 24.7, 21.4, 20.6, 20.9, 19.6, 20.3, 20.2, 19.5, 16.3 (series shown across years).
- o/w public and publicly guaranteed (PPG) external debt: 28.9, 24.9, 22.8, 19.9, 19.4, 19.9, 18.6, 19.1, 19.0, 19.1, 16.3.
- Change in external debt (selected entries): -3.4, -4.5, -2.1, -3.3, -0.8, 0.3, -1.2, 0.7, -0.1, -0.1, -0.3.
- Identified net debt-creating flows (selected entries): -5.2, -5.2, -4.8, 3.3, 2.0, 1.9, 1.5, 1.8, 1.8, 1.1, 0.5.
- Non-interest current account deficit (selected entries): 0.1, 1.8, 2.6, 0.6, 1.8, 6.3, 5.5, 4.8, 4.9, 4.9, 4.9.
- Exports (percent of GDP, series sample): 28.4, 25.1, 25.4, 25.7, 24.6, 25.8, 25.0, 26.2, 27.0, 28.2, 30.7.
- Imports (percent of GDP, series sample): 35.9, 35.0, 35.9, 39.6, 37.4, 38.1, 36.7, 37.9, 38.7, 38.3, 39.0.
- Net current transfers (negative = inflow, series sample): -7.0, -7.7, -7.6, -6.0, 1.5, -7.1, -6.9, -6.9, -6.4, -6.4, -6.4.
- Net FDI (negative = inflow, series sample): -1.0, -2.2, -3.4, -1.0, 1.0, -2.6, -2.5, -2.4, -2.2, -2.3, -2.3.

### Debt dynamics and sustainability metrics (selected)
- Endogenous debt dynamics (selected entries): -4.3, -4.7, -4.0, -0.5, -1.0, -0.5, -1.2, -0.8, -0.8, -0.7, -0.6.
  - Contribution from nominal interest rate (sample): 0.7, 0.5, 0.4, 0.4, 0.3, 0.4, 0.4, 0.4, 0.4, 0.4, 0.3.
  - Contribution from real GDP growth (sample): -1.7, -1.7, -1.6, -0.9, -1.3, -0.9, -1.5, -1.2, -1.2, -1.1, -0.9.
  - Contribution from price and exchange rate changes (sample): -3.2, -3.5, -2.9 (series continues in source).
- Residual (3-4) (selected entries): 1.8, 0.7, 2.7, -6.6, -2.9, -1.6, -2.7, -1.2, -1.9, -1.3, -0.8.
- PV of external debt (selected entries): 17.7, 15.2, 15.0, 15.1, 14.3, 14.8, 14.7, 13.7, 11.2 (series shown).
- PV of PPG external debt (selected entries): 15.7, 13.7, 13.8, 14.2, 13.2, 13.6, 13.5, 13.3, 11.2.
- PV of PPG external debt in percent of exports (selected entries): 62.0, 53.2, 56.2, 54.9, 52.9, 52.0, 50.0, 47.3, 36.4.
- PV of PPG external debt in percent of government revenues (selected entries): 70.0, 59.8, 65.3, 63.7, 61.7, 62.4, 62.9, 62.2, 52.2.
- Debt service-to-exports ratio (in percent, sample): 6.9, 7.0, 6.1, 5.4, 4.8, 4.7, 4.4, 4.2, 3.9, 3.0, 2.4.
- PPG debt service-to-exports ratio (in percent, sample): 6.0, 6.0, 5.0, 4.5, 3.9, 4.0, 3.9, 3.7, 3.4, 2.9, 2.4.
- PPG debt service-to-revenue ratio (in percent, sample): 8.0, 7.1, 5.7, 5.1, 4.5, 4.7, 4.5, 4.4, 4.3, 3.8, 3.5.

