## EXECUTIVE SUMMARY — _cr13358

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### Background and program context
- Recent reforms introduced a more comprehensive system of checks and balances, including accountability and transparency in expenditure control and management.
- The new government has taken decisive steps towards devolution supported by a renovated institutional framework and solid macroeconomic management.
- Fiscal policy emphasized sustainability while allowing infrastructure investment in roads and power generation and expanding protection of the vulnerable.
- Domestic and foreign investors have expanded operations; foreign investment flows have risen and boosted the stock market, allowing for a sustained accumulation of international reserves.
- Commercial prospects of oil discoveries and discovery of aquifers in Northern Kenya noted as potentially substantial long-term impacts.
- Kenya became the second largest African investor in other Sub-Saharan African countries; regional banks are rapidly expanding operations across Africa.
- Financial institutions are moving ahead of schedule in adopting prudential guidelines issued by the central bank.
- The Executive Board approved a three-year ECF program on January 31, 2011 (120 percent of quota), augmented on December 9, 2011, for a total of SDR 488.520 (180 percent of quota).
- All end-June 2013 quantitative targets were met; priority social expenditure was above the program floor; VAT Act approved by Parliament and enacted by the President.
- Structural benchmark on audits of 50 of the 100 largest VAT payers was fulfilled.

### Program performance, shocks, and outcomes
- Monetary and fiscal outcomes:
  - Significant monetary tightening and a new framework for monetary operations helped quickly curb inflation and stabilize the Shilling.
  - Additional fiscal effort supported the external position.
  - Financial supervision was enhanced to anticipate emerging risks.
- Adverse shocks during program period:
  - Terms of trade worsened by a cumulative 18 percent during the program period versus 10 percent envisaged at start.
  - Severe drought in the Horn of Africa in 2011 caused an inflationary shock and balance of payments pressure.
  - Tightly contested presidential elections added political uncertainty during transition to devolved government.
  - Global growth slowdown more protracted than anticipated.
- Box 1 outcomes:
  - Reserve accumulation exceeded program targets.
  - Public sector debt remained sustainable as measured by its present value.
  - External debt remained slightly below original projections due to prudent non-concessional borrowing.
  - Government guarantees were limited to energy-related projects.

### Macroeconomic outlook and key indicators
- Growth and inflation:
  - Economic activity gained momentum; growth likely to get close to 6 percent in 2013/14.
  - CBK target range: 5±2½ percent.
  - Inflation remained within CBK target range for one full year until end-August; rose to 8.3 percent in September reflecting VAT changes; expected to return within target by early 2014.
  - CBK policy rate (CBR) constant at 8.5 percent since May; interbank rate led close to upper bound of policy corridor.
- External sector:
  - International reserves were above US$6 billion (around 4 months of projected imports).
  - Current account deficit projected to narrow to 8.3 percent of GDP in 2013/14 despite substantial increase in capital-goods imports.
  - Updated service receipts suggest official external current account deficit has been significantly overstated; authorities agreed to revised projections.
  - Capital inflows intensified after political uncertainties subsided.
- Fiscal outlook and devolution:
  - 2013/14 revised budget targets a primary deficit lower than 2 percent of GDP to partially reverse the public debt to GDP ratio increase in 2012/13.
  - Devolution proceeding with counties taking over functions at a pace adapted to capacity; PFM law and IFMIS to guide spending.
  - 2012/13: primary deficit about 3 percent of GDP due to VAT shortfall, UN reimbursement delays, and faster execution of foreign-financed projects; additional spending mostly concessional.

### External outlook, risks, and recent events (section 11)
- Immediate effects of Westgate mall terrorist attack expected mostly in tourism, insurance, and large-scale supermarkets; foreign exchange reaction muted; stock prices dipped slightly and rebounded.
- Tourism receipts were already subdued due to political transition uncertainty and European slowdown.
- A large deterioration in terms of trade expected this fiscal year due to:
  - a significant upward revision of oil price projections (WEO projections), and
  - a sharp downward revision of tea price projections.
- Offsetting factors:
  - Kenya’s sound track record in macroeconomic management.
  - Revisions to service receipts and FDI figures may mean external vulnerability is less pressing than official BoP shows.
- Main domestic macro risks:
  - Renewed political uncertainty could hamper growth and deter investors and capital inflows.
  - Higher-than-expected devolution costs and overlap of functions between central and county levels could reverse fiscal sustainability gains.

### Fiscal policy, revenue measures, and wages
- Fiscal consolidation path aims for:
  - a net public debt ratio of about 40 percent in 2017/18, and
  - a deficit of 3 percent (meeting EAC convergence criteria earlier than 2024).
- Revenue mobilization measures (Box 2 highlights):
  - New VAT law expected to raise 1/4 percent of GDP in FY 2013/14.
  - KRA intensified auditing of large taxpayers; LTO collected equivalent of additional 2 percent of GDP in the first quarter of FY 2013/14.
  - Broadening excise taxes and streamlining customs expected to yield 1/3 percent of GDP in FY 2013/14.
  - The integrated tax management system (itax) implemented in October 2013; remote transmission of ETR data scheduled for December 2013.
  - Legislative amendments and a proposed Tax Appeals Tribunal Bill to improve tax administration and dispute resolution.
- Wages and public employment:
  - SRC conducting nationwide job evaluation to harmonize salary scales.
  - Government target ceiling of 7 percent of GDP for all general government wages in the medium term.
  - Note: current level of wage spending at general government not known due to absent economic classification at general government level.

### Debt management and Eurobond plans
- Planned Eurobond issuance of US$ 1.5 billion; part of proceeds (US$600 million) would repay maturing commercial obligations from a syndicated loan; issuance increases commercial lending by US$900 million.
- DSA update considering additional borrowing of US$500 million and recent discount rate revision shows a more favorable debt profile.
- World Bank upgraded Kenya to “strong performer” in 2012 CPIA, increasing relative indicative threshold for external debt.

