## _cr1148 - 65.1 million will become available upon approval of this request by the Executive Board ## Source details **Canonical URL:** [_cr1148 - 65.1 million will become available upon approval of this request by the Executive Board](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1148.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1148.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1148.pdf.json) --- ### Financing, term, and phasing - An amount of 65.1 million will become available upon approval of this request by the Executive Board. - Term and phasing: 36 months, with first and second reviews scheduled to take place by July 15 and October 15, 2011 respectively, and semiannual reviews thereafter. - Proposed total disbursements: 325.6 Millions of SDRs — 120.00 percent of quota. - Proposed timing (highlights): - January 31, 2011: 65.1 Millions of SDRs — 24.00 percent of quota. - July 15, 2011: 43.4 Millions of SDRs — 16.00 percent of quota. - October 15, 2011: 43.4 Millions of SDRs — 16.00 percent of quota. - Subsequent semi-annual reviews through October 15, 2013 at 43.4 Millions of SDRs each — 16.00 percent of quota. - Note: "Kenya's quota is SDR 271.4 million." ### Conditionality and safeguards - Conditionality: Focused on reserves build up, improvement in the primary fiscal balance, public finance management reform, tax reform, and strengthening of the financial system. - Safeguards assessment: The new arrangement will require an update of the safeguards assessment by the time of the first review. - Poverty Reduction Strategy Paper (PRSP): The authorities issued their current PRSP in October 2009. ### Program objectives and macroeconomic framework (Executive Summary) - Program aims: - Boost international reserves while adopting a gradual fiscal adjustment over a three-year horizon. - Provide a reserve cushion to reduce vulnerabilities to external shocks, including a projected deterioration of the terms of trade in the next two years. - Ensure fiscal discipline during implementation of fiscal decentralization, keep inflation low, and maintain the floating exchange rate regime. - Fiscal and structural objectives: - Gradual reduction in the central government primary balance through tax reform and strict control of current spending to bring the debt-to-GDP ratio below 45 percent at the end of the program period. - VAT and income tax reforms to broaden bases and improve compliance. - New framework for expenditure management and control to rein in current spending while allocating resources for constitution implementation over the next two years. - Poverty focus: - Continue pursuing poverty reduction objectives in line with the PRSP. ### Recent macroeconomic developments (background and external position) - Growth and output: - Projected real GDP growth at 5 percent in 2010, up from 2.6 percent in 2009. - External reserves and position: - International reserves have remained at 3.3 months of imports. - Reserves were boosted to 3½ months of imports by end-2009 following Fund support under the ESF and the 2009 SDR allocation. - Public debt and fiscal balances: - Public debt now lies above the 45 percent debt-to-GDP ceiling set by Kenya’s medium-term debt-management strategy. - Central government primary deficit projected at 4 percent of GDP for a second consecutive year in 2010/11. - Prices and credit: - Inflation reached 4.5 percent in December. - Credit growth picked up to 23 percent by September 2010. - Downward shift in government bond yield curve signaled improved inflationary expectations. ### Key issues and risks - Build up international reserves: - External current account deficit expected to widen to about 7½ percent of GDP in the next two years because of increased import demand and a cumulative 15 percent deterioration of Kenya’s terms of trade. - Indicators suggest reserves are low relative to peers and model-based estimates. - Kenya is more vulnerable to volatile private capital flows than many LICs holding larger reserve buffers. - Need for gradual fiscal consolidation: - Increase in debt-to-GDP ratio threatens fiscal sustainability and should be gradually reversed. - Limited room to tighten fiscal policy due to infrastructure and constitution implementation commitments. - Expanded geothermal power capacity required to reduce dependence on oil imports and hydropower. - Climate change impacts (selected figures): - El Niño flood 1997–98 cost: $1.2 billion. - La Niña drought 1998–2000 damages: $2.8 billion. - Drought 2008/09 prompted imports of maize and fuel worth US$1 billion. - Adaptation costs estimated at around $500 million per year starting 2011 and increasing to $1 billion by 2030. - Governance and constitutional reform: - New constitution (ratified August 2010) provides an opportunity for fiscal decentralization, PFM changes, and land ownership reforms. - Successful implementation expected to strengthen the judiciary and overhaul public management to reduce corruption. ### Program modalities and targets (summary) - Arrangement length: 36 months. - Reviews: First and second reviews by July 15 and October 15, 2011; semiannual reviews thereafter. - Program focus: Reserves build-up; gradual fiscal consolidation targeting debt-to-GDP below 45 percent by end of program; PFM reform; tax reform (VAT and income tax base broadening and compliance); financial system strengthening. - Safeguards: Update of safeguards assessment required by first review. --- ### Constitutional reforms and implementation - Main constitutional provisions: - Election of the President by a majority of all votes cast and requirement to obtain at least a quarter of votes in more than half of the 47 counties. - Creation of a Senate, a new Supreme Court, and a Judicial Service Commission. - Parliament involvement earlier in budget preparation. - New treasury law enhancing accountability and transparency. - Devolution of no less than 15 percent of government revenues over a period of three years after the constitution enters into force. - Harmonization of salary scales for public servants. - Initial constitution implementation costs: - Initial costs amount to around US$40 million. - Main cost components represent about 70 percent of implementation costs (operation of transitory commissions, review of legislation, preparation of judicial, land, and devolution reforms). - Government budget provision: - Government set aside an equivalent to 0.5 percent of GDP over the next two fiscal years for implementing the constitution. - Final cost estimates to be completed once legislative commissions become fully operational. ### Anticorruption and institutional reforms - Constitution-based measures: - Establish an independent Integrity and Anti-Corruption Committee. - Enhance judiciary independence and vet existing justices. - Opportunity to overhaul PFM system to reduce scope for corruption. - PFM reform measures: - New PFM legislation to support a fully functioning single treasury account system to be replicated in devolved governments. - Full implementation of IFMIS comprising budget execution, cash management and procurement. - Harmonize fiscal decentralization (including borrowing and fiscal reporting) with medium term fiscal policy strategy. --- ### The 2011–13 economic program: objectives and priorities - Program balance: - Boost international reserves while allowing gradual fiscal adjustment over three years. - Protect external position against higher domestic demand and an expected terms-of-trade shock. - Maintain fiscal discipline during decentralization and target low inflation with a floating exchange rate. - Reserve targets: - International reserve buffer projected to increase well above 4 months of prospective imports. - Monetary program aims to increase reserve coverage to over 4 month of prospective imports by the end of the program. ### Fiscal policy: targets and measures - Policy objective: - Gradual fiscal consolidation targeting a reduction in the central government primary deficit to 1.2 percent of GDP in 2013/14 (3.8 percent in 2010/11). - Aim to lower the debt burden to 45 percent of GDP in net terms by end of program. - Program focus initially on central government and expand to general government before fiscal decentralization. - Revenue measures: - One-off factors boosted tax collections in 2010/11 (regularization of arrears by large corporations). - Tax measures expected to have an impact of one percentage point of GDP on revenues over the program period. - VAT reform to be introduced in 2012/13 and yield 0.4 percent of GDP. - Income tax reform will yield a permanent tax revenue increase of 0.6 percent of GDP. - Actions: modern VAT law, appoint Tax Reform Commission (TRC), modernize tax administration, upgrade customs administration in line with EAC commitments. - Expenditure measures and control: - No increase in real wages for public servants. - Rationalize pay grading to eliminate distortions. - Reprioritize development expenditure to: (a) transform energy infrastructure; (b) narrow infrastructure gap; (c) protect the vulnerable and pursue MDGs per PRSP. - New PFM legislation and IFMIS to reinforce expenditure control and establish a single treasury account. - Following a one-off increase in civil service wages in 2011, wage growth to stay in line with inflation; reduce operational expenditure by hospitals and universities as percent of GDP through management measures. ### Financing policy and contingent liability management - External financing: - External financing mainly from concessional sources, including about US$1.6 billion in project loans in the next two fiscal years, mainly from the World Bank and AfDB. - Government plans to issue a sovereign bond in 2012/13, monitoring market conditions for possible earlier issuance. - Debt and contingent liabilities: - Gradual reduction of reliance on domestic financing by increasing concessional foreign financing. - Government committed to scrutinize PPP projects and introduce mechanism to assess fiscal risks from contingent liabilities. - All guarantees from PPP contracts and other contingent liabilities will be integrated into debt management. ### Monetary and financial sector policies - Monetary policy objectives and stance: - CBK to maintain medium term inflation target of 5 percent. - Refrain from financing government beyond short-term statutory overdraft. - Continue reduction in velocity and rise in money multiplier alongside expanding financial intermediation. - Private sector credit growth expected to remain higher than nominal GDP growth. - Operational measures: - Maintain floating exchange rate while purchasing foreign exchange as needed to achieve reserve targets. - Coordinate monetary and fiscal policy to minimize liquidity impact of government financial fluctuations. - Tighten monetary policy promptly if inflationary expectations emerge. - CBK to report to Ministry of Finance on deviations of 2 percent or more from the stated inflation target. - Revise CBK Act to enhance mandate, transparency, accountability, and operational autonomy. - Upgrade CBK inflation forecasting capacity. - Financial supervision and modernization: - Amend Banking Act to reinforce prompt corrective action by CBK. - Adapt supervision to monitor bank agents and mobile banking. - Address cross-border operations and mobile banking challenges. --- ### Selected macroeconomic and fiscal figures (2008/09–2013/14 as reported) - Nominal GDP (Market prices, in billions of Kenya shillings): 2,176; 2,410; 2,713; 3,075; 3,464; 3,880. - Real GDP growth (market prices): 2.1; 3.8; 5.4; 6.1; 6.7; 6.8. - GDP deflator (average): 9.3; 6.7; 6.9; 6.8; 5.6; 4.9. - Terms of trade, goods, and services (base year 2000): 6.5; 12.1; -7.3; -7.4; 0.2; -2.7. - Investment (percent of GDP): 19.9; 20.5; 23.1; 24.5; 25.2; 25.2. - Gross national saving (percent of GDP): 11.9; 15.1; 15.8; 17.0; 18.7; 20.2. - Central government primary budget balance: -1.5; -3.9; -3.8; -2.7; -1.9; -1.2. - Overall balance (commitment basis) excluding grants: -5.4; -7.4; -7.7; -6.6; -5.9; -5.2. - Current external balance, excluding official transfers: -7.9; -5.3; -7.2; -7.5; -6.4; -5.0. - Gross international reserves (end of period, in billions of U.S. dollars): 3.2; 3.8; 4.2; 4.6; 5.9; 7.4. - Gross international reserves (end of period, in months of next year imports): 3.1; 3.3; 3.3; 3.3; 3.8; 4.4. - Total public debt, net (percent of GDP): 41.7; 45.7; 47.1; 46.9; 45.1; 43.6. - Expected deterioration in the terms of trade: due to a 14 percent annual average increase in oil prices over 2010–12; coffee and tea prices projected to fall in 2011–12 by an annual average of 11 percent and 13 percent respectively. --- ### Box 6 — Financial Sector Deepening and Modernization (summary) - Financial access and inclusion: - 40.5 percent (7.6 million) of the adult population use services of financial intermediaries (26.4 percent in 2006). - Mobile-banking developments: - In H1 2010, mobile banking transfers increased by about US$115 million, equivalent to about 10 percent of currency in circulation. - M-kesho launched May 2010 to broaden mobile deposit services. - Aggregate effects: - Broad money growth doubled in 2006–10 relative to 2001–05. - Increased mobile banking contributed to a significant increase in the money multiplier. - Risks and policy recommendations: - Strengthen prudential regulation and supervision for new risks from rapid financial inclusion. - Upgrade crisis management and cross-border oversight; implement consolidated supervision; assess conglomeration risk. - Strengthen capital markets and enforce RBA regulations on NSSF. - Fully implement Crime and Anti-Money Laundering Act of 2009. - Increase Credit Reference Bureau coverage; supervise SACCOs; simplify collateral regime and stamp duties; create unique registry; promote alternative risk mitigators. - Capacity and safeguards: - Update of CBK safeguards assessment (completed November 2, 2009) required by first review. - Kenya’s obligations to the Fund low (SDR 273.2 million at end-November 2010); total debt was 47 percent of GDP and risk of debt distress reported as low per the DSA. --- ### Debt sustainability, risks, and staff appraisal - IMF/World Bank DSA findings: - External debt risk: low risk of external debt distress. - Public debt: higher vulnerability—public debt indicators deteriorated somewhat relative to 2009 and can worsen under growth shocks or realization of contingent liabilities. - Selected DSA numbers (examples): - NPV of PPG External Debt (percent of GDP baseline): 18.2; 18.2; 19.3; 19.6; 19.4; 18.9 (2010–2015 sequence). - Total public debt, net (percent of GDP baseline): 41.7; 45.7; 47.1; 46.9; 45.1; 43.6. - Gross financing need: 10.7; 12.2; 14.7; 15.9; 15.7; 15.6 (selected