### Financing needs and aid
- Total gross financing need (billions of U.S. dollars, sample): 0.2, 0.3, 0.2, 1.6, 1.5, 1.4, 1.7, 1.8, 2.0, 2.4, 4.7.
- Non-interest current account deficit that stabilizes debt ratio (sample): 3.5, 6.3, 4.7, 9.6, 6.3, 4.5, 6.1, 4.3, 5.0, 3.8, 2.6.
- Aid flows (in billions of US dollars, sample): 0.2, 0.2, 0.3, 0.8, 1.6, 2.4, 3.3, 4.3, 5.4, 13.3, 41.6.
  - o/w Grants (sample): 0.2, 0.2, 0.3, 0.4, 0.5, 0.5, 0.6, 0.7, 0.9, 1.5, 4.0.
  - o/w Concessional loans (sample): 0.0, 0.0, 0.0, 0.4, 1.1, 1.9, 2.6, 3.6, 4.6, 11.8, 37.6.
- Grant-equivalent financing (in percent of GDP, selected entries): 1.9, 1.9, 2.2, 2.1, 2.3, 2.4, 2.6, 2.2, 2.4.
- Grant-equivalent financing (in percent of external financing, selected entries): 72.5, 41.6, 57.2, 59.3, 59.1, 62.4, 63.4, 64.8, 62.9.

### Key macroeconomic assumptions (selected)
- Real GDP growth (in percent, series sample): 5.8, 6.4, 7.0, 3.8, 2.3, 4.1, 6.9, 4.7, 8.6, 6.6, 6.6, 6.2, 6.0, 6.0, 6.0.
- GDP deflator in US dollar terms (change in percent, sample): 10.2, 12.8, 12.2, 3.9, 8.9, 12.5, 8.3, 2.0, 7.4, 0.4, 3.0, 5.6, 5.0, 5.0, 4.9.
- Effective interest rate (percent, sample): 2.2, 2.0, 2.0, 1.8, 1.0, 1.8, 1.6, 2.0, 2.0, 2.1, 2.1, 1.9, 2.3, 2.1, 2.2.
- Growth of exports of G&S (US dollar terms, in percent, sample): 23.3, 6.0, 21.3, 9.2, 10.3, 18.6, 10.6, 12.3, 13.1, 11.9, 13.3, 13.3, 12.1, 12.5, 12.2.
- Growth of imports of G&S (US dollar terms, in percent, sample): 27.4, 17.0, 22.9, 10.9, 15.5, 29.4, 9.4, 8.7, 12.6, 10.3, 12.2, 13.7, 11.2, 11.7, 11.3.
- Grant element of new public sector borrowing (in percent, selected entries): 45.3, 18.4, 33.2, 33.1, 32.6, 33.9, 32.7, 36.5, 35.3, 34.7.
- Government revenues (excluding grants, in percent of GDP, sample): 21.2, 21.1, 22.5, 22.8, 21.1, 22.2, 21.4, 21.8, 21.5, 21.4, 21.4.

### Public sector debt indicators (selected)
- Public sector debt (percent of GDP, sample): 46.4, 42.9, 40.6, 39.7, 36.7, 38.8, 37.5, 38.8, 39.5, 40.1, 39.1.
- o/w foreign-currency denominated (percent of GDP, sample): 28.9, 24.9, 22.8, 19.9, 19.4, 19.9, 18.6, 19.1, 19.0, 19.1, 16.3.
- Change in public sector debt (sample): -7.5, -3.4, -2.4, -0.8, -3.0, 2.1, -1.3, 1.3, 0.7, 0.1, 0.1.
- Identified debt-creating flows (sample): -6.0, -4.2, -5.0, -0.5, -3.6, 1.7, -1.3, 1.2, 0.6, -0.1, -0.2.
- Primary deficit (percent of GDP, sample): -0.6, 0.1, 1.0, -1.3, 1.4, 2.5, 1.9, 1.5, 1.5, 1.6, 1.5.
- Revenue and grants (percent of GDP, sample): 22.4, 22.2, 23.6, 24.2, 22.4, 23.6, 22.8, 23.4, 23.1, 23.1, 22.9.
  - of which: grants (percent of GDP, sample): 1.2, 1.1, 1.1, 1.3, 1.3, 1.4, 1.4, 1.5, 1.6, 1.7, 1.5.
- Primary (noninterest) expenditure (percent of GDP, sample): 21.8, 22.3, 24.6, 26.6, 24.3, 25.1, 24.3, 25.0, 24.6, 24.6, 24.4.
- Automatic debt dynamics (sample): -5.2, -4.5, -4.4, -0.9, -5.2, 0.2, -2.8, -0.5, -0.9, -1.6, -1.6.
  - Contribution from interest rate/growth differential (sample): -2.5, -2.4, -1.8, -1.5, -2.9, 0.2, -2.1, -0.6, -1.3, -1.0, -1.2.
  - of which: contribution from average real interest rate (sample): 0.5, 0.4, 1.0, 0.1, -0.3, 1.8, 1.0, 1.7, 1.1, 1.2, 1.0.
  - of which: contribution from real GDP growth (sample): -3.0, -2.8, -2.8, -1.6, -2.6, -1.7, -3.1, -2.3, -2.4, -2.3, -2.2.
- Residual, including asset changes (sample): -1.5, 0.8, 2.7, -0.3, 0.6, 0.4, 0.0, 0.1, 0.1, 0.2, 0.3.
- PV of public sector debt (selected): 17.5, 18.0, 32.5, 34.2, 30.8, 32.8, 32.0, 33.0, 34.1, 34.4, 34.0.
  - o/w foreign-currency denominated (selected): 14.7, 14.4, 13.5, 13.9, 13.1, 13.4, 13.7, 13.3, 11.2.
- Gross financing need (percent of GDP, sample): 11.0, 11.6, 11.0, 12.1, 12.1, 11.8, 11.7, 11.3, 12.6, 11.6, 11.1.
- PV of public sector debt-to-revenue and grants ratio (in percent, sample): 78.0, 81.2, 137.8, 141.7, 137.6, 138.9, 140.3, 141.4, 147.7, 148.4, 148.0.
- Debt service-to-revenue and grants ratio (in percent, sample): 31.6, 30.0, 26.7, 25.1, 26.1, 24.6, 24.4, 27.5, 26.5, 23.0, 19.6.
- Primary deficit that stabilizes the debt-to-GDP ratio (sample): 6.9, 3.5, 3.4, 3.3, 4.9, -0.6, 2.8, 0.3, 0.8, 1.3, 1.4.

