## Appendix III. Appendix IV updates the debt sustainability analysis. Appendix V summarizes

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---

### Executive summary — political and economic setting
- Program implementation since December 2002: notable progress, although five performance criteria were not met.
- Program execution affected by protracted constitutional reform deliberations and capacity constraints in key ministries.
- Macroeconomic outcomes in 2003/04:
  - Real GDP growth: 2.1 percent (2003/04), above the program assumption of 1.9 percent.
  - Domestic debt (in percent of GDP): fell from 24.3 percent at end-June 2003 to 22.2 percent at end-June 2004.
  - Broad money expansion: 13 percent in 2003/04 following reduction in banks’ required reserves from 10 percent to 6 percent in July 2003.
  - Headline inflation: 19 percent in September 2004, up from 8 percent a year earlier.
- Authorities’ request: augmentation of access under the PRGF arrangement by SDR 50 million (18.4 percent of quota).
- Staff recommendation: complete the first review and approve the requested augmentation of access.

### Policy issues and priorities
- Entrench fiscal discipline:
  - Significant reduction of domestic borrowing essential for fiscal sustainability.
- Reorient the budget toward pro-poor spending and improve expenditure management.
- Restore price stability:
  - Better understand monetary transmission.
  - Clear commitment to price stability and efficient use of monetary instruments.
- Enhance effectiveness of governance institutions: improve capacities and budgetary resources.
- Strengthen external competitiveness: labor market reform, infrastructure upgrade, deepen structural reforms.

### Staff recommendations and program actions
- Complete the first review of the PRGF arrangement.
- Approve augmentation of access: SDR 50 million (18.4 percent of quota).
- Prioritize:
  - Sustained fiscal consolidation with reduced domestic borrowing.
  - Reorientation of public spending toward pro-poor priorities and modern PEM.
  - Price-stability-focused monetary policy and improved monetary instrument use.
  - Strengthening governance institutions through capacity and budgetary support.
  - Deepening structural reforms to enhance external competitiveness.

### Final source attribution
*Source: IMF staff report text as provided in the content unit.*

---

### Recent economic developments (detailed findings)
- Growth and sources:
  - Real GDP growth in 2003/04: 2.1 percent; driven primarily by recovery in tertiary sectors.
  - Primary sector output affected by drought.
  - Gross investment (in percent of GDP) remained at prereform levels.
  - Historical average growth: 1.6 percent a year since 1990.
  - Projected 2004 growth-accounting contributions (Proj.2004): output growth 2.37; physical capital 0.75; employment 0.98; education 0.45; TFP 0.18.
- Monetary developments and inflation:
  - Required reserves lowered from 10 percent to 6 percent in July 2003.
  - Money multiplier rose sharply; broad money expanded by 13 percent in 2003/04.
  - Result: negative real interest rates.
  - Headline inflation: 19 percent in September 2004; underlying inflation (excluding food, fuel, and energy): 7 percent; Central Bank of Kenya target for underlying inflation: 5 percent.
  - Inflation drivers: broad money growth, weakening nominal exchange rate, high energy prices, low agricultural output.
- Poverty and social indicators:
  - Drought and oil price shock may have worsened poverty indicators; real GDP growth broadly in line with population growth.
  - HIV/AIDS: adult infection rate estimated at 14 percent; estimated AIDS-related deaths: 150,000 in 2002.
  - Economic impact of HIV/AIDS: AIDS deaths may directly reduce potential annual economic growth by 1.0–1.2 percentage points a year.
- Fiscal performance:
  - Central government fiscal imbalances much lower than expected under the program in 2003/04.
  - Domestic debt ratio declined from 24.3 percent at end-June 2003 to 22.2 percent at end-June 2004.
  - Strong revenue collection and tightened recurrent-expenditure management contributed to improved fiscal performance.
- External sector:
  - Current account deficit (excluding official transfers) in 2003/04: 2.0 percent of GDP, narrower than projected.
  - Higher oil imports: US$1,048 million; drought-related food imports: US$83 million.
  - Export volumes grew by 7 percent in 2003/04.
  - Foreign exchange reserves exceeded the program target given the smaller-than-expected current account gap.
- Financial sector:
  - Ratio of nonperforming loans to total loans fell, but problems persist.
  - Decisive action needed to address distressed state banks.
- Structural reform implementation (mixed):
  - Telecommunications liberalization progressing; licensing of a third mobile operator.
  - Tax administration improvements at Kenya Revenue Authority.
  - Restructuring of expenditures to social sectors commenced.
  - Initial steps toward modern PEM taken.

---

### Boxes — select analytical findings (verbatim highlights)
- Box 1: Governance, fiscal sustainability, financial sector, and poverty reduction areas reviewed; steps taken since December 2002 include anticorruption and public ethics legislation, judiciary strengthening, tax administration improvements, PEM reforms, civil service rationalization, and a new wage-setting mechanism.
- Box 2: Growth accounting shows factor accumulation (physical capital and employment) as main drivers; TFP broadly declined over past two decades but projected positive in 2004; econometric results link TFP growth positively to governance and negatively to inflation.
- Box 3: Recent high inflation driven primarily by broad money growth, nominal exchange rate weakening, high energy prices, and low agricultural output; underlying inflation exceeded the CBK’s 5 percent target.
- Box 4: Adult infection rate 14 percent; 150,000 AIDS-related deaths in 2002; AIDS may reduce potential annual economic growth by 1.0–1.2 percentage points and exacerbate poverty.

---

### Outlook and Risks

### Baseline projections and scenarios
- Economic recovery projected to continue in 2004/05 with real GDP expected to grow by 2.7 percent; original program forecast was 3.1 percent.
- Inflation excluding food and oil expected to decline to 3.5 percent by June 2005 in response to monetary tightening.
- Medium-term baseline: growth reaching 4.0 percent in 2007/08 (below ERS target of 6 percent).
- Downside scenario (Table 7): increased political tensions and slowed reforms could suspend donor budgetary support, raise domestic financing, push government domestic debt above 25 percent of GDP, stall growth, and impede poverty reduction.
- Upside/high-case scenario (Table 7): strong fiscal consolidation and accelerated structural reforms with strong donor support could trigger higher growth and improved public finances.

### External accounts and financing
- External current account deficit (excluding grants) expected to widen considerably in 2004/05 due to drop in gross national savings from higher oil and food prices.
- Current base case projects external financing requirements to average about US$1.3 billion a year over 2004/05 to 2006/07.
- Financing sources expected: donor budgetary support, project support, private financing, Paris Club rescheduling, and Fund disbursements.
- Impact of oil price and drought shocks: projected to raise total imports by up to US$500 million (3.0 percent of GDP).

### PRGF augmentation request and reserves
- PRGF augmentation requested: SDR 50 million, with SDR 25 million disbursed at completion of the first review and SDR 25 million at completion of the second review.
- Augmentation would bring total access under the program to SDR 225 million or 82.9 percent of quota.
- Noted that 82.9 percent of quota is higher than the norm of access for fourth-time users of the PRGF of 45 percent of quota, but below the maximum limit of 140 percent.
- Reserve cover declined from 3.5 months in 2001/02 to 3.0 months in 2003/04.

### Main risks
- Political risks: intensified political tensions or delays in the constitution review could raise uncertainty, postpone budgetary support, and complicate macroeconomic management.
- Other vulnerabilities: weak growth, large fiscal imbalances, financial sector weakness, and relatively free capital movements.

---

### Fiscal Policy

### Medium-term fiscal strategy and 2004/05 targets
- Aim: balance debt sustainability with support for the poverty reduction strategy; slow resumption of donor assistance necessitates near-term fiscal adjustment.
- 2004/05 program emphasizes revenue improvements, a more modest expansion in poverty-reduction spending, and domestic borrowing of 2.5 percent of GDP.
- Table A (selected fiscal framework figures, percent of GDP):
  - Revenue: 20.5 (2002/03); 21.7 (2003/04 (Prel.)); 22.8 (Initial projection); 21.4 (Program projection)
  - Expenditure and net lending: 20.9 (2002/03); 23.5 (2003/04 (Prel.)); 29.2 (Initial projection); 25.5 (Program projection)
  - Overall fiscal balance (before grants): -5.4 (2002/03); -1.7 (2003/04 (Prel.)); -6.5 (Initial projection); -4.1 (Program projection)
  - Domestic borrowing: 4.6 (2002/03); 0.8 (2003/04 (Prel.)); -0.5 (Initial projection); 2.5 (Program projection)
  - Stock of domestic debt: 24.3 (2002/03); 22.2 (2003/04 (Prel.)); 24.8 (Initial projection); 22.3 (Program projection)
- Revenue target: maintain revenue at least 21.5 percent of GDP (Box 5).

### Expenditure restructuring and PEM
- Raise capital outlays from 2.7 percent of GDP in 2003/04 to 4.4 percent of GDP in 2004/05, with roads, health, and agriculture accounting for bulk of increase.
- New transitional procurement rules to institutionalize competition and lower supply costs.
- Medium-term initiatives: rationalize diplomatic representation, reform tertiary education funding.
- Strengthen links between annual budgets and medium-term framework; reform procurement; enhance monitoring/tracking/reporting of pro-poor operations; improve budget classification; establish consolidated financial reporting by state enterprises.
- Civil service reforms: reduce overall central government administrative staff by about 2,000 over time, fill critical vacancies in poverty-priority sectors, link future wage awards to revenue growth.

---

### Monetary and Exchange Rate Policies

### Objectives and instruments
- Exit strategy focus: move away from negative real interest rates and high inflation.
- Reserve money program to reduce broad money growth to 7.5 percent in 2004/05 (MEFP para.19).
- Three-month treasury bill rate increased from 2.75 percent in September 2004 to 5.2 percent in November (later cited increases to 7.2 percent in late November 2004).
- Strategy: reserve money targeting as main framework; broad money (M3X) as intermediate target; open market operations (repurchase and reverse) as main instrument.
- Continue flexible exchange rate system; CBK interventions limited to smoothing and meeting net foreign assets targets.

### Targets (selected)
- Inflation objective: reduce underlying inflation to 3.5 percent.
- Program reserve money growth target: 3.8 percent (assumption in MEFP).
- Broad money reduction target: reduce broad money growth to 7.5 percent in 2004/05.

---

### Competitiveness, Labor, and Trade

### Competitiveness challenges and policy responses
- Indicators show marked decline in competitiveness; high labor costs identified.
- Real effective exchange rate (REER) may be more appreciated than fundamentals suggest; staff suggested more flexibility in exchange rate management.
- Authorities: shilling to respond to market forces; interventions only to smooth short-run non-fundamental fluctuations.
- Investment Promotion Bill before Parliament aims to reduce business costs by eliminating unnecessary bureaucracy.
- Wage policy:
  - Discontinue annual minimum wage increases; review minimum wage once every two-year period.
  - New wage arbitration guidelines by March 2005 to emphasize productivity-based wage adjustments.

### Regional trade liberalization
- EAC common external tariff (CET) effective January 2005:
  - Tariff bands reduced from five to three.
  - Maximum tariff rate reduced from 35 to 25 percent.
  - Average tariff reduced from 17.2 percent to 10.9 percent (elsewhere cited as fall from 16.2 percent to 10.9 percent).
- Short-term losses expected from cheaper imports partly replacing domestic production; medium-term benefits expected from greater competition and export expansion.

---

### Governance, Anti-corruption, and Public Enterprise Reform

### Governance actions and needs
- Governance gaps identified by donors: inadequate funding of governance institutions; shortcomings in prosecution branches; weaknesses in management of security procurements.
- Positive developments: appointment of top management of the KACC; strengthening of police and Office of the Comptroller and Auditor General.
- Suggested amendment: modify Public Office Ethics Act to provide for regular review of asset declarations of prominent officials (MEFE para. 19).
- Audit and prosecution steps: audits of public bodies (including Anglo-Leasing case), suspension of senior officers involved, parliamentary inquiry conducted.

### Public enterprise restructuring and privatization
- Delays in forging consensus have slowed parastatal reforms.
- Government reaffirms commitment to privatization and enterprise reform; plans to present policy paper “Privatization of State Corporations” and resubmit the Privatization Bill to Parliament.
- Pending the Privatization Bill, focus on preparing enterprises for privatization with detailed financial reviews of key parastatals.

---

### Financial Sector

### Diagnosis and planned reforms
- System characterized by high NPLs, low capitalization, and vulnerability to shocks.
- Authorities intend to tighten loan classification and provisioning in January 2005 and strengthen CBK’s Banking Supervision Department.
- Staff recommended transferring bank regulatory functions from the Ministry of Finance to the CBK and removing provisions giving the Minister of Finance authority to control interest rates (MEFP para. 22).
- Kenya has over 40 commercial banks; support for national microfinance expansion and a comprehensive financial sector strategy.

### FSAP main conclusions (Box 6 — verbatim)
- The legal and judicial framework needs to be strengthened to promote financial sector development.
- The banking system has high levels of nonperforming loans and low capitalization and is vulnerable to shocks that could endanger its stability.
- To reduce the vulnerabilities, supervisors need to intervene rapidly to deal with problem financial institutions.
- Highest priority should be given to restructuring banks and divesting government stakes in the banking sector; also, the government should reevaluate its role in the development finance sector.
- The government is appropriately seeking to bolster the microfinance sector and, thereby, access to financial services for underserved segments of the population.
- The authorities are urged to move ahead with reforms of the payments and settlements systems.
- A program of technical assistance is under way to assist the authorities in their financial sector reform efforts.

---

### External Financing, Paris Club, and Debt Sustainability

### External financing requirements and resources (selected)
- External financing requirements (in millions of U.S. dollars): -538.8 -297.3 -880.5 -1,245.0 -1,365.4 -1,366.8 (series 2001/02–2006/07).
- Resources (in millions of U.S. dollars): 538.8 297.4 880.5 1,245.0 1,365.2 1,366.7 (same period).
- World Bank committed US$870 million in its Country Assistance Strategy base case for FY 2004–07.
- Paris Club rescheduling (Box 7): rescheduling on a total debt service of US$484 million in the consolidation period; assuming an additional US$52 million in comparable treatment, total relief US$402 million; ODA credits repaid over 20 years with 10 years grace; commercial credits repaid over 15 years including 5 years grace.

### Debt sustainability analysis (summary)
- Updated DSA (Appendix IV) confirms external debt sustainability improves under revised program framework compared to November 2003 assessment.
- Central government debt:
  - NPV of central government debt (end of period) series (Table 1 highlights): 51.9 55.6 49.6 49.6 49.6 48.5 46.4 (2002/03–2007/08).
  - Domestic debt, net (end of period, percent of GDP): 24.3 26.8 22.2 22.3 22.5 21.7 20.3 (2002/03–2007/08).
- External debt:
  - NPV of external debt (end of period, percent of GDP): 27.6 28.8 27.4 27.3 27.1 26.8 26.1 (2002/03–2007/08).
  - Total external obligations to private creditors estimated at US$296 million at end-2004, or 5.6 percent of Kenya's total external debt stock.
- Stress tests:
  - Most serious stress from a sharp real depreciation where NPV debt-to-GDP ratio increases to around 71 percent during the program period in tested scenarios.
  - Under combined real GDP growth and net non-debt creating low shock, NPV debt-to-exports ratio rises to 173 percent in 2005 then declines.

### Policy implications
- Debt appears sustainable under current scenario, but shocks could push indicators higher; continued vigilance required.
- Financing assurances reviews will be conducted for each disbursement as long as arrears to private creditors exist; escrow account established for unpaid commercial debts pending audit.

---

### Program performance, monitoring, and conditionality

### Performance to date
- For end-December 2003 and end-March 2004 PCs: Kenya met all structural PCs (some with delays) and all but two quantitative PCs.
  - Structural PC on audit of NSSF observed in February 2004 (was due end-December 2003).
  - Structural PC on submission of Banking Act Amendment Bill met in June 2004 (was due end-March 2004).
  - Continuous quantitative PC limiting contracting of nonconcessional external long-term debt breached when two security-related contracts signed in December 2003; contracts subsequently cancelled.
  - Continuous quantitative PC on nonaccumulation of external arrears breached for June 30, 2004 on two categories of arrears; late payment of nonrescheduled Paris Club arrears fully cleared by November 2004.
- MEFP sets structural and quantitative PCs and benchmarks for end-March and end-September 2005; end-September targets indicative and to be firmed in second review.

### Monitoring and reporting
- Program monitored using definitions, data sources, and frequency in the Technical Memorandum of Understanding (TMU).
- Key TMU quantitative test values (selected, in millions of Kenya shillings or as specified):
  - Cumulative change in net foreign assets of the CBK (December 2004 Benchmark): -7,022.
  - Cumulative change in reserve money of the CBK (December 2004 Benchmark): 2,728.
  - Cumulative change in net domestic financing of the central government (December 2004 Benchmark): 19,966.
  - Central government wages and salaries (December 2004 Benchmark): 52,064.
  - Program exchange rate (Kenya shillings per U.S. dollar): 78.95 (for December 2004, March 2005, June 2005, September 2005 test dates).
- Reporting requirements: weekly, monthly, and quarterly reporting timetables specified in TMU for CBK and government data (e.g., weekly CBK balance sheets, monthly NDF, monthly wages and salaries, monthly external arrears).

### Disbursement schedule under the PRGF arrangement (selected)
- Total amount with augmentation: 225 (In millions of SDRs).
- Disbursements (In millions of SDRs):
  - 1st: 25 — November 2003 (Contingent on Board Approval)
  - 2nd: 50 — December 2004 (end-December 2003 PC)
  - 3rd: 50 — July 1, 2005 (end-March 2005 PC and completion of second review by end-June 2005)
  - Subsequent disbursements through July 1, 2007 bring total to 225.

---

### Statistics, Safeguards, and Capacity

### Statistical issues and data improvements
- Revised national accounts data released.
- Steps to improve fiscal monitoring, including regular summary statistics on domestic arrears and pending bills, framework for monitoring productivity changes, and regular trade data production.
- Kenya participates in the GDDS; a statistics ROSC planned for early 2005.
- Monetary statistics broadly adequate; balance of payments and GFS need improvements and reconciliation between CBK and CBS datasets.

### Safeguards
- CBK safeguards assessment completed October 21, 2003 with notable progress since December 2000; CBK committed to implementing remaining recommendations.

---

### Executive Board assessment and conclusions (selected)
- Board conclusions (December 20, 2004): progress under PRGF-supported program—rebound in growth begun, domestic debt rise arrested, governance institutions upgraded, revenue administration enhanced.
- Main near-term challenge: accelerate broad-based growth to reduce poverty while securing fiscal consolidation and low inflation.
- Board approved augmented PRGF access by SDR 50 million (about US$ 76.9 million), bringing total drawn under arrangement to about SDR 75 million (about US$115.4 million).
- PRGF terms: annual interest rate 0.5 percent; repayable over 10 years with a 5½ year grace period on principal.