sequence). - Stress-test outcomes: - Combined shock could raise NPV of public external debt as share of GDP from 18¼ percent to 25 percent by 2015 and NPV of debt-to-exports from 66.0 percent to 96 1/3 percent. - Two-year growth shock could raise NPV of debt-to-GDP to 55 percent by 2014 in one scenario. - Policy implications: - Sustainability depends on macro performance and prudent borrowing strategy; prioritize infrastructure investment and reforms to sustain growth. - Continued monitoring and integration of contingent liabilities (e.g., PPP guarantees) into debt management essential. --- ### Program monitoring, performance criteria, and TMU highlights - Monitoring and coverage: - Quantitative performance criteria and structural benchmarks specified in Annexes; fiscal criteria cover central government with intention to expand to general government as fiscal decentralization proceeds. - Key quantitative performance figures (selected test dates): - Primary budget balance of the central government (floor): -20.7; -55.0; -25.0; -50.0 (presented as sequence). - Stock of central bank net international reserves (floor, in millions of US$): 3,505; 3,450; 3,480; 3,695. - Stock of net domestic assets of the CBK (ceiling): -45.0; -40.0; -40.0; -25.0. - Ceilings on contracting or guaranteeing medium- and long-term nonconcessional external debt by central government (millions of US$): 450; 700; 700 (test date sequence). - Indicative targets — Priority Social Expenditures of central government (floor): 5.9; 17.6; 24.8; 7.0. - TMU definitions and adjustors: - NIR definition and adjustors; NIR = gross official international reserves minus official reserve liabilities; NIR monitored in U.S. dollars and computed as daily average for the month when testing date is due. - NDA definition and accounting: NDA = reserve money minus NIR converted at accounting exchange rate of 81 shillings per US$, plus medium- and long-term CBK liabilities, minus encumbered reserves. - Performance criterion on nonconcessional external debt follows Executive Board Decision definitions; concessionality threshold: present value/nominal < 65 percent. - Ceiling on nonconcessional external borrowing excludes proceeds of sovereign bond issuance up to US$500 million. - Reporting requirements (selected): - Central government primary balance including grants — Monthly — Within 15 days after end of month — CBK. - Net domestic bank financing — Monthly — Within 15 days — CBK. - Disbursements of external nonconcessional project loans — Quarterly — Within 45 days — MoF. - Gross official international reserves components — Monthly — Within 15 days — CBK. - Program exchange rates (Rates as of September 1, 2010; accounting exchange rate for monitoring: 81 shillings per US$): - U.S. dollar: 81.001.0000 - SDR: 122.651.5147 - Euro: 103.651.2800 - Pound sterling: 124.651.5394 - (Full Table 1 rates provided in TMU.) --- ### Letter of Intent — key commitments and measures (summary) - Background and priorities: - New constitution promulgated on August 27, 2010; Vision 2030 MTP aims to raise real GDP growth to 10 percent. - Priority areas: agriculture productivity, public investment in roads/rail/ports/ICT/power—target to triple national electricity supply to 3,000 megawatts by 2018 with emphasis on geothermal power. - Fiscal policy commitments: - Gradual reduction of overall fiscal deficit to about 5 percent of GDP over the medium term. - Target primary budget deficit about 2 percent of GDP in 2012/13 (performance criterion) from 3.8 percent projected for 2010/11. - Maintain fiscal revenue-to-GDP ratio at around 25 percent. - Specific measures and benchmarks: - Appoint Tax Reform Commission (TRC); modernize VAT legislation (structural benchmark: VAT modernization). - Increase automation of KRA processes; roll-out Electronic Cargo Tracking System. - Submit draft PFM Bill to Commission for Implementation of the Constitution by December 2011 (structural benchmark). - Adopt a Single Treasury Account by June 2012 (structural benchmark). - Implement IFMIS across Ministries and Departments and roll out to county governments. - Financing and limits: - Domestic financing expected to decline from 70 percent of financing in current fiscal year to about 60 percent next year. - External financing mainly concessional, including about US$2 billion in project loans in next two fiscal years. - World Bank expected budget support of US$100 million through a Development Policy Loan. - Nonconcessional financing limits (performance criteria): below US$700 million in remainder of FY 2010/11; US$700 million in 2011/12. - Intend to issue a sovereign bond in 2012/13 subject to market conditions. - Continued policy of not incurring external arrears (performance criterion). --- ### Financial access, microfinance, and SACCOs (selected) - Access indicators: - Share with access to formal financial services: 40 percent in 2009, up from 26 percent in 2006. - Mobile penetration: one cell phone per adult. - World Bank estimate: about ¾ of population transfer cash equivalent to 20 percent of GDP annually. - About 250 deposit-taking SACCOs in rural areas; estimated about 3,800 SACCOs operate in Kenya overall (TMU note). - Reform actions: - Facilitate increased information coverage by Credit Reference Bureau. - Amend Microfinance Act to allow use of third-party agents by deposit-taking MFIs. - Complete regulatory and supervisory frameworks for SACCOs. - Implement currency centers outside Nairobi to reduce cash-in-transit costs. --- ### Program risks and staff recommendation - Staff view: "Risks to the program are present, but the possible benefits from its successful implementation largely outweigh them." - Political/social risks: New flare up in social tensions "cannot be ruled out, but its likelihood has declined following the approval of the new constitution." - Staff assessment: Improved political climate opens window to push forward reforms that could transform the economy; Fund support will help authorities seize opportunity and mobilize development partner support. - Recommendation: Staff recommends approval of the authorities’ request for an ECF arrangement. *Source: _cr1148 - 65.1 million will become available upon approval of this request by the Executive Board.* ### 65.1 million will become available upon approval of this request by the Executive Board. ### _cr1148 - 65.1 million will become available upon approval of this request by the Executive Board. ### Financing, term, and phasing - An amount of 65.1 million will become available upon approval of this request by the Executive Board. - Term and phasing: 36 months, with first and second reviews scheduled to take place by July 15 and October 15, 2011 respectively, and semiannual reviews thereafter. ### Conditionality and safeguards - Conditionality: Focused on the program’s objectives of reserves build up, improvement in the primary fiscal balance, public finance management reform, tax reform, and strengthening of the financial system. - Safeguards assessment: The new arrangement will require an update of the safeguards assessment by the time of the first review. - Poverty Reduction Strategy Paper (PRSP): The authorities issued their current PRSP in October 2009. ### Program objectives and macroeconomic framework (Executive Summary) - Program aims: - Boost international reserves while adopting a gradual fiscal adjustment over a three-year horizon. - Provide a reserve cushion to reduce vulnerabilities to external shocks, including a projected deterioration of the terms of trade in the next two years. - Ensure fiscal discipline during implementation of fiscal decentralization, keep inflation low, and maintain the floating exchange rate regime. - Fiscal and structural objectives: - Gradual reduction in the central government primary balance through tax reform and strict control of current spending to bring the debt-to-GDP ratio below 45 percent at the end of the program period. - Tax measures include reform of the value-added tax (VAT) and the income tax to broaden their bases and improve compliance. - New framework for expenditure management and control to allow the government to reign in current spending while allocating resources for implementation of the constitution over the next two years. - Poverty focus: - The government will continue pursuing the poverty reduction objectives in line with the PRSP. ### Recent macroeconomic developments (Background and external position) - Growth and output: - Projected real GDP growth at 5 percent in 2010, up from 2.6 percent in 2009. - External reserves and position: - International reserves have remained at 3.3 months of imports. - Reserves were boosted to 3½ months of imports by end-2009 (from almost three months a year earlier) following Fund support under the ESF and the 2009 SDR allocation. - Public debt and fiscal balances: - Public debt now lies above the 45 percent debt-to-GDP ceiling set by Kenya’s medium-term debt-management strategy. - Following an expansionary budget in 2009/10, the central government primary deficit is projected at 4 percent of GDP for a second consecutive year in 2010/11. - Prices and credit: - Inflation reached 4.5 percent in December. - Credit growth picked up to 23 percent by September 2010. - Downward shift in government bond yield curve signaled improved inflationary expectations. ### Key issues and risks - Build up international reserves: - The external current account deficit is expected to widen to about 7½ percent of GDP in the next two years because of increased import demand and a cumulative 15 percent deterioration of Kenya’s terms of trade. - Several indicators suggest reserves are low relative to peer groups and model-based estimates suggest Kenya’s reserves fall short of predicted levels. - Kenya is more vulnerable to volatile private capital flows than many LICs holding larger reserves buffers. - Need for gradual fiscal consolidation: - The increase in the debt-to-GDP ratio threatens fiscal sustainability and should be gradually reversed. - Room for tightening fiscal policy is limited due to infrastructure investment needs and commitments associated with implementing the new constitution. - Expanded geothermal power capacity is required to reduce dependence on oil imports and hydropower, and to enhance resilience to climate-change shocks. - Implementation of the constitution entails new fiscal challenges, from initial implementation spending to managing regional demands after fiscal decentralization. - Climate change impacts (selected figures): - The El Niño flood in 1997–98 had an estimated cost of $1.2 billion. - The La Niña drought in 1998–2000 had estimated total damages of $2.8 billion. - The drought in 2008/09 prompted imports of maize and fuel worth US$1 billion to cover shortfalls. - Adaptation costs to climate change have been estimated at around $500 million per year starting 2011 and increasing to $1 billion by 2030, including investing in geothermal power generation. - Governance and constitutional reform: - The new constitution (ratified August 2010) provides an opportunity for meaningful reforms including fiscal decentralization, public expenditure framework changes, and land ownership reforms. - Successful implementation is expected to strengthen the judiciary and lay the ground for overhauling the public management system to reduce scope for corruption. ### Program modalities and targets (summary) - Arrangement length: 36 months. - Reviews: First and second reviews by July 15 and October 15, 2011; semiannual reviews thereafter. - Program focus: Reserves build-up, gradual fiscal consolidation targeting debt-to-GDP below 45 percent by end of program, public financial management reform, tax reform (VAT and income tax base broadening and compliance), and financial system strengthening. - Safeguards: Update of safeguards assessment required by first review. *Source: _cr1148 - 65.1 million will become available upon approval of this request by the Executive Board.* ### 5. The new constitution provides an opportunity to address deep-seated social and ### _cr1148 - 5. The new constitution provides an opportunity to address deep-seated social and ### Constitutional reforms and implementation - Main provisions (Box 3): - election of the President by a majority of all votes cast and a new requirement to obtain at least a quarter of votes in more than half of the 47 counties; - creation of a Senate as a new legislative chamber, a new Supreme Court, and a Judicial Service Commission; - parliament involvement at earlier stages of the preparation of the budget; - a new treasury law enhancing accountability and transparency in expenditure control and management; - devolution to county level of no less than 15 percent of government revenues over a period of three years after the constitution enters into force; - harmonization of the salary scales for public servants. - Initial constitution implementation costs: - Initial constitution implementation costs amount to around US$40 million. - Main cost components (representing about 70 percent of implementation costs) are associated with the operation of transitory commissions, review of legislation, and preparation of judicial, land, and devolution reforms. - Government budget provision for implementation: - The government has set aside an equivalent to 0.5 percent of GDP over the next two fiscal years for implementing the constitution. - Final cost estimates will be completed once legislative commissions become fully operational. ### Anticorruption and institutional reforms - Constitution provides basis to bolster anticorruption efforts by: - establishing an independent Integrity and Anti-Corruption Committee; - enhancing the independence of the judiciary, and requiring all existing justices to be vetted for suitability; - providing an opportunity for an overhaul of the public finance management system that could go a long way towards reducing the scope for corruption. - Public finance management (PFM) reform measures: - New PFM legislation to revitalize reforms and provide legal support for a fully functioning single treasury account system for the central government, to be replicated in devolved governments. - Full implementation of an integrated financial management information system (IFMIS) comprising budget execution, cash management and procurement. - Harmonize fiscal decentralization (including borrowing and fiscal reporting) with the medium term fiscal policy strategy. ### The 2011–13 economic program: objectives and priorities - Program balance: - Boost international reserves while allowing gradual fiscal adjustment over a three-year horizon. - Protect external position against higher domestic demand and an expected terms-of-trade shock. - Implement gradual fiscal