### Monetary, financial sector policies, and banking soundness
- CBK forward-looking steps:
  - Moving gradually to an inflation targeting framework; incorporating policy analysis and forecasting among key functions.
  - Prompt implementation of TSA expected to reduce Treasury reliance on short-term central-bank financing.
  - Intends to further accumulate international reserves until they cover 4.5 months of projected imports, thereafter intervening occasionally to smooth volatility.
- Market and liquidity conditions:
  - Tight liquidity kept interbank interest rate above CBR; transition to devolved government increased government deposits at CBK, reducing market liquidity at times.
  - Capital inflows continued due to foreign participation in domestic bond markets.
- Banking sector preparedness:
  - Banks implementing CBK prudential guidelines ahead of end-2014 deadlines; systemically important banks increasing capital adequacy buffers and contingency liquidity provisions.
  - Banks increasing provisioning in line with slightly higher non-performing loans expected to reverse with recovery.
  - Financial inclusion expanding via mobile-phone payment linkages; CBK introducing regulations for mobile-phone banking, e-money, and consolidated supervision of cross-border holdings; seven joint-inspections of financial groups by 2015 planned.
- Selected financial soundness indicators (selected percent):
  - Regulatory capital to risk-weighted assets: 20.8 19.0 19.4 20.3 21.9 23.3
  - Non performing loans to total gross loans: 6.2 5.4 4.4 4.5 4.5 5.3
  - Return on assets (ROA): 3.7 3.3 3.3 3.8 3.8 3.9

### Program monitoring, targets, and structural benchmarks
- All June 2013 quantitative performance criteria were met; staff recommends completion of the sixth review of the ECF arrangement.
- Selected performance criteria outcomes (Program vs Actual):
  - Primary budget balance (End-June program -40.0; Actual -31.9) — met.
  - Stock of central bank net international reserves (End-June program 4,250; Actual 4,919) — met.
  - Stock of net domestic assets (End-June program -35; Actual -79.3) — met.
  - Contracting/guaranteeing medium- and long-term nonconcessional external debt (End-June program 2,500; Actual 1,170) — met.
  - New central government external payment arrears (End-Dec program 0; Actual 2.47) — not met (End-Dec); subsequent tests met.
  - Priority Social Expenditures (End-Dec program 15.0; Actual 11.9) — not met (End-Dec); End-Mar and End-June targets met.
- Structural benchmarks completed include VAT legislation submission, VAT audits of 50 largest taxpayers, submission of PFM legislation, adoption of a Single Treasury Account, amendments to Banking Act, and legislation for demutualization of the Nairobi Stock Exchange.

### National accounts, fiscal and monetary statistics (selected exact figures)
- Nominal GDP (market prices, in billions of Kenya shillings): 3,244 3,728 3,661 4,167 4,774 5,434 6,130
- Real GDP growth (market prices, annual percent): 4.5 5.3 5.1 5.9 6.3 6.4 6.4
- Consumer price index (annual average): 16.0 4.4 4.6 7.1 6.0 5.1 5.0
- CBK net foreign assets (in millions of US dollars, Jun-11 to Jun-14): 3,147 3,041 3,923 4,234 4,854 5,136 5,852
- Gross official reserves (end of period, in millions of US dollars): 5,241.4 5,522.0 6,222.0 7,422.0 8,022.0 8,822.0 9,722.0
- Gross official reserves (months of following year's imports): 3.4 3.4 3.8 4.2 4.2 4.3 4.4
- Current account (in millions of US dollars): -3,343.2 -3,696.5 -3,568.0 -4,101.7 -4,336.2 -4,675.4 -4,871.2
- Exports, f.o.b. (in millions of US dollars): 5,960.9 6,251.1 6,152.8 5,994.7 6,322.3 6,788.6 7,415.2
  - Tea (in millions of US dollars): 1,138.2 1,347.2 1,291.0 1,049.3 1,012.9 1,054.4 1,157.1
  - Horticulture (in millions of US dollars): 647.9 725.5 731.8 755.7 795.4 838.5 909.8
- Imports, f.o.b. (in millions of US dollars): -14,903.0 -15,833.0 -15,840.9 -16,913.3 -18,180.5 -19,554.3 -20,952.5
  - Oil imports (in millions of US dollars): -4,192.3 -4,126.9 -3,954.4 -4,362.0 -4,531.2 -4,591.4 -4,619.3
  - Capital imports (in millions of US dollars): -3,116.8 -4,209.4 -3,679.7 -4,398.1 -4,910.7 -5,526.7 -6,255.9

### Balance-of-payments data quality and the “Exchange Rate–Current Account Puzzle” (Appendix I)
- Puzzle: Current account deficit >10 percent of GDP in last two years appears at odds with observed 5-10 percent REER appreciation.
- Explanatory factors:
  - Rise in capital-good imports tied to higher investment; external current account excluding capital-good imports would be in surplus.
  - "Unclassified" services reported by commercial banks quadrupled in last four years; some include new service categories not in current framework and may contain unreported remittances.
  - KNBS 2010 survey found FDI underreporting higher than 50 percent; UNCTAD shows ratio of official FDI to Greenfield projects below 5 percent in Kenya versus 55 percent for SSA and 100 percent for all developing economies.
- Re-estimation exercise (conservative adjustments to service receipts and FDI) indicates:
  - A significantly lower current account deficit.
  - A larger share of long-term financing in the financing composition.
  - The external current account net of long-term financing may be close to balance.
- Policy implications:
  - Improve BoP data classification and coverage; reclassify appropriate "unclassified" services to service receipts or remittances where applicable.
  - Address FDI underreporting to better reflect inward FDI and greenfield investment.
  - Do not treat substantial "unclassified" items as short-term capital inflows without further investigation.
  - Continue KNBS Balance-of-Payments upgrades.