### Selected indicators (preserved exactly as presented)
- Real GDP growth: 2003/04 (Prelim.) = 2.1 (annual percent change).
- Consumer price index (annual average): 2003/04 = 8.2.
- M3X (M3 plus foreign currency deposits, end of period): 2003/04 = 12.9.
- Reserve money (end of period): 2003/04 = 5.5.
- Interest Rate (90-day Treasury Bill, period average): 2003/04 = 1.6.
- Central government total revenue (percent of GDP): 2003/04 = 21.7.
- Central government domestic debt, net: 2003/04 = 22.2 (percent of GDP).
- NPV of central government debt (end of period): 2003/04 = 49.6 (percent of GDP).
- Current external balance, excluding official transfers (percent of GDP): 2003/04 = -2.0.
- Gross international reserve coverage in months of next year imports (end of period): 2003/04 = 3.0.

---

*Source: IMF staff report excerpts and MEFP as provided in content unit _cr09225.*

### Appendix III. Appendix IV updates the debt sustainability analysis. Appendix V summarizes

### _cr09225 - Appendix III. Appendix IV updates the debt sustainability analysis. Appendix V summarizes

### Executive summary — political and economic setting
- Program implementation since December 2002 has shown notable progress, although five performance criteria were not met.
- Program execution was adversely affected by protracted constitutional reform deliberations and capacity constraints in key ministries.
- Macroeconomic outcomes in 2003/04:
  - Real GDP growth: 2.1 percent (2003/04), above the program assumption of 1.9 percent.
  - Domestic debt (in percent of GDP): fell from 24.3 percent at end-June 2003 to 22.2 percent at end-June 2004.
  - Broad money expansion: 13 percent in 2003/04 following a reduction in banks’ required reserves from 10 percent to 6 percent in July 2003.
  - Headline inflation: 19 percent in September 2004, up from 8 percent a year earlier.
- Medium-term outlook is promising conditional on deepened structural reforms, addressing capacity constraints, and restoration of strong donor support.
- Risks: Intensified political tensions or delays in the constitution review could raise uncertainty, postpone budgetary support, and complicate macroeconomic management.
- Authorities’ request: augmentation of access under the PRGF arrangement by SDR 50 million (18.4 percent of quota) to address balance of payments pressures from oil price increases and drought-related food imports.
- Staff recommendation: complete the first review and approve the requested augmentation of access.

### Policy issues and priorities
- Entrench fiscal discipline:
  - A significant reduction of domestic borrowing is essential for fiscal sustainability.
- Reorient the budget toward pro-poor spending and improve expenditure management:
  - Reorientation of expenditure priorities and modern public expenditure management are required to place the economy on a sustainable, poverty-reducing growth path.
- Restore price stability:
  - Need to better understand the monetary transmission mechanism.
  - Provide a clear commitment to price stability as the main focus of monetary policy and use monetary instruments efficiently.
- Enhance effectiveness of key governance institutions:
  - Improve capacities and budgetary resources of governance institutions.
- Strengthen external competitiveness:
  - Reform labor markets, upgrade infrastructure, and deepen the structural reform agenda.
- Agreement: Some progress has been made and an agreement on the way ahead has been reached.

### Recent economic developments (detailed findings)
- Growth and sources:
  - Real GDP growth in 2003/04: 2.1 percent; growth driven primarily by recovery in tertiary sectors.
  - Primary sector output affected by drought.
  - Gross investment (in percent of GDP) remained at prereform levels.
  - Kenya’s growth has been driven primarily by factor accumulation, with total factor productivity (TFP) declining historically but projected positive in 2004.
  - Historical average growth: 1.6 percent a year since 1990.
  - Projected 2004 contributions from growth accounting: output growth 2.37; physical capital 0.75; employment 0.98; education 0.45; TFP 0.18 (as listed under “Proj.2004”).
- Monetary developments and inflation:
  - Required reserves lowered from 10 percent to 6 percent in July 2003.
  - Money multiplier rose sharply; broad money expanded by 13 percent in 2003/04.
  - Result: negative real interest rates.
  - Headline inflation: 19 percent in September 2004; underlying inflation (excluding food, fuel, and energy): 7 percent; Central Bank of Kenya target for underlying inflation: 5 percent.
  - Drivers of inflation identified: high growth of broad money, weakening nominal exchange rate, high energy prices, and low agricultural output.
- Poverty and social indicators:
  - Recent developments (drought, oil price shock) may have worsened poverty indicators; real GDP growth broadly in line with population growth.
  - Delays in initiating major poverty reduction programs have hampered progress.
  - HIV/AIDS: adult infection rate estimated at 14 percent; estimated AIDS-related deaths: 150,000 in 2002.
  - Economic impact of HIV/AIDS:
    - AIDS deaths may directly reduce potential annual economic growth by 1.0–1.2 percentage points a year.
    - Poor worker health weakens labor productivity; high medical costs reduce resources for productive uses.
- Fiscal performance:
  - Central government fiscal imbalances much lower than expected under the program in 2003/04.
  - Domestic debt ratio declined from 24.3 percent at end-June 2003 to 22.2 percent at end-June 2004.
  - Strong revenue collection and tightened management of recurrent expenditure contributed to improved fiscal performance.
  - Some planned large domestic borrowing fears induced authorities to curtail some spending programs and delayed some initiatives (e.g., recapitalization of the National Bank of Kenya).
- External sector:
  - Current account deficit (excluding official transfers) in 2003/04: 2.0 percent of GDP, narrower than projected.
  - Higher oil imports: US$1,048 million.
  - Drought-related food imports: US$83 million.
  - Export volumes grew by 7 percent in 2003/04 (tea, horticulture, and AGOA-related garments performed well).
  - Foreign exchange reserves exceeded the program target given the smaller-than-expected current account gap.
- Financial sector:
  - Ratio of nonperforming loans to total loans fell, but problems persist.
  - Decisive action needed to address distressed state banks to tackle the NPL problem effectively.
- Structural reform implementation (mixed):
  - Telecommunications liberalization progressing; licensing of a third mobile operator.
  - Recent significant steps to improve domestic tax administration at Kenya Revenue Authority consistent with FAD recommendations.
  - Restructuring of expenditures to social sectors, notably education, has commenced.
  - Initial steps toward a modern public expenditure management system were taken (see MEFP para. 17).

### Boxes — select analytical findings highlighted in the source
- Box 1 (Past Fund Policy Recommendations and Implementation): Governance, fiscal sustainability, financial sector, and poverty reduction areas reviewed; governance and fiscal steps taken since December 2002 include anticorruption and public ethics legislation, judiciary strengthening, tax administration improvements, PEM reforms, civil service rationalization, and a new wage-setting mechanism.
- Box 2 (Sources of Economic Growth): Growth accounting shows factor accumulation (physical capital and employment) as main drivers; TFP broadly declined over past two decades but projected positive in 2004; econometric results link TFP growth positively to governance and negatively to inflation.
- Box 3 (Inflation Dynamics and Its Determinants): Recent high inflation driven primarily by broad money growth, nominal exchange rate weakening, high energy prices, and low agricultural output; underlying inflation exceeded the CBK’s 5 percent target.
- Box 4 (Economic and Social Impact of HIV/AIDS): Adult infection rate 14 percent; 150,000 AIDS-related deaths in 2002; AIDS may reduce potential annual economic growth by 1.0–1.2 percentage points and exacerbate poverty via income loss and high medical costs.

### Staff recommendations and program actions
- Complete the first review of the PRGF arrangement.
- Approve the requested augmentation of access: SDR 50 million (18.4 percent of quota).
- Prioritize:
  - Sustained fiscal consolidation with reduced domestic borrowing.
  - Reorientation of public spending toward pro-poor priorities and modern PEM.
  - A clear, price-stability-focused monetary policy stance and improved monetary instrument use.
  - Strengthening governance institutions through capacity and budgetary support.
  - Deepening structural reforms to enhance external competitiveness.

*Source: IMF staff report text as provided in the content unit.*

### 8.      Against the backdrop of a challenging political and economic environment, the

### _cr09225 - 8.      Against the backdrop of a challenging political and economic environment, the

### Outlook and Risks
- Economic recovery projected to continue in 2004/05 with real GDP expected to grow by 2.7 percent; original program forecast was 3.1 percent.
- Inflation, excluding food and oil, expected to decline to 3.5 percent by June 2005 in response to monetary tightening.
- Baseline medium-term projection: growth reaching 4.0 percent in 2007/08, achievable with a modest reform effort but below the ERS target of 6 percent and implying delays in MDG achievement.
- Baseline assumes much lower donor assistance than in the original program due to governance concerns; overall deficits (before grants) and domestic financing requirements over the medium term would be higher; targets for domestic debt above earlier projections.
- Downside scenario (Table 7): increased political tensions and slowed reforms could lead to suspension of donor budgetary support, substantial rise in domestic financing, government domestic debt exceeding 25 percent of GDP, stalled growth, and little progress on poverty reduction.
- Upside/high-case scenario (Table 7): strong fiscal consolidation and accelerated structural reforms supported by strong donor support could trigger higher growth and improved public finances.
- External accounts:
  - External current account deficit (excluding grants) expected to widen considerably in 2004/05, primarily from a drop in gross national savings due to higher oil and food prices.
  - Current account deficit forecast to widen through 2005/06 as imports remain robust, then decline thereafter with strengthened national savings.
  - Exports projected to perform strongly as reforms enhance competitiveness.
- External financing:
  - Current base case projects external financing requirements to average about US$1.3 billion a year over 2004/05 to 2006/07.
  - Financing sources expected: donor budgetary support, project support, private financing, debt service relief from the January 2004 Paris Club rescheduling, and Fund disbursements.
- Impact of oil price and drought shocks:
  - Sharp rise in oil prices and drought-related food imports projected to raise total imports by up to US$500 million (3.0 percent of GDP).
- PRGF augmentation request:
  - Authorities requested an augmentation of PRGF access of SDR 50 million, with SDR 25 million disbursed at completion of the first review and SDR 25 million at completion of the second review.
  - Augmentation would bring total access under the program to SDR 225 million or 82.9 percent of quota.
  - Noted that 82.9 percent of quota is higher than the norm of access for fourth-time users of the PRGF of 45 percent of quota, but below the maximum limit of 140 percent.
  - The augmentation does not materially worsen Kenya’s debt profile or ability to repay the Fund.
- Reserve cover and vulnerability:
  - Import cover declined from 3.5 months in 2001/02 to 3.0 months in 2003/04.
  - Staff warned that weak growth, large fiscal imbalances, financial sector weakness, and relatively free capital movements could build vulnerabilities vulnerable to exogenous shocks.
  - Authorities cited intended lowering of external tariffs from January 2005 and uncertain oil and maize prices as reasons for seeking additional external support, including PRGF augmentation.
- Main risks to macroeconomic outlook identified as political; intensification of political tensions or security shocks could reduce private investment. Upside linked to speedy constitutional reform resolution and accelerated reforms, especially in financial and parastatal sectors.

### Fiscal Policy
- Medium-term fiscal policy aims to balance debt sustainability with support for the poverty reduction strategy; slow resumption of donor budgetary assistance necessitates near-term fiscal adjustment.
- 2004/05 program emphasizes revenue improvements, a more modest expansion in spending on poverty reduction outlays, and domestic borrowing of 2.5 percent of GDP (Table A and Figure 3).
- Government borrowing absorption (about 50 percent of projected financial savings) would be consistent with targeted decline in underlying inflation amid projected interest rate increases and lower private credit growth.
- Table A. Kenya: Fiscal Framework for 2004/05 (In percent of GDP)
  - Revenue: 20.5 (2002/03); 21.7 (2003/04 (Prel.)); 22.8 (Initial projection); 21.4 (Program projection)
  - Expenditure and net lending: 20.9 (2002/03); 23.5 (2003/04 (Prel.)); 29.2 (Initial projection); 25.5 (Program projection)
  - Overall fiscal balance (before grants): -5.4 (2002/03); -1.7 (2003/04 (Prel.)); -6.5 (Initial projection); -4.1 (Program projection)
  - Domestic borrowing: 4.6 (2002/03); 0.8 (2003/04 (Prel.)); -0.5 (Initial projection); 2.5 (Program projection)
  - Stock of domestic debt: 24.3 (2002/03); 22.2 (2003/04 (Prel.)); 24.8 (Initial projection); 22.3 (Program projection)
- Strengthening revenue collection considered appropriate response to donor shortfalls; current efforts aim to partially offset lower budgetary resources in 2004/05.
- Revenue target: maintain revenue as a proportion of GDP of at least 21.5 percent of GDP (Box 5).
- Fiscal strategy highlights (Box 5):
  - Overall fiscal stance: gradually reduce NPV of total debt to GDP; strengthen structural fiscal position; address contingent-fiscal liabilities from pensions, financial sector, and local governments.
  - Reorient budget toward pro-poor expenditure: increase priority social and economic outlays; reduce wage bill ratio via civil service reforms and new wage-setting mechanism; tackle excessive budget rigidity.
  - Upgrade expenditure management: strengthen link between annual budgets and medium-term framework; reform procurement; enhance monitoring/tracking/reporting of pro-poor operations; refine control of expenditure commitments; improve budget classification; establish consolidated financial reporting by state enterprises.
  - Strengthen revenue performance: maintain revenue at least 21.5 percent of GDP; broaden tax base by removing most exemptions; tax a larger share of informal transactions; simplify and rationalize tax system.
  - Capacity building: build budget and economic management capacity of the Ministry of Finance; strengthen budget management and accounting capacity of key line ministries.
- Expenditure restructuring measures:
  - Reverse recent trend toward increased current spending by raising capital outlays from 2.7 percent of GDP in 2003/04 to 4.4 percent of GDP in 2004/05, with roads, health, and agriculture accounting for bulk of increase.
  - New transitional procurement rules to institutionalize competition and lower supply costs.
  - Medium-term initiatives to lower spending on noncore activities: rationalization of diplomatic representation and reform of tertiary education funding.
  - Address budget rigidity via new wage-setting mechanism and targeted lowering of domestic debt.
- Public expenditure management modernization underway with World Bank and Fund assistance.
- Civil service and capacity building:
  - Central government administrative staff cut from 272,000 in 1993/94 to about 190,000 in 2003/04; number of teachers rose from 210,724 to 236,000.
  - General hiring freeze to continue, applied flexibly: half of vacancies from natural attrition to be filled primarily in poverty reduction priority sectors.
  - Plan to reduce wage bill as proportion of total revenue by linking future wage awards to revenue growth and aligning executive compensation to comparable pay in other African countries and private sector; move gradually to incentive-based wage for professional cadre.

### Monetary and Exchange Rate Policies
- Exit strategy focus: move away from negative real interest and high inflation.
- Staff pressed for speedy monetary tightening; authorities tightened gradually due to concerns about banks rediscounting government bonds and potential loss of control over monetary aggregates.
- After November 2004 MFD technical assistance suggested low risk of significant flight from bonds, central bank accelerated monetary tightening under a reserve money program designed to reduce broad money growth to 7.5 percent in 2004/05 (MEFP para.19).
- Three-month treasury bill rate increased from 2.75 percent in September 2004 to 5.2 percent in November.
- Authorities noted that reserve money performance targets would ease control of monetary aggregates.

### Competitiveness Issues
- Strengthening Kenya’s competitive position necessary to accelerate growth and reduce unemployment and poverty.
- Business community consultations indicated need for concerted action across areas to improve business climate.
- Indicators show marked decline in competitiveness in recent years, including high labor costs.
- Real effective exchange rate (REER) review indicates REER may be more appreciated than fundamentals (productivity changes and commodity prices) suggest; staff suggested more flexibility in floating exchange rate management.
- Authorities stated shilling would continue to respond to market forces; interventions only to smooth short-run fluctuations not related to fundamentals.
- Investment Promotion Bill before Parliament aims to reduce business costs by eliminating unnecessary bureaucracy and rationalizing regulatory system.
- Wage-setting considerations:
  - Average nominal dollar wages for unskilled workers in Kenya are above those in other EAC member countries and competitor countries such as India and China.
  - Annual average real wage increases in manufacturing averaged 8 percent during the past five years while labor productivity reportedly fell.
  - Real minimum wage raised markedly in past five years amid declining per capita real GDP.
  - Authorities agreed that reverting to productivity-based wage awards should help dampen wage awards.

### Governance
- Government implementing broad-based governance strategy amid debate on gaps in anticorruption agenda.
- Donor-identified governance gaps include:
  - Inadequate funding of governance institutions.
  - Shortcomings in prosecution branches.
  - Weaknesses in management of security procurements.
- Positive developments: appointment of top management of the KACC and recent strengthening of the police and Office of the Comptroller and Auditor General, bolstering investigative branches.
- Success in prosecutions depends on effectiveness of the Attorney General’s office.
- Suggested modification of the Public Office Ethics Act to provide for regular review of asset declarations of prominent officials to close a major loophole (MEFE para. 19).
- Governance agenda also includes comprehensive actions to improve transparency of budget and financial management systems.

*Source: IMF staff report excerpt in _cr09225.*

### 28.      The authorities acknowledged that more steps were needed to address

### _cr09225 - 28.      The authorities acknowledged that more steps were needed to address

### Anti-corruption, public accounts, and governance (paras. 28–29)
- Authorities view ongoing reforms to produce, disseminate, and audit public accounts as critical to addressing corruption.
- Capacity-building in the Ministry of Finance expected to facilitate timely production of more comprehensive annual and medium-term budgets and a more transparent budget-management process.
- Strengthening public sector accounting capacity and systems, and requiring:
  - government to produce final accounts within four months of the end of the fiscal year, and
  - accounts audited by the Auditor General within nine months of the end of the fiscal year,
  will facilitate parliamentary scrutiny of public operations.
- The Auditor General’s report will serve as a key reference point for investigations by the KACC.
- Restructuring of the Auditor General’s office enabled more timely audits of state bodies (including parastatals and local governments) and a more proactive role in investigating potential misuse of public funds, as evidenced in the Anglo-Leasing case and a review of improper contracting by government officials of commercial debt.
- Staff view these steps, together with other measures in para. 20 of the MEFP, as important progress toward closing remaining governance gaps.
- Draft constitution provisions cited to enhance inclusiveness and transparency, including:
  - devolving more authority to local governments,
  - enshrining the independence of the judiciary and the public prosecution office.
- Authorities are addressing prosecution-branch weaknesses by hiring more and better-qualified staff.
- Actions taken in the Anglo-Leasing scandal:
  - all senior officers involved suspended;
  - KACC asked to initiate detailed investigations (ongoing);
  - a parliamentary inquiry conducted.
- Authorities concerned that difficult budgetary situation constrains adequate funding of key anticorruption agencies; optimistic that donor assistance will help.