adjustment that protects priority spending. - Maintain fiscal discipline in the implementation of decentralization envisaged in the constitution. - Target low inflation and maintain the floating exchange rate regime. - Reserve and external position: - International reserve buffer projected to increase well above 4 months of prospective imports of goods and services. - Monetary program aims to increase reserve coverage to over 4 month of prospective imports of goods and services by the end of the program period. ### Fiscal policy: targets and measures - Policy objective: - Gradual fiscal consolidation targeting a reduction in the central government primary deficit to 1.2 percent of GDP in 2013/14 (3.8 percent in 2010/11). - Aim to lower the debt burden to 45 percent of GDP in net terms by the end of the program period. - Program will focus initially on the central government and expand to general government before fiscal decentralization. - Revenue measures: - One-off factors have boosted tax collections in 2010/11; one-off revenue items include mainly regularization of arrears by large Kenyan corporations. - Tax measures are likely to have an impact of one percentage point of GDP on revenues over the program period. - Reform of the VAT to be introduced in the 2012/13 fiscal year and yield 0.4 percent of GDP. - Reform of the income tax will yield a permanent tax revenue increase of 0.6 percent of GDP. - Government will introduce a modern value-added tax (VAT) law, appoint a Tax Reform Commission (TRC), modernize tax administration, and upgrade customs administration in line with EAC commitments. - Expenditure measures and control: - No increase in real wages for public servants. - Rationalize the pay grading system to eliminate existing distortions. - Ensure fiscal decentralization (including borrowing and fiscal reporting) is consistent with the medium term fiscal policy strategy. - Reprioritize development expenditure to: (a) transform energy infrastructure; (b) narrow the infrastructure gap; (c) protect the vulnerable and pursue MDGs in line with the PRSP. - New PFM legislation and IFMIS to reinforce expenditure control and establish a single treasury account. - Following a one-off increase in civil service wages in 2011, wage growth will stay in line with inflation; operational expenditure by hospitals and universities to be reduced as a percent of GDP through management and control measures. ### Financing policy and contingent liability management - External financing: - External financing will come mainly from concessional sources, including about US$1.6 billion in project loans in the next two fiscal years, mainly from the World Bank (WB) and the African Development Bank (AfDB). - Government plans to issue a sovereign bond in 2012/13, while monitoring market conditions for possible earlier issuance. - Debt and contingent liabilities: - Program envisages gradual reduction of government’s reliance on domestic financing by increasing concessional foreign financing. - Government committed to scrutinize PPP projects to preserve fiscal discipline and introduce a mechanism to assess fiscal risks from contingent liabilities. - All guarantees arising from PPP contracts and all other contingent liabilities will be integrated into the debt management process. ### Monetary and financial sector policies - Monetary policy objectives and stance: - CBK to maintain a prudent policy stance focused on medium term inflation target of 5 percent. - Refrain from financing the government beyond short-term use of its statutory overdraft facility. - Assume continuation (at a slower pace) of recent reduction in velocity and rise in the money multiplier, alongside expanding financial intermediation and modernization. - Private sector credit growth expected to remain higher than nominal GDP growth consistent with monetization trends. - Operational measures: - Maintain the floating exchange rate regime while continuing to purchase foreign exchange as needed to achieve reserve targets. - Enhance coordination of monetary and fiscal policy to minimize liquidity impact of short-term government financial fluctuations with the CBK. - Tighten monetary policy promptly if signs of inflationary expectations emerge. - CBK to report to the Ministry of Finance on deviations of 2 percent or more from the stated inflation target. - Revise the CBK Act to enhance operational mandate, transparency, accountability, and operational autonomy. - Upgrade CBK inflation forecasting capacity. - Financial supervision and modernization: - Amend the Banking Act to reinforce prompt corrective action by the CBK. - Adapt banking supervision to monitor financial business driven by bank agents and mobile banking. - Financial sector modernization to address cross-border operations and mobile banking challenges. ### Selected macroeconomic and fiscal figures (as reported) - Nominal GDP (Market prices, in billions of Kenya shillings): 2,176; 2,410; 2,713; 3,075; 3,464; 3,880 (2008/09–2013/14). - Real GDP growth (market prices): 2.1; 3.8; 5.4; 6.1; 6.7; 6.8 (2008/09–2013/14). - GDP deflator (average): 9.3; 6.7; 6.9; 6.8; 5.6; 4.9 (2008/09–2013/14). - Terms of trade, goods, and services (base year 2000): 6.5; 12.1; -7.3; -7.4; 0.2; -2.7 (2008/09–2013/14). - Investment: 19.9; 20.5; 23.1; 24.5; 25.2; 25.2 (percent of GDP, 2008/09–2013/14). - Gross national saving: 11.9; 15.1; 15.8; 17.0; 18.7; 20.2 (percent of GDP, 2008/09–2013/14). - Central government primary budget balance: -1.5; -3.9; -3.8; -2.7; -1.9; -1.2 (2008/09–2013/14). - Overall balance (commitment basis) excluding grants: -5.4; -7.4; -7.7; -6.6; -5.9; -5.2 (percent of GDP, 2008/09–2013/14). - Current external balance, excluding official transfers: -7.9; -5.3; -7.2; -7.5; -6.4; -5.0 (percent of GDP, 2008/09–2013/14). - Gross international reserves (end of period, in billions of U.S. dollars): 3.2; 3.8; 4.2; 4.6; 5.9; 7.4 (2008/09–2013/14). - Gross international reserves (end of period, in months of next year imports): 3.1; 3.3; 3.3; 3.3; 3.8; 4.4 (2008/09–2013/14). - Total public debt, net (percent of GDP): 41.7; 45.7; 47.1; 46.9; 45.1; 43.6 (2008/09–2013/14). - Expected deterioration in the terms of trade: due to a 14 percent annual average increase in oil prices over 2010–12; coffee and tea prices are projected to fall in 2011–12 by an annual average of 11 percent and 13 percent respectively. *Source: _cr1148 - 5. The new constitution provides an opportunity to address deep-seated social and* ### Box 6. Kenya: Financial Sector Deepening and Modernization ### Box 6. Kenya: Financial Sector Deepening and Modernization ### Overview - The Kenyan financial sector is described as the most complex and dynamic within the EAC and the third largest in SSA. - Financial access and inclusion: - 40.5 percent (7.6 million) of the adult population use the services of financial intermediaries. - 26.4 percent in 2006. ### Financial deepening and mobile-banking innovations - Mobile-banking and “agency banking” have materially deepened financial intermediation. - Key developments and statistics: - In the first half of 2010, mobile banking transfers (mainly through Equity Bank’s M-pesa) increased by about US$115 million, equivalent to about 10 percent of currency in circulation. - Launched in May 2010, M-kesho (mobile-phone based deposit accounts) broadens money services and the potential mobilization of resources, further reducing the need to hold cash. - Enabling third parties or “agents” to conduct banking activities on behalf of financial institutions will further reduce barriers to financial penetration and the cost of credit. - Aggregate effects: - Broad money growth doubled in 2006–10 relative to 2001–05. - Increased use of mobile-based banking contributed to a significant increase in the money multiplier in the same period. ### Implications for monetary stability and risks - Prudential and macro risks: - New sources of risk from rapid financial inclusion require strengthened prudential regulations for evaluation and monitoring. - There is a real risk that increased liquidity in the banking system may fuel credit growth further. - Monetary policy considerations: - The deepening of Kenya’s financial system through rapid financial inclusion has lowered the income velocity of money; thus, inflation has declined despite abundant liquidity. - The lagged impact of money growth on prices remains uncertain; the CBK should monitor developments closely and stand ready to tighten liquidity conditions if signs of inflationary pressures materialize. - Looking forward, the CBK should consider adopting a formal inflation targeting framework and further develop its inflation forecasting capacity. ### Regulatory, supervisory, and institutional reforms (policy recommendations) - Strengthen crisis management and cross-border oversight: - Upgrade the crisis management framework taking into consideration the expansion of cross-border banking activities, in line with Financial Sector Assessment Program (FSAP) recommendations. - Implement consolidated supervision and assess conglomeration risk of relevant local groups. - Enhance openness and transparency in supervision and markets: - Strengthen capital markets by demutualizing the stock market, in line with Monetary and Capital Market Department (MCM) recommendations. - Enforce compliance of Retirement Benefit Authority (RBA) regulations on the insolvent National Social Security Fund (NSSF), in particular the appointment of external fund managers and external custodians. - Fully implement the Crime and Anti-Money Laundering Act of 2009, including by-laws and regulations. - Modify the CBK Act to allow the central bank to share information obtained from surveillance of authorized foreign exchange bureaus for criminal investigations. - Expand access to credit for small enterprises: - Increase the information coverage by the Credit Reference Bureau. - Implement supervision of Savings and Credit Cooperatives (SACCOs) to help improve consumers’ confidence. - Simplify the collateral regime, reduce the number of stamp duties; create a unique registry and promote the use of alternative risk mitigators. ### Program linkages, capacity, and safeguards - The financial-sector recommendations are embedded within the broader ECF arrangement (January 2011–14) aimed at strengthening external and fiscal positions while allowing time for key structural reforms. - Capacity and safeguards: - An update of the safeguards assessment of the CBK that was completed on November 2, 2009, including an evaluation of the implementation of its recommendations, will take place by the time of the first review. - Kenya’s current obligations to the Fund are low (SDR 273.2 million at end-November 2010); total debt was 47 percent of GDP and the risk of debt distress is reported as low according to the most recent Debt Sustainability Analysis (DSA). ### Staff appraisal: opportunities and cautions - Opportunities: - Kenya has the chance to become a dynamic, fast-growing economy if reforms build momentum, lower external and fiscal vulnerabilities, and raise infrastructure investment. - Higher infrastructure investment (including increasing geothermal power capacity) will remove key hurdles to growth and help address global warming impacts. - Governance and public finance: - Weak governance remains a chief impediment to growth; the program seeks to reduce the scope for corruption by increasing accountability in public financial management (PFM). - The implementation of the new constitution provides an opportunity to pass legislation to overhaul the PFM system and establish a single Treasury account. - Revenue mobilization and fiscal decentralization: - Redesigning the tax structure is a priority; revamping VAT legislation and reducing income-tax exemptions are highlighted as measures to boost revenue and improve perceived fairness. - Substantial decentralization envisaged by the new constitution may improve service delivery but must not compromise sound fiscal management principles. - Financial stability vigilance: - Banking soundness indicators have continued to improve, but rapid credit growth associated with increasing financial inclusion should not translate into lower quality of banks’ loan portfolios. - The CBK needs to adapt banking supervision to the changing financial landscape and to challenges from financial inclusion and growing regionalization of the banking system. *Source: Box 6. Kenya: Financial Sector Deepening and Modernization (IMF staff report content).* ### 38. Risks to the program are present, but the possible benefits from its successful ### _cr1148 - 38. Risks to the program are present, but the possible benefits from its successful ### Program risks and benefits - "Risks to the program are present, but the possible benefits from its successful implementation largely outweigh them." - A new flare up in social tensions "cannot be ruled out, but its likelihood has declined following the approval of the new constitution." - "The improved political climate has opened a window of opportunity for pushing forward economic reforms that could radically transform the Kenyan economy." - "Fund support will help the authorities to seize this opportunity and to mobilize support from developments partners." - "Staff recommends approval of the authorities’ request for an ECF arrangement." ### Key macroeconomic indicators and projections (national accounts and prices) - Nominal GDP (market prices, in billions of Kenya shillings): 2,176; 2,410; 2,713; 3,075; 3,464; 3,880 - Real GDP growth (market prices): 2.1; 3.8; 5.4; 6.1; 6.7; 6.8 - GDP deflator (average): 9.3; 6.7; 6.9; 6.8; 5.6; 4.9 - Consumer price index (annual average): 15.0; 5.3; 3.4; 5.0; 5.0; 5.0 - Consumer price index (end of period): 8.6; 3.5; 4.0; 5.0; 5.0; 5.0 - Import volume growth, goods, and services: 13.6; 8.7; 5.5; 5.8; 6.6; 7.2 - Import value growth, goods, and services: 9.5; 2.9; 12.5; 9.1; 12.0; 7.8 - Export volume growth, goods, and services: -1.5; 5.9; 11.0; 10.5; 9.7; 10.5 - Export value growth, goods, and services: 0.5; 12.8; 8.8; 5.6; 15.5; 8.3 - Terms of trade, goods, and services (Base year 2000): 6.5; 12.1; -7.3; -7.4; 0.2; -2.7 - Ksh per US$ exchange rate (end of period): 77.28; 81.98; 81.0 - Nominal effective exchange rate (- depreciation; end of period): -10.4; -1.2 - Real effective exchange rate (- depreciation; end of period): -4.3; -2.4 ### Money, credit, and monetary aggregates - M3 (broad money and foreign currency deposits, end period): 13.0; 26.2; 19.2; 16.6; 14.1; 14.7 - Reserve money (end periods listed): 163.6; 182.0; 210.3; 209.9; 215.7; 214.1; 216.6; 220.7; 252.4 - M1 (levels): 392.8; 442.2; 511.6; 536.9; 571.1; 597.1; 619.0; 657.3; 688.5 - M2 (levels): 766.4; 898.1; 1,033.7; 1,078.3; 