### Staff appraisal: achievements, challenges, and policy recommendations
- Achievements:
  - ECF-supported objectives met: stronger external and fiscal positions, tamed inflation, reduced vulnerability to shocks.
  - Structural reforms delivered in expenditure and social protection systems, tax system, financial system, and business regulatory framework.
- Challenges and risks:
  - Domestic: unsuccessful fiscal devolution could derail fiscal discipline.
  - External: vulnerabilities in emerging-market partners could affect Kenya.
- Policy recommendations and priorities:
  - Preserve low inflation, continue increasing foreign reserves, and aim to gradually lower the public debt-to-GDP ratio while raising infrastructure investment.
  - Continue structural reforms to remove bottlenecks in regulatory framework and in ports and airports.
  - Fiscal policy: maintain fiscal discipline during devolution; consider market conditions and provide timely detailed information when issuing the planned Eurobond.
  - Revenue policy: continue closing tax-administration gaps; maintain broader and simplified VAT without unduly broadening exemptions; focus tax reform on customs and income taxes.
  - Expenditure policy: rein in wage-bill increases to avoid crowding out infrastructure and social protection; implement SRC harmonization recommendations within the existing resource envelope; promptly implement PFM regulations and an operational TSA at central and county levels.
  - Monetary and exchange-rate policy: CBK should not lower the CBR until inflation is closer to the lower bound of its target range; continue building analytical capacity and move gradually to inflation targeting; continue accumulating foreign exchange reserves until they cover 4.5 months of projected imports, then intervene only occasionally to smooth excessive volatility.

*Source: _cr13358 — IMF staff report excerpts (Executive Summary; Sections 11, 29, 31; Appendix I), dated November 18, 2013.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Background
- Recent reforms introduced a more comprehensive system of checks and balances, including accountability and transparency in expenditure control and management.
- The new government has taken decisive steps towards devolution supported by a renovated institutional framework and solid macroeconomic management.
- Fiscal policy emphasized sustainability while allowing infrastructure investment in roads and power generation and expanding protection of the vulnerable.
- Domestic and foreign investors have expanded operations in a market-friendly environment; foreign investment flows have risen and boosted the stock market, allowing for a sustained accumulation of international reserves.
- Commercial prospects of oil discoveries are promising; discovery of aquifers in Northern Kenya could have a substantial long-term impact.
- Kenya became the second largest African investor in other Sub-Saharan African countries; regional banks are rapidly expanding operations across Africa.
- Financial institutions are moving ahead of schedule in adopting prudential guidelines issued by the central bank in line with international best practices.
- The International Criminal Court trial of President Kenyatta for crimes against humanity was postponed until February 5, 2014.
- The impact of the September 21 terrorist attack has been limited so far and largely circumscribed to the tourist sector.

### Program
- The Executive Board approved a three-year Extended Credit Facility (ECF) program for Kenya on January 31, 2011 (120 percent of quota), augmented on December 9, 2011, for a total of SDR 488.520 (180 percent of quota).
- All end-June 2013 quantitative targets were met.
  - Net Domestic Assets (NDA) and Net Foreign Assets (NFA) were comfortably within program bounds.
  - The authorities’ primary fiscal balance outcome was in line with the program.
  - Priority social expenditure was above the program’s indicative target.
  - Structural benchmark on auditing compliance with VAT obligations by 50 large taxpayers before June 2013 was fulfilled.
  - The VAT Act was approved by Parliament and enacted by the President.
- No external payments arrears by the central government were reported.
- The structural benchmark on audits of 50 of the 100 largest VAT payers was met.
- The central government’s priority social expenditure was above the program floor.

### Staff views and procedural actions
- Staff recommends completion of the review.
- The authorities have consented to publication of the staff report and Letter of Intent and its attachments.
- Report dated November 18, 2013.
- Approved by Roger Nord (AFR) and Dan Ghura (SPR).
- A staff team visited Nairobi during September 19–October 2, 2013.

### Performance under the program
- Program adaptation and outcomes:
  - Significant monetary tightening and a new framework for monetary operations helped quickly curb inflation and stabilize the Shilling.
  - Additional fiscal effort supported the external position.
  - Financial supervision was enhanced to anticipate emerging risks.
  - Program objectives were achieved despite adverse shocks.
- Adverse shocks affecting the program:
  - Terms of trade worsened by a cumulative 18 percent during the program period versus 10 percent envisaged at start.
  - Severe drought in the Horn of Africa in 2011 caused an inflationary shock and balance of payments pressure.
  - Tightly contested presidential elections added political uncertainty during transition to devolved government.
  - Global growth slowdown was more protracted than originally anticipated.
- Box 1 key outcomes:
  - Reserve accumulation exceeded program targets.
  - Public sector debt remained sustainable as measured by its present value.
  - External debt remained slightly below original projections due to prudent non-concessional borrowing.
  - Government guarantees were limited to energy-related projects.