### Sensitivity and stress scenarios (high-level)
- The DSA includes alternative scenarios and bound tests (e.g., A1, A2, A3; B1–B6) that examine impacts on PV of debt-to-GDP, PV of debt-to-exports, PV of debt-to-revenue, and other ratios under shocks including:
  - Key variables at historical averages;
  - New public sector loans on less favorable terms (interest rate on new borrowing 2 percentage points higher than baseline per footnote);
  - Growth lower by one standard deviation 2009-2013;
  - Bound tests: real GDP growth at historical average minus one standard deviation; export value growth shock; US dollar GDP deflator shock; net non-debt creating flows shock; combination shocks; one-time 30 percent nominal depreciation in 2009.
- Example stress outcomes (selected): PV of debt-to-exports and PV of debt-to-revenue ratios can rise materially under combination shocks and export shocks (detailed year-by-year results provided in the DSA tables and figures).

### Policy implications highlighted by staff
- Use the joint Fund-Bank DSA template as a tool to:
  - Inform a prudent borrowing strategy that accounts for concessionality, interest costs, project returns, and growth impacts;
  - Quantify vulnerabilities under alternative scenarios and bound tests;
  - Guide decisions on reserve accumulation to mitigate volatility from shocks and fluctuating external assistance.
- Improve data and analysis on holdings of shilling-denominated debt by non-residents to better assess currency and rollover risks.

*Sources: Country authorities and staff estimates and projections; Table 1a, Table 1b, Table 2a, Table 2b, and accompanying figures and text in the IMF staff report excerpt.*

### 1.      Data provision has some shortcomings, but is broadly adequate for surveillance and

### 1.      Data provision has some shortcomings, but is broadly adequate for surveillance and 

### Overview
- Weaknesses in macroeconomic statistics reflect organizational and skill shortcomings, and inadequate resources.
- In line with the new Statistics Law, the government established the autonomous Kenya National Bureau of Statistics (KNBS) in 2007 to replace the Central Bureau of Statistics (CBS).
- The Report on the Observance of Standards and Codes—Data Module (IMF Country Report No. 05/388) published on October 31, 2005 found:
  - Methodological soundness is uneven across datasets.
  - Significant improvement is required in government finance statistics and national accounts.
  - Accuracy and reliability do not receive adequate attention in any of the datasets.
  - Accessibility of disseminated macroeconomic statistics is adequate, except for the balance of payments statistics.
- Kenya participates in the Fund’s General Data Dissemination System (GDDS) and the GDDS project for Anglophone Africa; metadata and detailed plans for improving the data are posted on the Fund’s Dissemination Standards Bulletin Board (DSBB).
- Kenya has received Fund technical assistance; further assessment of capacity building requirements has been undertaken by the AFRITAC East Statistical Advisor.
- Monetary, exchange rate, and some external data are published on a monthly and biannual basis by the KNBS in its Monthly Economic Review.
- Core financial data are made available to the Fund on a regular basis.
- KNBS publishes an annual Economic Survey containing detailed sectoral activity and corresponding statistical data.