1,153.9; 1,206.5; 1,250.8; 1,328.1; 1,391.1 - M3 (levels): 901.1; 1,045.7; 1,198.9; 1,243.6; 1,327.9; 1,388.4; 1,429.5; 1,517.8; 1,584.2 - M3 plus nonbank holdings of government debt (L): 1,091.9; 1,280.5; 1,443.4; 1,527.4; 1,598.6; 1,671.5; 1,720.9; 1,827.3; 1,907.2 - Memorandum item annual percent change (M3): 15.9; 16.0; 26.2; 26.0; 27.0; 25.3; 19.2; 22.0; 19.3 ### Investment and saving - Investment (percent of GDP): 19.9; 20.5; 23.1; 24.5; 25.2; 25.2 - Central government (investment): 7.5; 8.9; 10.3; 10.6; 11.1; 10.9 - Other (investment): 12.4; 11.6; 12.8; 13.9; 14.1; 14.3 - Gross national saving: 11.9; 15.0; 15.8; 17.0; 18.7; 20.2 - Central government saving (revenue plus program grants minus recurrent expenditure): 2.2; 1.6; 2.7; 3.7; 5.1; 5.6 - Other saving: 9.7; 13.6; 13.1; 13.3; 13.7; 14.6 ### Central government budget (levels and percent of GDP) - Total revenue (in billions): 507.7; 656.8; 716.5; 815.0; 920.4; 1,043.9 - Total revenue (percent of GDP): 22.4; 22.7; 25.2; 25.3; 25.3; 25.6 - Total expenditure and net lending (in billions): 601.8; 725.2; 892.3; 978.7; 1,081.4; 1,194.6 - Total expenditure and net lending (percent of GDP): 27.8; 30.0; 32.9; 31.8; 31.2; 30.8 - Overall balance (commitment basis) excluding grants (percent of GDP): -5.4; -7.4; -7.7; -6.6; -5.9; -5.2 - Overall balance (commitment basis) including grants (percent of GDP): -4.5; -6.5; -6.5; -5.3; -4.6; -3.9 - Primary budget balance (percent of GDP): -1.5; -3.9; -3.8; -2.7; -1.9; -1.2 - Net domestic borrowing (in billions): 3.1; 5.5; 4.6; 3.2; 1.3; 1.2 ### Central government revenues and expenditures (detailed items, in billions) - Tax revenue: 417.4; 466.5; 555.5; 635.6; 720.9; 818.7 - Income tax: 184.4; 209.1; 252.0; 288.4; 326.0; 367.0 - Import duty (net): 36.2; 41.3; 48.6; 54.2; 57.8; 67.0 - Excise duty: 69.9; 74.1; 86.2; 98.8; 111.7; 125.2 - Value-added tax: 126.9; 142.0; 168.7; 194.3; 225.4; 259.6 - Nontax revenue: 68.2; 81.6; 128.7; 141.7; 155.3; 173.6 - Grants (total): 19.7; 20.7; 32.3; 37.8; 44.2; 51.6 - Recurrent expenditure: 435.5; 504.3; 602.3; 637.4; 688.3; 765.6 - Interest payments: 47.3; 63.5; 74.9; 82.0; 94.7; 104.9 - Wages and benefits (civil service): 155.2; 172.6; 197.7; 218.4; 247.1; 274.3 - Development and net lending: 166.3; 214.7; 281.9; 327.8; 387.1; 423.8 - Domestically financed development: 109.6; 151.9; 174.2; 203.1; 207.7; 272.0 - Foreign financed development: 54.3; 61.6; 105.4; 122.2; 176.8; 151.4 ### Fiscal balances (percent of GDP) — summary table entries - Balance (commitment basis, excluding grants): -113.9; -177.1; -208.1; -201.4; -205.2; -202.2 (in billions) - Balance (commitment basis, including grants): -94.2; -156.4; -175.8; -163.7; -161.0; -150.6 (in billions) - Balance (cash basis, including grants): -81.5; -156.4; -176.9; -163.7; -161.0; -150.6 (in billions) - Financing (total): 88.7; 156.4; 176.9; 163.7; 161.0; 150.6 (in billions) - Net foreign financing: 16.8; 22.9; 51.9; 66.5; 115.6; 102.9 (in billions) ### Public debt and debt metrics - Total public debt, net (percent of GDP): 41.7; 45.7; 47.1; 46.9; 45.1; 43.6 - External debt (percent of GDP): 23.3; 23.5; 22.8; 22.2; 21.9; 21.7 - Domestic debt, net of deposits (percent of GDP): 18.5; 22.2; 24.3; 24.6; 23.3; 21.9 - Stock of domestic debt, net (end of period, in billions): 401.5; 534.8; 659.8; 757.0; 802.5; 850.2 - Net present value (NPV) of total public debt, net: 694.4; 913.5; 1,097.3; 1,251.6; 1,367.5; 1,476.9 - Total public debt, net of deposits (in billions): 907.7; 1,100.4; 1,277.3; 1,441.0; 1,561.2; 1,692.5 ### Balance of payments and external sector - Exports value, goods, and services (percent of GDP): 26.6; 27.3; 27.9; 26.0; 26.6; 25.8 - Imports value, goods, and services (percent of GDP): 42.0; 39.4; 41.6; 40.0; 39.8; 38.2 - Current external balance, including official transfers (percent of GDP): -8.0; -5.3; -7.3; -7.5; -6.5; -5.0 - Gross international reserve coverage (end of period, billions of U.S. dollars): 3.2; 3.8; 4.2; 4.6; 5.9; 7.4 - Gross official reserves (end of period, memorandum): 3,443; 3,219; 3,799; 4,153; 4,627; 5,872; 7,363; 8,765 - Gross official reserves (months of following year's imports): 3.4; 3.1; 3.3; 3.3; 3.3; 3.8; 4.4; 4.8 - Current account (levels, in millions of dollars) (examples): -1,182.6; -2,288.6; -1,680.6; -2,430.4; -2,851.1; -2,776.6; -2,408.2; -2,015.8 - Exports, f.o.b. (millions of dollars): 4,545.4; 4,641.6; 4,885.5; 5,395.8; 5,846.5; 6,626.4; 7,072.9; 7,633.7 - Imports, f.o.b. (millions of dollars): -9,139.0; -10,232.8; -10,480.1; -11,765.3; -12,802.2; -14,491.7; -15,735.0; -17,052.5 - Net foreign direct investment (FDI, net): 891.7; 652.5; 403.5; 549.2; 661.0; 721.2; 786.7; 744.0 - Proposed IMF ECF financing (memorandum line): 0.00; 0.00; 0.09; 197; 132; 660 ### Financial sector soundness indicators (banking sector) - Regulatory capital to risk-weighted assets: 18.0; 18.9; 19.8; 19.5; 19.6; 20.6 - Regulatory tier 1 capital to risk-weighted assets: 16.8; 16.9; 17.6; 17.2; 17.5; 18.6 - Total capital to total assets: 12.0; 12.6; 13.0; 12.7; 14.0; 12.8 - Nonperforming loans to total gross loans: 10.6; 9.0; 9.0; 7.9; 7.4; 7.0 - Return on assets: 3.0; 2.8; 3.1; 2.9; 3.5; 3.4 - Return on equity: 27.5; 25.2; 28.5; 24.8; 31.4; 31.3 - Liquid assets to total assets: 37.5; 36.4; 35.0; 35.9; 39.7; 39.9 - Total loans to total deposits: 71.3; 73.3; 75.8; 72.4; 68.0; 69.2 - Spread between lending and deposit rate: 7.5; 7.8; 8.8; 8.8; 7.9; 4.9; 9.3 ### Proposed timing of Fund disbursements and reviews under the 2011–14 ECF Arrangement (Table highlights) - January 31, 2011: Board approval of the arrangement — 65.1 Millions of SDRs — 24.00 percent of quota - July 15, 2011: Observance of the end-March 2011 performance criteria and structural benchmarks, and completion of first review — 43.4 Millions of SDRs — 16.00 percent of quota - October 15, 2011: Observance of the end-June 2011 performance criteria and structural benchmarks, and completion of second review — 43.4 Millions of SDRs — 16.00 percent of quota - Subsequent semi-annual reviews and disbursements listed through October 15, 2013 each at 43.4 Millions of SDRs — 16.00 percent of quota - Total proposed disbursements: 325.6 Millions of SDRs — 120.00 percent of quota - Note: "Kenya's quota is SDR 271.4 million." ### Indicators of capacity to repay the Fund (projections, selected lines) - Fund obligations based on existing credit (principal, in millions of SDRs): 2.5; 15.0; 18.8; 30.0; 38.6; 47.1; 42.1; 38.4; 27.1; 13.6 (2010–2019 as listed) - Obligations to the Fund from existing and prospective credit (in millions of U.S. dollars): 4.0; 24.2; 31.9; 50.1; 63.8; 77.2; 79.5; 118.2; 127.6; 126.4 - Outstanding Fund credit (end-of-period, in millions of SDRs): 273.2; 410.2; 478.3; 535.1; 496.6; 449.4; 400.8; 327.6; 248.4; 169.7 - Outstanding Fund credit (end-of-period, in millions of U.S. dollars): 435.4; 653.1; 762.0; 852.7; 790.6; 715.5; 638.1; 521.6; 395.5; 270.2 - Memorandum nominal GDP (selected years, levels): 32,088; 35,611; 40,349; 45,172; 50,632; 56,726; 63,789; 71,463; 79,600; 88,641 *Sources: Kenyan authorities; and IMF staff estimates and projections.* ### Appendix I. Letter of Intent ### _cr1148 - Appendix I. Letter of Intent ### I. Background - New constitution promulgated on August 27, 2010 expected to support institutional checks and balances, judiciary reform, devolution of resources, land-ownership reform, and improvements in the public expenditure framework. - Vision 2030 Medium-Term Plan (MTP) aims to raise real GDP growth to 10 percent. - Priority areas: agriculture productivity (reduce cost of farm inputs; improve farm prices; expand irrigation; increase water access; preserve the environment), public investment in roads, railroad, ports, information and communication technology, and power generation—target to triple national electricity supply to 3,000 megawatts by 2018 with emphasis on geothermal power. ### II. Recent Economic Developments - Real GDP growth reached 5 percent in the first half of 2010. - Inflation has remained well below the 5 percent target. - Vulnerabilities: - International reserves remain below target despite ESF support and the 2009 SDR allocation. - Public debt in NPV terms at the 40 percent debt-to-GDP ceiling (or over 45 percent of GDP in nominal terms). - Fiscal deficit expected to remain around 7½ percent of GDP for a second consecutive year in 2010/11 due to large investment needs and constitution implementation. ### III. Program Objectives and Macroeconomic Policies (2011–13 ECF) - Program aims: - Protect external position. - Provide a reserve cushion against adverse external shocks. - Maintain macroeconomic stability during decentralization under the new constitution. - Growth and external targets: - Expect real GDP growth to rise close to 7 percent over the program period. - External current account deficit expected to decline to about 5 percent of GDP. #### A. Fiscal Policy — Objective - Gradual reduction of the overall fiscal deficit to about 5 percent of GDP over the medium term. - Target primary budget deficit: about 2 percent of GDP in 2012/13 (performance criterion) from 3.8 percent projected for 2010/11. - Maintain fiscal revenue-to-GDP ratio at around 25 percent. #### Implementation of the New Constitution - Constitution-related expenditures include drafting laws, review of legislation, civic education, winding up/setting up offices, capacity building for counties, construction/rehabilitation of county assemblies, National Assembly and Senate, and establishment of the new judicial system. - Allocations set aside: - Ksh 4 billion in the current fiscal year. - Ksh 9.5 billion for the next year. - Fiscal targets will be updated as detailed costing becomes available and as development partner support is confirmed. #### Revenue Measures - Appoint a Tax Reform Commission (TRC) to simplify the tax code, rationalize tax incentives, expand the income tax base, and remove tax exemptions as envisaged in the constitution. - Improve property tax collection infrastructure for counties. - Request technical assistance from the Fund. #### VAT Modernization (structural benchmark) - Modernize VAT legislation to improve administration and compliance. - Measures to include rationalization of VAT expenditures and exemptions, improved VAT filing, VAT refund processing, and VAT withholding. - Continued assistance from the World Bank and the Fund. #### Revenue Administration Measures - Increase automation of KRA processes to combat tax evasion and support customs reform. - Use cameras and digital video clips to accompany verification reports; progress roll-out of the Electronic Cargo Tracking System. - Reduce face-to-face interaction with KRA officials and shift from paper to electronic applications. #### Expenditure Measures - Rationalize recurrent expenditure, restrain growth in wage payments to free resources for development expenditure. - Protect pro-poor wage expenditure in health and education. - Limit new public service recruitment to sustainable levels. - Ensure development expenditure supports critical infrastructure aligned with Vision 2030’s first MTP. #### Public Financial Management (PFM) Reforms (structural benchmarks) - Submit a draft PFM Bill to the Commission for the Implementation of the Constitution by December 2011. - Adopt a Single Treasury Account by June 2012 to strengthen cash management and improve resource management (structural benchmark). - Review procurement legislation, enhance Public Procurement Oversight Authority capacity. - Implement Integrated Financial Management Information System (IFMIS) across government Ministries and Departments and eventually roll out to county governments. - Deepen Performance Based Budgeting. #### Poverty and Social Impact - Continue pursuing poverty reduction objectives and MDGs. - Protect priority social expenditures (indicative target). - Rationalize and expand social protection programs; ensure adequate spending on education and health. - Recognize need for strong donor assistance to sustain high public investment levels given limited fiscal space. #### Financing Policy - Domestic financing expected to decline from 70 percent of financing in the current fiscal year to about 60 percent next year. - External financing mainly concessional, including about US$2 billion in project loans in the next two fiscal years, mainly from the World Bank and the African Development Bank. - World Bank expected to provide budget support of US$100 million through a Development Policy Loan. - Nonconcessional financing including guarantees: - Below US$700 million in the remainder of fiscal year 2010/11 (performance criterion). - US$700 million in the year 2011/12 (performance criterion). - Nonconcessional financing, including sovereign bond proceeds, will be limited to investment projects with demonstrable revenue streams and high social returns. - Intend to issue a sovereign bond in 2012/13, timing dependent on international capital market conditions. - Continued policy of not incurring external arrears (performance criterion). *Source: Letter of Intent and Memorandum of Economic and Financial Policies, January 17, 2011.