### Macroeconomic outlook and key indicators
- Growth and activity:
  - Economic activity gained momentum supported by strong macroeconomic policies, growing investor confidence, and good weather.
  - Growth likely to get close to 6 percent in 2013/14.
- Inflation and monetary policy:
  - CBK target range: 5±2½ percent.
  - Inflation remained within the CBK target range for one full year until end-August.
  - Inflation rose to 8.3 percent in September reflecting the one-off impact of removing widespread VAT exemptions; this effect should taper off and inflation should return within the CBK’s target range by early 2014.
  - CBK policy rate has been constant at 8.5 percent since May.
  - CBK adopted a monetary tightening bias by leading the interbank rate close to the upper bound of its policy corridor around its policy rate (CBR).
- External sector:
  - International reserves were above US$6 billion (around 4 months of projected imports).
  - Current account deficit projected to narrow to 8.3 percent of GDP in 2013/14 despite substantial increase in capital-goods imports for oil-exploration equipment.
  - Updated service receipts information suggests the official external current account deficit has been significantly overstated; authorities agreed to revised current account projections.
  - Capital inflows intensified after political uncertainties subsided following largely peaceful Presidential elections earlier in 2013.
- Fiscal outlook and devolution:
  - The 2013/14 revised budget targets a primary deficit lower than 2 percent of GDP to partially reverse the public debt to GDP ratio increase that occurred in 2012/13.
  - Devolution is underway with counties taking over functions from central government at a pace adapted to existing capacity.
  - Spending at national and county levels will follow procedures set by the Public Financial Management (PFM) law and within the Integrated Financial Management Information System (IFMIS) to limit overspending risks and emphasize lowering non-priority outlays.
- 2012/13 specifics:
  - Fiscal discipline maintained despite spending pressures and revenue challenges.
  - A shortfall in VAT performance, UN delays in reimbursing AMISOM security operation costs, and faster-than-expected execution of foreign-financed concessional projects boosted the primary deficit to about 3 percent of GDP, slightly raising the debt-to-GDP ratio.
  - Additional spending was mostly concessional; present value of debt is close to the program objective.

### Policy discussions and risks
- Program achievements as it nears completion:
  - Strong external position supporting the Shilling.
  - Improved public debt sustainability enabling better access to international capital markets.
  - Tax measures increased revenue mobilization potential.
  - Public finance management reforms supported devolution to counties.
  - Modernization of CBK monetary policy framework helped keep inflation expectations in check despite adverse shocks.
  - Stronger supervisory powers for CBK helped consolidate financial stability.
  - Opening capital markets to more competition attracted capital inflows.
  - Economic activity momentum supported by Kenya’s role as a regional hub, strides in financial inclusion, dynamic services sector, and higher investment in oil and mining exploration.
- Identified risks to the outlook (section header present; detailed risks discussed in full report).

*Source: _cr13358 - EXECUTIVE SUMMARY (IMF staff report), November 18, 2013.*

### 11.      Risks to the external outlook have risen somewhat, but Kenya’s strong external

### _cr13358 - 11.      Risks to the external outlook have risen somewhat, but Kenya’s strong external

### External outlook and risks
- The Westgate mall terrorist attack is expected to impact mostly tourism, the insurance industry and large-scale supermarkets.
- So far the foreign exchange market reaction has been muted; stock prices declined only slightly and bounced back the following days.
- Capital inflows continued, reflecting strong foreign investors’ interest in Kenya’s stock market and increased appetite for medium-term government securities.
- Tourism receipts were already subdued because of uncertainty surrounding the political transition and the protracted slowdown in Europe.
- Experts compare the attack with the one in Mumbai 2008, where tourism reversed after just three quarters.
- A large deterioration in Kenya’s terms of trade is expected this fiscal year due to:
  - a significant upward revision of oil price projections (WEO projections), and
  - a sharp downward revision of tea price projections.
- Offsetting factors noted:
  - Kenya’s sound track record in macroeconomic management during periods of adverse terms of trade deterioration.
  - External vulnerability may be less pressing than the official balance of payments shows, in light of ongoing revisions to service receipts and foreign direct investment figures (See Appendix).

### Main macro risks (domestic)
- Renewed political uncertainty could hamper economic growth and deter investors and capital inflows.
- Higher-than-expected devolution costs and possible overlap of functions between the central and county levels could reverse recent gains in fiscal sustainability.

### Fiscal discipline and devolution
- Fiscal policy aims at gradual consolidation while providing resources for infrastructure investment and fiscal devolution rollout.
- Authorities plan to stick to a fiscal consolidation path implying:
  - a net public debt ratio of about 40 percent in 2017/18, and
  - a deficit of 3 percent (meeting EAC monetary union convergence criteria much earlier than 2024).
- The 2013–14 budget targets a primary deficit that would allow Kenya to resume a path toward a declining debt-to-GDP ratio.
- Revenue mobilization measures include implementation of the new-VAT law and measures to enforce tax collection from sectors showing lower compliance and amendments to broaden the tax base.
- Devolution status:
  - Implementation has started as mandated by the 2010 Constitution.
  - Committees established to guide counties on managing devolved powers; some functions remain at the central government to allow adaptation.
  - PFM regulations expected to be submitted to the National Assembly in December, and should be fully in place shortly after to enhance expenditure control.
  - Introduction of the Treasury Single Account (TSA) is a high priority; the government is recruiting a resident advisor.

### Recent tax-revenue enhancing measures (Box 2)
- The new VAT law is expected to raise 1/4 percent of GDP in additional revenue in FY 2013/14.
- Kenya Revenue Authority (KRA) intensified auditing of large taxpayers; the large taxpayers’ office (LTO) collected the equivalent of additional 2 percent of GDP in the first quarter of FY 2013/14.
- Broadening coverage of excise taxes to include financial transaction and mobile-phone transfers and streamlining customs services is expected to yield 1/3 percent of GDP in FY 2013/14.
- The integrated tax management system (itax) was implemented in October 2013; remote transmission of Electronic Tax Register (ETR) data scheduled for December 2013.
- KRA adopted a new strategy to enforce compliance in declaring real estate-related income, including rental income.
- Legislative amendments to make Excise, VAT and Income Tax legislation consistent with the new Constitution include:
  - streamlining Income Tax Exemption management processes,
  - empowering the Commissioner to access books of accounts when tax evasion is proved in Court,
  - collecting corporate tax from officers of corporate bodies when convicted of tax fraud,
  - amending the Income Tax Act to broaden its base to include capital gains and earnings from gambling.
- A proposed Tax Appeals Tribunal Bill will establish a single tax appeals body to improve dispute resolution and fast-track conclusion of tax cases.