### National accounts
- Data quality has deteriorated significantly because of budgetary and staff constraints at the KNBS.
- GDP is believed to be significantly underestimated because important and increasing parts of the economy are not properly covered, including:
  - the informal sector
  - nonagriculture subsistence
  - horticulture
  - self-employed professionals
- An STA peripatetic advisor assisted the authorities in rebasing the national accounts estimates at constant 2001 prices and compiling institutional accounts for the general government sector.
- As a result, national accounts estimates for the years 1996–2005 in current and constant (2001) prices have been published.
- Quarterly national accounts are being developed with the assistance of the AFRITAC East.
- Quarterly GDP estimates are now published.

### Prices and production
- In early 2002, the KNBS (then CBS) began publication of a new national CPI covering 13 urban towns, with 1997 as reference year and weights and basket of items derived from the 1993-94 Household Budget Survey (HBS).
- Indices are produced for lower and middle/upper income groups in Nairobi and other cities.
- The index is compiled and published on a timely basis.
- No producer, export, or import price indices are produced.
- In March 2008, a TA mission assisted the authorities in identifying methodological issues relating to the measurement of inflation.
- The current methodology of aggregating prices at the elementary level was found to impart a substantial upward bias on CPI measurement.
- In line with STA recommendations, the KNBS plans to switch to a formula consistent with international best practices later in 2008, together with a rebasing and reweighing of the CPI basket.

### Government finance statistics (GFS)
- The data ROSC mission emphasized key areas in GFS compilation to be improved, including:
  - (i) migration to the GFSM 2001 methodology;
  - (ii) broadening the coverage to include extrabudgetary and social security funds and report on a general government level;
  - (iii) reconciliation of fiscal statistics from various sources to limit discrepancies;
  - (iv) improve information on external financing, particularly on expenditure directly financed from abroad;
  - (v) compilation and dissemination of monthly and quarterly budget execution data;
  - (vi) training of Ministry of Finance (MOF) staff in the GFS methodology.
- Since the beginning of FY 2005/06, Kenya has followed a new economic classification of the budget based on GFSM 2001 (with assistance from the AFRITAC-East).
- Serious delays have emerged in reporting, reflecting difficulties in establishing budget execution and accounting systems consistent with the new classification.
- To ensure timely reconciliation and monitoring of budget execution, existing systems need to be promptly upgraded and made operational.
- Progress has been made toward moving to the IFMIS.
- Important gaps remain in reconciling fiscal data from different sources, including various units within the MOF.
- Discrepancies in budget outturn data (between deficit/surplus and financing) remain significant.
- Recording of external financing and expenditure directly financed from abroad remains an important area for improvement.
- Government has taken steps to initiate a project to rationalize/eliminate extrabudgetary funds, but progress in compiling consolidated fiscal statistics has remained limited.
- The country reports data to STA for the budgetary central government for inclusion in the GFS Yearbook, albeit with a significant lag—the last data reported were for the year ending June 2005.
- KNBS compiles aggregate annual GFS revenue and expenditure data for the budgetary central government based on detailed data in the reports of the Controller and Auditor General.
- The data submitted for publication in the 2007 GFS Yearbook was reported in GFSM 2001 format, using bridge tables developed by the technical assistance missions.
- Recent steps in the migration to GFSM 2001 may help reduce significant differences between KNBS data and data compiled by the MOF and reported to AFR for surveillance and program monitoring purposes.
- Monthly and quarterly data are regularly reported for inclusion in the IFS.

### Monetary statistics
- Progress has been shown in the implementation of the Monetary and Financial Statistics Manual (MFSM) and development of the standardized report forms (SRFs).
- The authorities submitted SRF test data; however, there has not been further progress.
- In March 2007, a STA mission:
  - established the standardized report form for data on the central bank;
  - reviewed and revised the reporting form and compilation notes for the other depository corporations (ODCs) in line with MFSM data requirements;
  - identified the coverage of the ODC subsector.
- The mission found misclassification of a number of central government deposits as private sector deposits.
- A major issue for future work relates to the expansion of the coverage of the ODCs to include the Savings and Credit Cooperatives (SACCOS).
- As of end-March, 2007, there were 3,800 SACCOs, accounting for about 30 percent of the total deposits of the banking system.
- When implemented, a new bill providing for increased supervision over SACCOs would generate data as part of the supervisory function.
- A follow-up mission in June 2007 conducted a workshop for officials of ODCs and established a system for reporting Form 1SR to the IMF.
- The new Standardized Reporting System for reporting ODCs’ data to the central bank was finalized.