### Public enterprise restructuring and privatization (para. 30)
- Delays in forging consensus to restructure and privatize parastatals have slowed reforms.
- Government acknowledges past political and rent-seeking considerations in privatization decisions; reaffirms strong commitment to privatization and enterprise reform.
- Plan to build broad parliamentary support via presentation of the policy paper “Privatization of State Corporations” before resubmitting the Privatization Bill to Parliament.
- Pending enactment of the Privatization Bill, focus on preparing enterprises for privatization, including detailed reviews of the financial position of key parastatals.

### Financial sector (paras. 31–33; Box 6)
- Authorities intend to tighten loan classification and provisioning in January 2005, in line with FSAP recommendations, and to strengthen CBK’s Banking Supervision Department (BSD).
- Staff stressed need for prompt follow-up on BSD recommendations and welcomed proposed amendments to the CBK and Banking Acts to:
  - transfer bank regulatory functions from the Ministry of Finance to the CBK, and
  - remove provisions giving the Minister of Finance authority to control interest rates (MEFP para. 22).
- Authorities cite large interest rate spreads as inhibiting bank lending and economic growth; causes cited by banks include:
  - low business volumes,
  - legal and administrative impediments to enforcement of contracts,
  - inefficiencies in the labor market contributing to significant increases in labor costs.
- Staff note interest rate spreads in Kenya not significantly different from those in countries at a similar stage of development.
- Nonperforming loans (NPLs) have declined recently, but decisive steps are needed to address public sector banks to resolve the NPL problem.
- Authorities attribute most public-bank NPLs to:
  - old government-intermediated credits, and
  - banks’ historical failure to enforce contracts due to legal, political, and judicial hurdles.
- Authorities favor cautious privatization of public banks with explicit links to predetermined thresholds of banking service penetration to rural communities and disadvantaged groups.
- Staff note Kenya has over 40 commercial banks and support national microfinance expansion and a comprehensive financial sector strategy paper (World Bank recommendation).

Box 6 — FSAP main conclusions (verbatim findings)
- The legal and judicial framework needs to be strengthened to promote financial sector development.
- The banking system has high levels of nonperforming loans and low capitalization and is vulnerable to shocks that could endanger its stability.
- To reduce the vulnerabilities, supervisors need to intervene rapidly to deal with problem financial institutions.
- Highest priority should be given to restructuring banks and divesting government stakes in the banking sector; also, the government should reevaluate its role in the development finance sector.
- The government is appropriately seeking to bolster the microfinance sector and, thereby, access to financial services for underserved segments of the population.
- The authorities are urged to move ahead with reforms of the payments and settlements systems.
- A program of technical assistance is under way to assist the authorities in their financial sector reform efforts.

### External trade and regional integration (para. 34)
- EAC common external tariff (CET), taking effect in January 2005, central to government trade initiatives.
- CET changes:
  - number of tariff bands reduced from five to three;
  - maximum tariff rate from 35 to 25 percent;
  - average tariff from 17.2 percent to 10.9 percent.
- Fiscal and trade impact for Kenya will depend on:
  - temporary protection accorded to Tanzanian and Ugandan producers for a specified list of commodities for five years, and
  - resolution of potential conflicts with other regional trade agreements (COMESA in the case of Kenya).
- Members agreed to maintain existing legal obligations beyond January 2005 until conflicts are settled.
- Authorities expect some near-term losses as domestic production is replaced by cheaper imports; over the medium term they expect benefits from lower tariffs, greater competition, and export expansion.

### External financing requirements and debt (paras. 35–37)
- Kenya’s projected external financing requirements are high but appear achievable based on experiences of other low-income countries implementing strong policy reforms (Table 8 referenced).
- World Bank committed US$870 million in its Country Assistance Strategy base case for Kenya for FY 2004–07.
- African Development Bank and European Union expected to provide significant budget support under the base case scenario, with other donors contributing some budget support.
- Next Consultative Group meeting for Kenya scheduled for early 2005.
- Reflecting scaling down of concessional financing since last staff report, Kenya’s external debt (in percent of GDP) remains on a declining trend and well below enhanced HIPC Initiative thresholds (Table 9 referenced).
- Updated debt sustainability analysis (Appendix IV) confirms external debt sustainability improves under revised program framework compared to November 2003 assessment.
- Projected increase in domestic borrowing over the near term would only marginally increase the NPV of central government debt relative to GDP.
- As a result of an audit of external commercial contracts for governance reasons, Kenya has begun to accumulate some arrears on these obligations.
- Government establishing an escrow account into which debt service due on commercial credits will be placed to settle fully all legitimate debts.
- In accordance with Fund policy on lending into arrears, financing assurances reviews will be conducted under the PRGF arrangement for each disbursement as long as arrears to private creditors exist.
- Total external obligations to private creditors estimated at US$296 million at end-2004, or 5.6 percent of Kenya's total external debt stock.
- Authorities intend to complete the audit in a timely fashion; escrow account established for unpaid amounts; staff view Kenyan authorities as showing good-faith intentions to resolve the problem.

### Paris Club rescheduling (Box 7)
- Paris Club met on January 14-15, 2004; Kenya requested and received Houston rescheduling terms despite IDA-only status.
- Rescheduling details:
  - US$350 million arrears and maturities falling due in consolidation period January 1, 2004 to December 31, 2006 were rescheduled on a total debt service of US$484 million due to Paris Club creditors during this period.
  - Assuming an additional US$52 million in comparable treatment from other creditors, total relief would be US$402 million.
  - Cutoff date: December 31, 1991 (same as November 2000 rescheduling).
  - ODA credits to be repaid over 20 years with 10 years grace at interest rates at least as favorable as concessional rates applying to those loans.
  - Commercial credits to be repaid over 15 years, including 5 years of grace, with progressive repayments at an appropriate market interest rate.
  - One hundred percent of service on not-previously rescheduled debt was rescheduled; previously rescheduled debt treated less generously.
  - Sixty percent of arrears to the Paris Club as of end-2003 that had not previously been rescheduled were rescheduled.
- Paris Club creditors and Kenyan authorities considered this rescheduling under the Evian Approach should allow Kenya to graduate from future Paris Club treatments.
- Deadline for signing bilateral agreements extended until December 31, 2004.
- Footnote on previously rescheduled debt treatment: For previously rescheduled debt, 100 percent of total debt service (principal and interest) due in 2004 and 100 percent of principal and 50 percent of interest due in 2005 was rescheduled; no debt service on previously rescheduled debt due in 2006 was treated.

### Program performance, monitoring, and other issues (paras. 38–41)
- For end-December 2003 and end-March 2004 performance criteria (PC) under the program, Kenya met all structural PCs (some with delays) and all but two quantitative PCs (MEFP Tables 1 and 2 referenced).
  - Structural PC on completion by end-December 2003 of an audit of the National Social Security Fund (NSSF) was observed in February 2004.
  - Structural PC on submission to Parliament by end-March 2004 of the Banking Act Amendment Bill was met in June 2004.
  - PC on completion of an audit of the stock of pending bills and adoption of measures for their clearing: financial audit completed by December 2004; awaiting results of legal audit before finalizing clearance plan.
  - Continuous quantitative PC limiting contracting of nonconcessional external long-term debt breached when financing contracts for two security-related procurements were signed in December 2003; contracts subsequently cancelled, correcting the breach.
  - Continuous quantitative PC on nonaccumulation of external arrears breached for June 30, 2004 on two categories of arrears:
    - late payment of nonrescheduled component of Paris Club arrears required to be settled by July 1, 2004, but not fully cleared until November 2004;
    - some late payments and arrears resulted from suspension of payments while audit of all central government commercial credits is conducted.
- MEFP sets structural and quantitative performance criteria and benchmarks (MEFP Tables 3 and 4) for monitoring performance under the 2004/05 program, with target dates of end-March and end-September 2005; targets for end-September are indicative and to be firmed up in second review discussions when fiscal framework for 2005/06 will be agreed.
- Kenya’s reporting of economic and financial data is adequate for surveillance and program-monitoring, though improvements needed (notably monitoring fiscal performance and domestic arrears); authorities addressing shortcomings with AFRITAC assistance.
- Kenya is a participant in the GDDS.
- Anti-money-laundering legislation being drafted; expected to be presented to parliament by mid-2005.
- CBK has made progress implementing recommendations of the 2003 Safeguards Assessment; authorities committed to implementing all staff recommendations (MEFP, para. 27).

*Source: _cr09225 - 28. The authorities acknowledged that more steps were needed to address (IMF staff report excerpts).*

### 42.      Kenya has made significant gains during the past year. Broad agreement has been

### _cr09225 - 42.      Kenya has made significant gains during the past year. Broad agreement has been

### Gains and progress
- Broad agreement has been reached on most of the constituent elements of the new constitution, and a consensus appears to be emerging on the remaining contentious issues.
- A rebound in economic activity is under way.
- The recent sharp growth in Kenya’s domestic debt has been arrested.
- The governance architecture and key institutions have been upgraded and enforcement of elements of the apparatus strengthened.
- Revenue administration has been enhanced.

### Remaining challenges and medium-term outlook
- Major challenges remain: the political outlook is uncertain; inflationary pressures have increased with monetary policy responding too slowly; the restructuring of the fiscal position necessary for the realization of the MDGs has barely begun; some important gaps in the governance architecture have yet to be filled; implementation of key structural reforms has been slow, constrained, in part, by weak international support; and concerted actions are needed to address the recent erosion in Kenya’s international competitiveness.
- Medium-term growth hinges on deepening reforms and addressing capacity constraints, and the resumption of strong donor support if the authorities are to fulfill their appropriately ambitious vision for Kenya.

### Monetary policy and inflation
- Decisive actions are needed to reduce inflation, which requires an early tightening of monetary policy.
- The continued tightening of monetary policy envisaged under the program should bring real interest rates back to positive levels.
- Risk: persistence of inflationary pressures could affect expectations and complicate the authorities’ ability to resist wage pressures and the restoration of a competitive economic environment.
- The staff supports the authorities’ decision to maintain the current managed floating exchange rate system.

### Fiscal policy and domestic debt
- Fiscal policy must balance fiscal consolidation with support for poverty reduction programs.
- Managing the near-term temporary increase in domestic borrowing and domestic debt will be a major challenge.
- The increase in domestic borrowing planned for 2004/05 appears reasonable in view of the large shortfalls in donor inflows and likely contractionary effects of the expected rise in interest rates.
- For the following year and over the medium term, the budget should begin the consolidation.
- Strengthening revenue collection is welcome and should be supported by decisive efforts to control and prioritize expenditure programs, determined steps to cut nonessential outlays, and the resumption of strong donor support.

### Expenditure management and poverty reduction
- Improved expenditure management is essential to achieving rapid poverty reduction and economic growth.
- Promising steps outlined in the authorities’ program:
  - Strengthening of the expenditure commitment control system.
  - An early start and lengthening of the budget preparation period.
  - Enhanced links between the annual budget and the MTEF.
  - Strengthening of the MTEF as a budget management tool.
  - Consolidation of the budget management organizational structures.
- If effectively implemented, these measures should hasten the trend toward pro-poor spending and enhance budget transparency and accountability.

### Competitiveness, labor market, and trade liberalization
- Authorities adopted a multifaceted strategy to improve competitiveness: streamlining the regulatory framework, improving essential infrastructure, reforming the labor market, and liberalizing trade.
- The intended change in the private sector wage-setting mechanism to arrest the recent inflation in wage demands is welcome and should not be delayed.
- Government is making progress in liberalizing external trade; the lowering of the average external tariff, in the context of the EAC, is a step in the right direction to foster a more competitive domestic environment and expand exports over the medium term.

### Governance and anticorruption
- Authorities are pursuing a broad-based strategy to promote good governance, but closing gaps in the anticorruption agenda remains a priority.
- Noteworthy restructuring during the past year: the police, the judiciary, the Office of the Ombudsman, and the Auditor General.
- Recent establishment of the KACC is an important milestone.
- Program includes steps to fill governance gaps: regular verification of asset declarations of senior officials and the production of budget outlook papers to make parliamentary oversight more effective.
- Long overdue steps taken to strengthen prosecution capacity and to increase oversight over military procurement.
- Steadfast implementation, including enforcement, will be key to success; donors have an important role in supporting key governance institutions.

### Public enterprise restructuring and privatization
- Public enterprise restructuring and privatization are essential to promoting strong economic growth.
- Delay in the enactment of the Privatization Bill has fostered inefficient enterprises and slowed economic growth.
- Authorities need to redouble efforts to secure parliamentary support for the bill.
- Establishing the Privatization Commission is important to managing privatization transparently.
- Decision to begin a detailed systematic assessment of the financial position of key parastatals is welcome; assessments should establish the magnitude of government contingent liabilities and help expedite the retrenchment process.

### Financial sector reform and intermediation
- Ongoing reform should help enhance financial intermediation.
- Program measures: transfer regulatory framework from the government to the CBK, revise banking legislation to remove restrictive provisions for banks’ pricing decisions, tighten prudential regulations, and restructure state-owned banks.
- Recent improvement in banking sector performance indicators, including the fall in NPLs, is welcome.
- Resolution of the NPL problem will require restructuring and privatization of publicly owned banks.
- Staff supports focus on promoting financial intermediation in rural areas and increasing access of small and medium-sized firms to formal sector financial resources.
- This will require broadening the scope and outreach of microfinance institutions and a more coherent and targeted strategy for promoting development finance institutions.

### Program monitoring, waivers, and financing request
- In light of Kenya’s performance under the program, the staff recommends completion of the first review under the PRGF arrangement.
- The staff supports the authorities’ request for three waivers for nonobservance of structural PC and two waivers for nonobservance of quantitative PC.
  - Footnote: The circumstances of these waivers are described in the section on program monitoring.
- The staff supports the authorities’ request for a rephasing of disbursements.
- The staff also supports the authorities’ request for an augmentation of access under the PRGF arrangement of SDR 50 million.

* _cr09225 - 42.      Kenya has made significant gains during the past year. Broad agreement has been*

### 53.      It is proposed that the next Article IV consultation with Kenya be held in

### _cr09225 - 53.      It is proposed that the next Article IV consultation with Kenya be held in

### Proposed consultation timing
- It is proposed that the next Article IV consultation with Kenya be held in accordance with the provisions of the decision on consultation cycles approved on July 15, 2002.

### Real and external developments (summary of Figure 1)
- Real GDP growth (factor cost and market price) displayed for 1999–2004 with a projection for 2004; panel annotations indicate "A rebound in economic activity has begun."
- Contributions to real GDP growth by sector (Primary sector; Secondary sector; Tertiary sector) show the pickup is "driven mainly by a pickup in the tertiary (service) sector."
- Consumer Price Index (annual % change): "Inflation has surged recently..."
- Effective exchange rates (annual % change): REER and NEER series indicate "partly due to a weakening of KSH."
- Current account (percent of GDP): CAB, Exports, Imports series show "CA has worsened, as imports have picked up."
- Reserves (Millions of USD) and Months of imports (right scale) show declining reserve coverage: "...resulting in a declining reserve coverage."

### Monetary and financial developments (summary of Figure 2)
- Reserve money growth has exceeded program expectation: "Reserve money growth has exceeded program expectation..."
- Net foreign assets (NFA) overperformance not adequately sterilized by slowdown in net domestic assets (NDA): "...as the overperformance in NFA was not adequately sterilized by the slowdown in NDA."
- Excessive liquidity produced negative real short-term interest rates: "Excessive liquidity has resulted in negative real short-term interest rates."
- Interest rate spreads remained high: "But interest rate spreads have remained high, reflecting structural weaknesses in the financial system."
- Broad money and money multiplier: "Owing to a reduction in reserve requirements, the multiplier rose and broad money surged."
- Private credit growth aided by ample liquidity and decline in lending rates: "Ample liquidity and the decline in lending rates have helped private credit to grow."

### Fiscal developments (summary of Figure 3)
- Widening deficit in 2004/05 financed by increased domestic borrowing: "The widening deficit in 2004/05 will be financed by an increase in domestic borrowing,..."
- Resulting in a small rise in domestic debt while external debt continues to fall: "...resulting in a small rise in domestic debt, while external debt continues to fall."
- Revenue projected to decline in 2004/05 while expenditure will rise: "Revenue is projected to decline in 2004/05,......while expenditure will rise."