### Wages and public employment
- The Salaries and Remuneration Commission (SRC) is conducting a nationwide job evaluation to move gradually to a harmonized salary scales framework across central and county levels.
- The government has set a target ceiling of 7 percent of GDP for all general government wages in the medium term.
- Note: The current level of wage spending at the general government level is not known because an economic classification for general government level is not yet available.

### Debt management and Eurobond plans
- The planned Eurobond issuance does not modify the favorable conclusions of the last Debt Sustainability Analysis (DSA) on Kenya’s external and public debt position.
- A DSA update considering additional borrowing by US$500 million relative to the April 2013 DSA and the recent revision of the discount rate shows a more favorable debt profile.
- The planned issuance amounts to US$ 1.5 billion, which would increase commercial lending by US$900 million as part of the proceeds would be used to repay maturing commercial obligations from a syndicated loan (US$600 million).
- The World Bank upgraded Kenya to “strong performer” in terms of quality of its policies and institutions (2012 CPIA), increasing the relative indicative threshold for external debt.

### Monetary and financial policies (forward-looking)
- Current monetary policy stance has helped keep inflation expectations in check despite the short-term impact of higher VAT rates on consumer prices.
- Tight liquidity conditions have kept the interbank interest rate above the CBR in recent weeks.
- Transition to devolved government and new organizational arrangements has contributed to lower market liquidity at times as government deposits at the CBK increased well above usual levels; these pressures are easing as transfers to counties proceed.
- The CBK’s forward-looking approach:
  - Inflation expectations reflected in the yield curve remain consistent with the government’s inflation target.
  - The CBK and Ministry of Finance are moving gradually to an inflation targeting framework.
  - The CBK incorporated monetary policy analysis and forecasting among its key functions to support MPC decisions.
  - Prompt implementation of the TSA will help reduce Treasury’s reliance on short-term central-bank financing and support the move to inflation targeting.
- The CBK intends to further accumulate international reserves.
  - Capital inflows have continued due to foreign investor participation in domestic bond markets attracted by high interest rates and a stable exchange rate.
  - Currency risk hedging by large institutions prior to the elections has been unwinding, adding to local foreign exchange supply.
  - More active private equity investments and other long-term financing transactions increase supply of foreign exchange funds.
- Banking sector preparedness:
  - Banks are implementing CBK prudential guidelines ahead of end-2014 deadlines.
  - Systemically important banks are increasing capital adequacy buffers and introducing contingency liquidity provisions.
  - Banks are increasing provisioning in line with slightly higher non-performing loans expected to reverse as the economy recovers.
  - Financial inclusion continues via instruments linking mobile-phone payments accounts with bank products.
  - CBK is introducing guidelines for consolidated supervision of cross-border non-operating holdings and expects seven joint-inspections of financial groups by 2015 in coordination with regional supervisors (forming “supervisory colleges”).
  - Credit reference bureaus now allowed to provide positive information; CBK introducing regulations specific to mobile-phone banking, e-money, and enlarging oversight powers.

### Program issues, PRSP, and upcoming consultations
- Authorities expressed interest in a future program with the Fund; discussions expected during the forthcoming Article IV consultation tentatively planned for March 2014.
- A new Poverty Reduction Strategy Paper (PRSP) updating Vision 2030 Medium-Term Plan 2008-2012 has been circulated to the Executive Board; the Kenyan authorities consented to the Fund’s publication. A JSAN of the new PRSP would be issued to the Board in the coming months.

### Staff appraisal — achievements, challenges, and policy recommendations
- Achievements:
  - Objectives set by the ECF-supported economic program have been met: stronger external and fiscal positions, tamed inflation, reduced vulnerability to shocks.
  - Structural reforms achieved in expenditure and social protection systems; tax system; financial system; and business regulatory framework.
- Challenges and risks:
  - Domestic: unsuccessful fiscal devolution could derail fiscal discipline and erode consolidation gains.
  - External: new vulnerabilities in emerging-market partners could affect Kenya.
- Policy recommendations and priorities:
  - Preserve low inflation, continue increasing foreign reserves, and aim at gradually lowering the public debt-to-GDP ratio while raising infrastructure investment.
  - Continue structural reforms to remove bottlenecks in regulatory framework and functioning of ports and airports.
  - For fiscal policy:
    - Maintain commitment to fiscal discipline during the devolution transition.
    - Pay attention to market conditions when issuing the planned Eurobond and provide timely, detailed information on economic conditions and policy plans.
  - For revenue policy:
    - Continue closing tax-administration gaps; maintain the broader and simplified VAT without unduly broadening exemptions.
    - Focus tax reform on customs and income taxes to remove distortions while safeguarding revenue mobilization.
  - For expenditure policy:
    - Reign in recent increases in the wage bill to avoid crowding out infrastructure and social protection spending.
    - Implement SRC recommendations for harmonizing pay scales within existing resource envelope.
    - Promptly implement PFM regulations and an operational TSA at central and county levels to enhance expenditure control and facilitate monetary policy.
  - For monetary and exchange rate policy:
    - CBK should not lower the CBR until inflation gets closer to the lower bound of its target range.
    - Continue improving analytical capacity for monetary policy and move gradually to a fully-fledged inflation targeting framework.
    - Continue gradually accumulating foreign exchange reserves until they cover 4.5 months of projected imports, and thereafter intervene only occasionally to smooth out excessive exchange-rate volatility.

