## _cr14302

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### Kenya’s debut Eurobond issuance and market reaction
- Issuance details:
  - Total size: US$2.0 billion.
  - Oversubscription: more than four times.
  - Use of proceeds:
    - US$600 million used to repay a syndicated loan contracted in 2012.
    - Remaining proceeds to substitute for domestic financing of energy and infrastructure projects.
  - Government also signed a loan with China in May 2014 for the Mombasa-Nairobi standard gauge railway: US$3.6bn, expected to start in October 2014 and to be implemented in around 5 years.
- Tranches and yields:
  - Five-year US$500 million bond at a yield of 5.875 percent.
  - Ten-year US$1.5 billion bond at a yield of 6.875 percent.
- Investor composition:
  - Demand from US investors: 68 percent of total placement.
  - British investors: 25 percent of total placement.
- Contractual law clause:
  - Agency Agreements, Deeds of Covenant and the Notes governed by English law (per prospectus).
- Additional loan detail (Chinese loan package):
  - Two loans: a 15-year US$2 billion loan from Eximbank China at Libor plus 3.6 percent, and a 20-year US$1.6 billion loan from the Chinese government at 2 percent.
  - Repayment sources: Kenya Railways dividends and proceeds from the 1.5 percent railway levy on imports already in place.
- Market reaction and comparative yields:
  - Favorable terms reflect Kenya’s position relative to frontier markets and sound policies.
  - Post-issuance, the bond yield in the secondary market declined below comparable securities such as Zambia’s and Ghana’s.

### Macroeconomic background, growth, inflation, and monetary policy
- Growth dynamics (selected):
  - Non-agriculture growth: 5.1 percent in January-March 2014.
  - Agriculture growth: 2.0 percent in January-March 2014.
- Inflation and policy rate:
  - Headline inflation: 7.7 percent in July (2014); 8.4 percent in August (2014).
  - Monetary policy target: 5 ± 2.5 percent.
  - Central bank policy rate (CBR): 8.5 percent (unchanged since May 2013).
- Concerns and indicators:
  - Potential impact of spike in food and energy prices and rapid credit growth on inflation expectations.
  - Interbank rates converging toward the CBR; market-determined exchange rate stability noted.
- Staff recommendation:
  - CBK should stand ready to tighten monetary policy to keep inflation expectations anchored around the mid-point of the target band.

### External sector, reserves, and exchange rate
- External current account:
  - External current account deficit: 7.7 percent in 2013/14 (source section).
  - Current account balance (US$ millions): -4,240.3; -4,504.3; -5,371.8; -5,718.1; -5,672.7; -5,786.4; -6,158.7 (selected series).
- Reserve buildup and adequacy:
  - Gross international reserves increased from USD 4.3 billion (2.9 months of next year’s imports) at end-2011 to USD 6.4 billion (3.9 months) at end-2013, and to USD 7.5 billion (4.5 months) at end-June 2014.
  - Reserve assets (gross, end of period, in millions of US$): 6,222.0; 7,475.0; 8,275.0; 9,325.0; 10,325.0; 11,209.7; 12,484.7 (selected series).
  - Months of next year imports (end period): 4.0; 4.3; 4.4; 4.6; 4.6; 4.6; 4.6.
- Exchange rate assessments and misalignment estimates:
  - CPI-based REER appreciated by 17½ percent from December 2010 to July 2014.
  - Quantitative misalignment estimates range from -1 to 17 percent across methodologies (MB, ES, PPP, equilibrium REER) and are sensitive to data gaps and rebased GDP.
  - On August 28, 2014, the exchange rate was KSh88.3786=US$1.00.
- Staff recommendations:
  - Maintain exchange rate flexibility and a strong foreign exchange reserves position.
  - Improve liquidity forecasting to support prudent monetary policy.