### Medium-Term Macroeconomic Framework — Base Case (Table 1 highlights, 2002/03–2007/08)
- Nominal GDP (Market prices, in billions of Kenya shillings): 1,027 1,076 1,162 1,301 1,423 1,533 1,651
- GDP volume (factor cost): 1.5 1.9 2.1 2.7 3.2 3.6 4.0
- GDP deflator: 10.1 4.5 10.9 9.0 6.0 3.9 3.6
- Consumer price index (annual average): 6.6 4.1 8.2 12.1 4.1 3.5 3.5
- Consumer price index (end of period): 13.7 -4.0 5.9 5.0 3.5 3.5 3.5
- Ksh per US $ exchange rate (end of period): 76.4 76.0 78.9 ............
- Net domestic assets (end of period): 12.0 5.0 12.2 7.3 10.1 9.2 7.8
- M3 (broad money, end of period): 9.3 8.9 12.3 7.9 8.1 7.9 8.0
- Investment: 13.8 17.9 13.2 14.1 16.3 18.5 19.5
- Gross national saving: 14.7 13.1 11.7 9.6 10.6 13.3 15.2
- Total revenue (percent of GDP): 20.5 22.2 21.7 21.4 21.1 21.9 22.9
- Total expenditure and net lending (percent of GDP): 25.9 27.8 23.5 25.5 28.6 28.8 28.8
- Overall balance (commitment basis) excluding grants (percent of GDP): -5.4 -5.6 -1.7 -4.1 -7.5 -6.9 -5.9
- Overall balance (including grants): -3.9 -3.3 -0.3 -2.5 -3.5 -3.5 -2.9
- Current external balance, including official transfers (percent of GDP): 1.0 -4.8 -1.5 -4.5 -5.7 -5.2 -4.3
- Gross international reserve coverage in months of next year imports (end of period): 3.3 2.8 3.0 3.1 3.1 3.2 3.1
- NPV of central government debt (end of period): 51.9 55.6 49.6 49.6 49.6 48.5 46.4
- Domestic debt, net (end of period, percent of GDP): 24.3 26.8 22.2 22.3 22.5 21.7 20.3
- NPV of external debt (end of period, percent of GDP): 27.6 28.8 27.4 27.3 27.1 26.8 26.1

### Monetary Survey — key figures (Table 2 highlights)
- Net foreign assets (in Millions of US $) — selected end-periods: 1,032 1,065 1,118 1,211 1,098 1,009 1,070 1,212 1,253 1,305
- Reserve money (RM) (levels reported in Table 2; growth rates memorandum): Reserve Money growth series: 11.2 0.1 4.1 -5.5 -1.1 -4.1 3.0 -5.4 5.5 9.8 6.2 7.7 3.8 6.8 7.0
- M3 (levels and growth): M3 levels series: 362.6 368.8 370.3 376.3 395.1 383.4 394.8 394.7 407.3 417.0 424.3 431.8 439.3 474.7 512.2; M3 growth (memorandum): 9.3 9.8 10.3 7.3 12.7 8.7 11.9 8.9 12.3 12.6 7.4 9.4 7.9 8.1 7.9
- M3X (M3 plus foreign currency deposits) levels and growth: 419.4 425.0 424.7 432.0 453.3 438.5 460.6 449.3 473.4 486.5 493.9 501.3 508.8 544.0 581.4; M3X growth series: 10.9 9.7 9.6 6.4 11.7 7.3 12.7 7.1 12.9 14.5 8.9 8.8 7.5 6.9 6.9
- Multiplier (M3X/RM): 4.9 5.4 5.2 5.2 5.2 5.4 5.3 5.6 5.2 5.4 5.3 5.4 5.4 5.4 5.4
- Reserve cover, in months of next year's imports: 2.9 2.8 3.0 2.9 3.4 2.6 2.8 2.8 2.8 2.6 2.8 2.7 3.0 3.0 3.1

### Central government financial operations (Table 3a and 3b highlights)
- Total revenue (levels KSh): 197,768 210,750 239,177 252,681 259,660 277,809 285,205 300,371 336,471 378,001
- Total expenditure and net lending (levels KSh): 228,980 265,947 299,321 272,705 333,563 331,695 363,497 406,716 441,803 476,034
- Interest payments (levels KSh): 30,384 36,026 33,742 29,700 34,936 38,361 35,357 39,849 42,503 45,579
  - Domestic interest (levels KSh): 23,744 27,567 27,323 23,281 27,596 30,700 26,759 34,097 36,309 37,028
  - Foreign interest due (levels KSh): 6,640 8,459 6,419 6,419 7,340 7,661 8,598 5,752 6,194 8,551
- Wages and benefits (civil service) (levels KSh): 78,125 85,087 93,380 95,850 92,624 104,128 93,637 113,941 122,737 132,195
- Development and net lending (levels KSh): 24,954 43,526 54,636 31,280 73,826 55,594 94,519 109,736 117,986 125,462
  - Domestically financed (levels KSh): 10,873 12,778 15,885 16,297 24,991 19,633 36,416 36,826 45,981 49,523
  - Foreign financed (levels KSh): 15,381 21,951 35,854 17,487 48,000 30,987 57,000 71,409 70,505 75,938
- Balance (commitment basis, excluding grants) (levels KSh): -31,212 -55,197 -60,144 -20,024 -73,902 -53,886 -78,291 -106,345 -105,332 -98,033
- Grants (levels KSh): 6,823 14,942 25,051 16,224 25,000 20,828 30,000 57,022 51,841 50,540
- Balance (commitment basis, including grants) (levels KSh): -24,389 -40,255 -35,093 -3,800 -48,902 -33,058 -48,291 -49,323 -53,491 -47,493
- Net domestic borrowing (levels KSh): 39,704 46,922 35,481 8,809 -5,400 31,982 -25,457 30,279 11,216 2,403
- Stock of domestic debt, net (end of period, levels KSh): 202,775 249,697 288,592 258,506 283,192 290,488 257,736 320,767 331,982 334,385
- Primary budget balance (levels KSh): 3,163 2,934 -2,851 27,370 -13,966 4,955 -12,935 -9,473 -10,988 -1,914

### Balance of payments (Table 4 highlights, 2001/02–2007/08)
- Current account (excluding official transfers) (in millions of US$): -86.5 144.2 -282.3 -763.7 -1,030.0 -1,009.3 -813 (series by year)
- Exports, f.o.b. (in millions of US$): 1,962 2,322 2,491 2,807 3,068 3,324 3,661
  - Coffee: 85 85 82 91 102 115 133
  - Tea: 42 143 134 150 177 185 1661 (note: table lists series under exports)
  - Horticulture: 24 129 63 71 40 85 94 (series as reported)
- Imports, f.o.b. (in millions of US$): -2,823 -3,215 -3,870 -4,726 -5,139 -5,363 -5,730
- Balance on goods and services (in millions of US$): -587 -396 -889 -1,427 -1,670 -1,645 -1,478
- Current transfers (net) (in millions of US$): 690 644 821 845 826 830 799
- Gross official reserves (end of period, in millions of US$): 1,137 1,260 1,399 1,629 1,723 1,829 1,942
  - In months of next year's imports of goods and services: 3.5 3.3 3.0 3.1 3.1 3.2 3.1
- Overall balance (in millions of US$): 98 232 240 -32 -91 -131 22

### Financial soundness indicators for the banking sector (Table 5, selected items, 1999–Jun-04)
- Regulatory capital to risk-weighted assets: 17.6 17.3 17.0 17.3 16.5 (series beginning Dec-00)
- Regulatory Tier I capital to risk-weighted assets: 14.2 14.5 14.1 16.3 15.6
- Capital (net worth) to assets: 11.4 12.9 13.3 11.6 11.8 11.4
- Nonperforming loans (gross) to gross loans: 33.3 30.1 29.8 25.6 22.9 (series beginning Dec-01)
- Nonperforming loans (net of provisions) to capital: 78.7 78.8 77.8 60.7 52.9
- Foreign currency loans to total loans: 2.2 12.5 14.9 15.4 15.8 14.9
- Return on average assets (before tax): 0.7 0.5 1.6 1.0 2.3 2.1
- Return on average equity (before tax): 7.9 4.9 15.7 10.9 23.2 22.7
- Spread between average lending and deposit rates: 13.4 13.8 13.6 10.2 10.0
- Liquid assets to total assets: 28.4 29.5 34.4 33.7 33.2 35.7
- Customer deposits to total (non-interbank) loans: 111.0 113.7 121.2 125.2 131.6 139.1

### Disbursement schedule under the three-year PRGF arrangement (Table 6)
- Total amount: 225 (In millions of SDRs)
- Disbursement schedule:
  - 1st: 25 — November 2003 (Contingent on Board Approval)
  - 2nd: 50 — December 2004 (end-December 2003 performance criteria (PC))
  - 3rd: 50 — July 1, 2005 (end-March 2005 PC, and completion of the second review by end-June 2005)
  - 4th: 25 — January 1, 2006 (end-September 2005 PC, and completion of the third review by end-December 2005)
  - 5th: 25 — July 1, 2006 (end-March 2006 PC, and completion of the fourth review by end-June 2006)
  - 6th: 25 — January 1, 2007 (end-September 2006 PC, and completion of the fifth review by end-December 2006)
  - 7th: 25 — July 1, 2007 (end-March 2007 PC, and completion of the sixth review by end-June 2007)
- Note: "While these disbursements at present fall outside the period of the arrangement, it is expected that the authorities will in the future request an extension of the arrangement."

### Macroeconomic alternative scenarios (Table 7)
- A) Base Case (selected series, percent of GDP unless indicated)
  - GDP volume (annual percentage change): 2.1 2.7 3.2 3.6 4.0 (2003/04–2007/08)
  - Total revenue: 21.7 21.4 21.1 21.9 22.9
  - Total expenditure and net lending: 23.5 25.5 28.6 28.8 28.8
  - Overall balance excluding grants: -1.7 -4.1 -7.5 -6.9 -5.9
  - Net domestic borrowing: 0.8 2.5 2.1 0.7 0.1
  - Current external balance, excluding official transfers: -2.0 -4.9 -6.1 -5.6 -4.2
  - Gross international reserve coverage (months next year imports): 3.0 3.1 3.1 3.2 3.1
- B) High Case (selected)
  - GDP volume: 2.1 3.5 4.3 5.0 5.5
  - Gross international reserve coverage (months): 3.0 3.3 4.0 4.1 4.5
  - NPV of central government debt (end of period): 49.6 48.1 45.7 42.4 38.6
- C) Low Case (selected)
  - GDP volume: 2.1 1.7 2.2 2.5 2.9
  - Gross international reserve coverage (months): 3.0 2.8 2.7 2.5 2.5
  - NPV of central government debt (end of period): 49.6 52.4 53.7 54.2 54.8
- Note: "The fiscal financing gap is set to be the same across all scenarios, with the net domestic borrowing treated as a residual."

### External financing requirements and resources (Table 8, selected items)
- External financing requirements (in millions of U.S. dollars): -538.8 -297.3 -880.5 -1,245.0 -1,365.4 -1,366.8 (2001/02–2006/07)
  - Current account (excl.official transfers): -86.5 144.2 -282.3 -763.7 -1,030.0 -1,009.3
  - Scheduled amortization (official): -294.0 -209.1 -274.0 -238.4 -235.5 -240.4
  - IMF payments, gross: -24.2 -18.6 -15.6 -12.9 -6.3 -10.8
  - Buildup of gross official reserves: -182.0 -123.6 -138.7 -230.0 -93.6 -106.2
- Resources (in millions of U.S. dollars): 538.8 297.4 880.5 1,245.0 1,365.2 1,366.7
  - Program support (committed and tentatively identified): 23.4 0.0 177.3 302.4 237.0 247.5
  - Project support: 197.5 288.9 461.8 568.5 522.2 572.2
  - Private financing (incl. short-term (net) and errors & omissions): 214.6 -47.4 130.5 170.8 406.4 394.7
  - Rescheduling of debt: 61.0 0.0 48.0 128.8 118.1 55.5

### External debt indicators (Table 9 highlights)
- Stock of external debt by creditor (in millions of U.S. dollars): 5,117 5,250 5,562 5,854 6,128 6,324 (2003–2008 series)
  - Multilateral creditors: 3,159 3,264 3,558 3,783 3,953 4,058
    - IMF: 104 165 268 329 357 348
    - World Bank: 2,545 2,544 2,683 2,745 2,826 2,882
  - Bilateral creditors: 1,631 1,690 1,762 1,868 2,005 2,125
    - Paris Club: 1,551 1,593 1,645 1,730 1,839 1,934
- Net present value (NPV) of debt (in million U.S. dollars): 3,972 4,287 4,597 4,912 5,152 5,318 (2003–2008)
  - NPV in percent of exports of goods and services (three-year backward-looking average): 111 109 105 103 100 94
  - NPV in percent of government revenue, excluding grants: 132 129 130 126 119 112
  - NPV in percent of GDP: 28 27 27 27 27 26
- Debt-service ratios (before 2004 Paris Club rescheduling): Debt-service in percent of current year exports: 12% 9% 8% 8% 7% 7%; in percent of fiscal revenue: 14% 10% 10% 9% 8% 8%
- Debt-service ratios (after 2004 Paris Club rescheduling): Debt-service in percent of current year exports: -5% 6% 6% 7% 7% (series as presented); in percent of fiscal revenue: -6% 7% 7% 8% 8%

### Actual and projected payments to the Fund (Table 10 highlights)
- Principal payments (SDRs, selected years): 18.6 14.0 7.0 9.5 5.0 9.2 6.7 6.7 14.2 29.2 37.4 (series by year)
- Charges and interest (SDRs): 1.9 1.2 0.8 0.9 1.5 1.4 1.4 1.4 1.3 1.3 1.2 (2001–2011)
- Outstanding Fund credit (SDRs): 78.6 57.6 75.6 116.1 186.1 226.9 245.2 238.5 224.3 195.1 157.7 (series by year)
- FCO (Fund credit outstanding) in percent of Gross official reserves and GDP and other indicators are reported in the table (series by year).
- Table assumption: "The table assumes that the remaining amount of the PRGF arrangement of SDR 175 million agreed in November 2003 (which is SDR 150 million as of 10/31/04) will be disbursed, along with an augmentation of SDR 50 milllion requested by the authorities, to be disbursed in two equal installements of SDR 25 million at the time of the completion of the first and second reviews, in addition to the SDR 25 million disbursements at the completion of each of those reviews expected under the original program."

*Source: _cr09225 (IMF staff report content provided).*

### 1.      The annexed Memorandum of Economic and Financial Policies (MEFP) describes

### _cr09225 - 1.      The annexed Memorandum of Economic and Financial Policies (MEFP) describes

### Overview and objectives
- The MEFP describes performance under the Poverty Reduction and Growth Facility (PRGF) arrangement and outlines policies for the remainder of 2004/05 (July/June).
- The government’s primary goal: reducing poverty by creating an environment conducive to strong economic and employment growth as outlined in the Investment Program for the Economic Recovery Strategy for Wealth and Employment Creation (ERS).
- The government requests an SDR 50 million augmentation of access under the PRGF arrangement to mitigate balance-of-payments pressures from a sharp rise in oil prices and drought-induced food imports.
- The government requests waivers for the nonobservance of five performance criteria and a rephasing of remaining disbursements under the arrangement.

### Program performance and compliance
- Quantitative performance criteria:
  - All quantitative performance criteria for end-December 2003 were met, except:
    - Continuous criterion on contracting/guaranteeing of nonconcessional external long-term debt (two security-related clauses concluded in December 2003; these were subsequently cancelled).
    - Continuous criterion on accumulation of external payments arrears (breached after June 30, 2004 for two categories of arrears).
  - Late payment: nonrescheduled share of Paris Club arrears existing at the time of the January 2004 rescheduling was required to be settled by July 1, 2004 but was not fully settled until November 2004.
  - An audit of all central government contracts of commercial external debt is being undertaken; while the audit is ongoing, debt service on these loans will be placed in an escrow account and used to resolve any arrears promptly and fully if obligations are found legitimate.
- Structural performance criteria (second disbursement):
  - All but one were completed; two completed with delays.
  - Audit on the financial position of the National Social Security Fund (NSSF) due end-December 2003 was completed in February 2004.
  - Submission to parliament of a Banking Act Amendment Bill due end-March 2004 was done in June 2004.
  - Completion of a financial audit of the stock of pending bills was done, but final clearance plan awaits results of a legal audit of pending bills (expected by June, 2005).

### Economic developments in 2003/04 and program results
- Real GDP growth:
  - 2003/04 (July/June): real GDP growth was 2.1 percent, moderately above program expectations.
  - 2004/05 projection (below): see “Macroeconomic outlook” section.
- Inflation:
  - Overall consumer price inflation was well above projections in 2003/04.
  - Excluding food and oil, inflation was 4 percent at end-June 2004 (higher than programmed).
- Monetary and money supply dynamics:
  - Legal reserve requirement reduced from 10 percent to 6 percent in July 2003.
  - Reserve money multiplier rose from 4.9 to 5.3.
  - Broad money expanded 13 percent in 2003/04 versus 7 percent projected under the program.
  - Resulting negative real yields on money market instruments; bank credit to the private sector grew substantially.
- Fiscal and debt outcomes:
  - Net domestic borrowing and the NPV of total central government debt (in percent of GDP) were well within program targets for 2003/04.
  - Contributing factors:
    - Stronger than budgeted revenue performance (including aggressive collection of tax arrears and new administrative measures).
    - Tightened management of the recurrent budget despite persistent wage pressures.
    - Delays in the recapitalization of the National Bank of Kenya, which had been programmed to cost about Ksh 12 billion.
- External sector:
  - External current account deficit (before grants) expanded relative to 2002/03 but was lower than programmed in 2003/04.
  - Buildup of foreign reserves in dollar terms was lower than program target but exceeded the target after adjustment for shortfall in external donor support.
- Investment and savings:
  - Slight decline in gross investment and a marked fall in the national savings ratio (partly attributable to drought-related shifts toward increased consumption).
  - Modest fall in gross investment partly due to lower public investment (development budget execution below budgeted level), problems with the transitional procurement system, and lower-than-expected donor inflows.
  - Private savings declined sharply; significant increase in public savings partially offset this.

### Structural reforms and governance
- Progress mixed: delays in public expenditure, financial sector, and parastatal reforms, partly due to capacity constraints and legislative crowding from constitutional reform.
- Specific developments:
  - Weakness in moving toward a comprehensive medium-term expenditure framework consistent with PRSP priorities—largely attributable to organizational and capacity constraints at the Ministry of Finance.
  - Privatization Bill enactment delayed by lack of consensus.
  - New wage-setting mechanisms for public employees developed.
  - Governance improvements and anti-corruption measures:
    - Enactment of the Anti-Corruption and Economic Crimes and Public Officer Ethics Acts in May 2003.
    - Completion of asset declarations by all public officers in November 2003.
    - Major restructurings of the judiciary and the police over 2003/04.
    - Establishment of the Kenya Anti-Corruption Commission (KACC) in May 2004.

### Medium-term framework and adjustments
- Key modifications to the medium-term macroeconomic framework:
  - Terms of trade projected to deteriorate moderately instead of modest gains previously envisaged.
  - Donor assistance expected to fall significantly short of earlier expectations.
  - Capacity constraints in key areas recognized as more severe than initially assumed.
  - Some financial and parastatal sector reforms delayed.
- Policy adjustments:
  - Strengthened domestic revenue effort.
  - Accelerated expenditure restructuring and management reforms.
  - Domestic borrowing targets relaxed somewhat.
  - Public investment will be scaled down over the medium term relative to original program assumptions.
  - Expected outcomes:
    - External current account deficit lower than earlier projections primarily because investment is projected to be markedly lower.
    - Ratio of savings to GDP broadly as assumed earlier.
    - Private investment significantly below program expectations.
    - Net foreign reserve targets for the medium term somewhat less ambitious than the original three-year program.
    - Medium-term inflation objectives remain as previously set; monetary policy to be tightened to correct overshooting in 2003/04.

### Economic policies for 2004/05
H3: Macroeconomic outlook
- Projected real GDP growth for 2004/05: 2.7 percent (lower than the 3.1 percent expected in the original program).
- Growth outlook reflects:
  - Negative effects of high oil prices and depressed prices for some traditional exports.
  - Impact of drought on agricultural production.
  - Strong performance projected for the tourism sector as it recovers from last year’s travel ban.
- Inflation: drought and high oil prices expected to contribute to a pickup in overall consumer price inflation to well above earlier projections.

H3: Fiscal policy
- Fiscal targets and domestic debt:
  - Budget before parliament targeted an overall deficit (before grants) of 7.2 percent of GDP and implied domestic borrowing of 4.7 percent of GDP if envisaged budgetary support was not forthcoming.
  - A revision to the budget announced on June 12, 2004 will be presented to parliament during the first quarter of 2005.
  - Pending the revision, the new fiscal framework will be implemented through quarterly releases of expenditures.
  - The revised budget assumes domestic borrowing equivalent to 2.5 percent of GDP.
  - Domestic debt would remain broadly unchanged at 22 percent of GDP compared with the original program target of 24.7 percent of GDP; the domestic debt-ratio is expected to decline thereafter.
  - Some crowding out of private activity is expected as the public sector would absorb a sizable proportion of projected financial savings.
- Revenue measures and customs changes:
  - East African Community (EAC) Customs Protocol (effective January 1, 2005) lowers the top tariff rate from 35 percent to 25 percent and reduces tariff bands from 5 to 3; projected revenue losses of 0.3 percent of GDP.
  - Measures included in the program to raise compliance and expand the tax base:
    - Creation of one-stop shops that bring together business licensing and tax payments operations;
    - Full integration of the VAT and Income Tax Departments in a single function-based Domestic Tax Department (DTD);
    - Strengthening and rationalizing the Large Taxpayer Office (LTO);
    - Introduction of computerized audits for LTO and DTD;
    - Implementation, on a pilot basis, of simplified customs procedures;
    - Modernization of customs computer systems.
  - Expected effects: strengthen revenue performance, significantly raise efficiency of the tax system over the medium term, and lay the basis for further tax system reform beginning later in the fiscal year.
  - Medium-term revenue goal: broaden the tax base, simplify and improve the neutrality and revenue-yielding capacity of the system.