* ### 17. Contingent liabilities management: Following issuance of the government’s Public ### 17. Contingent liabilities management: Following issuance of the government’s Public Procurement and Disposal regulations in March 2009 ### Contingent liabilities management - Government committed to adopt a PPP policy to address gaps in the legal and regulatory framework and provide a clear and mandatory regulatory framework to guide PPP investments. - Administrative arrangements and processes will be introduced to guide selection and implementation of PPP projects. - PPP projects will be scrutinized to preserve fiscal discipline and safeguard the interest of tax payers. - All guarantees provided under the PPP agenda, together with all other contingent liabilities, will be integrated into the debt management process. ### Monetary policy - Policy objective: - The CBK will keep the 5 percent inflation target and maintain a floating exchange rate regime. - Pursue prudent money supply growth and gradual accumulation of international reserves to lift import coverage to over four months of following year’s imports of goods and services by the end of the program period (performance criterion). - Monetary policy will focus on its medium-term inflation target, with net domestic assets as an intermediate target (performance criterion). - CBK will monitor monetary aggregates and enhance coordination of monetary and fiscal policy to minimize liquidity impact of government financial transactions and respond timely to external shocks. - Monetary policy framework: - Strategy to move away from monetary targeting towards an appropriate monetary policy framework, reflecting expected reduction in velocity of circulation and rise in the money multiplier with deeper financial intermediation and modernization. - Inflation targeting considered viable; CBK will refine required infrastructure for adoption. - Minister of Finance will continue to convey to the CBK the inflation objective for the fiscal year after the budget presentation to parliament. - CBK will report on deviations of 2 percent or more from the stated inflation target. - CBK Act will be refined to enhance operational mandate, transparency, and accountability while preserving operational autonomy (in line with the new constitution). ### Financial policy and supervision - Policy objective: strengthen financial infrastructure to adapt to modernization, cross-border operations, and mobile banking. - Measures: - Upgrade crisis management frameworks for cross-border banking, including implementation of consolidated supervision. - Reinforce prompt corrective action by the banking supervision authority by amending the Banking Act by March 2011 (structural benchmark). - Give powers to the Deposit Protection Fund Board to hold and sell unrealizable securities after winding up an institution. - Strengthen risk-based supervision, including a time-bound program to assess conglomeration risk of relevant local groups. - Expand supervisory procedures to monitor financial business driven by bank agents and mobile banking. - Modify the CBK Act to allow the central bank to share or disclose information from surveillance of authorized foreign exchange bureaus for criminal investigations. - Introduce legislation by March 2011 to allow demutualization of the Nairobi Stock Exchange (structural benchmark). - Enforce compliance of Retirement Benefit Authority (RBA) rules on National Social Security Fund (NSSF), including appointment of external fund managers and external custodians. - Fully implement the Crime and Anti-Money Laundering Act of 2009, including necessary by-laws and regulations. ### Financial access and microfinance/SACCOs - Progress and statistics: - Share of people with access to formal financial services: 40 percent in 2009, up from 26 percent in 2006. - Mobile penetration: one cell phone per adult. - World Bank estimate: about ¾ of the population transfer cash equivalent to 20 percent of GDP annually. - About 250 deposit-taking SACCOs exist in rural areas. - Following Microfinance Act (2008), CBK has licensed three deposit-taking MFIs; others are in licensing process. - Measures to support credit access: - Facilitate increase in information coverage by the newly introduced Credit Reference Bureau. - Amend the Microfinance Act to facilitate the use of third party agents by Deposit-Taking Microfinance Institutions. - Complete regulatory and supervisory frameworks for Savings and Credit Cooperatives (SACCOs). - Implement currency centers outside Nairobi to reduce cash-in-transit costs to banks’ branches. - Structural/legal reforms to be assessed to broaden access to productive credit: - Unify framework for use of immovable property as collateral, including land; create streamlined system for noncorporate movable assets as collateral. - Simplify regime for stamp duties charged at different stages of collateralization and execution. - Create a unique registry for encumbrances within the Register General and establish simplified registration process. - In amending the Company’s Act, remove limits to types of security interests a company can register, and give same preference to creditors charging fixed and floating rates. - Reform legal framework and tax treatment of alternative risk mitigators (hire purchases, invoice discounting and factoring, warehouse receipts); consider promoting their use by financially sound SACCOs. ### Safeguards and statistics - Safeguards: - Government committed to protecting CBK financial soundness and adhering to principles of good governance and IMF safeguards policy. - Safeguards assessment of the CBK was conducted in September 2009 and found notable progress; CBK committed to address remaining vulnerabilities. - Statistics: - Government plans to release a revised set of national accounts data in 2012. - Steps to improve monitoring of fiscal data, including regular summary statistics on domestic arrears and pending bills. - Plans to develop a framework to monitor productivity changes and to produce regular trade data. - Kenya participates in the General Data Dissemination System (GDDS) project for Anglophone Africa. ### Program monitoring for 2011/12 and reviews - TMU: program monitored using definitions, data sources, and frequency in the accompanying TMU; government to make available reconciled data on a timely basis. - Performance criteria and structural benchmarks: Annex 1 and Annex 2 identify quantitative performance criteria and structural benchmarks (with dates). - Program reviews: - First review (assessing end-March 2011 performance criteria) to be completed by July 15 2011; focus on maintaining fiscal discipline while prioritizing social and economic spending. - Second review (assessing end-June 2011) expected to be completed by October 15, 2011. - Third review (assessing end-December performance criteria) expected to be completed by April 15, 2012. - Coverage: Fiscal performance criteria will cover the central government, with preparation to expand coverage to general government as early as possible in anticipation of fiscal decentralization. ### Key quantitative performance figures (as presented) - Primary budget balance of the central government (primary balance; - = deficit, floor): - -20.7 - -55.0 - -25.0 - -50.0 - Stock of central bank net international reserves (floor, in millions of US$): - 3,505 - 3,450 - 3,480 - 3,695 - Stock of net domestic assets of the central bank (ceiling): - -45.0 - -40.0 - -40.0 - -25.0 - Contracting or guaranteeing of medium- and long-term nonconcessional external debt by the central government (ceiling; millions of US$): - ... - 450 - 700 - 700 - New central government and central government guaranteed external payment arrears (ceiling, millions of US$): - 0 - 0 - 0 - 0 - Indicative targets — Priority Social Expenditures of the central government (floor): - 5.9 - 17.6 - 24.8 - 7.0 ### Technical Memorandum of Understanding (TMU) — selected definitions and adjustors - Quantitative performance criteria (for March 31, 2011; June 30, 2011; December 31, 2011) cover: - Primary balance of the central government including grants, excluding external concessional project loans, cash basis (floor). - Net official international reserves (NIR) of the CBK (floor). - Net domestic assets (NDA) of the CBK (ceiling). - Nonconcessional medium- and long-term external debt contracted or guaranteed by the central government (ceiling). - Medium- and long-term external public debt arrears (continuous ceiling). - Indicative targets for the same test dates: priority social spending of the central government (floor). - Primary balance definition and measurement: - Primary balance excluding external concessional project loans on cash basis = central government revenues and grants minus expenditures and net lending, plus due interest payments and investment expenditure financed through external concessional project loans, adjusted for cash basis. - Cumulative from October 1, 2010 for March, June test dates; for December 31, 2011 test date, cumulative from July 1, 2011. - Financing-side measurement components: (a) negative of net domestic financing; (b) negative of net external financing excluding external concessional project loans; (c) domestic and external interest payments. - NIR definition and adjustors: - NIR = gross official international reserves minus official reserve liabilities. - Gross official international reserves include CBK holdings of monetary gold (excluding amounts pledged as collateral); holdings of SDRs (including the August 28, 2009 General allocation and the September 9, 2009 Special allocation); CBK holdings of convertible currencies in cash or in nonresident financial institutions. - Exclusions: reserve position in the IMF; pledged, swapped, or encumbered reserve assets; deposits with Crown agents; precious metals other than gold; assets in nonconvertible currencies and illiquid foreign assets. - Official reserve liabilities include CBK liabilities to the IMF (except those arising from the August 28, 2009 SDR general allocation and the September 9, 2009 SDR special allocation); convertible currency liabilities to nonresidents with original maturity up to and including one year; commitments to sell foreign exchange arising from derivatives. - NIR target adjustors: - If budgetary support (external grants and loans) and external commercial debt exceed programmed amounts, NIR target adjusted upward by the difference. - If budgetary support and external commercial debt fall short of programmed amounts, NIR target adjusted downward by the difference. *Source: _cr1148 - 17. Contingent liabilities management: Following issuance of the government’s Public Procurement and Disposal regulations in March 2009* ### 7. NIR are monitored in U.S. dollars, and, for program monitoring purposes, assets ### _cr1148 - 7. NIR are monitored in U.S. dollars, and, for program monitoring purposes, assets ### Net International Reserves (NIR) — measurement and conversion - NIR are monitored in U.S. dollars. - For program monitoring, assets and liabilities in currencies other than the U.S. dollar shall be converted into dollar equivalent values using the exchange rates specified in Table 1. - Net international reserves will be computed as the daily average for the month when the testing date is due. ### Performance criterion on Net Domestic Assets (NDA) of the Central Bank of Kenya (CBK) - Definition and accounting: - NDA = reserve money minus NIR converted in shillings at the accounting exchange rate of 81 shillings for one U.S. dollar, plus medium and long term liabilities (maturity of one year or more) of the CBK (including those arising from the August 28, 2009 SDR General allocation and the September 9, 2009 SDR Special allocation); minus the value in shillings of encumbered reserves converted at the accounting exchange rate of 81 shillings for one U.S. dollar. - NDA components: - net CBK credit to the central government; - outstanding net credit to domestic banks by the CBK (including overdrafts); - other items net. - Reserve money is defined as: - currency in circulation; and - required and excess reserves. - Adjustors to the NDA target: - If budgetary support (external grants and loans) and external commercial debt exceed the programmed amounts, the target for NDA will be adjusted downward by the difference. - If budgetary support (external grants and loans) and external commercial debt fall short of the programmed amounts, the target for NDA will be adjusted upward by the difference. - Monitoring frequency and unit: - NDA are monitored in shillings and will be computed as the daily average for the month when the testing date is due. ### Performance criterion on nonconcessional external debt contracted or guaranteed by the central government - Definitions: - “Debt” follows point 9 of Executive Board Decision No. 6230-(79/140), as amended, including Executive Board Decision No. 14416-(09/91), effective December 1, 2009. - Debt means a direct, not contingent, liability created under a contractual agreement through provision of value (assets or services) requiring future payments in assets or services to discharge principal and/or interest. - Forms of debt include: - loans (including deposits, bonds, debentures, commercial loans, buyers’ credits; repurchase agreements and official swap arrangements); - suppliers’ credits; - leases (debt equals the present value at lease inception of all lease payments expected during the agreement, excluding payments covering operation, repair, or maintenance). - Arrears, penalties, and judicially awarded damages arising from failure to make payment under a contractual obligation that constitutes debt are debt. - Failure to make payment on an obligation that is not debt under this definition (for example, payment on delivery) will not give rise to debt. - Concessional borrowing: - Debt is concessional if, on the contract signing date, the ratio of present value (based on CIRRs) to nominal value is less than 65 percent (grant element at least 35 percent). - Present value is calculated by discounting future payments using OECD CIRRs. - Reference rates: 10-year average of CIRRs for loans with maturities longer than 15 years; six-month average of CIRRs for loans with shorter maturities. - Margins for different repayment periods to be added to the reference rate as established by the OECD: - 0.75 percent for repayment periods of less than 15 years; - 1 percent for repayment periods of 15–19 years; - 1.15 percent for repayment periods of 20–29 years; - 1.25 percent for repayment periods of 30 years or more. - External debt definition for the program: - Any debt as defined above denominated in foreign currency (currency other than Kenyan shillings (Ksh)). - External borrowing is borrowing denominated in foreign currency. - Measurement and ceiling: - Performance criterion is measured as a cumulative flow of nonconcessional external debt contracted or guaranteed by the central government. - The ceiling on nonconcessional external borrowing will exclude proceeds of a sovereign bond issuance up to a maximum amount of US$500 million. - Medium- and long-term debt refers to debt with maturity of one year or longer. ### Performance criterion on central government and central government guaranteed external payment arrears to official creditors - Definition: - Overdue payments (principal or interest) not made by contract due date nor during the applicable grace period, on debt contracted or guaranteed by the central government. - Excludes arrears relating to debt subject to renegotiation (dispute) or rescheduling. - Coverage: - Applies only to newly accumulated arrears on or after December 31, 2010. ### Indicative target on priority social spending - The program sets a floor on priority social spending of the central government. - Priority social spending is defined as the sum of: - cash transfers to orphans and vulnerable children; - cash transfers to elderly; - anti-retroviral treatment expenditures; - free primary education expenditure; - free secondary education expenditure. ### Coverage and institutional change - All references to central government in the TMU will be changed to general government to include local governments whenever fiscal decentralization takes place according to the new constitution. ### Program exchange rates (Table 1) — Rates as of September 