### External sector statistics
- KNBS compiles annual balance of payments statistics in Kenya shillings that are regularly reported to STA, although with considerable delay.
- The Central Bank of Kenya (CBK) compiles a complete set of annual balance of payments statistics in U.S. dollars, which are reported to AFR and used for programming and surveillance purposes.
- The two datasets are not entirely consistent; Fund staff has strongly encouraged the authorities to reconcile them.
- More recently, the CBK also started to compile and publish quarterly balance of payments estimates.
- Although the overall quality of trade data may be reasonably good, data for other current account and many financial account transactions are rather weak.
- Following the liberalization of the exchange system in 1993–94, gaps emerged in coverage.
- The compilation system (other than that used for compiling customs statistics), used since 1994, relies on reports from domestic banks and may result in substantial under-recording of:
  - current earnings, including tourism receipts;
  - investment flows of the private sector;
  - transactions that are settled via accounts held abroad.
- Present estimates of direct and portfolio investment are believed to be substantially understated.
- Large positive errors and omissions in the central bank data that have emerged in the balance of payments since 1994 give rise to uncertainties as to the potential size of external obligations.
- The MOF compiles data covering public and publicly guaranteed external debt obligations to official and commercial creditors; this database does not take into account nonresident purchases of the government’s domestic currency-denominated debt securities.
- In developing the loan-by-loan debt sustainability analysis (DSA) in 2002, Fund and World Bank staff identified several significant debt data problems that have been addressed by the authorities; nevertheless, significant debt data management problems remain, along with more general issues in external debt management and its integration in budget formulation and expenditure management systems.
- To help address these issues, a 2006 technical assistance mission recommended:
  - introducing a foreign investment survey;
  - enhancing the foreign exchange statistics survey;
  - using a common methodology, including for estimations, in the use of available data in the KNBS and CBK.
- In 2007, a DFID funded enterprise survey failed to materialize.
- There are plans to conduct a foreign investment survey in 2008, which planned DFID-funded and STA external sector missions will support.

*IMF staff report excerpt.*

### 15.      Kenya does not report international investment position statistics to STA.

### _cr08339 - 15.      Kenya does not report international investment position statistics to STA.

### Data reporting
- Kenya does not report international investment position statistics to STA.
- Date of the table of common indicators: as of August 19, 2008.
- Exchange Rates: latest observation 8/18/08; date received 8/18/08; Frequency of Data D; Frequency of Reporting D; Frequency of publication M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: latest observation 8/18/08; date received 8/18/08; Frequency of Data D; Frequency of Reporting D; Frequency of publication M.
- Reserve/Base Money: latest observation 8/18/08; date received 8/18/08; Frequency of Data D; Frequency of Reporting D; Frequency of publication M.
- Broad Money: latest observation 6/30/08; date received 7/15/08; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Central Bank Balance Sheet: latest observation 8/18/08; date received 8/18/08; Frequency of Data D; Frequency of Reporting D; Frequency of publication M.
- Consolidated Balance Sheet of the Banking System: latest observation 6/30/08; date received 7/15/08; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Interest Rates: latest observation 6/30/08; date received 7/20/08; Frequency of Data D; Frequency of Reporting D; Frequency of publication M.
- Consumer Price Index: latest observation 6/30/08; date received 7/20/08; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: latest observation 6/2008; date received 7/2008; Frequency of Data NA; Frequency of Reporting NA; Frequency of publication NA.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: latest observation 6/2008; date received 7/2008; Frequency of Data Q; Frequency of Reporting I; Frequency of publication Q.
- Stocks of Central Government and Central Government-Guaranteed Debt: latest observation 6/30/08; date received 7/15/08; Frequency of Data Q; Frequency of Reporting Q; Frequency of publication Q.
- External Current Account Balance: latest observation December 2007; date received 6/08; Frequency M.
- Exports and Imports of Goods and Services: latest observation December 2007; date received 6/08; Frequency M.
- GDP/GNP: latest observation 2008 Q1; date received 6/07; Frequency M.
- Gross External Debt: latest observation March 2008; date received 6/07; Frequency M; Frequency of Reporting Q; Frequency of publication Q.