### Implementation, monitoring, and consultation
- The MEFP spells out quantitative performance criteria and benchmarks, structural performance criteria and benchmarks for monitoring under the 2004/05 program.
- End-September 2005 targets are indicative and will be firmed up once a more comprehensive macroeconomic framework and the 2005/06 budget are developed.
- The government is taking prior actions to the issuance of the staff report on the first review of the PRGF arrangements.
- The government will consult with the Fund in advance of revisions to policies contained in the MEFP and will provide the Fund with all required information in a timely manner.
- The government expects to complete the first progress report of the ERS by June 2005.

*Memorandum of Economic and Financial Policies (MEFP) annexed to the Letter of Intent*

### 16.      Government remains firmly committed to the reorientation of public

### 16.      Government remains firmly committed to the reorientation of public expenditures in favor of growth and poverty-related outlays.

### Public expenditure reorientation and fiscal constraints
- Government will increase employment in critical social and economic sectors (including teachers, healthcare, and security personnel) while overall civil service positions would fall by about 2,000 through retrenchments and attrition.
- Budget inflexibility pressures identified:
  - Projected rise in interest payments.
  - Continuing sharp increase in pension payments partly attributable to recent retrenchment of public servants.
  - Impact of persistent wage pressures on the wage bill.
  - Lower-than-expected external budget support.
- Measures to reduce noncore outlays over time:
  - Develop new wage-setting mechanisms for public employees.
  - Rationalize diplomatic missions to reduce number of staff.
  - Privatize parastatals.
  - Review the role of the state in provision and funding of university education.
- Budget provisions:
  - Ksh 2 billion provision for payment of pending bills in 2004/05 following completion of a legal audit in December 2004; contested audits could lengthen the process.
  - Remaining bills to be paid off over a two-year period.
  - Ksh 1 billion provision for rehabilitation of stalled projects; objective to sell most projects and rehabilitate remaining ones in priority areas.
- External payment arrears: ongoing audit of central government contracts of commercial external debt has led to accumulation of some external payments arrears; all debt-service on these obligations will be paid on due dates into an escrow account pending legitimacy verification.

### Public expenditure management reforms
- Key initiatives to build a sound expenditure management system:
  - Complete the budget outlook paper for 2005/06 by November 2004 linking the budget and ERS priorities.
  - Expand comprehensiveness of the three-year medium-term expenditure framework (MTEF) and coverage of programs included in protected social programs.
  - Strengthen links between the MTEF and the annual budget system.
  - Improve budget transparency by adopting the classification system proposed in the Government Financial Statistics Manual for all budget votes.
  - Broaden consultative mechanisms in preparation of sectoral programs and medium-term budgets.
  - Create over time an Integrated Financial Management System; strengthen the expenditure commitment control system (ECCS) in the interim. Full application of ECCS will help prevent build up of new arrears.
  - Strengthen procurement systems and accounting capacity and practices in line ministries and procedures; facilitate enactment of the Procurement Bill by March 2005.

### Public service reforms and capacity building
- Reforms stepped up to control wage bill, address capacity constraints, and improve public service efficiency:
  - New wage-setting guidelines for public employees aimed at reducing, over the medium term, the wage bill as a proportion of revenue.
  - Streamline terms and conditions of service for top management in government and state bodies.
  - New regulations emphasizing merit as a key determinant for promotion.
- Capacity building and institutional strengthening:
  - Consolidation of planning and budget functions within the Ministry of Finance.
  - Setting up a robust debt management unit.
  - Enhancing capacity and mechanisms for managing and monitoring macroeconomic and structural reforms.
  - Restructuring of Ministries of Education, Health, and Agriculture with assistance of private consultants.

### Monetary policy (2004/05)
- Inflation objective: reduce underlying inflation to 3.5 percent.
- Strategy and instruments:
  - Reserve money targeting as main framework; broad money (M3X) as intermediate target; open market (repurchase and reverse) operations as main instrument.
  - Program consistent with targeting a growth rate of reserve money of 3.8 percent, assuming a moderate increase in the money multiplier in response to expected pickup in interest rates.
  - CBK will sterilize excess liquidity timely and leave interest rates to be determined by market forces in line with the monetary program.
  - With Fund technical assistance, auction system for government bonds to be improved.
  - Continue flexible exchange rate system; CBK intervention limited to meeting net foreign assets target under the program and smoothing disruptive short-term fluctuations.

### Structural reforms and governance
- Main elements to promote good governance:
  - Continued strengthening of governance architecture and enforcement of key anticorruption laws and regulations, including full enforcement of the Anti-Corruption and Economic Crimes and Public Officer Ethics Acts 2003, implementation of the United Nations Convention against Corruption, and Ratification of the African Union Convention on Corruption.
  - Enhance effectiveness of anticorruption investigative agencies, including Kenya Anti-Corruption Commission; hiring of key personnel targeted for completion by July 2005.
  - Build prosecution capacity in the Department of Public Prosecution; completion of capacity-building program targeted for early 2005.
  - Develop systems for annual declaration and verification of wealth, assets, and liabilities of ministers and other senior public officials as provided under the Public Officers Ethics Act 2003; computerization of wealth declaration forms initiated; submission to Parliament by April 2005 of an amendment to provide for annual verification of asset declarations by the KACC.
  - Develop robust asset recovery and restitution program following three phases: international freezing of assets; restitution and vesting in aggrieved country; domestic recovery of returned assets if nonmonetary; restitution advisory group established.
  - Deepen transparency in public operations: timely production of accounts by all public institutions, auditing and presentation to Parliament, and production of comprehensive annual and medium-term expenditure frameworks consistent with ERS priorities.
  - Improve procurement system and enact Public Procurement and Disposal Bill 2004 to establish Public Procurement Oversight Authority (PPOA); develop regulations, strategic plan 2005–10, training and capacity-building program, appeals body, periodic media publication of contract awards, and IT capacity for dissemination.

### Addressing past economic crimes and public agencies
- Focus on Goldenberg Commission of Inquiry and Presidential Commission on Illegal and Irregular Allocations of Public Land.
- Upgrade key public agencies:
  - Implement recommendations of the task force on reform of the police beginning December 2004 (retraining, oversight, corruption).
  - Continue corruption prevention in civil service under Public Service Integrity Programme (PSIP) in conjunction with KACC.
  - Strengthen Governance Justice Law and Order Sector Reform Program.
  - Enhance public interaction via a Public Complaints Unit (PCU) under the Department of Governance and Ethics with the Ministry of Justice and Constitutional Affairs.

### Parastatal restructuring and privatization
- Program will accelerate once the Privatization Bill is enacted; bill foreseen by April 2005.
- Pending parliamentary consideration, initiate by December 2004 a comprehensive review of financial position of key parastatals to identify contingent liabilities and develop privatization options.
- Bank restructuring:
  - Bank Restructuring and Privatization Unit established in the Ministry of Finance.
  - Restructuring of National Bank of Kenya (NBK) has begun.
  - At next Annual General Meeting of NBK board around April 2005, all state nominated Board members will be replaced by independent professional directors; pending completion of restructuring NBK will desist from disposing assets and from raising its liabilities with CBK from the end-June 2004 position; its outstanding loans and advances will not exceed the end-June 2004 level.
  - Government will prepare by March 2005 a time-bound plan for divesting public ownership and control of other public banks.

### Financial sector and regulatory measures
- Amendments to CBK and Banking Acts before parliament to:
  - Transfer virtually all banking sector regulatory and supervisory authority from the Ministry of Finance to the Central Bank.
  - Remove requirement for prior approval of the Minister of Finance when setting banks’ fees and charges.
  - Change definition of a significant shareholder and fit-and-proper criteria for managers and significant shareholders.
- New regulations tightening loan provisioning and classification to be introduced in January 2005.
- Review of management and financial position of the NSSF to be completed by March 2005 to set stage for restructuring.

### Competitiveness and wage policy
- Discontinue practice of raising minimum wage yearly; minimum wage to be reviewed once every two-year period based on wage trends in informal sector and formal sector productivity gains for unskilled labor.
- New guidelines for wage arbitration by the Industrial Court to be issued by March 2005 emphasizing productivity change as key criterion for wage adjustments.
- Trade reform and regional integration:
  - In EAC context, external tariff and number of tariff bands will be reduced, resulting in a fall in the average tariff rate from 16.2 percent to 10.9 percent.
  - Kenya’s rating under the IMF’s trade restrictiveness index expected to fall significantly after accounting for absence of non-tariff barriers, toward a more open trade regime.
  - Complete a trade policy strategy by December 2004 to spell out reforms needed to enhance efficiency and international competitiveness, including additional EAC reforms.

### Poverty and Social Impact Analysis (PSIA)
- PSIA of key policy reforms will be conducted.
- Terms of reference for a PSIA of the EAC tariff reform and a possible further lowering of tariff rates within EAC is under consideration.
- Study will assess likely impact of trade reforms on cost of living of the poor, main economic sectors, employment, and regions likely to suffer most to fine tune reforms and develop mitigating measures.

### External financing
- External financing requirements for 2004/05 are US$ 1,245 million, reflecting higher import payments from increased oil prices and drought-related food imports, and lower projected investment.
- Indicative donor/partner commitments and timing:
  - World Bank base-case commitment of US$140 million under PSAC and FSAC; disbursement of US$75 million expected in late FY2004/05, and US$65 million in early FY2005/06.
  - AfDB plans to disburse US$21 million of program support in 2004/05.
  - European Union projected to disburse US$60 million of program support in early 2005.
  - Debt relief of about US$130 million from Paris Club creditors.
- Together with envisaged project support and private financing in FY2004/05 under the PRGF arrangement, these resources will cover the estimated financing need of about US$ 1.2 billion in 2004/05.

### Safeguards and statistics
- Government committed to protecting financial soundness of the CBK and to adhering to principles of good governance and best practices including IMF safeguards policy.
- Safeguards assessment of CBK conducted in September 2003 found notable progress since December 2000 on-site assessment.
- CBK committed to implementing measures to address remaining vulnerabilities and further strengthen operations.

*Source: _cr09225 - 16.      Government remains firmly committed to the reorientation of public expenditures in favor of growth and poverty-related outlays.*

### 28.      On statistical issues, the government has released a revised set of national

### _cr09225 - 28. On statistical issues, the government has released a revised set of national

### Statistical issues and data improvements
- The government has released a revised set of national accounts data.
- Steps being taken:
  - Improve monitoring of fiscal data, in particular, the preparation, on a regular basis, of summary statistics on domestic arrears and pending bills.
  - Develop a framework for systematically monitoring productivity changes in the economy.
  - Produce, on a regular basis, trade data.
- Participation and planned assessments:
  - Kenya participates in the General Data Dissemination System project for Anglophone Africa.
  - A statistics ROSC will be conducted in early 2005.

### Program monitoring for 2004/05 — overview
- Monitoring framework:
  - The program will be monitored using the definitions, data sources, and frequency of monitoring set out in the accompanying Technical Memorandum of Understanding (TMU).
  - The government will make available to Fund staff all data appropriately reconciled and on a timely basis, as specified in the TMU.
- Prior actions:
  - The government is taking a number of actions prior to the issuance of the staff report on the first review of the PRGF arrangement. The prior actions are described in this memorandum (Table 3).
- Reviews:
  - The second review under the PRGF arrangement will be completed no later than end-June 2005. This review will focus on:
    - restructuring of expenditure in favor of social and economic spending;
    - actions to enhance competitiveness;
    - progress in rationalizing the financial system;
    - progress in improving the auction system for government debt-instruments taking into account the recommendations of the November 2004 MFD technical assistance mission;
    - fiscal implications of restructuring the National Social Security Fund.
  - The third review under the PRGF arrangement is expected to be completed no later than end-December 2005.

### Structural performance criteria and benchmarks — implementation status (2003/04)
- Prior Actions (implementation dates and status):
  - Presentation to parliament of a budget for 2003/04 consistent with program understandings. — End June 2003 — Observed
  - Government to decide on transfer of financial sector regulatory functions from the Ministry of Finance to the Central Bank of Kenya (CBK). — End June 2003 — Observed
  - Reaching an understanding with staff on a time bound plan for restructuring the National Bank of Kenya (NBK). — End June 2003 — Observed. Subsequently, differences arose between Fund and Bank programs.
- Structural Performance Criteria (implementation dates and status):
  - Finalize an audit of the stock of pending bills and adopt measures that provide for the clearing of the stock of pending bills over a three-year period. — End December 2003 — Not observed. Financial audit completed but clearance plan to await conclusion of legal audit.
  - Completion of a report of the Committee of Officials on the new mechanism for determining the salaries of public officials to ensure the reduction of the wage bill in total expenditure. — End December 2003 — Observed
  - Completion of an audit on the financial position of National Social Security Fund (NSSF). — End December 2003 — Not observed. Audit was completed in March 2004
  - Submission to Parliament of a Banking Act Amendment Bill providing for transfer of all financial sector regulatory functions from the Ministry of Finance to the CBK. — End March 2004 — Not observed. Draft legislation was held up in Attorney General's office on account of limited drafting capacity. Presented to Parliament in June 2004.
  - No imposition of controls by the government or the CBK on the determination by commercial bank of bank fees, charges, or interest rates. — Continuous — Observed
- Structural Benchmarks (implementation dates and status):
  - Presentation of 2002/03 final budgetary accounts to the Auditor General. — End March 2004 — Observed
  - Reaching an understanding with staff on new wage setting mechanisms for public employees designed to reduce the share of the wage bill in total expenditure. — End March 2004 — Not observed. New wage setting mechanism agreed and incorporated in program for 2004/05.
  - Presentation to parliament of a bill to establish a framework for the transparent privatization and sale of public assets. — September/December 2003 — Not observed. Privatization bill presented to Parliament in January 2004.
  - Development of an action plan and timetable for introducing a Commitment Control System (CCS) to minimize deviations of expenditure outcomes from targets and the buildup of arrears. — End December 2003 — Partially observed. Most of the elements of a CCS have been implemented. A technical evaluation of the current expenditure control system to identify required actions has not yet been undertaken.
  - Establishment of a clear timetable for completion of initial asset declarations by all senior public officials. — End December 2003 — Observed. Initial declarations completed in November 2004.
  - Establishment of the Kenya Anticorruption Commission (KACC), with a credible management. — End December 2003 — Not observed. KACC became operational in September 2004.
  - Reaching of understandings on the fiscal implications of restructuring the NSSF. — End March 2004 — Not observed. NSSF restructuring to be undertaken in the context of the second World Bank FSAC beginning 2005/06.

### Quantitative performance criteria and benchmarks under the program for 2004/05 (Table 4) (In millions of Kenya shillings)
- Notes:
  - 1/ The fiscal year begins on July 1, 2004.
  - 3/ Floor.
  - 4/ Ceiling.
  - 5/ Continuous performance criterion.
  - 6/ Cumulative.
  - 2/ The performance criteria and benchmark under the program, and their adjusters, are defined in the technical memorandum of understanding (TMU). All test dates for the performance criteria and benchmarks are on an end-of-period basis.
- Cumulative change in net foreign assets of the Central Bank of Kenya (CBK) 3/:
  - December 2004 Benchmark: -7,022
  - March 2005 Performance Criterion: -2,213
  - June 2005 Benchmark: 9,028
  - September 2005 Indicative Target: 677
- Cumulative change in reserve money of the CBK 4/:
  - December 2004 Benchmark: 2,728
  - March 2005 Performance Criterion: 3,022
  - June 2005 Benchmark: 3,432
  - September 2005 Indicative Target: 3,494
- Cumulative change in net domestic financing of the central government, excluding government debt issued for any bank restructuring, and the new securitization of expenditure arrears. 4/:
  - December 2004 Benchmark: 19,966
  - March 2005 Performance Criterion: 27,252
  - June 2005 Benchmark: 26,982
  - September 2005 Indicative Target: 44,600
- Central government wages and salaries 4/:
  - December 2004 Benchmark: 52,064
  - March 2005 Performance Criterion: 78,096
  - June 2005 Benchmark: 104,128
  - September 2005 Indicative Target: 132,613
- New contracted or guaranteed nonconcessional external medium- and long-term debt by the central government or the CBK 4/ 5/:
  - December 2004 Benchmark: 0000
  - March 2005 Performance Criterion: 0000
  - June 2005 Benchmark: 0000
  - September 2005 Indicative Target: 0000
- New contracted or guaranteed external short-term debt by the central government or the CBK 4/:
  - December 2004 Benchmark: 0000
  - March 2005 Performance Criterion: 0000
  - June 2005 Benchmark: 0000
  - September 2005 Indicative Target: 0000
- Accumulation of domestic budgetary arrears 4/ 5/:
  - December 2004 Benchmark: 0000
  - March 2005 Performance Criterion: 0000
  - June 2005 Benchmark: 0000
  - September 2005 Indicative Target: 0000
- Accumulation of external payments arrears 4/ 5/:
  - December 2004 Benchmark: 0000
  - March 2005 Performance Criterion: 0000
  - June 2005 Benchmark: 0000
  - September 2005 Indicative Target: 0000
- Memorandum items:
  - Programmed external budgetary support 6/:
    - December 2004 Benchmark: 0
    - March 2005 Performance Criterion: 4,750
    - June 2005 Benchmark: 11,949
    - September 2005 Indicative Target: 16,010
  - Privatization receipts 6/:
    - December 2004 Benchmark: 100
    - March 2005 Performance Criterion: 169
    - June 2005 Benchmark: 200
    - September 2005 Indicative Target: 200
  - Program exchange rate (Kenya shillings per U.S. dollar):
    - December 2004 Benchmark: 78.95
    - March 2005 Performance Criterion: 78.95
    - June 2005 Benchmark: 78.95
    - September 2005 Indicative Target: 78.95

### Disbursement schedule under the three-year PRGF arrangement (Table 5)
- Disbursement amounts (In millions of SDRs) and conditions:
  - 1st: 25 — November 2003 — Contingent on Board Approval
  - 2nd: 50 — December 2004 — end-December 2003 performance criteria (PC)
  - 3rd: 50 — July 1, 2005 — end-March 2005 PC, and completion of the second review by end-June 2005
  - 4th: 25 — January 1, 2006 — end-September 2005 PC, and completion of the third review by end-December 2005
  - 5th: 25 — July 1, 2006 — end-March 2006 PC, and completion of the fourth review by end-June 2006
  - 6th: 25 — January 1, 2007 — end-September 2006 PC, and completion of the fifth review by end-December 2006
  - 7th: 25 — July 1, 2007 — end-March 2007 PC, and completion of the sixth review by end-June 2007
  - Total: 225
- Note:
  - 1 While these disbursements at present fall outside the period of the arrangement, it is expected that the authorities will in the future request an extension of the arrangement.