*Source: _cr13358 - 11.      Risks to the external outlook have risen somewhat, but Kenya’s strong external*

### 29.      Statistical issues: As Kenya moves toward emerging-market status, investors are following

### 29.      Statistical issues: As Kenya moves toward emerging-market status, investors are following

### Statistical issues
- Reliable statistical information is essential for investors to gauge how effective government policies are in establishing a consistent track record by addressing existing vulnerabilities.
- Two priority areas:
  - Balance-of-payment statistics need to be reviewed to better reflect growing trade in services and record accurately capital flows, particularly those linked to the financing of direct investment.
  - Government statistics should promptly shift to monitoring the position of the general government because devolution spending by counties constitutes a substantial component of fiscal policy.

### Structural Policies
- Strong policy ownership has allowed the authorities to respect all the structural benchmarks under the program.
- The current reforms address only part of a wider structural agenda that is, by no means, exhausted.
- Key forward-looking priorities:
  - Review of the fiscal regime for the extractive and oil industry given the new-found natural resource wealth.
  - Ongoing work to streamline the large number of existing parastatals and to better monitor their financial position, which would contribute to improving the fiscal position and to creating more scope for private economic activity.

*Source: IMF staff report excerpt.*

### 31.      Program performance: All June 2013 targets quantitative performance criteria were met.

### 31. Program performance: All June 2013 targets quantitative performance criteria were met.

### Program performance and policy status
- "All June 2013 targets quantitative performance criteria were met."
- The structural benchmark and indicative targets for June 2013 were observed.
- The authorities’ second PRSP has been circulated to the Executive Boards of the Fund and of the World Bank.
- Staff recommends completion of the sixth review of the ECF arrangement.
- The authorities have indicated interest in a successor program with the Fund.

### National accounts and inflation (selected indicators)
- Nominal GDP (market prices, in billions of Kenya shillings): 3,244 3,728 3,661 4,167 4,774 5,434 6,130
- Real GDP growth (market prices): 4.5 5.3 5.1 5.9 6.3 6.4 6.4 (annual percent)
- GDP deflator (average): 10.9 8.9 7.4 7.5 7.8 7.0 6.0
- Consumer price index (annual average): 16.0 4.4 4.6 7.1 6.0 5.1 5.0
- Consumer price index (end of period): 10.0 5.0 4.9 6.8 5.5 5.0 5.0
- Import volume growth, goods: 11.7 9.5 10.5 5.1 9.1 8.6 9.0
- Export volume growth, goods: 3.7 6.9 8.7 6.0 9.1 8.7 9.9
- Ksh per US$ exchange rate (end of period): 82.9 ... 85.8 4/
- Nominal effective exchange rate (- depreciation; end of period): 18.2
- Real effective exchange rate (- depreciation; end of period): 12.4

### Money and credit (selected)
- M3 (broad money and foreign currency deposits, end period): 15.5 16.8 14.2 17.0 .........
- Reserve money: 16.7 14.9 11.7 17.5 .........
- Investment (percent of GDP): 20.2 20.7 20.0 22.2 22.3 22.5 22.6
- Gross national saving (percent of GDP): 11.5 12.3 11.7 13.8 14.6 15.2 15.9

### Central government budget (selected; percent of GDP and levels)
- Total revenue (percent of GDP): 23.1 24.5 23.1 24.7 24.7 24.8 24.9
- Total expenditure and net lending (percent of GDP): 29.2 31.5 30.5 30.4 29.7 29.4 29.0
- Overall balance (commitment basis) excluding grants (percent of GDP): -6.2 -6.9 -7.4 -5.7 -5.0 -4.6 -4.1
- Overall balance (commitment basis) including grants (percent of GDP): -5.7 -4.9 -6.8 -4.8 -4.3 -3.9 -3.5
- Primary budget balance (percent of GDP): -2.2 -2.0 -3.0 -1.9 -1.6 -1.4 -1.1
- Net domestic borrowing (percent of GDP): 2.0 4.4 4.6 1.6 3.3 2.6 2.2

Selected levels (in billions of Kenyan shillings)
- Revenues and grants: 763.5 990.8 868.2 1,066.9 1,212.6 1,384.7 1,567.7
- Revenue: 748.2 914.4 847.2 1,031.1 1,179.9 1,347.7 1,528.0
- Tax revenue: 626.5 739.9 701.2 863.7 988.8 1,130.7 1,283.7
- Total expenditure and net lending: 947.9 1,172.9 1,117.7 1,267.1 1,418.0 1,599.2 1,779.3
- Recurrent expenditure: 642.3 854.4 809.0 897.8 1,008.5 1,120.2 1,249.6
- Development and net lending: 300.7 300.7 298.9 359.3 409.5 468.6 529.7
- Balance (commitment basis, including grants) (in billions): -184.4 -182.1 -249.6 -200.2 -205.3 -214.4 -211.6
- Financing (in billions): 162.0 182.1 232.5 200.2 205.3 214.4 211.6
- Net foreign financing (in billions): 98.5 17.9 62.7 131.9 49.4 75.2 79.5
- Net domestic financing (in billions): 63.5 164.2 169.8 68.3 155.9 139.2 132.0
- Nominal GDP (in billions): 3,244.5 3,728.3 3,661.4 4,167.4 4,774.1 5,433.7 6,129.9
- Stock of domestic debt, net (end of period, in billions): 688.7 852.9 858.5 926.8 1,082.7 1,222.0 1,354.0
- Total public debt, net of deposits (in billions): 1,447.9 1,630.0 1,680.3 1,880.5 2,085.9 2,300.3 2,557.5