### Macroeconomic performance and outlook
- GDP growth reached 7.0 percent in 2007, described as the highest in more than two decades.
- Real GDP is expected to have slowed to about 4 percent in 2007/08 (July/June).
- Inflation increased sharply in recent months (context: global food and fuel prices).
- Fiscal deficit (including grants) for 2007/08 is estimated at 4.8 percent of GDP.
- Budget for 2008/09 envisages a deficit of 5.3 percent of GDP.
- Monetary policy was tightened in June 2008 to address rising inflationary pressures.
- Reserve international reserves increased to the equivalent of 3.1 months of imports.
- External current account deficit almost doubled in 2007/08 to 4.6 percent of GDP, due largely to higher oil import prices.
- Sizable capital inflows contributed to an appreciation of the Shilling and strengthening of the overall balance of payments position.

### Executive Board assessment and directors’ views
- Directors commended Kenyan authorities for maintaining economic stability after post-election turmoil and for sound macroeconomic policies and progress with economic reform.
- Directors noted downside risks: rising food and fuel prices and weakening global demand.
- Directors supported 2008/09 budget focus on removing growth bottlenecks and improving social cohesion, while stressing fiscal restraint and accommodating spending priorities within a smaller-than-budgeted deficit.
- Directors encouraged adopting a fiscal anchor based on the ratio of total public debt to GDP in light of the planned sovereign bond issue.
- Directors advised careful consideration of the size, timing, and modalities of the planned international sovereign bond issue to safeguard debt sustainability and recommended proceeds be used for high-return infrastructure projects.
- Directors stressed establishing a comprehensive debt management strategy and continuing to seek concessional financing as the best source for public investment.
- Directors welcomed the tightening of monetary policy and the authorities’ readiness to tighten further to prevent second-round effects of rising food and fuel prices.
- Directors called for quick action to address an upward methodological bias in the compilation of the consumer price index.
- Directors supported plans to reform the monetary operations framework, including through the introduction of inflation targeting, while stressing the need for more analytical work and institutional and statistical pre-conditions before adoption.
- Directors observed the managed float exchange rate regime has served Kenya well and considered the real exchange rate appreciation broadly consistent with improving fundamentals, but stressed monitoring competitiveness given the widening external current account deficit.
- Directors emphasized the need for far-reaching structural reforms and infrastructure improvements to achieve Vision 2030 growth objectives, with priority reforms in the financial sector, public financial management, and regulatory and trade regimes.
- Directors welcomed authorities’ intention to update the 2006/07 Governance Action Plan and encouraged more progress on unmet objectives, including wealth declarations and verifications for senior public officials.
- Directors broadly concurred with the findings of the Ex Post Assessment of Kenya’s long-term program engagement with the Fund, noting macroeconomic policy design was broadly appropriate though past program engagement had an excessive protracted focus on governance issues.

### Authorities’ statement and assessments
- Authorities noted real GDP grew by 7 percent in 2007; post-election turbulence early 2008 interrupted growth in tourism, agriculture, and transport.
- With the grand coalition government formed in February 2008, the economy is regaining footing.
- Overall real GDP is expected to grow by 4 percent in 2007/08 and rebound to 7.2 percent in 2008/09.
- Authorities agree the real exchange rate appreciation reflects economic fundamentals, with exports, capital inflows, and foreign reserves robust.
- Authorities have taken steps to implement policies to bring CPI compilation in line with international best practice and measures to deal with second-round effects of food and fuel prices.
- The country's fiscal stance described as continuing to be prudent.