### Technical Memorandum of Understanding — key quantitative definitions and reporting requirements (selected)
- I. Introduction:
  - Memorandum sets out understandings regarding definitions of quantitative and structural performance criteria and benchmarks for the second annual program (for 2004/05, July to June) under the three-year PRGF arrangement, and related reporting requirements.
- A. Net Foreign Assets (NFA) of the Central Bank of Kenya (CBK):
  - Definition: NFA are defined as the average over the calendar month of the test dates of the difference between CBK holdings of gross official reserves (excluding crown agents and reserve tranche, pledged, swapped, or any encumbered reserves assets, including but not limited to reserve assets used as collateral or guarantees for third-party external liabilities) and its foreign liabilities (including IMF loans and other short- and long-term liabilities) of the CBK.
  - Exchange rates prevailing on September 28, 2001 will be used to convert the NFA into Kenya shillings at the end of each test period.
  - Adjustment clauses: NFA floors will be adjusted upward (or downward) by the sum of (i) excess (shortfall) in non-project-related external budgetary support relative to the programmed amount; and (ii) excess (shortfall) in privatization proceeds from external sources. Downward adjustment capped at the equivalent of US$280 million, converted at the program exchange rate prevailing on September 28, 2001. All targets cumulative from July 1, 2004 onward.
  - Reporting requirements: Data on gross international reserves, encumbered reserves, and foreign liabilities of the CBK will be transmitted to the Fund on a weekly basis within five working days of the end of each week. Detailed data on external project-related and non-project-related budgetary support (by donor/creditor and by currency of denomination) will be transmitted on a monthly basis within five working days of the end of each week.
- B. Reserve Money (RM) of the CBK:
  - Definition: RM is defined as the average over the calendar month of the test dates of reserve money, defined as total currency outside banks and bank reserves including till cash with the CBK.
  - The authorities will consult with the Managing Director of the Fund on any changes in the ratio of reserve requirements.
  - Reporting requirement: Daily balance sheets of the CBK will be transmitted on a weekly basis within five working days of the end of each week.
- C. Net Domestic Financing (NDF) of the Central Government:
  - Definition: NDF includes financing by the banking system (the CBK and commercial banks), non-bank financial institutions, and the nonbank public of the budget of the central government of Kenya; central government defined as in the Appropriation Accounts and in the parliament approved budget estimates for 2004/05.
  - Components: treasury bills, government stocks and bonds, promissory notes and other domestic debt instruments; loans and advances net of government deposits with the CBK and the banks. Excludes privatization proceeds not included in the budget, and government debt issued for any bank restructuring.
  - Calculation: cumulative change from July 1, 2004 onward in (i) loans and advances to the government by the CBK, including any interest arrears, minus government deposits with the CBK; (ii) loans and advances to the government by commercial banks, including interest arrears, minus government deposits held with the banks; (iii) changes in outstanding stock of treasury bills, government stocks and bonds, promissory notes and other domestic debt instruments, including interest arrears.
  - Adjustment clauses: Ceiling on NDF adjusted upward (downward) by the shortfall (excess) in non-project-related external budgetary support. Externally caused part of any upward adjustment in NDF capped at the equivalent of US$ 280 million less any shortfall in external privatization receipt, converted at the exchange rate prevailing at the time of disbursement.
  - Reporting requirements: Data on NDF of the central government will be submitted monthly within four weeks of the end of each month.
- D. Central Government Wages and Salaries:
  - Definition: Consists of all compensation of central government employees (excluding social contributions paid by employer). Central government defined as in the Appropriation Accounts and in the parliament approved budget estimates for 2004/05.
  - Reporting requirement: Data on central government wages and salaries will be provided monthly within three weeks of the end of each month.
- E. Contracting or Guaranteeing of New Nonconcessional External Medium- and Long-Term Borrowing Public External Debt:
  - Definition: Applies to debt as defined in Guidelines on Performance Criteria with Respect to Foreign Debt and to commitments contracted or guaranteed for which value has not been received. Applies to debt with original maturities of more than one year by the CBK or the general government. Excludes financial obligations to the Fund, domestically issued Kenya Shilling denominated treasury bonds with maturity greater than a year held by non-residents, and debt subject to debt rescheduling and debt reorganization.
  - Ceiling: zero on a continuous basis throughout 2004/05.
  - Concessionality: A debt is concessional if it includes a grant element of at least 35 percent, calculated using currency-specific CIRRs published by the OECD. For maturity at least 15 years, ten-year average CIRR used; for maturity less than 15 years, six-month average CIRR used.
  - Reporting requirement: Data on all new debt and guarantees by the CBK and the general government (including terms of loans and creditors) will be provided monthly within three weeks of the end of each month.
- F. New External Nonconcessional Short-Term Debt Contracted or Guaranteed by the General Government or the CBK:
  - Definition: Applies to nonconcessional debt with original maturities up to and including one year contracted or guaranteed by the CBK or the general government. Excludes financial obligations to the Fund, normal trade-related credits, and domestically issued Kenya Shilling denominated treasury bills with maturity of less than a year held by non-residents.
  - Ceiling: zero on a continuous basis throughout 2004/05.
  - Reporting requirement: Data on all new debt and guarantees by the CBK and the general government (including terms of loans and creditors) will be provided monthly within three weeks of the end of each month.

*Source: _cr09225 - 28. On statistical issues, the government has released a revised set of national (IMF staff report excerpt).*

### 17.      Definition. Domestic budgetary arrears are defined as the sum of all due and unpaid

### 17.      Definition. Domestic budgetary arrears are defined as the sum of all due and unpaid

### Domestic budgetary arrears — definition and program rule
- Domestic budgetary arrears are defined as the sum of all due and unpaid obligations of the central government of Kenya, where the central government is defined as in the Appropriation Accounts and in the Parliament approved budget estimates for 2004/05.
- Included obligations (but not limited to):
  - payment obligations from procurement contracts for goods and services and other contracts providing for payment in domestic currency;
  - statutory obligations for payment (e.g., of domestic debt, domestic interest, civil service wages, and other entitlements).
- Changes in domestic budgetary arrears are defined as: the stock of outstanding domestic arrears on the test date minus the stock of outstanding domestic arrears as of June 30, 2004.
- Under the program, the nonaccumulation of new domestic budgetary arrears is a continuous performance criteria.

### Domestic arrears — reporting requirement
- Detailed data on repayment and new accumulation of domestic budgetary arrears and the remaining previous-year stock of domestic budgetary arrears will be transmitted on a monthly basis within four weeks of the end of each month.

### External payments arrears (on nonreschedulable debt) — definition and program rule
- External payments arrears are defined as the non-payment of external obligations of the CBK or the general government of Kenya (general government as defined by the 2001 IMF Government Finance Statistics Manual) both with regard to principal and interest that are valid and due, but shall exclude arrears on obligations that are subject to rescheduling or restructuring.
- Under the program, the nonaccumulation of new external payments arrears is a continuous performance criteria.

### External arrears — reporting requirement
- Detailed data on the repayment and new accumulation of external payments arrears by the CBK and the general government and the stock of arrears at the beginning and end of each month will be transmitted on a monthly basis within four weeks of the end of each month.

### III. Other reporting requirements for program monitoring — I. Public Finance
- Monthly data on domestic financing (bank and nonbank) of the budget (including treasury bills and government bonds held by the nonbank public), domestic and external privatization proceeds, government debt instruments issued for bank restructuring, and new securitization of expenditure arrears will be transmitted on a monthly basis within three weeks of the end of each month.
- Data on the implementation of the development budget, with detailed information on the sources of financing, will be transmitted on a quarterly basis within four weeks of the end of each quarter.
- Public sector external and domestic scheduled debt service and payments will be transmitted on a monthly basis within three weeks of the end of each month.

### J. Monetary Sector — required data and timetables
- Daily/weekly (within one/five working day of the end each day/week):
  - Treasury-bill rates (weekly);
  - Interbank interest rate (daily).
- Monthly (or as specified) within four weeks of the end of the month:
  - The consolidated balance sheets of deposit money banks and the individual bank balance sheet, as needed;
  - The monetary survey;
  - Lending and deposit rates;
  - Standard bank supervision indicators for banks and nonbank financial institutions, respectively, and for individual institutions as needed;
  - Net foreign assets of commercial banks and nonbank financial institutions, broken down by instruments.

### K. External Sector — required data and timetables
- Weekly (within five working days of the end of each week): the following daily buying, selling, and average exchange rates:
  - (i) exchange rates used in interbank transactions among the commercial banks;
  - (ii) the average of (i) (official exchange rate, quoted daily based on the transactions of the previous day); and
  - (iii) foreign exchange purchases and sales by the CBK on interbank market and other inflows and outflows of foreign exchange to/from the CBK, separately.
- Export and import data, including volumes and prices, will be transmitted on a quarterly basis within eight weeks of the end of each quarter.
- Other balance of payments data, including the data on services, private transfers, official transfers, and capital account transactions, will be transmitted on a monthly basis within four weeks of the end of each month.

### L. Real Sector — required data and timetables
- Monthly disaggregated consumer price indices for Nairobi (Central Bureau of Statistics) will be transmitted on a monthly basis within four weeks of the end of each month.
- Any revisions to the national accounts data will be transmitted within three weeks of the date of revision.
- Data on real sector leading indicators will be transmitted within three weeks of the end of each month.
- Data on employment (formal and informal) and wages (including minimum wages and collective wage agreements) will be transmitted within four weeks of the end of each month.

### M. Governance and other structural reforms — reporting
- Documentation of all measures undertaken by the government will be transmitted to the IMF’s African Department within five working days after the day of implementation.

### Kenya: Relations with the Fund (selected factual points as presented)
- Membership Status: Joined February 3, 1964; Article VIII.
- General Resources Account (SDR million; Percent of quota):
  - Quota: 271.40 — 100.00
  - Fund holdings of currency: 258.71 — 95.32
  - Reserve position in Fund: 12.70 — 4.68
- SDR Department (SDR million; Percent of allocation):
  - Net cumulative allocation: 36.99 — 100.00
  - Holdings: 0.19 — 0.52
- Outstanding Purchases and Loans (SDR million; Percent of quota):
  - Poverty Reduction and Growth Facility (PRGF) arrangements: 70.83 — 26.10
- Financial Arrangements (type, approval date, expiration date, Amount Approved (SDR million), Amount Drawn (SDR million)):
  - PRGF: 11/21/03 – 11/20/06 — 175.00 approved — 25.00 drawn
  - PRGF/ESAF entries and ESAF entries listed with approval and expiration dates and amounts as presented.
- Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs) — Forthcoming:
  - 2004 Principal: 4.75
  - 2004 Charges/interest: 0.36
  - 2004 Total: 5.11
  - 2005 Principal: 4.99
  - 2005 Charges/interest: 1.07
  - 2005 Total: 10.24
  - 2006 Principal: 9.21
  - 2006 Charges/interest: 1.03
  - 2006 Total: 7.77
  - 2007 Principal: 6.72
  - 2007 Charges/interest: 0.99
  - 2007 Total: 7.68
  (Values presented exactly as in source.)
- Safeguards Assessments: CBK subject to a full safeguards assessment for the PRGF Arrangement approved on November 21, 2003; assessment completed on October 21, 2003.
- Exchange Arrangements: Kenya shilling; unitary exchange rate structure determined in the interbank market; official exchange rate set at the previous day’s average market rate for specified government uses; managed float with the U.S. dollar as principal intervention currency. On November 3, 2004, the exchange rate was K Sh 81.2=US$1.
- Article IV Consultations: Kenya is on the 24-month cycle; 2003 Article IV consultation concluded on May 2, 2003 (IMF Country Report No. 03/199, July 9, 2003).
- FSAP Participation: Joint IMF-World Bank FSAP missions took place in Nairobi in July and October, 2003.
- Technical Assistance: Multiple missions and activities listed by department and date ranges (e.g., MAE, STA, FAD, MFD) as presented in the source.
- Resident Representative: The Fund has had a resident representative in Kenya since December 1993. Mr. Jürgen Reitmaier is the current Senior Resident Representative.

*Source: _cr09225 - 17.      Definition. Domestic budgetary arrears are defined as the sum of all due and unpaid*

### 7.      Financial sector development. The IP-ERS identifies the urgent need to reform the

### 7.      Financial sector development. The IP-ERS identifies the urgent need to reform the financial sector in Kenya

### Financial sector diagnosis and planned support
- The financial sector is characterized by a high level of nonperforming loans, wide interest rate spreads, and operation within a weak legal and judicial system.
- The government is considering divesting the state’s stake in two of the biggest banks.
- Recent joint Financial Sector Assessment Program (Bank and IMF) significantly deepened knowledge of financial sector issues.
- World Bank support instruments and objectives:
  - Financial and Legal Sector Technical Assistance Credit (Board-approved October 2004) to:
    - support development of financial and legal sector strategies;
    - strengthen financial and legal sector regulations and institutions;
    - establish a bank restructuring and privatization project within the Ministry of Finance to guide bank privatizations.
  - Financial Sector Adjustment Credit (FSAC) planned for fiscal 2005 (budget support) to support:
    - divestiture of the state’s remaining ownership stakes in the banks;
    - enhanced banking supervision;
    - design of a policy to expand access to financial services, including in rural areas.

### Privatization and private sector participation
- Bank activity focused on technical advice for strategies to enable private sector participation in major public utilities.
- Grants from the Public-Private Infrastructure Advisory Facility (PPIAF) supported:
  - a study on concessioning of trunk roads;
  - a study on the legal and regulatory framework for the transport sector.
- Projects and roles:
  - Northern Corridor Transport Improvement Project (effective September 2004) to facilitate private sector participation in financing, construction, and management of the road.
  - IFC is transaction adviser for concessioning Kenya Railways jointly with Uganda Railways.
  - Public-private partnerships under consideration for water and energy services.

### Private sector development and MSMEs
- Joint Bank and IFC supported Micro, Small and Medium Enterprise Project approved July 2004 to facilitate MSME creation and growth.
- A three-year pilot Small and Medium Enterprises Solutions Center planned for fiscal 2005.
- IFC supports:
  - the multidonor Africa Project Development Facility (firms’ access to financial and other services);
  - the African Management Services Company (management expertise).
- Recent analytical work:
  - investment climate assessment;
  - administrative barriers study (Bank Group’s Foreign Investment Advisory Service).
- ERSSC planned for Board approval in fiscal 2006 to support implementation of study recommendations.

### Infrastructure development
- IP-ERS highlights inadequate physical infrastructure as a major impediment to private sector development.
- World Bank and IFC support:
  - Northern Corridor Transport Improvement Project to reconstruct road network linking Kenya with Uganda, Rwanda, Burundi, and the Democratic Republic of Congo, and to help upgrade Nairobi’s Jomo Kenyatta International Airport to address the threat of terrorism.
  - IFC as transactions advisor for joint concessioning of Kenya’s and Uganda’s national railways (expected completion by summer 2005).
  - Nairobi Water and Sewerage Institutional Restructuring Project (grant-financed; effective September 2004) to build institutional and governance framework for water and sewerage services in Nairobi.
  - Energy Sector Recovery Project (effective November 2004) to improve efficiency of electricity production and distribution, promote private sector participation, and improve power sector management and corporate governance.

### Agriculture and environment
- Bank contributions include analyses of agricultural markets, rural service delivery, linkages between poverty and agricultural growth, and sector studies (cotton, coffee, sugar, pyrethrum, horticulture).
- Operations and planned support:
  - ERSSC and subsequent PRSCs to support reform implementation.
  - Agricultural Productivity Project (effective October 2004) to transform research and extension to a demand driven, farmer-led, pluralistic system and support associated policy reforms.
  - Arid Lands Resource Management Project Phase Two (effective September 2003) using multisectoral, district based, community driven development in arid and semiarid districts.
  - Multicountry Lake Victoria Environmental Project to establish sustainable management institutions.
  - GEF-supported Western Kenya Integrated Ecosystem Management Project (Board presentation planned January 2005) to improve soils, water, biodiversity management and raise agricultural productivity.
  - GEF-supported Agriculture Productivity and Sustainable Land Management Project (Board presentation scheduled May 2005) to promote improved soil and water management of key water catchments.
  - Bank water resources sector memorandum preparing ground for a future water resources management project.

### Education and health
- Education:
  - Free Primary Education Project (US$50 million grant) effective July 2003.
  - Recently completed analytical work on primary and secondary education and support to ministerial PER.
  - Preparing a sectorwide (SWAp) education program for approval in fiscal 2006 to support primary and secondary education; will strengthen monitoring and evaluation, financial management, and planning/allocation of expenditures to prepare for future PRSC support.
  - Global Development Learning Network project (grant-financed; effective February 2004) to develop learning and knowledge-sharing mechanisms among policy makers.
- Health:
  - Analytical work planned: pharmaceutical sector review (fiscal 2005) and comprehensive health sector PER.
  - Decentralized AIDS and Reproductive Health Project ongoing to improve mother and child health through integrated child survival, reproductive health, and HIV/AIDS services; prepares ground for a health sector SWAp in fiscal 2006 developed with major stakeholders.

### HIV/AIDS
- Bank support:
  - Kenya first country to access funds under the Africa Region’s Multi-Country AIDS Program (MAP).
  - Follow-on MAP planned for fiscal 2006 focusing on prevention, reaching vulnerable groups, and increasing access to comprehensive care and treatment.
  - Support to National AIDS Control Council and provincial, district, local-level bodies and line ministries for mainstreaming HIV/AIDS activities.

### Nonlending activities and analytic priorities
- Strategic Gender Assessment completed fiscal 2003 highlighting high poverty and vulnerability of many Kenyan women and discrimination in access to health, education, and employment.
- Planned analytical work (next two fiscal years) to:
  - support efficient public allocation of funds to priority development areas;
  - expand poverty analysis, particularly rural poverty;
  - expand findings of the 2003 country economic memorandum on sources of growth and competitiveness;
  - support growth in agricultural and livestock production;
  - better understand barriers to trade;
  - deepen knowledge of labor markets.
- Preparatory core diagnostic work for budget support credits planned for fiscal 2005, including:
  - country procurement assessment report;
  - updated country financial accountability assessment;
  - poverty analysis.