1, 2010 - Per Currency Unit — Kenyan Shillings: - Australian dollar: 72.880.9000 - Canadian dollar: 77.140.9526 - Chinese yuan: 11.890.1468 - Danish krone: 13.920.1719 - Euro: 103.651.2800 - Japanese yen: 0.960.0118 - Norwegian krone: 13.050.1612 - Pound sterling: 124.651.5394 - Swedish krone: 10.990.1358 - SDR: 122.651.5147 - U.S. dollar: 81.001.0000 ### External budget support programmed amounts (Table 2 notes) - For end-December, 2010, end-March 2011 and end-June 2011, the programmed amounts are cumulative from July 1, 2010. - For end-December 2011, the programmed amounts are cumulative from July 1, 2011. - Table 2 headline figures (in millions of U.S. dollars) for External Budget Support to the Central Government 2010–11: - External Budget Grants: 0.0 0.0 0.0 0.0 - External Budget Concessional Loans: 0.0 0.0 0.0 100.0 - External Budget Commercial Loans: 0.0 0.0 0.0 0.0 - Total External Budgetary Support: 0.0 0.0 0.0 100.0 - Source: Kenyan authorities data. ### Summary of data to be reported (Table 3) — key items, frequency, deadlines, responsible entity - Central government fiscal and financing data: - Primary balance of the central government including grants — Monthly — Within 15 days after the end of the month — CBK. - Net domestic bank financing (including net commercial bank credit to the central government and net CBK credit to the central government) — Monthly — Within 15 days after the end of the month — CBK. - Net nonbank financing — Monthly — Within 15 days after the end of the month — CBK. - Central government arrears accumulation to domestic private parties and public enterprises outstanding for 60 days or longer — Monthly — Within 15 days after the end of the month — Ministry of Finance (MoF). - Proceeds from privatization — Monthly — Within 15 days after the end of the month — CBK. - Interest paid on domestic debt — Monthly — Within 15 days after the end of the month — CBK. - Interest paid on external debt — Quarterly — Within 4 weeks after the end of the quarter — CBK. - Disbursements of external nonconcessional project loans, including securitization — Quarterly — Within 45 days after the end of the quarter — MoF. - Disbursements of budget support loans — Quarterly — Within 45 days after the end of the quarter — MoF. - Principal repayments on all external loans — Monthly — Within 15 days after the end of the month — CBK. - Net proceeds from issuance of external debt — Monthly — Within 15 days after the end of the month — CBK. - Any exceptional financing (including rescheduled principal and interest) — Monthly — Within 15 days after the end of the month — MoF. - Net changes in the stock of short-term external debt — Quarterly — Within 45 days after the end of the quarter — MoF. - Net change in external arrears, including interest — Quarterly — Within 45 days after the end of the quarter — MoF. - Gross official international reserves: - CBK’s holding of monetary gold (excluding amounts pledged as collateral) — Monthly — Within 15 days after the end of the month — CBK. - Holdings of SDRs — Monthly — Within 15 days after the end of the month — CBK. - CBK holdings of convertible currencies in cash or in nonresident financial institutions — Monthly — Within 15 days after the end of the month — CBK. - Official reserve liabilities: - Total outstanding liabilities of the CBK to the IMF except those arising from the August 28,2009 SDR general allocation and the September 9, 2009 SDR special allocation — Monthly — Within 15 days after the end of the month — CBK. - Convertible currency liabilities of the CBK to nonresidents with an original maturity up to and including one year — Monthly — Within 15 days after the end of the month — CBK. - Commitments to sell foreign exchange arising from derivatives — Monthly — Within 15 days after the end of the month — CBK. - Net domestic assets: - Net CBK credit to the central government — Monthly — Within 15 days after the end of the month — CBK. - Outstanding net CBK credit to domestic banks (including overdrafts) — Monthly — Within 15 days after the end of the month — CBK. - Reserve money: - Currency in circulation — Monthly — Within 15 days after the end of the month — CBK. - Required and excess reserves — Monthly — Within 15 days after the end of the month — CBK. - Other quarterly items (within 45 days after the end of the quarter) — MoF responsible: - Nonconcessional medium- and long-term external debt contracted or guaranteed by the central government. - Accumulation of central government and central government guaranteed external payment arrears. - Social priority spending. ### Selected institutional and program context (high-level items from the Annex) - Accounting exchange rate for program monitoring: 81 shillings for one U.S. dollar. - Exchange rate regime: float; official exchange rate set at previous day’s average market rate for certain government transactions; U.S. dollar is the principal intervention currency. - On November 30, 2010, the exchange rate was KSh 80.97=US$1.00. - Table 1 rates are dated "Rates as of September 1, 2010." *International Monetary Fund — Kenya: Request for a Three-Year Arrangement Under the Extended Credit Facility — Informational Annex (Prepared by the African Department; Approved January 14, 2011).* ### 1. The Fund Kenya team led by Mr. Fanizza (mission chief) met with the World ### _cr1148 - 1. The Fund Kenya team led by Mr. Fanizza (mission chief) met with the World ### Meeting purpose and shared macro assessment - The Fund Kenya team led by Mr. Fanizza (mission chief) met with the World Bank Kenya team led by Mr. Zutt (country director) on September 21, 2010 to identify macro critical structural reforms and coordinate the two teams’ work for the period October 2010–September 2011. - Agreed main macroeconomic challenges: - Ensure public debt sustainability while strengthening the investment climate to diversify the economy. - Consolidate the fiscal position over the medium term to bring the public debt-to-GDP ratio back to about 45 percent while creating the right environment for investments to unlock growth potential. ### Macro-critical structural reform areas (identified as key to sustained growth, fiscal strengthening, and debt sustainability) - Public financial management reform: - Progress: linking expenditure to medium term policy objectives. - Remaining needs: strengthen preparation, execution, and monitoring of the budget, important given planned devolution of at least fifteen percent of government revenues to local levels of government by 2015. - Key reform elements: - (i) supporting the complete roll out of IFMIS in all ministries through the Institutional Reform and Capacity Building project; - (ii) establishing a Single Treasury Account to improve Treasury control; - (iii) implementing a comprehensive Public Finance Administration bill prior to the transfer of resources to decentralized units. - Tax reform: - Enhance tax policy and administration centered on implementation of a new VAT to be modernized and simplified in line with best practice. - Strengthen customs administration in line with commitments under the EAC Common Market Protocol. - Financial sector reform: - Need for enhanced consolidated and cross-border supervision and upgrade in the crisis management framework due to modernization and regional growth of financial institutions. - Strengthen capital markets: demutualization of the stock exchange, enhancing the Capital Markets Authority, and further development of debt and capital markets regionally. - Strengthen insurance markets (highlighted by the FSAP update as a weaker area). - Address NSSF and other sustainability aspects of the public pension system (also highlighted by the FSAP update). - Infrastructure reform: - Identified as one of the most problematic factors for doing business in Kenya. - Focus areas: (i) improvements at the Mombasa port; (ii) strengthening infrastructure in transportation, energy, water and sanitation; (iii) improving PPP institutional capacity at the ministries. - Investment climate reform: - Kenya has made important progress but other countries reformed faster; post-election violence slowed reform momentum. - Need to revive reform momentum through interventions in private sector competitiveness and financial sector deepening and strengthening. ### Division of labor between Fund and World Bank - Public financial management reform: - Fund: technical assistance (TA) on a comprehensive Public Financial Management bill, on program budgeting, and support on establishment of a Single Treasury Account. - WB: support implementation of IFMIS and essential PFM reforms through the Institutional Reform and Capacity Building Project and proposed DPL. - Tax reform: - Fund: TA on enhancing customs administration, including improvements to inspection procedures and information technology. - Public Expenditure Review: - WB: lead the PER focusing on service delivery in agriculture, education, and health; building capacity for social accountability, including expenditure tracking and public expenditure analysis. - Financial sector reform: - WB: support through FLSTAP since 2005 with strong agenda on regulatory and supervisory agents; support for pension markets and insurance linked to FLSTAP. - Fund: TA on focalized aspects such as stress testing; coordinate on establishment of a crisis management framework and pension markets (particularly NSSF). - Infrastructure reform: - WB: supporting PPPs and infrastructure finance; creation of PPP secretariat; authorities requested support for new PPP/infrastructure finance project. - Coordination with Fund on contingent liabilities analysis related to PPP and beyond. - Investment climate reform: - WB: support via FLSTAP, Kenya investment climate program (KICP), MSME competitiveness project, and analytical work on industry mapping/clusters; proposed DPL expected to complement these efforts. - Fiscal decentralization: - WB and Fund: jointly provide TA on fiscal decentralization envisaged in the new constitution, focusing on equitable and efficient fiscal and public finance management systems for county governments. - ECF arrangement with the Fund: - Program focus: strengthen Kenya’s external position, promote gradual fiscal consolidation while stepping up infrastructure investment and providing sufficient resources to implement the new constitution, bring back the debt burden to the government’s medium-term target, maintain the floating exchange rate regime, and move gradually to an inflation targeting framework. - Program will seek to strengthen public financial management, modernize and simplify tax policy, and broaden access to financial services. ### Information exchange requests and timing - Fund request: be kept informed of progress in macro critical structural reform areas. Timing: when milestones are reached (and at least semi-annually). - WB request: be kept informed of the Fund’s assessments of macroeconomic policies and prospects. Timing: in the context of Article IV and other missions (and at least semi-annually). ### Work programs and provisional timing (October 2010–September 2011 highlights) - WB Work Program (selected items and timing): - Kenya economic update (bi-annually): Dec. 2010 & June 2011. - Institutional reform and Capacity building (PFM; institutional reform and capacity building): Continuous. - Public expenditure review: November 2010. - Development Policy Loan (DPL): TBD. - PPPs/Infrastructure Finance: N/A (mission timing lists April 2011 and July 2011 for related activities). - FLSTAP—financial regulators and market development; housing finance analysis: July 2011. - MSME, KICP, analytical work on investment climate: Continuous. - Fund Work Program (selected items and timing): - Missions: Staff mission for negotiations on a financing arrangement: November 2010. - Article IV consultation: To be determined (TBD). - TA on fiscal regulations; program budgeting; fiscal decentralization; IFMIS and treasury single account support: Ongoing; Implementation throughout fiscal year 2011. - TA on customs administration and modern risk management: November 2010; TA report in February 2011. - TA on crisis management framework: January 2011. - Joint Work Program: - Various TA provisions on PFM reforms, fiscal decentralization, crisis management framework (FLSTAP, FIRST) and Pensions (NSSF and contingent liabilities): November 2010 and continuous. - Public and external debt Sustainability Analysis: December 2010 as part of the DPL and continuous. ### Key statistical assessment (As of January 10, 2011) - Overall adequacy: - Data provision has some shortcomings, but is broadly adequate for surveillance and program monitoring. - Further methodological improvements desirable for real, fiscal, and external sector statistics. - Quality, timeliness, and coverage of macroeconomic statistics have significantly improved over the past few years—assisted by Fund TA from the Statistics Department, Fiscal Affairs Department, and Monetary and Capital Markets Department. - National accounts: - KNBS published annual national accounts estimates for 1996–2008 in current and constant (2001 prices) from both expenditure and production approaches. - Quarterly GDP at constant prices now published. - Remaining problems: estimates of the informal sector, use of deflators, coverage of electricity generation, mining/petroleum exploration, private water supply and sewerage, and excessive use of fixed ratios. - Price statistics: - Challenges in compiling CPI with historical dimension. - New national CPI (since early 2002) covered 13 urban towns with 1997 reference year and weights from the 1993–94 Household Budget Survey. - STA-assisted mission in March 2008 identified methodological issues; KNBS released revised series in November 2009 correcting elementary aggregation bias; KNBS rebased the series in February 2010. - Current series starts in February 2009; KNBS plans to publish a historical series based on this methodology in 2012. - KNBS does not compile producer, export, or import price indices. - Government finance statistics: - Since FY 2005/06, Kenya follows GFSM 2001 classification; migration may reduce differences between KNBS and MoF/AFR data. - Serious delays in reporting due to establishing budget execution and accounting systems consistent with new classification. - Need to upgrade and operationalize systems for timely reconciliation and monitoring of budget execution; progress toward IFMIS but gaps remain in fiscal data reconciliation and recording of external financing and expenditure directly financed from abroad. - Initiatives to rationalize/eliminate extrabudgetary funds begun but consolidated fiscal statistics progress limited. - Monetary statistics: - Progress in implementing the Monetary