### Monetary survey (selected levels and growth)
- Central Bank of Kenya net foreign assets (in millions of US dollars, Jun-11 to Jun-14): 3,147 3,041 3,923 4,234 4,854 5,136 5,852 (corresponding to 282.8 258.7 330.5 364.1 402.1 425.8 485.1)
- Reserve money (Jun-11 to Jun-14): 220.4 255.0 257.3 293.6 287.4 344.0 337.6
- M2 plus resident foreign currency deposits (M3) (Jun-11 to Jun-14): 1,380.7 1,514.2 1,594.7 1,727.3 1,820.6 2,038.2 2,130.7
- M3 plus nonbank holdings of government debt (L) (Jun-11 to Jun-14): 1,720.6 1,876.1 1,970.1 2,129.5 2,277.4 2,549.6 2,665.2
- Memorandum annual percent change (selected): M3: 15.2 19.1 15.5 14.1 4.2 18.0 17.0; Deposits: 15.1 20.0 15.9 14.8 14.0 18.2 17.0; Reserve money: 4.8 14.5 16.7 15.1 11.7 17.1 17.5

### Balance of payments (selected; in millions of US dollars)
- Current account (2011/12–2016/17): -3,343.2 -3,696.5 -3,568.0 -4,101.7 -4,336.2 -4,675.4 -4,871.2
- Exports, f.o.b.: 5,960.9 6,251.1 6,152.8 5,994.7 6,322.3 6,788.6 7,415.2
  - Tea: 1,138.2 1,347.2 1,291.0 1,049.3 1,012.9 1,054.4 1,157.1
  - Horticulture: 647.9 725.5 731.8 755.7 795.4 838.5 909.8
- Imports, f.o.b.: -14,903.0 -15,833.0 -15,840.9 -16,913.3 -18,180.5 -19,554.3 -20,952.5
  - Oil imports: -4,192.3 -4,126.9 -3,954.4 -4,362.0 -4,531.2 -4,591.4 -4,619.3
  - Capital imports (of which): -3,116.8 -4,209.4 -3,679.7 -4,398.1 -4,910.7 -5,526.7 -6,255.9
- Balance on goods: -8,942.2 -9,581.9 -9,688.1 -10,918.5 -11,858.3 -12,765.7 -13,537.3
- Balance on services: 2,651.4 2,246.7 2,782.1 3,174.4 3,512.2 3,656.1 3,683.4
- Current transfers (net): 3,092.5 3,897.2 3,550.8 3,856.4 4,188.2 4,537.6 4,838.5
  - Remittances: 1,658.1 2,130.8 2,086.0 2,409.5 2,656.6 2,910.8 3,118.2
- Capital and financial account (total): 4,150.4 3,788.6 4,339.6 5,246.7 5,006.7 5,570.3 5,911.8
  - Net FDI: 830.0 1,382.6 993.9 1,233.6 1,424.2 1,641.9 1,868.0
  - Net other investment: 2,186.4 1,756.2 2,707.8 3,726.2 3,328.0 3,642.8 3,730.8
- Gross official reserves (end of period, in millions of US dollars): 5,241.4 5,522.0 6,222.0 7,422.0 8,022.0 8,822.0 9,722.0
- Gross official reserves (months of following year's imports of goods and services): 3.4 3.4 3.8 4.2 4.2 4.3 4.4
- Current account balance (excluding official transfers, percent of GDP): -8.7 -8.9 -8.4 -8.3 -7.7 -7.3 -6.7

### Financial soundness indicators (banking sector; selected percent)
- Regulatory capital to risk-weighted assets: 20.8 19.0 19.4 20.3 21.9 23.3
- Non performing loans to total gross loans: 6.2 5.4 4.4 4.5 4.5 5.3
- Return on assets (ROA): 3.7 3.3 3.3 3.8 3.8 3.9
- Liquid assets to total assets: 38.4 34.9 33.3 34.2 35.2 35.3
- Total loans to total deposits: 72.5 76.6 77.4 77.2 76.9 77.8
- Spread between lending and deposit rate: 9.3 8.8 8.4 9.9 10.3 9.4

### Performance criteria for the Sixth Review (selected quantitative tests; in billions of Kenyan shillings or specified units)
- Primary budget balance of the central government (-=deficit, floor):
  - Program (End-Dec): -64.0; Actual: -60.7 — met
  - Program (End-Mar): -62.0; Actual: -39.3 — met
  - Program (End-June): -40.0; Actual: -31.9 — met
- Stock of central bank net international reserves (floor, in millions of US$):
  - Program (End-Dec): 4,460; Actual: 4,530 — met
  - Program (End-Mar): 4,150; Actual: 4,238 — met
  - Program (End-June): 4,250; Actual: 4,919 — met
- Stock of net domestic assets of the central bank (ceiling):
  - Program (End-Dec): -50; Actual: -81 — met
  - Program (End-Mar): -40; Actual: -46.6 — met
  - Program (End-June): -35; Actual: -79.3 — met
- Contracting or guaranteeing of medium- and long-term nonconcessional external debt by the central government (ceiling; millions of US$):
  - Program (End-Dec): 1,500; Actual: 1,130 — met
  - Program (End-Mar): 1,500; Actual: 1,200 — met
  - Program (End-June): 2,500; Actual: 1,170 — met
- New central government and central government guaranteed external payment arrears (ceiling, millions of US$):
  - Program (End-Dec): 0; Actual: 2.47 — not met
  - Program (End-Mar): 0; Actual: 0 — met
  - Program (End-June): 0; Actual: 0 — met
- Indicative target — Priority Social Expenditures of the central government (floor):
  - Program (End-Dec): 15.0; Actual: 11.9 — not met
  - Program (End-Mar): 21.0; Actual: 26.8 — met
  - Program (End-June): 28.3; Actual: 33.8 — met

Notes on targets and definitions (as provided)
- The primary budget balance of the central government is defined as overall balance including grants, minus concessional project loans, plus interest payments.
- Targets for end-September 2012, end-December 2012, end-March 2013, and end-June 2013 are cumulative flows from July 1, 2012 (beginning of the 2012/13 fiscal year).
- For program monitoring, the daily average for the month when testing dates are due.
- The NIR floor will be adjusted upward (downward) by the excess (shortfall) of external budgetary support (grants and loans) and external commercial debt relative to the programmed amounts. The NDA ceiling will be adjusted downward (upward) by the excess (shortfall) of external budgetary support (grants and loans) and external commercial debt relative to the programmed amounts.
- Stock and contracting ceilings on nonconcessional external debt combine nonconcessional project loans, syndicated loan and sovereign bond.
- Continuous reporting for new external payment arrears.