### Summary of Bank’s Lending Portfolio (As of October 31, 2004)
- Total Active = 15; Loan/Credit Amount = 761.20 (in millions of US dollars); Undisbursed on 10/31/04 = 538.28 (in millions of US dollars).
- Selected projects, sectors, closing dates, loan/credit amounts, and undisbursed amounts (as presented):
  - Urban Transport Infrastructure — Transport — 6/05 — 115.00 — 25.78
  - Development Learning Center — Public Admin — 12/08 — 2.7 — 2.42
  - HIV/AIDS Disaster Response — Health — 6/05 — 50.00 — 20.13
  - Decentralized AIDS and Reproductive Health Project — Health — 6/05 — 50.00 — 33.85
  - Regional Trade Facilitation Project — Private Sector — 6/11 — 25.00 — 14.78
  - Public Sector Management TA Program — Public Sector — 06/05 — 15.00 — 6.34
  - Arid Lands II — Agriculture — 6/09 — 60.00 — 53.47
  - Free Primary Education — Education — 12/06 — 50.00 — 6.64
  - Lake Victoria Environment (GEF) — Environment — 12/05 — 11.50 — 4.66
  - Nairobi Water & Sewerage TA — Water — 06/07 — 15.00 — 13.69
  - Agricultural Productivity — Agriculture — 12/07 — 40.00 — 39.79
  - Northern Corridor Transport — Transport — 12/09 — 207.00 — 196.28
  - Energy Sector Recovery — Energy — 03/10 — 80.00 — 80.64
  - Financial and Legal Technical Assistance — Finance — 03/10 — 18.00 — 17.90
  - MSME Competitiveness — Private Sector — 06/10 — 22.00 — 21.91

### IMF-World Bank collaboration — overview and specific areas
- General: IMF and World Bank staffs maintain close collaboration in support of Kenya’s structural reforms through lending, analytic work, and technical assistance.
- Joint assessment: Bank and IMF jointly assessed the government’s IP-ERS in April 2004; Bank Board discussed May 6, 2004; IMF Board discussed May 10, 2004.

### Macroeconomic framework and roles
- IMF leads analysis and dialogue on monetary policy (money supply, inflation, exchange rate changes, central bank operations).
- Bank collaborates with IMF on fiscal policy dialogue (fiscal sustainability, size of public sector); current focus includes:
  - size of overall fiscal deficit;
  - fiscal risks;
  - public service wage bill;
  - pay reform;
  - revenue performance, including tax administration and adjustment to tax policy;
  - domestic debt financing of the deficit.
- Bank leads analysis on economic growth and poverty; both institutions collaborate on trade reform.

### Budgetary and public expenditure reforms
- Bank leads dialogue on planning, MTEF preparation, strategic resource allocation (aligning budget allocations with IP-ERS priorities), expenditure restructuring, stakeholder participation, and efficiency of public spending (including expenditure tracking).
- Joint Bank-IMF Public Expenditure Management Assessment and Action Plan (PEM-AAP) completed April 2004.
- A technical working group (Bank, IMF, donors, stakeholders) monitors PER process and reform implementation.
- Bank and IMF collaborate on internal audit reform and IFMIS.
- Both are members of the Budget Support Donor Coordination Group and the Joint Technical Working Group preparing government for budget support.
- Bank and IMF coordinating closely on ERSSC conditionality and PRGF arrangement conditionality.

### Revenue administration and customs
- Joint detailed assessments of tax administration and customs operations recently carried out.
- Fund providing technical assistance to the Kenya Revenue Authority.
- Bank assisting customs department study of container clearance time.
- Fund (through AFRITAC) and Bank collaborating to support Kenya Revenue Authority prepare reform and modernization plan for funding under follow-on PSMTAP planned for fiscal 2006.

### Debt management and debt sustainability
- IMF recently updated external debt sustainability analysis.
- In the Financial Sector Assessment Program, a joint World Bank/IMF initiative supports capacity-building in sovereign debt management and domestic debt market development.

### Governance reforms
- High levels of public corruption and poor security contributed to poor economic performance in the last decade; governance reforms are key to promoting growth and reducing poverty.
- New PRGF arrangement will support deepening anticorruption measures.
- Bank supports strengthening legal and judicial institutions through the Financial and Legal Sector Technical Assistance Project.
- Bank will prepare a country procurement assessment report in fiscal 2005 jointly with the government.

### Financial sector reforms (joint actions)
- Joint in-depth Financial Sector Assessment Program (banking, insurance, capital markets) led by the IMF produced:
  - technical notes on selected topics;
  - detailed assessments of standards and codes;
  - the IMF’s Financial System Stability Assessment;
  - the Bank’s Financial Sector Assessment.
- Bank and IMF expected to coordinate closely on prior actions and conditionality of the FSAC.

### Privatization, private sector development, trade reforms, and regional integration
- Bank leads dialogue on privatization and regulatory reforms; IMF partners on fiscal burden issues.
- Bank supports private sector participation via regulatory reform and assistance for privatization/restructuring in power, railways (IFC), and urban water.
- MIGA supports private sector development through competitiveness comparisons, technical assistance, capacity building, and political risk guarantees.
- Trade and regional integration:
  - Kenya expected to form a customs union with Tanzania and Uganda in 2005 (East African Community).
  - Kenya active in COMESA negotiations and activities.
  - Bank produced a technical note on implications of an EAC customs union for revenue and trade flows; IMF served as peer reviewer; note being updated for the latest common external tariff agreement.
  - Bank conducting diagnostic trade integration study to be completed in fiscal 2005.
  - Bank assessing nonfiscal investment incentives in each of the three EAC states; complemented by an IMF assessment of fiscal investment incentives; both to be used to harmonize incentives for the planned customs union.
  - Regional Trade Facilitation Project (US$25 million) aimed at improving access to finance for cross-border trade; follow-on project planned for fiscal 2006.
  - Bank preparing an EAC Regional Transport and Trade Facilitation Project for fiscal 2006 to support customs union implementation and institutional/investment support for regional transport.

*Prepared by World Bank staff.*

### 1. Weaknesses in key macroeconomic statistics hamper economic analysis and

### 1. Weaknesses in key macroeconomic statistics hamper economic analysis and surveillance

### Overview
- Kenya's macroeconomic statistics have deteriorated significantly over the past decade, reflecting primarily managerial and organizational weaknesses, and inadequate resources provided to the Central Bureau of Statistics (CBS).
- During the 2003 Article IV consultation discussions, staff emphasized the need to improve timeliness and quality of statistics and encouraged prompt implementation of STA recommendations from previous technical assistance.

### Actions under way and donor assistance
- Kenya participates in the General Data Dissemination System (GDDS) and the GDDS project for Anglophone Africa; metadata and detailed plans for short- and medium-term improvements have been posted on the Fund’s DSBB.
- Kenya received Fund technical assistance under this project; further capacity-building assessment undertaken by the AFRITAC East Statistical Advisor.
- Authorities are preparing a statistical development plan and a new statistical act to strengthen CBS independence.
- A 1998 STA multitopic mission prepared a work program to implement principal recommendations; a peripatetic STA advisor assisted in improving balance of payments and national accounts data.

### National accounts
- Data quality, previously reported as good, has deteriorated significantly because of budgetary and staff constraints at the CBS.
- GDP is believed to be significantly underestimated because important and increasing parts of the economy (informal sector, nonagriculture subsistence, horticulture, self-employed professionals) are not properly covered.
- STA peripatetic advisor assisted in rebasing national accounts estimates at constant 2001 prices and compiling institutional accounts for the general government sector.
- In May 2004, revised national accounts estimates following the 1993 SNA (at constant 2001 prices) for the years 1996–2003 were released.

### Prices and production
- CBS commenced publication in early 2002 of a new national CPI (covering 12 urban areas), base year 1997, weights derived from the 1992–93 HBS.
- The CPI index is compiled and published on a timely basis.
- There is no producer price index, nor short-term export and import price indices produced.

### Government finance statistics (GFS)
- The 1998 multisector statistics mission found problems with cumulative year-to-date monthly and quarterly fiscal data compiled by the Ministry of Finance (MoF) for AFR budget-monitoring: data do not conform to Fund GFS methodology and inadequately facilitate economic analysis, mainly due to inappropriate classification of expenditure data.
- MoF has not developed a system to adequately monitor expenditure commitments or domestic arrears, relying mainly on monitoring cash movements in government accounts at the CBK.
- Recording of external financing and expenditure directly financed from abroad remains an area for improvement.
- The 1998 mission made several recommendations for improving data; most have not been implemented.
- CBS compiles and reports aggregate annual GFS revenue and expenditure data for budgetary central government based on Controller and Auditor General reports, using a methodology established by a 1999 STA GFS mission.
- Lack of proper computerization prevents CBS from compiling more detailed GFS data.
- Considerable differences exist between CBS GFS data and MoF data reported to AFR for surveillance and program monitoring.
- If implemented, recommendations of the February 2004 technical assistance mission in GFS will significantly improve quality and availability of fiscal data.

### Monetary statistics
- Monetary statistics are compiled from a bank reporting system and are broadly adequate for policy, analytical, and supervisory purposes.
- A STA technical assistance mission in January 2000 observed that authorities had implemented virtually all recommendations of previous STA missions, leading to several improvements.
- The mission identified further problems and made recommendations, in particular on:
  - (a) asymmetrical interbank positions,
  - (b) statistical implications of numerous bank closures,
  - (c) coverage of international reserves.
- Authorities have initiated revisions to monetary statistics in line with mission recommendations.

### Balance of payments statistics
- CBS compiles and reports balance of payments data in Kenya shillings annually on a regular basis to STA, although with a considerable lag.
- CBK compiles a complete set of annual balance of payments statistics in U.S. dollars, reported to AFR and used for programming and surveillance.
- The two datasets are not entirely consistent; Fund staff has strongly encouraged authorities to reconcile them.
- CBK recently started to compile and publish discrete quarterly balance of payments estimates.
- Quality of balance of payments data has deteriorated. While trade data may be reasonably good, data for other current account and many financial account transactions are weak.
- Since liberalization of the exchange system in 1993-94, gaps emerged in coverage of BOP source statistics. The compilation system used since 1994 (other than customs statistics) relies on reports from domestic banks and may result in substantial underrecording of current earnings (including tourism receipts) and failure to capture transactions settled via accounts held abroad.
- Present estimates of direct and portfolio investment are believed to be substantially understated.
- Large positive errors and omissions in central bank data since 1994 raise concerns about the potential size of external obligations.
- MoF compiles data covering Kenya’s public and publicly guaranteed external obligations to official and commercial creditors; this database does not take account of nonresident purchases of the government’s domestic currency-denominated debt securities.

### External debt statistics and management
- In developing the loan-by-loan DSA in 2002, Fund and World Bank staff identified several significant debt data problems that have since been addressed by the authorities.
- Significant debt data management problems remain, along with general issues in external debt management and its integration into budget formulation and expenditure management systems.
- An ongoing project supported by, inter alia, a World Bank Financial Sector and Legal Technical Assistance credit, is expected to produce significantly strengthened debt data; an updated DSA will be conducted when these data are available.

### Debt Sustainability Analysis (DSA) update — central government and external debt
- Broad conclusions of prior DSA (IMF Country Report No. 03/400 and No. 03/399, January 8, 2004) remain valid: debt is sustainable (taking into account Paris Club rescheduling), and under the revised program framework, external and central government debt sustainability improves.
- Central government debt:
  - Updated DSA shows a steady decline in central government debt (Table 1 referenced).
  - In 2004 and 2005, the ratio is lower under the present scenario than under the November 2003 baseline, reflecting underperformance of domestic borrowing and donor inflows in 2003/04 and expectations of lower donor inflows throughout the program period.
  - In the medium/long-term (2007 to 2015), the ratio is not even one full percentage point higher under the updated analysis compared to the earlier DSA, indicating the projected increase in domestic borrowing does not materially jeopardize debt sustainability.
  - Kenya’s central government debt profile appears relatively robust to various shocks; the most serious stress would come from a sharp real depreciation where the NPV debt to GDP ratio increases to around 71 percent during the program period.
- External debt:
  - Under the revised program scenario, the NPV of debt to exports ratio averages 104 percent over 2004–07 versus 120 percent over the same period in the November 2003 analysis.
  - Factors for the lower profile:
    - Expectations of donor inflows did not materialize in the first program year and projections were lowered.
    - Kenya secured a rescheduling with the Paris Club in January 2004; Houston terms rescheduling does not lower debt stock but reduces debt service paid during 2004–2007 consolidation period.
    - DSA covers official debt only due to unavailability of private sector external debt stock data; expected future private external borrowing could add to the projected NPV of debt to GDP ratio.
    - Debt data weaknesses mean DSA results must be interpreted with caution.
  - A combined real GDP growth and net non-debt creating low shock pushes the NPV debt to exports ratio to 173 percent in 2005; the ratio declines relatively quickly to below 150 percent.
  - The debt service due ratio averages 8 percent during the program period, and declines further over the long-term.
  - Alternative scenarios indicate the debt service ratio would increase significantly under stresses tested but generally not to levels of concern; the debt service ratio is most affected by a fall in export value growth and the combined GDP growth and non-debt creating flow shock.

*IMF staff report excerpt: "Weaknesses in key macroeconomic statistics hamper economic analysis and surveillance."*

### Conclusions

### Conclusions

### Main finding
- Kenya’s debt appears sustainable under the current scenario, but certain shocks could push debt indicators to higher levels, requiring continued vigilance.
- The authorities state that fiscal and external debt management policies will continue to balance the commitment to debt sustainability with the need to support the poverty reduction strategy.

### Projections and key indicators
- Total central government debt (percent of GDP): 51.5, 53.6, 51.1, 49.7, 49.4, 48.8, 47.3, 44.6, 39.9 (2001–2015 sequence as presented).
- Foreign-currency denominated debt (percent of GDP): 30.7, 30.1, 27.8, 27.4, 27.2, 27.1, 26.7, 23.3, 18.6.
- Domestic currency denominated debt (percent of GDP): 20.9, 23.5, 23.3, 22.3, 22.1, 21.7, 20.6, 21.3, 21.3.
- Change in NPV (percent of GDP): -6.1, 2.0, -2.5, -1.4, -0.3, -0.5, -1.5, -3.9, -0.8.
- Identified debt-creating flows (percent of GDP): -1.3, 0.8, -4.8, -2.9, -3.2, -1.2, -0.5, -0.7, 0.3.
- Primary deficit (percent of GDP): -1.9, 0.4, -1.1, -1.2, 0.1, 0.7, 0.4, 0.5, 0.5.
- Revenue and grants (percent of GDP): 24.1, 21.9, 22.6, 22.7, 23.7, 25.2, 25.7, 19.9, 19.9.
  - Grants (percent of GDP): 2.2, 0.8, 2.0, 1.5, 2.8, 3.7, 3.2, 1.5, 1.5.
- Primary (noninterest) expenditure (percent of GDP): 22.2, 22.3, 21.6, 21.5, 23.8, 25.9, 26.1, 20.4, 20.4.
- Grant element of new concessional loans (percent of GDP): 0.0, 0.0, -2.0, -2.3, -3.3, -3.2, -2.4, -2.1, -1.4.
- Automatic debt dynamics (percent of GDP): 0.6, 0.5, -1.8, 0.5, -0.1, 1.3, 1.5, 0.9, 1.2.
  - Contribution from real discount rate on foreign-currency debt: 2.7, 2.7, 2.5, 2.4, 2.2, 2.1, 2.0, 1.8, 1.4.
  - Contribution from real interest rate on domestic debt: 1.1, 1.1, 0.0, 0.0, 0.7, 1.3, 1.5, 1.7, 1.9.
  - Contribution from real GDP growth: -0.6, -0.5, -0.9, -1.2, -1.5, -1.6, -1.8, -2.3, -1.9.
  - Contribution from real exchange rate depreciation: -2.6, -2.7, -3.3, -0.7, -1.5, -0.5, -0.2, -0.3, -0.3.
- Residual, including asset changes (percent of GDP): -4.8, 1.2, 2.3, 1.6, 2.9, 0.7, -1.1, -3.2, -1.0.
- Nominal value of Central Government debt (percent of GDP): 65.3, 65.7, 59.5, 55.6, 54.6, 53.6, 52.0, 48.7, 41.2.
- Gross financing need (percent of GDP): 13.4, 13.9, 9.5, 8.1, 9.1, 9.6, 9.3, 3.5, 3.3.
- Central Government debt-to-revenue-and-grants ratio (percent): 271, 299, 263, 245, 231, 212, 202, 245, 207.
- Debt service-to-revenue-and-grants ratio (percent): 60.0, 65.4, 47.9, 41.3, 37.6, 35.5, 34.5, 30.1, 28.7.
- Primary deficit that stabilizes the NPV of debt-to-GDP ratio (percent): 4.2, -1.7, 1.4, 0.2, 0.5, 1.2, 1.9, 4.4, 1.3.

### Key macroeconomic and fiscal assumptions (as presented)
- Real GDP growth (in percent): 1.1, 1.1, 1.7, 2.4, 3.0, 3.4, 3.8, 5.0, 5.0.
- Average nominal interest rate on forex debt (in percent): 2.1, 1.8, 1.7, 1.9, 1.9, 1.9, 1.9, 1.9, 1.8.
- Average real interest rate on domestic debt (in percent): 5.6, 5.5, -0.1, 0.2, 3.3, 6.1, 7.0, 7.4, 9.6.
- Real exchange rate depreciation (percentage change, +=depreciation): -6.7, -8.2, -10.4, -2.3, -5.2, -1.7, -0.7, -1.3, -1.3.
- Inflation rate (GDP deflator, in percent): 9.1, 8.4, 11.5, 10.3, 7.8, 4.4, 3.6, 3.3, 3.3.
- US Inflation rate (GDP deflator, in percent): 2.4, 1.1, 1.5, 1.2, 1.7, 2.0, 2.0, 2.0, 2.0.
- Growth of real primary spending (deflated by GDP deflator, in percent): 2.8, 1.5, -1.7, 1.9, 14.2, 12.6, 4.6, 5.0, 5.0.
- Major commodity price (tea): 1.6, 1.6, 1.7, 1.8, 1.8, 1.9, 1.9, 1.9, 1.9.

### Stress tests and alternative scenarios
- Alternative scenarios considered include:
  - A1. Real GDP growth and primary balance at historical averages.
  - A2. Primary balance unchanged from 2002 / New public sector loans on less favorable terms in 2004-23 (less favorable financing specification noted in footnotes).
- Bounds and stress tests considered include shocks such as:
  - B1. Real GDP growth at baseline minus two standard deviations (or minus one standard deviation in other tables).
  - B2. Primary balance at baseline minus two standard deviations.
  - B3. Combination scenarios using one standard deviation shocks.
  - B4. Long-run real GDP growth at baseline minus two standard deviations.
  - B5. One-time 30 percent real depreciation in 2003 (or in 2004 in other tables).
  - B6. 10 percent of GDP increase in other debt-creating flows in 2003.
  - B7. Permanent, two standard deviation negative shock to the major commodity price in 2003.
- Stress-test results indicate that under some scenarios debt and debt-service indicators rise significantly (tables and figures present NPV of debt-to-GDP, NPV of debt-to-exports, and debt service-to-exports under baseline, historical scenario, and most extreme stress test).