### Key numerical indicators (Selected Economic Indicators, 2005/06–2009/10)
- Real GDP growth (market prices): 2005/06 6.1; 2006/07 6.7; 2007/08 3.9; 2008/09 7.2; 2009/10 6.0.
- Consumer price index (annual average): 2005/06 11.1; 2006/07 10.4; 2007/08 18.5; 2008/09 14.5; 2009/10 5.0.
- Consumer price index (end of period): 2005/06 10.9; 2006/07 11.1; 2007/08 29.3; 2008/09 8.0; 2009/10 5.0.
- Ksh per US $ exchange rate (end of period): 2005/06 69.3; 2006/07 62.6; 2007/08 64.6; 2008/09 ...; 2009/10 ....
- M3 (broad money, end of period): 2005/06 18.0; 2006/07 16.0; 2007/08 18.3; 2008/09 21.8; 2009/10 17.2.
- M3X (broad money and foreign currency deposits, end period): 2005/06 14.9; 2006/07 18.9; 2007/08 19.4; 2008/09 17.3; 2009/10 16.0.
- Reserve money (end of period): 2005/06 14.0; 2006/07 17.5; 2007/08 19.6; 2008/09 15.0; 2009/10 14.6.
- Investment (percent of GDP): 2005/06 18.0; 2006/07 19.1; 2007/08 20.0; 2008/09 22.0; 2009/10 22.1.
- Central government investment (percent of GDP): 2005/06 4.2; 2006/07 4.6; 2007/08 6.7; 2008/09 7.4; 2009/10 7.3.
- Gross national saving (percent of GDP): 2005/06 16.0; 2006/07 16.7; 2007/08 15.4; 2008/09 15.3; 2009/10 16.6.
- Total revenue (central government, percent of GDP): 2005/06 20.5; 2006/07 21.7; 2007/08 22.3; 2008/09 21.6; 2009/10 21.6.
- Total expenditure and net lending (central government, percent of GDP): 2005/06 25.2; 2006/07 24.4; 2007/08 28.3; 2008/09 27.6; 2009/10 26.7.
- Overall balance (commitment basis) excluding grants (percent of GDP): 2005/06 -4.7; 2006/07 -2.7; 2007/08 -6.0; 2008/09 -5.9; 2009/10 -5.2.
- Overall balance (commitment basis) including grants (percent of GDP): 2005/06 -3.4; 2006/07 -1.8; 2007/08 -4.8; 2008/09 -4.6; 2009/10 -3.8.
- Exports value, goods and services (percent of GDP): 2005/06 26.6; 2006/07 25.5; 2007/08 24.9; 2008/09 25.2; 2009/10 25.1.
- Imports value, goods and services (percent of GDP): 2005/06 35.9; 2006/07 35.2; 2007/08 36.6; 2008/09 39.2; 2009/10 37.6.
- Current external balance, including official transfers (percent of GDP): 2005/06 -2.0; 2006/07 -2.4; 2007/08 -4.6; 2008/09 -6.7; 2009/10 -5.4.
- Gross international reserve coverage in months of next year imports (end of period): 2005/06 3.3; 2006/07 2.9; 2007/08 3.1; 2008/09 3.1; 2009/10 3.1.
- Domestic debt, net (end of period, percent of GDP): 2005/06 18.4; 2006/07 19.5; 2007/08 18.5; 2008/09 17.7; 2009/10 18.5.
- Nominal central government debt (end of period, percent of GDP): 2005/06 45.1; 2006/07 42.3; 2007/08 38.8; 2008/09 38.0; 2009/10 38.6.
- External debt (end of period, percent of GDP): 2005/06 26.7; 2006/07 22.8; 2007/08 20.3; 2008/09 20.3; 2009/10 20.2.

*Source: IMF staff report and Public Information Notice (PIN) No. 08/127, October 1, 2008; Table of Common Indicators required for Surveillance (as of August 19, 2008).*

### 4.8 percent of GDP in 2007/08, below the original budget target but more than twice the

### _cr08339 - 4.8 percent of GDP in 2007/08, below the original budget target but more than twice the

### Fiscal performance and near-term budget priorities
- Fiscal deficit was 4.8 percent of GDP in 2007/08, below the original budget target but more than twice the deficit of the previous year.
- Lower-than-budgeted deficit mainly reflected a shortfall in foreign-financed development spending.
- Revenue performance strengthened due to:
  - continued improvements in tax administration,
  - a buoyant economy that boosted income tax collections,
  - a one-off transfer of collected road fees.
- Privatization receipts rose sharply to almost 4 percent of GDP, which led to a decline in domestic financing and a fall in public debt below 40 percent of GDP.
- 2008/09 budget realigns spending toward infrastructure and social objectives (including free secondary education).
- Additional spending needed to provide targeted support to those most vulnerable to increases in food and fuel prices.
- Authorities intend to target some reduction in the fiscal deficit to around 4½ percent of GDP—somewhat below the budget proposal—to allow a further reduction in the public debt-to-GDP ratio.
- Devolution of more spending to subnational levels requires mechanisms to ensure:
  - effective coordination with fiscal policy at the central level,
  - strengthened budget reporting and control.