and Financial Statistics Manual and development of SRFs. - Major future issue: expand coverage of ODCs to include SACCOS—estimated about 3,800 SACCOs operate in Kenya, accounting for about 30 percent of the total deposits of the banking system. - ODCs coverage also needs to include licensed microfinance institutions, the Post Office Savings Bank, deposit taking investment banks, and mutual funds. - Kenya to participate in monetary module of the DFID/EDDI project for Africa; first mission under this project scheduled for April 2011. - Balance of payments: - KNBS compiles annual BOP statistics in Kenya shillings following BPM5 classifications. - Financial account largely drawn from the International Transactions Reporting System (ITRS) which has a large and growing element of unclassified inflows and outflows that might include settlements of current account transactions. - Kenya participates in the external sector module of the EDDI Project; three TA missions conducted for cross-border financial flows and stocks enterprise survey to improve BOP and compile IIP statistics. - Latest TA mission: November 8–19, 2010 assessed results of the 2009 IIP survey and the 2010 Foreign Investment Survey (2010 FIS) and designed the frame for a 2011 FIS. - 2009 IIP Survey limited by budget and confined to position data; 2010 FIS collected BOP data for 2008 and 2009 and related IIP data with World Bank Statistics Capacity Building project assistance. - Establishment of a MEFMI-developed database proved effective for private capital flows surveys; additional tables recommended to be added by MEFMI. - Once established annually, the FIS will be a major data source supporting direct reporting and integration of BOP and IIP compilation, replacing the ITRS as a data source. - Data standards and reporting: - Kenya participates in the Fund’s GDDS and the EDDI project for Anglophone Africa. - A Data ROSC was conducted in October 2005. - Budgetary central government data submitted for publication in the GFS Yearbook have been reported in GFSM 2001 format, albeit with significant lag. - Monthly and quarterly GFS data regularly reported for inclusion in the IFS. - Monetary data for the central bank and ODCs regularly reported for inclusion in the IFS. - Annual BOP data following BPM5 classifications regularly reported to STA. ### Joint IMF/World Bank Debt Sustainability Analysis (executive overview) - This analysis updates the May 2009 joint Bank/Fund debt sustainability analysis (DSA). - Compared to the 2009 analysis (Country Report No. 09/191), debt sustainability indicators have deteriorated somewhat, reflecting a projected faster debt accumulation over the medium term. - Risks are somewhat greater for public debt, particularly in the event of lower growth. - Despite deterioration, Kenya remains at low risk of external debt distress. - At end-2009: - Nominal public external debt was estimated at $7.1 billion (23¾ percent of GDP). - About 60 percent of this debt was to multilateral creditors (including 47 percent owed to the World Bank) and 39 percent to bilateral creditors. - A small share (under 2 percent), owed to commercial creditors, represents disputed arrears on security-related contracts. - Notes and policy-relevant points: - Projected investment in infrastructure and assumed improvement in the investment climate would be crucial to sustaining strong exports and GDP growth. - Strategies to guard against shocks could include a build-up in international reserves as envisaged in the ECF framework. - Kenya classifies as a medium performer in policies and institutions per the World Bank’s CPIA three-year average. - For a medium performer, indicative thresholds for external debt sustainability include: - NPV of debt-to-GDP ratio of 40 percent, - NPV of debt-to-exports ratio of 150 percent, - NPV of debt-to-revenue ratio of 250 percent, - debt service-to-exports ratio of 20 percent, - debt service-to-revenue ratio of 30 percent. *Prepared from IMF/World Bank joint mission notes and statistical assessment as presented in the source document.* ### 2. Kenya has managed its debt relatively well and has regularly met its obligations, ### _cr1148 - 2. Kenya has managed its debt relatively well and has regularly met its obligations, ### Overview of public debt management and recent history - Kenya has managed its debt relatively well and has regularly met its obligations, except for some disputed commercial arrears. - Limited external borrowing has left Kenya with more manageable debt ratios than many low-income country peers. - Kenya benefited from Paris club rescheduling but did not qualify for heavily indebted poor countries (HIPC) debt relief as its debt indicators have been below the HIPC Initiative thresholds. ### Disputed external commercial arrears - Disputed external commercial arrears are estimated at US$242 million and are a subject of on-going investigations and litigation. - The time-line for clearance of these arrears has not been determined. - The amount was revised upward from an earlier estimate of US$91 million following completion of independent valuation of works, goods, and services delivered under each contract. - Authorities consider it prudent to estimate a higher figure to reflect the likelihood of court rulings in favor of all creditors. ### Domestic debt and contingent liabilities - Kenya’s net domestic debt stood at Ksh 584 billion at end-2009 (20¾ percent of GDP). - During 2003–07, domestic debt declined to 13½ percent of GDP due to strong growth, prudent fiscal policies, and lower interest rates. - The downward trend reversed during 2008–09 reflecting fiscal stimulus measures. - Potential contingent liabilities could be very large, including parastatals debt and unfunded obligations: - Unfunded obligations of the National Social Security Fund and government’s current pay-as-you-go pension scheme for civil servants are equivalent to 11.8 percent of 2008/09 GDP. - Public domestic debt comprises central government debt; total public debt refers to the sum of public domestic and public external debt but does not cover the entire public sector (e.g., parastatal borrowing without a government guarantee is not covered). ### DSA methodology and coverage - The DSA is based on nonreconciled debt data provided by the authorities, available data on private sector debt, and staff estimates. - It consists of two parts—external and fiscal: - External DSA covers external debt of the central government (including parastatal borrowing with a government guarantee) and the central bank, and includes estimates of private sector debt based on available information. External debt sustainability is assessed in relation to policy-dependent debt-burden thresholds. A single discount rate is used. - Fiscal DSA covers total debt—external and domestic—incurred or guaranteed by the central government. - Public domestic debt in this analysis refers to central government debt. ### Key macroeconomic assumptions underlying the DSA - Real GDP growth projections: - 5 percent for 2010. - Projected at an annual average of about 6 1/3 percent during 2010–15, and just above 6 percent thereafter. - Average inflation: about 5 percent for 20111–15 as measured by the GDP deflator. - Broadly constant real exchange rate during the medium term. - Noninterest external current account deficit: - Rises to about 7¼ percent of GDP in 2010. - Falls to about 3 percent of GDP by 2015. - Fiscal assumptions: - Broadly constant revenue and grants as a share of GDP (about 26 percent). - Domestically financed development spending gradually increasing from just about 6.0 percent of GDP in 2008 to about 6.8 percent by 2029. - Constant wage bill of 7.1 percent of GDP. - Gradual decline in other recurrent spending from 8.9 percent of GDP in 2008 to 7.2 percent of GDP over the long-term. - Primary fiscal deficit was 3.7 percent of GDP in 2009/10 and gradually declines to 1.2 by the end of the forecast period. - Real interest rates on domestic public debt: - 3 percent for short-term debt. - 5 percent for medium- and long-term debt. - New domestic borrowing composition: - One quarter short-term debt and three-quarters medium- and long-term debt with average maturity of about seven years. - NPV of domestic debt assumed equal to its face value. - New external borrowing as a share of GDP: - Projected to average 2½ percent of GDP during 2011–15, up from 2 percent of GDP in 2009. - Declines, falling below 1 percent by the end of the forecast period. - New external borrowing assumptions include sovereign bond issuance of $500 million in 2012, additional commercial borrowing of about US$450 million during 2013–14 and about US$200 million per year in the long run. - Assumed terms: 7½ percent fixed interest rate and a bullet amortization in year 10. - Continued eligibility for concessional borrowing from the International Development Association is assumed, although achievement of assumed growth rates could imply graduation during the forecast period. ### External debt sustainability findings - Kenya faces a low risk of external debt distress reflecting limited reliance on external borrowing and expected improvement in macroeconomic performance. - Baseline scenario: - Initial debt ratios are well below all indicative thresholds for a medium performer, even if they increase over the medium-term. - Stress-test results: - A combined shock (lower GDP growth, weaker exports, lower GDP deflator, fall in nondebt creating flows) over 2011–15 would push: - NPV of public external debt as a share of GDP from 18¼ percent to 25 percent. - NPV of debt-to-exports from almost 66 percent to 96 1/3 percent. - The most extreme shocks to debt dynamics by 2020 generally stem from a one-time 30 percent depreciation in 2011 or from a one standard deviation shock to exports growth. - Selected summary external DSA indicators (baseline vs combined shocks): - NPV of PPG External Debt (In percent of GDP; threshold=40) - Baseline: 2010=18.2, 2011=18.2, 2012=19.3, 2013=19.6, 2014=19.4, 2015=18.9 - Combined shocks: 2010=18.2, 2011=19.8, 2012=26.4, 2013=26.4, 2014=25.9, 2015=25.0 - NPV of PPG External Debt (In percent of exports; threshold=150) - Baseline: 2010=66.0, 2011=69.2, 2012=70.9, 2013=73.2, 2014=77.8, 2015=74.7 - Combined shocks: 2010=66.0, 2011=71.5, 2012=94.7, 2013=96.2, 2014=101.1, 2015=96.3 - PPG External Debt Service (In percent of exports; threshold=20) - Baseline: 2010=4.1, 2011=4.1, 2012=3.9, 2013=4.0, 2014=4.4, 2015=4.2 - Combined shocks: 2010=4.1, 2011=4.1, 2012=4.4, 2013=4.9, 2014=5.3, 2015=5.0 ### Public debt sustainability findings and scenario analysis - Baseline public debt path: - NPV of total public debt-to-GDP at 42 percent in 2010. - Peaks at 43 percent in 2012. - Gradually trends down to 40 percent of GDP by 2015. - Afterwards trends down to around 26 percent. - Given strong revenue performance, NPV of debt-to-revenue ratio declines to below 150 percent after 2015. - Debt service-to-revenue ratio falls to 22 percent by 2015, from 25 in 2009, and declines to below 20 percent by 2030. - Vulnerabilities from scenarios and stress tests: - A scenario assuming that 10 percent of 2010 GDP in potential domestic currency liabilities as of end-2010 would be paid by the government in equal tranches over a 10-year period shows notable deterioration in debt indicators compared with the baseline. - A two-year growth shock leads to: - NPV of debt-to-GDP ratio rising to 55 percent by 2014. - NPV of debt-to-revenue ratio rising to over 200 percent by 2020. - Debt service-to-revenue ratio rising to over 31 percent by 2030. - Permanently lower growth—baseline minus half a percentage point—results in considerably higher long-term debt indicators (e.g., by the end of the forecast period the NPV of debt-to-GDP ratio would be 50 percent). - These results reinforce the importance of implementing fiscal consolidation, expanding productive capacity, and pursuing a prudent borrowing approach to avoid a rising debt burden. ### Conclusions and policy implications - External risk: - Kenya faces a low risk of external debt distress; all external public debt indicators remain below the relevant country-specific debt burden thresholds. - Standard stress tests worsen indicators but do not breach thresholds during the projection period. - Public debt risk: - Total public debt shows greater risk of unfavorable developments, especially under GDP growth shocks, an unchanged fiscal policy, or realization of contingent liabilities. - Even temporary lower GDP growth or a permanently unchanged primary balance from its 2010 level would sharply worsen public debt dynamics. - Potentially large but unreported contingent liabilities pose additional risks. - Policy implications: - Sustainability depends on macroeconomic performance and a prudent borrowing strategy. - Projected investment in infrastructure and improvement in the investment climate are crucial to sustaining strong exports and GDP growth. - Kenya’s avoidance of unsustainable debt to date reflects both good management and limited willingness of some creditors to provide financing at times due to governance concerns. *Source: _cr1148 - 2. Kenya has managed its debt relatively well and has regularly met its obligations,* ### conclusions. The staffs encourage Kenyan authorities to build on their recent medium-term ### _cr1148 - conclusions. The staffs encourage Kenyan authorities to build on their recent medium-term ### Conclusions and policy recommendations - Staffs encourage Kenyan authorities to build on their recent medium-term debt strategy and to use tools such as the joint IMF/WB DSA template to help maintain a prudent borrowing strategy. - Such a strategy should continue to consider the total concessionality and interest costs of Kenya’s borrowing, maturity structure, and steps that would help guard against volatility, whether due to shocks such as droughts or to fluctuations in external assistance. - Strategies to guard against shocks could include a build-up in international reserves as envisaged in the ECF framework. ### Public and publicly guaranteed external debt: stress tests and indicators - The most extreme stress test is defined as the test that yields the highest ratio in 2020; examples identified: - Figure b: One-time depreciation shock. - Figure c: Exports shock. - Figure d: One-time depreciation shock. - Figure e: Debt service shock. - Figure f: One-time depreciation shock. - Key graphical indicators covered for 2010–30 include: - Debt Accumulation (grant-equivalent financing (% of GDP); grant element of new borrowing (percent, right scale)). - PV of debt-to-GDP ratio. - PV of debt-to-exports ratio. - PV of debt-to-revenue ratio. - Debt service-to-exports ratio. - Debt service-to-revenue ratio. ### Debt