### Policy implications and recommendations
- Continue vigilant fiscal and external debt management to preserve sustainability given vulnerability to shocks.
- Balance debt sustainability objectives with support for the poverty reduction strategy, as stated by the authorities.
- Monitor identified debt-creating flows (including primary balance, grant element of new concessional loans, and automatic debt dynamics) and residuals closely, since these items materially affect NPV and nominal debt paths.

*Sources: Country authorities; and Fund staff estimates and projections.*

### 1.      We have received confirmation from the Ministry of Finance in Nairobi that the four

### We have received confirmation from the Ministry of Finance in Nairobi that the four prior actions for the issuance of the staff report have been met

### Prior actions and institutional reforms
- Prior action met: transfer in September 2004 of departments responsible for budget monitoring and the medium-term expenditure framework from the Ministry of Planning and National Development to the Ministry of Finance.
- Strengthening of management teams in the Debt Management and Fiscal and Monetary Analysis Units of the Ministry of Finance completed, fulfilling the prior action on restructuring and strengthening Ministry of Finance capacity to manage macroeconomic and fiscal policies.
- Expenditure releases are managed within the program’s fiscal framework, which limits domestic borrowing in 2004/05 to Ksh 32 billion (2.5 percent of GDP).
- Revenue collection increased by about 25 percent during the first five months of 2004/05, well above the assumed increase of 7 percent under the program.
- Government agreed on a system of annual declarations and verifications of the assets of ministers, permanent secretaries, and heads of state corporations.
- Budget Outlook Paper for 2005/06-2007/08 completed in November 2004.

### Banking, Central Bank of Kenya (CBK) amendments, and regulatory implications
- Parliament passed the CBK (Amendment) and Banking (Amendment) Bills; CBK (Amendment) Bill passed as presented, Banking (Amendment) Bill modified to retain Section 44 requiring prior approval of the Minister of Finance when setting banks’ fees and charges.
- Main implications:
  - Virtually all banking sector regulatory and supervisory authority have been transferred from the Ministry of Finance to CBK.
  - Provisions of the CBK (Amendment) Act that provided for the control of interest rates have been removed.
- Structural performance criterion (presentation to parliament of an amendment to the Banking Act to transfer all financial sector regulatory functions from the Ministry of Finance to CBK) was under the program for end-March 2004.
- Minister of Finance confirmed the government will continue to desist from applying Section 44 of the Banking Act despite its retention.

### Macroeconomic developments and near-term outlook
- Real GDP growth projected at 2.7 percent in 2004/05 after an estimated 2.1 percent in the previous year.
- Headline consumer price inflation accelerated sharply and reached 16.6 percent in October 2004.
- Monetary policy was expansionary since 2003/04 to promote growth; ex post real interest rates were negative over much of the past year.
- Central Bank began to tighten monetary policy in September 2004; three-month Treasury bill rates increased from 2.75 percent in September to 7.2 percent in late November 2004.
- Recent shocks: drought and sharp increase in oil prices—these contributed to higher food prices and inflationary pressures and may have worsened poverty indicators.
- Current account shifted from a surplus of 1.2 percent of GDP in 2002/03 to a deficit of 2.0 percent in 2003/04, reflecting a drop in private savings.
- Foreign reserves rose by about U.S. $140 million but declined moderately in percent of imports.

### Fiscal developments and risks
- Overall fiscal performance strengthened during 2003/04 due to strong revenue collection and steps to control recurrent expenditure.
- Domestic borrowing was much lower than budgeted; ratio of domestic debt to GDP fell from 24.3 percent at end-June 2003 to 22.2 percent of GDP at end-June 2004.
- Directors noted significant fiscal risks: projected high deficits and uncertain magnitude of donor support; fiscal risks from weak public enterprises and costs of addressing HIV/AIDS.
- Directors advised against contracting any new nonconcessional debt.
- Emphasis on effective expenditure monitoring and building a robust public expenditure management (PEM) system; strengthening links between medium-term expenditure framework and annual budget.

### Structural reforms, governance, and financial sector priorities
- Progress mixed: some governance strengthening (establishment of Kenya Anti-Corruption Commission), but important gaps remain; Directors urged adequate funding of anticorruption agencies and full investigation, disclosure, and punishment in corruption cases.
- Urged continuation of asset declarations by senior officials.
- Need to accelerate public enterprise restructuring and privatization; urged parliamentary enactment of the Privatization Bill and prompt implementation.
- Financial system reforms: welcomed amendments that transfer bank regulatory functions to CBK and remove official controls of interest rates; noted ongoing fragility due to large nonperforming loans (NPLs) and distressed banks, particularly public banks.
- Recommended prompt action on distressed banks, reduction of large NPLs, and acceleration of bank privatizations.
- Need to strengthen Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework.
- Capacity constraints: shortages of skilled personnel and weaknesses in public administration constrain implementation of poverty programs and absorption of donor support; welcomed restructuring to rebuild capacity in Ministry of Finance and key line ministries.
- Statistics: welcomed revised national accounts data and steps to improve fiscal monitoring; quality of statistics remains weak and further improvements urged with AFRITAC support as appropriate.

### Executive Board assessment and policy recommendations
- Board conclusions (December 20, 2004): progress under PRGF-supported program—rebound in growth begun, domestic debt rise arrested, structural reforms underway; capacity constraints being addressed.
- Main near-term challenge: accelerate broad-based growth to reduce poverty while securing fiscal consolidation and low inflation.
- Near-term policy prescriptions:
  - Prudent fiscal management.
  - Firm control over monetary aggregates to bring down inflation.
- Medium-term prescriptions:
  - Tight fiscal policy supported by broadening and acceleration of structural reforms to enhance economic efficiency, expand private sector role, and promote increased donor support.
  - Strengthen governance and anti-corruption measures to enhance donor support and poverty reduction prospects.
- PRGF financing decision: Executive Board approved augmented access under the PRGF by SDR 50 million (about US$ 76.9 million), bringing total drawn under the arrangement to about SDR 75 million (about US$115.4 million).
- PRGF terms: annual interest rate of 0.5 percent; repayable over 10 years with a 5½ year grace period on principal payment.

### Selected economic indicators (2000/01–2003/04) — key figures preserved exactly as presented
- GDP volume (factor cost): 2000/01 = 0.5; 2001/02 = 1.2; 2002/03 = 1.5; 2003/04 (Prelim.) = 2.1 (Annual percent change).
- Consumer price index (annual average): 2000/01 = 10.0; 2001/02 = 2.3; 2002/03 = 6.6; 2003/04 = 8.2.
- Nominal effective exchange rate (- depreciation; end of period): 2000/01 = 8.3; 2001/02 = -5.9; 2002/03 = -5.2; 2003/04 = -11.1.
- Real effective exchange rate (- depreciation; end of period): 2000/01 = 10.2; 2001/02 = -4.7; 2002/03 = 4.7; 2003/04 = -8.2.
- M3X (M3 plus foreign currency deposits, end of period): 2000/01 = 2.1; 2001/02 = 6.7; 2002/03 = 10.9; 2003/04 = 12.9.
- Reserve money (end of period): 2000/01 = -8.5; 2001/02 = 10.9; 2002/03 = 11.2; 2003/04 = 5.5.
- Interest Rate (90-day Treasury Bill, period average): 2000/01 = 12.1; 2001/02 = 10.9; 2002/03 = 7.2; 2003/04 = 1.6.
- Central government budget (percent of GDP):
  - Total revenue: 2000/01 = 23.0; 2001/02 = 21.5; 2002/03 = 20.5; 2003/04 = 21.7.
  - Total expenditure and net lending: 2000/01 = 27.8; 2001/02 = 24.9; 2002/03 = 25.9; 2003/04 = 23.5.
  - Overall balance (commitment basis) excluding grants: 2000/01 = -4.8; 2001/02 = -3.4; 2002/03 = -5.4; 2003/04 = -1.7.
  - Net domestic borrowing: 2000/01 = 0.1; 2001/02 = 4.3; 2002/03 = 4.6; 2003/04 = 0.8.
  - Total donor support (grants & loans): 2000/01 = 4.5; 2001/02 = 1.9; 2002/03 = 2.2; 2003/04 = 2.4.
- Balance of payments:
  - Exports goods, f.o.b. (in million of U.S. dollars): 2000/01 = 1,870.0; 2001/02 = 1,962.0; 2002/03 = 2,322.0; 2003/04 = 2,491.0.
  - Imports goods, f.o.b. (in million of U.S. dollars): 2000/01 = 3,310.0; 2001/02 = 2,823.0; 2002/03 = 3,215.0; 2003/04 = 3,870.0.
  - Current external balance, excluding official transfers (percent of GDP): 2000/01 = -3.7; 2001/02 = -0.8; 2002/03 = 1.2; 2003/04 = -2.0.
  - Gross international reserve coverage in months of next year imports (end of period): 2000/01 = 3.5; 2001/02 = 3.3; 2002/03 = 3.3; 2003/04 = 3.0.
- Public debt:
  - NPV of central government debt (end of period): 2000/01 = 54.0; 2001/02 = 53.4; 2002/03 = 51.9; 2003/04 = 49.6.
  - Domestic debt, net: 2000/01 = 19.6; 2001/02 = 22.0; 2002/03 = 24.3; 2003/04 = 22.2.
  - External debt: 2000/01 = 34.4; 2001/02 = 31.4; 2002/03 = 27.6; 2003/04 = 27.4.

*Source: IMF staff report excerpts and IMF Public Information Notice and Press Release (December 20, 2004).*

### Introduction and Background

### _cr09225 - Introduction and Background

### Introduction and Background
- Kenyan authorities welcome staff papers and request Executive Board support for:
  - Completion of the First Review under the Poverty Reduction and Growth Facility (PRGF).
  - Augmentation of Access, Rephasing of the Arrangement and Waiver of Performance Criteria.
- Authorities agree with the thrust of the staff assessment and view reports as fair and balanced.
- Commitment highlights:
  - Continued prudent macroeconomic policy measures and wide-ranging reforms.
  - Prioritization of expenditures in line with the Economic Recovery Strategy (ERS) with gradual reorientation towards pro-poor expenditure and investments.
  - Improved donor coordination to ensure efficient fiscal management and mobilization of resources for poverty reduction.
  - Political will to enhance the investment climate, strengthen governance institutions, deepen the financial sector, and enact a new constitution.

### Recent Economic Developments and Prospects
- Growth and projections:
  - Kenyan economy estimated to have grown by 2.1 percent in 2004.
  - Real GDP projected at 2.7 percent in 2004/05, lower than the 3.1 percent expected in the original program.
  - ERS target growth: 6 percent.
- Factors affecting performance:
  - High oil prices, severe drought, depressed prices for some traditional exports impacted agricultural production and growth.
- Policy implications:
  - Medium-term prospects hinge on pace of reforms, fiscal consolidation, and resumption of strong donor support.
  - Authorities have strengthened domestic revenue effort, restructured expenditure, and accelerated management reforms.

### Structural Reforms
- Governance and anti-corruption:
  - Since December 2003, implemented reforms including key anti-corruption and public ethics legislation, strengthening the judiciary and public audit system, implementation of the United Nations Convention against Corruption, and Ratification of the African Union Convention on Corruption.
  - Measures to enhance anti-corruption agencies: swearing-in of senior personnel in the Kenya Anti-Corruption Commission in September 2004; hiring of additional personnel targeted for completion by July 2005.
  - Implementation of a Public Officer Ethics Act: first round of asset declarations completed; second round in process.
- Other institutional reforms and actions:
  - Strengthening judiciary under a newly appointed Chief Justice.
  - Completion of pro-poor recurrent and development expenditures.
  - Preparation of comprehensive public finance reforms and strengthening of Central Bank of Kenya (CBK) operations.
  - Improved procurement system, task force recommendations for police reform beginning December 2004.
  - Establishment of a Public Complaints Unit (PCU) under the Department of Governance and Ethics and Ministry of Justice and Constitutional Affairs.
  - Initiation of comprehensive land reforms with committees and a commission completing initial work and publishing its report.
- Accountability actions:
  - Increased budget for Kenya Anti-Corruption Commission (KACC).
  - Legal investigations on the Anglo-Leasing scandal proceeding; senior officials suspended with prosecution to follow investigations.
  - KUTIB culprits dismissed and in courts; an external forensic audit supported by the World Bank completed and presented to the Minister of Finance; further forensic audits invited.

### Structural and Capacity Constraints
- Constraints and responses:
  - Slow progress toward a comprehensive medium-term expenditure framework and robust expenditure management system largely due to organizational and capacity constraints at the Ministry of Finance; these are being addressed.
  - Financial sector and parastatal reforms delayed by capacity constraints and lack of consensus on objectives and modalities; enactment of the Privatization Bill delayed.
  - New wage-setting mechanisms for public employees developed.
  - Strengthening of the prosecution branch and enforcement of anti-corruption regulations advanced.

### Fiscal Policy
- Monetary policy stance and instruments:
  - Objective: support non-inflationary economic recovery.
  - After July 2003 reduction in legal reserve requirement, reserve money multiplier rose, putting downward pressure on yields; bank credit to private sector grew substantially, generating inflationary pressure.
  - Inflation objective to be achieved through reserve money targeting, with broad money as intermediate target and open market operations as main instruments.
  - Enhanced open market operations and treasury bill auctions have resulted in increased real interest rates to help stem inflation resurgence.
  - Continued use of a flexible exchange rate system; CBK intervention limited to meeting net foreign assets target under the program and smoothing short-term fluctuations.
- Fiscal outcomes and strategy:
  - Overall fiscal performance better than anticipated by the program; central government fiscal imbalances much lower than expected due to anti-corruption efforts and improved revenue collection capacity.
  - Fiscal policy aims to support macroeconomic stability and fiscal sustainability via:
    - Strengthening revenue performance.
    - Lowering the wage bill as a proportion of GDP, including a new wage-setting mechanism.
    - Tackling contingent fiscal liabilities.
    - Strengthening tax administration.
    - Implementing public expenditure management (PEM) reforms.
    - Continuing civil service rationalization.
    - Increasing poverty reduction spending.
  - Domestic debt reduction is a key component to avoid crowding out the private sector while preserving resources for priority poverty reduction spending.
- Budget revision and domestic borrowing:
  - A revision to the budget announced on June 12, 2004 will be presented to Parliament during the first quarter of 2005; pending this, the new fiscal framework will be implemented through quarterly releases.
  - Revised budget assumes domestic borrowing would amount to the equivalent of 2.5 percent of GDP.
  - Fiscal framework envisages a marked decline in overall and primary deficits relative to ERS targets, largely because of significant shortfall of donor budgetary support.
  - Domestic borrowing would exceed ERS expectations, with some crowding out of private activity expected.
  - Projected domestic debt would remain broadly unchanged at 22 percent of GDP compared with the original program target of 24.7 percent of GDP.
  - Authorities aim to raise capital outlays from 2.7 percent of GDP in 2003/04 to 4.4 percent of GDP in 2004/05, with allocations for roads, health and agriculture accounting for the bulk of the increase.
- Revenue and arrears management:
  - Comprehensive audit of external commercial contracts has necessitated a relatively small accumulation of arrears; an escrow account established to settle fully all legitimate debt once audit is completed.
  - Authorities plan to maintain revenue as a proportion of GDP of at least 21.5 percent.
  - Plans to broaden the tax base by removing most exemptions, taxing a larger share of informal transactions, and simplifying and rationalizing the tax system.
  - Measures to strengthen revenue collection will be supported by controlling and prioritizing expenditure programs and cutting non-essential outlays.

### Financial Sector Issues
- Financial sector reform agenda:
  - Implementation of FSAP recommendations, drawing on World Bank support for a Financial Sector Adjustment Credit (FSAC).
  - Measures include amendments to the CBK and Banking Acts, new regulations, and tighter loan provisioning and classification to be introduced in 2005.
  - Notable improvement in banking sector performance indicators, including a fall in non-performing loans.
- Development objectives:
  - Promote financial intermediation in rural areas and increase access of small and medium-sized firms to formal sector financial resources.
  - Broaden scope and outreach of micro finance institutions and develop a more coherent and targeted policy for promoting development finance institutions.

### Trade Reforms and Regional Integration Efforts
- Competitiveness and reforms:
  - Address international competitiveness through reforms in utility and telecommunications sectors, external trade, the labor market, and infrastructure upgrading.
- Regional integration:
  - Kenya expected to form a customs union with Tanzania and Uganda in 2005 in the context of the East African Community (EAC).
  - Kenya is a member of COMESA, which aims at establishing a customs union via removal of trade barriers, a common external tariff and rules of origin.
  - IMF and World Bank assistance: IMF and the Bank providing assistance with reform of the tariff regime; the Bank providing technical advice on regional integration issues.

### Poverty Reduction Strategy Process
- ERS objectives and core measures:
  - ERS addresses low growth, low savings and investment, poor public service, large domestic debt, distortions in the financial system, unemployment, and poverty.
  - Core poverty expenditures derived from development targets include improving access to primary education, health care, and safety nets.
  - Priority on reforming the agricultural sector and encouraging growth of medium and small-scale enterprises; upgrading micro finance institutions.
  - Measures to tackle HIV/AIDS in rural areas, including rehabilitation of rural health facilities to improve agricultural productivity and rural incomes.
- Data and AML measures:
  - Authorities to initiate new anti-money laundering legislation reflecting FSAP recommendations.
  - Plans to improve the quality and timeliness of data in budget, foreign trade and national accounts; a data ROSC mission invited and to be undertaken in early 2005.

### Need for Donor Support
- External account and financing needs:
  - External current account deficit estimated to widen to 4.9 per cent of GDP in 2003/04, with prospects of rising further to 11.0 per cent of GDP by 2005/006.
  - Programme requires increased donor assistance from 6.5 per cent of GDP to 9.9 per cent in 2005/06 to support implementation.
  - Total financing needs projected to average about $1.3 billion per year through 2005/06.
  - Program support and Paris Club rescheduling are expected to fill the financing gap during the period; authorities intend to seek rescheduling from the Paris Club and are discussing terms with key creditors and donors.

### Conclusion
- Authorities reiterate strong political will to revive the Kenyan economy, achieve sustainable and job-creating growth, and reduce poverty.
- Priorities and progress:
  - Fighting corruption has been prioritized with significant progress in the reform agenda.
  - Fiscal performance exceeded program expectations and monetary policy tightened to support price stability.
  - Overall economic condition improved compared with two years prior when the new coalition government took office.
- Appeal for continued support:
  - Authorities hope for sustained understanding and support from the Fund and the international community in the form of timely and adequate financial support, advice and technical assistance to achieve objectives under the PRGF arrangement and the ERS.

*Source: _cr09225 - Introduction and Background*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09225.pdf_