### Public debt management and borrowing strategy
- Government is considering making the public debt-to-GDP ratio a medium-term anchor for fiscal policy, covering both domestic and external debt.
- External commercial borrowing is an increasingly important consideration.
- A sovereign bond could help finance some high-return infrastructure projects where concessional resources are not available; size, timing, and modalities are important considerations.
- Authorities have prepared a comprehensive Debt Management Framework to help preserve recent gains in debt sustainability.
- The DSF is providing guidance on borrowing strategy, procedures, acceptance terms and conditions of loans, their disposition and servicing.

### Monetary policy and inflation control
- Monetary policy of the Central Bank of Kenya (CBK) is geared towards containing inflationary pressures arising mostly from food and rising fuel prices.
- Policy had been accommodative including crisis-related liquidity needs early in the year; monetary conditions tightened considerably thereafter.
- The Central Bank Rate (CBR) was raised by ¼ percentage point to 9 percent in response to continued inflationary pressures.
- Authorities have identified additional steps needed to deal with second-round effects of food and fuel price increases.
- Monetary policy during 2008/09 will continue to focus on the primary objective of price stability by:
  - employing instruments to limit monetary growth to rates consistent with the inflation objectives,
  - resolving methodological issues of the current consumer price index to allow accurate inflation assessment,
  - considering broader reforms of the monetary framework over the medium-term, including planned analytical work,
  - strengthening coordination between fiscal and monetary policies to avoid undue market volatility,
  - seeking an appropriate mix of available monetary instruments to ensure orderly market developments.

### Financial sector reform
- Authorities consider a vibrant financial sector critical for dynamic, broad-based growth.
- Plans include finalizing a Financial Sector Strategy and moving forward with comprehensive revision of the Central Bank and the Banking Acts.
- Reforms aim to incorporate mandatory and prompt corrective actions in line with international best practices.
- Acceleration of financial sector reforms is key to increasing domestic resource mobilization.

### Structural reforms and Vision 2030
- Vision 2030 aims to accelerate annual GDP growth to 10 percent per year by 2012 and sustain this growth thereafter, making Kenya a middle-income country by 2030.
- A medium-term plan has been derived to guide the new poverty reduction strategy from Vision 2030.
- Private sector lead role requires substantial infrastructure investment and structural reforms in:
  - the financial sector,
  - public financial management,
  - governance,
  - trade policy.
- Progress on governance and transparency includes important steps in implementing the 2007/08 governance action plan, particularly in public procurement and business regulation.
- Further improvements in public financial management are important, including measures to expand IFMIS and ensure efficient use of devolved public resources.

### Trade reforms and regional integration
- Regional cooperation, especially within the East African Community (EAC), is recognized as important for sustaining macroeconomic policies and enhancing growth.
- Government will work with EAC partner states on coordinated approaches to investment and trade liberalization.
- Efforts continue to lower the common external tariff and remove nontariff barriers.
- An EAC common market agreement was expected to be signed by July 2009, after which discussions on a full Economic Partnership Agreement with the EU would be scheduled.

### Debt sustainability analysis
- DSA reflects the country’s relatively limited reliance on external borrowing and expected improvement in macroeconomic performance.
- Kenya faces a low risk of external debt distress as all external public debt indicators remain below the relevant country-specific debt burden thresholds.

### Ex post assessment of Fund engagement
- Authorities welcomed lessons from longer-term program engagement with the Fund and broadly agreed with most of the EPA conclusions.
- EPA highlighted Kenya’s track record of relatively prudent macroeconomic management and improved performance over the past five years.
- Authorities and several non-governmental representatives considered that some conditionality—particularly in governance—had not reflected realistic timetables or the constraints of Kenya’s legal and political systems.
- Concern expressed that the Fund–Kenya relationship had sometimes been unequal, with adjustments imposed in difficult circumstances having negative consequences for growth and poverty reduction.
- Imperative to ensure program ownership and to always consider the macro criticality of conditionality when designing programs.

### Conclusion and policy direction
- Authorities remain committed to implementing prudent policies and deepening the reform agenda through Vision 2030 to:
  - attain macroeconomic stability,
  - enhance public resource mobilization and efficiency in spending,
  - strengthen the contribution of the financial sector to overall growth to make Kenya a middle-income country by 2030.
- Government will continue measures to improve the business environment.
- Consistent with Vision 2030, the government will continue to limit domestic financing to reduce inflation and facilitate expansion in private sector credit for productive purposes.
- Authorities count on continued support from the Fund and the international community.

*IMF staff report content provided in the source PDF.*

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