### Structural benchmarks (status summary)
- VAT legislation submitted to help improve administration and compliance — Completed (first review).
- VAT audits of the 50 largest taxpayers — Completed (second review).
- Submit Public Finance Management legislation to the Commission of Implementation of the Constitution — Completed (sixth review).
- Adopt a Single Treasury Account to strengthen cash management and improve resource management — Completed (third review).
- Amend the Banking Act to reinforce prompt corrective action by the banking supervision authority — Completed (fourth review).
- Introduce legislation to allow demutualization of the Nairobi Stock Exchange — Completed (first review).

### Timing of disbursements and reviews under the 2011–14 ECF Arrangement (selected)
- January 31, 2011: Board approval of the arrangement — 65.136 Millions of SDRs (24.00 percent of quota)
- June 29, 2011: Completion of first review — 43.424 Millions of SDRs (16.00 percent of quota)
- December 9, 2011: Completion of second review — 92.276 Millions of SDRs (34.00 percent of quota) total for that date (43.424 + 48.852)
- April 17, 2012: Completion of third review — 71.921 Millions of SDRs (26.50 percent of quota)
- October 24, 2012: Completion of fourth review — 71.921 Millions of SDRs (26.50 percent of quota)
- April 16, 2013: Completion of fifth review — 71.921 Millions of SDRs (26.50 percent of quota)
- December xx, 2013: Observance of the end-June 2013 performance criteria and structural benchmark, and completion of the sixth review — 71.921 Millions of SDRs (26.50 percent of quota)
- Total original ECF disbursement: 325.680 Millions of SDRs (120.00 percent of quota)
- ECF augmentation: 162.840 Millions of SDRs (60.00 percent of quota)
- Total disbursement: 488.520 Millions of SDRs (180.00 percent of quota)
- Kenya's quota is SDR 271.4 million.

*Source: IMF staff report — Kenya: 2011–14 ECF Arrangement (performance through end-June 2013).*

### Appendix I. Kenya’s Exchange Rate-Current Account Puzzle

### Appendix I. Kenya’s Exchange Rate-Current Account Puzzle

### Current account balance versus REER appreciation
- Kenya’s current account deficit, at more than 10 percent of GDP in the last two years, seems at odds with observed 5-10 percent REER appreciation.
- The rise of capital-good imports associated with higher investment is part of the explanation; the external current account excluding capital-good imports would be in surplus.
- Ongoing upgrades in Balance-of-Payments statistics by the Kenya Bureau of National Statistics (KNBS) suggest that other factors may overstate the current account deficit and understate the share of long-term inflows in its financing.

### Data and measurement issues identified
- "Unclassified" services:
  - Part of "unclassified" services reported by commercial banks are excluded from current account receipts because of possible inappropriate classification by commercial banks.
  - These "Unclassified” services quadrupled in the last four years.
  - At least some of the "Unclassified" services include new service categories not classified in the current framework.
  - Part of this figure may reflect unreported remittances, but remaining "unclassified" items are still substantial and should not be treated as short-term capital inflows.
- Foreign direct investment (FDI) underreporting:
  - A KNBS survey in 2010 found that FDI underreporting was higher than 50 percent.
  - UNCTAD information indicates the ratio of official FDI to Greenfield projects does not even reach 5 percent in Kenya, compared to 55 percent for SSA countries and 100 percent for all developing economies.

### Re‑estimation of BoP components and implications
- A conservative adjustment to service receipts and FDI (re-estimating main BoP components) results in:
  - A significantly lower current account deficit.
  - A larger share of long-term financing in the financing composition.
- To keep the illustrative re‑estimation balanced, additional corrections were introduced to items that are clearly understated:
  - Kenya’s investment abroad and portfolio inflows.
  - Remittances (deducting its adjustment from the adjustment in service receipts).
- The exercise shows:
  - The external current account net of long-term financing may be close to balance.
  - The share of BoP long-term financing is quite significant.

### Charts and comparative indicators (summarized findings)
- Time-series comparisons presented show divergences between:
  - Current account balance (percent of GDP) and current account excluding capital good imports.
  - REER index (2005 = 100) appreciated in the period shown.
- Financing composition comparisons (2010–2012) indicate:
  - Substantial inward FDI and long-term financing when adjustments are applied.
  - A notable reclassification from short-term financing and "others" into long-term financing and inward FDI under the adjusted BoP.

### Policy-relevant conclusions and actions implied by the analysis
- Improve BoP data classification and coverage to:
  - Reclassify appropriate items currently reported as "unclassified" services into service receipts or remittances where applicable.
  - Address FDI underreporting to better reflect inward FDI and greenfield investment links.
- Do not treat substantial "unclassified" items as short-term capital inflows without further investigation.
- Continue KNBS Balance-of-Payments upgrades to ensure current account and financing composition accurately reflect underlying economic flows.

*Source: Appendix I. Kenya’s Exchange Rate-Current Account Puzzle (IMF staff calculations and KNBS/CBK data as presented in the source).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13358.pdf_