sustainability framework — selected exact figures (as reported) - Public sector debt 1/: 34.6, 41.3, 44.4, 47.6, 49.0, 49.1, 48.1, 47.0, 45.4, 36.9, 28.8 - o/w foreign-currency denominated: 21.1, 23.7, 23.8, 24.2, 24.4, 25.2, 25.5, 25.1, 24.3, 20.9, 9.2 - Change in public sector debt: -3.5, 6.7, 3.1, 3.2, 1.4, 0.1, -1.0, -1.1, -1.6, -1.1, -0.6 - Identified debt-creating flows: -5.6, 2.5, 1.0, 2.5, 0.1, -1.2, -1.4, -1.6, -2.1, -1.5, -1.2 - Primary deficit: 0.5, 2.0, 3.1, -0.1, 1.7, 3.8, 3.2, 2.3, 1.6, 1.3, 0.8 - Revenue and grants: 23.1, 23.2, 23.7, 25.2, 26.6, 26.5, 26.8, 26.8, 26.3, 25.2, 24.2 - of which: grants: 1.1, 1.1, 0.9, 1.0, 1.2, 1.3, 1.3, 1.3, 0.9, 0.6, 0.2 - Primary (noninterest) expenditure: 23.6, 25.3, 26.7, 29.0, 29.8, 28.9, 28.4, 28.1, 27.1, 25.7, 24.3 - Automatic debt dynamics: -4.4, 2.2, -2.1, -1.3, -3.1, -3.6, -2.9, -2.9, -2.9, -2.0, -1.3 - Contribution from interest rate/growth differential: -1.8, -0.5, -0.3, -1.3, -2.1, -2.5, -2.2, -2.2, -2.2, -1.4, -1.0 - Contribution from average real interest rate: 0.6, 0.0, 0.8, 0.8, 0.5, 0.6, 0.9, 0.9, 0.8, 0.8, 0.7 - Contribution from real GDP growth: -2.5, -0.5, -1.0, -2.1, -2.6, -3.0, -3.1, -3.1, -2.9, -2.2, -1.7 - Contribution from real exchange rate depreciation: -2.6, 2.7, -1.8, 0.0, -1.0, -1.1, -0.7, -0.7, -0.7, ... - Other identified debt-creating flows: -1.6, -1.8, 0.1, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 - Privatization receipts (negative): -2.2, -1.8, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 - Residual, including asset changes: 2.1, 4.2, 2.1, 0.7, 1.2, 1.3, 0.4, 0.5, 0.5, 0.4, 0.6 - Other sustainability indicators — PV of public sector debt: 13.5, 17.7, 38.2, 41.7, 42.7, 43.1, 42.2, 41.4, 40.0, 32.2, 26.5 - o/w foreign-currency denominated: 0.0, 0.0, 17.6, 18.2, 18.2, 19.3, 19.6, 19.4, 18.9, 16.2, 6.9 - Gross financing need 2/: 10.7, 12.2, 14.7, 15.9, 15.7, 15.6, 14.6, 13.6, 12.7, 10.3, 9.8 - PV of public sector debt-to-revenue and grants ratio (in percent): 58.3, 76.0, 161.5, 165.0, 160.8, 162.5, 157.1, 154.6, 152.3, 127.8, 109.6 - Debt service-to-revenue and grants ratio (in percent) 4/: 26.9, 26.4, 27.2, 25.1, 23.1, 25.3, 24.6, 22.9, 22.4, 20.0, 17.9 - Debt service-to-revenue ratio (in percent) 4/: 28.3, 27.7, 28.3, 26.2, 24.3, 26.6, 25.9, 24.1, 23.2, 20.5, 18.0 - Primary deficit that stabilizes the debt-to-GDP ratio: 4.0, -4.7, 0.0, 0.6, 1.8, 2.3, 2.5, 2.4, 2.4, 1.6, 0.7 ### Sensitivity analysis and alternative scenarios (selected) - Table 1b and Table 2b present alternative scenarios and bound tests for key indicators (PV of debt-to-GDP, PV of debt-to-exports, PV of debt-to-revenue, debt service ratios) for 2010–30 under: - A1. Key variables at historical averages. - A2. Primary balance unchanged from 2010 (or new loans on less favorable terms). - A3. Permanently lower GDP growth. - A4. Recognition of domestic contingent liabilities during 2011. - B1–B6. Bound tests including one-time 30 percent real depreciation in 2011 and combinations of standard deviation shocks. - Examples of selected scenario outcomes (PV of debt-to-GDP ratio, PV of debt-to-revenue ratio, Debt service-to-revenue ratio): - Baseline PV of debt-to-GDP ratio: 165, 161, 162, 157, 155, 152, 128, 110 (reported across columns). - A2 (Primary balance unchanged from 2010) PV of debt-to-GDP ratio: 165, 164, 172, 175, 181, 189, 215, 268. - B1 (Real GDP growth at historical average minus one standard deviation in 2011-2012): PV of debt-to-GDP ratio: 165, 173, 193, 196, 201, 207, 215, 238. - Table 2b (external debt sensitivity) samples: Baseline PV of debt-to-GDP ratio: 18.2, 18.2, 19.3, 19.6, 19.4, 18.9, 16.2, 6.9; A2 (less favorable terms) rises to values such as 22.4, 22.8, 22.9, 22.0, 11.9 in the projection sequence. - Memorandum item: Grant element assumed on residual financing (i.e., financing required above baseline) 6/: 20.7, 20.7, 20.7, 20.7, 20.7, 20.7, 20.7, 20.7 ### Program approval, objectives, and press-release highlights - IMF Executive Board approved a three-year arrangement under the Extended Credit Facility (ECF) for Kenya in an amount equivalent to SDR 325.68 million (about US$508.7 million). - The Executive Board’s approval will immediately enable an initial disbursement of an amount equivalent to SDR 65.1 million (about US$101.7 million). - Program aims: - Protect Kenya’s external position while allowing a gradual fiscal adjustment. - Help rebuild Kenya’s international reserves. - Address balance-of-payments financing needs and provide a reserve cushion to deal with adverse shocks. - Maintain fiscal discipline as fiscal decentralization gets underway, while keeping inflation low under a floating exchange rate regime. - Target a gradual reduction in the central government primary balance through tax reform and strict control of current spending; tax measures include reform of value-added and income taxes to improve coverage and compliance. - Create fiscal space to implement the new constitution, raise infrastructure investment, and protect spending aimed at poverty reduction. - Excerpts from Mr. John Lipsky (First Deputy Managing Director and Acting Chair) highlight: - Kenya’s economy is bouncing back; fiscal stimulus and benign weather supported recovery. - Need to reverse the rise in public debt resulting from fiscal expansion while accommodating costs of implementing the new constitution and high-priority public investments. - The arrangement provides a reserves cushion to reduce vulnerabilities to external shocks, including projected deterioration of the terms of trade in the next two years. ### Key macroeconomic and fiscal assumptions (selected exact values) - Real GDP growth (in percent) sequence reported: 7.0, 1.6, 2.6, 3.7, 2.4, 5.0, 5.7, 6.5, 6.8, 6.8, 6.7, 6.3, 6.1, 6.1, 6.1 - Average nominal interest rate on forex debt (in percent): 1.5, 1.4, 1.3, 1.7, 0.8, 1.2, 1.1, 1.2, 1.6, 1.7, 1.8, 1.5, 2.1, 1.9, 2.0 - Average real interest rate on domestic debt (in percent): 7.3, 1.1, 4.0, 7.4, 5.6, 3.8, 2.5, 2.5, 4.1, 4.2, 3.7, 3.4, 5.1, 3.9, 4.4 - Real exchange rate depreciation (in percent, + indicates depreciation): -11.7, 13.3, -7.7, -4.5, 8.0, 0.2, ... - Inflation rate (GDP deflator, in percent): 5.3, 11.9, 6.7, 5.9, 3.1, 6.6, 7.1, 6.5, 4.8, 4.9, 5.0, 5.8, 5.0, 5.0, 5.1 - Growth of real primary spending (deflated by GDP deflator, in percent): 0.1, 0.1, 0.1, 0.1, 0.0, 0.1, 0.1, 0.0, 0.1, 0.1, 0.0, 0.1, 0.1, 0.1, 0.1 - Grant element of new external borrowing (in percent) (where reported): 31.4, 35.1, 16.9, 25.2, 21.1, 23.3, 25.5, 27.2, 23.4, ... *Sources: Country authorities; and staff estimates and projections.* ### 2.6 percent in 2009, driven mainly by a rebound in agriculture and a boost in construction ### 2.6 percent in 2009, driven mainly by a rebound in agriculture and a boost in construction activity, helped in particular by the government’s renewed efforts to upgrade infrastructure. ### Program summary - Program objectives: - raise real GDP to close to 7 percent; - bring the public debt-to-GDP ratio to below 45 percent over the medium term; - keep inflation at 5 percent while maintaining a floating exchange rate regime. - Key program features: - boost international reserves while adopting a gradual fiscal adjustment over a three-year horizon; - scale up investment in key priority social and economic sectors and critical infrastructures, in particular geothermal power generation; - implement structural reforms in public financial management, public services, business regulation, and the financial sector. ### Recent economic developments and medium-term outlook - 2010 growth: estimated at just over 5 percent. - Authorities’ forecast: growth expected to accelerate to 5.7% in 2011. - Inflation: kept well below the authorities’ target of 5 percent due to ample food supply and competition in telecommunications. - International reserves: described as relatively low with modest capital inflows. - Remittances: account for over 70 percent of total remittance flow to Kenya coming from North America and Europe. ### Fiscal policy (objectives and measures) - Fiscal targets and stance: - overall fiscal balance target: decline to 5 percent; - maintain debt ratio at a sustainable level. - Financing and debt management: - maintain significant concessional external financing; - shift composition of domestic debt towards longer term maturities (government bond term lengthened to 25 years); - intend to access international capital markets with issuance of a sovereign bond when global financial conditions permit. - Revenue and tax reform: - aim to maintain a revenue effort of about 25 percent of GDP; - plan to appoint a Tax Reform Commission (TRC) to simplify the tax code, modernize VAT legislation, and increase automation of the Kenya Revenue Authority. - Expenditure and PFM: - increase budgetary allocations to development expenditure while containing growth of total expenditure; - prioritize infrastructure investments and enhance execution rate through (i) more frequent monitoring and review of projects; (ii) active engagement of development partners; (iii) more rigorous selection criteria for new projects; - implement new Public Finance Management legislation and institutionalize IFMIS on a single integrated platform. ### Monetary policy - Medium-term monetary policy objectives: - deliver low and stable inflation and continued stability in long term interest rates; - maintain a competitive, market-determined exchange rate with interventions limited to smoothing excessive volatility; - gradually build international reserves to the statutory level of 4 months of import cover. - Reforms: review the monetary policy framework and deepen ongoing financial sector reforms to improve monetary policy transmission. ### Financial stability - Observations: increased competition, innovation, expanded access to financial services, and growing cross-border banking services. - Planned actions: - strengthen supervision and regulatory framework, including demutualization of the Nairobi Stock Exchange and completing regulatory framework of Savings and Credit Cooperatives; - give more powers to the Deposit Insurance Fund, strengthen risk-based supervision, expand supervisory procedures; - modify the Banking Act to allow the Central Bank to disclose surveillance information of foreign exchange bureaus; - enforce compliance of Retirement Benefit Authority rules on National Social Security Fund; - fully implement the Crime and Anti-Money Laundering Act of 2009; - upgrade crisis management framework for cross-border banking; - continue promoting financial access to the unbanked. ### External sector outlook - Projection: deterioration in the terms of trade due to rising oil prices and declining export prices for tea and coffee. - Current account: expected to widen to about 7.5 percent in the next two years. - Reserves: buildup of international reserves buffers will be constrained. - Regional integration: committed to implementing the Common Market Protocol for EAC. ### Key statistics and projections (selected figures from Kenya: Selected Economic Indicators, 2008/09–2013/2014) - Nominal GDP (market prices, in billions of Kenya shillings): 2,176; 2,410; 2,713; 3,075; 3,464; 3,880. - Real GDP growth (market prices): 2.1; 3.8; 5.4; 6.1; 6.7; 6.8. - GDP deflator (average): 9.3; 6.7; 6.9; 6.8; 5.6; 4.9. - Consumer price index (annual average): 15.0; 5.3; 3.4; 5.0; 5.0; 5.0. - Consumer price index (end of period): 8.6; 3.5; 4.0; 5.0; 5.0; 5.0. - Import volume growth, goods, and services: 13.6; 8.7; 5.5; 5.8; 6.6; 7.2. - Export volume growth, goods, and services: -1.5; 5.9; 11.0; 10.5; 9.7; 10.5. - M3 (broad money and foreign currency deposits, end period): 13.0; 26.2; 19.2; 16.6; 14.1; 14.7. - Investment (percent of GDP): 19.9; 20.5; 23.1; 24.5; 25.2; 25.2. - Central government investment (percent of GDP): 7.5; 8.9; 10.3; 10.6; 11.1; 10.9. - Gross national saving (percent of GDP): 11.9; 15.1; 15.8; 17.0; 18.7; 20.2. - Central government total revenue (percent of GDP): 22.4; 22.7; 25.2; 25.3; 25.3; 25.6. - Central government total expenditure and net lending (percent of GDP): 27.8; 30.1; 32.9; 31.8; 31.2; 30.8. - Overall balance (commitment basis) excluding grants (percent of GDP): -5.4; -7.4; -7.7; -6.6; -5.9; -5.2. - Overall balance (commitment basis) including grants (percent of GDP): -4.5; -6.5; -6.5; -5.3; -4.6; -3.9. - Primary budget balance (percent of GDP): -1.5; -3.9; -3.8; -2.7; -1.9; -1.2. - Net domestic borrowing (percent of GDP): 3.1; 5.5; 4.6; 3.2; 1.3; 1.2. - Exports value, goods, and services (percent of GDP): 26.6; 27.3; 27.9; 26.0; 26.6; 25.8. - Imports value, goods, and services (percent of GDP): 42.0; 39.4; 41.6; 40.0; 39.8; 38.2. - Current external balance, including official transfers (percent of GDP): -8.0; -5.3; -7.3; -7.5; -6.5; -5.0. - Gross international reserves (end of period, in billions of U.S. dollars): 3.2; 3.8; 4.2; 4.6; 5.9; 7.4. - Gross international reserves (end of period, in months of next year imports): 3.1; 3.3; 3.3; 3.3; 3.8; 4.4. - Total public debt, net (percent of GDP): 41.7; 45.7; 47.1; 46.9; 45.1; 43.6. - External debt (percent of GDP): 23.3; 23.5; 22.8; 22.2; 21.9; 21.7. - Domestic debt, net of deposits (percent of GDP): 18.5; 22.2; 24.3; 24.6; 23.2; 21.9. - Ksh per US$ exchange rate (end of period): 77.2; 81.9; 81.0 (actual as of June, 2010). - Nominal effective exchange rate (- depreciation; end of period): -10.4; -1.2. - Real effective exchange rate (- depreciation; end of period): -4.3; -2.4. ### The New Constitution and implementation costs - New constitution promulgated on 27th August 2010. - Implementation progress: three Commissions established — Judicial Service Commission (JSC); Constitution Implementation Commission (CIC); Commission on Allocation of Resources (CAR). - CAR mandate highlights: stable and predictable allocations of revenue; promote affirmative action for disadvantaged areas and groups; develop fiscal capacity and efficiency for county governments. - Authorities note that more structures will be created during the Fund program and associated costs will be known as they are gradually established. ### Conclusion and program rationale - After impacts from post-election conflict, drought and the global economic crisis, the economy is gradually recovering. - Remaining challenges: expected weakening of the external position; resource needs to implement the new constitution and build essential infrastructure; low international reserves. - Proposed ECF: designed to assist in rebuilding international reserves, achieving debt sustainability, expanding infrastructure, and financing implementation of the new constitution. *Statement by Mr. Majoro, Executive Director, Kenya, January 31, 2011* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1148.pdf_