### Fiscal policy, devolution, and public financial management
- Fiscal balances and budgetary outcomes:
  - Fiscal deficit in 2013/14 remained unchanged from the previous year due to higher revenue offset by sizeable transfers to counties and a larger-than-envisaged wage bill.
  - Central government fiscal operations (levels, billions Ksh) — Revenues and grants: 868.2; 1,106.2; 994.4; 1,238.4; 1,204.8; 1,363.8; 1,555.8; 1,785.2; 2,016.4 (selected years).
  - Balance (commitment basis, excluding grants): -269.8; -411.2; -312.0; -400.5; -383.8; -384.1; -407.1; -413.7; -422.5 (selected series).
- Devolution impacts:
  - County development budget execution low due to capacity constraints.
  - Counties’ budgets for FY 2013/14: KSh261bn, or 5.2 percent of GDP.
  - Counties financed by equitable share transfers: 74 percent; conditional grants: 1 percent; own-source revenue: 25 percent.
  - Counties projected local revenue collections: KSh68bn during the fiscal year; actual first three quarters: KSh19.1bn; expected end-year: around KSh24bn.
  - Counties received KSh133.3bn during the first three quarters but spent only KSh106.6bn; total spending expected to rise to around KSh169bn by end-year.
  - Under-spending projected to leave counties with around KSh50bn in bank deposits (about 1 percent of GDP).
- Wage bill and payroll measures:
  - Wages and benefits (civil service) series (billions Ksh): 274.4; 263.0; 288.5; 302.4; 303.3; 338.0; 368.9; 416.3; 468.8 (selected series).
  - Measures: hiring freeze for this fiscal year; planned payroll audits; streamlining allowances; staff rationalization across counties; reforms to be implemented gradually with a clear timetable and social dialogue.
- PFM and cash/debt management:
  - Introduction of the Treasury Single Account (TSA) to improve cash and debt management.
  - Measures: procurement module of IFMIS, Digital Government Payment Gateway.
  - Staff recommended: staff the Intergovernmental Fiscal Relations Department; enhance accountability under the PFM framework; revise revenue allocation formula to weight fiscal performance and accountability; verify county legacy assets and liabilities.
- Revenue measures in 2014/15 budget and expected yield:
  - Revision of the Excise and Income Tax Acts; higher duties on iron and steel products; improved tax administration (VAT); amendments to Income Tax Act to address tax avoidance; incorporation of landlords into tax base.
  - Expected yield: about 1.3 percent of GDP in 2014/15.

### Public debt, contingent liabilities, and debt sustainability
- Public debt levels and composition:
  - Total public debt, gross (percent of GDP): 42.1; 42.2; 45.8; 45.5; 45.4; 45.0; 44.3 (selected series).
  - External debt (percent of GDP): 18.8; 19.4; 19.0; 19.3; 19.7; 19.7; 20.1.
  - Domestic debt, gross (percent of GDP): 23.4; 22.8; 26.8; 26.8; 26.2; 25.7; 25.2.
  - Memorandum gross debt (billions Ksh): 1,856.5; 2,180.5; 2,130.8; 2,370.3; 2,624.3; 2,971.7; 3,371.6; 3,784.7; 4,213.3.
- Key DSA findings:
  - NPV of external debt would rise to 16 percent of GDP at end-2014 and stabilize at 16–17 percent thereafter (well below 50 percent indicative threshold).
  - Public debt projected to rise to 45 percent of GDP in 2014; sovereign bond issuance and railway loan disbursements lift public debt to around 46 percent of GDP in 2015.
  - With primary deficit kept to 3 percent of GDP in 2016 and gradually reduced thereafter, public debt eases below 46 percent of GDP by 2018.
  - PV public debt-to-GDP around 41–42 percent through end-2018, falling thereafter.
- Contingent liabilities and SOEs:
  - Guaranteed loans to public entities reached KSh43.5bn (1 percent of GDP), of which 15 percent have been called to date.
  - Transfers to SOEs reached KSh354.3bn (8 percent of GDP) in 2013/14, of which 66 percent for development spending.
  - Government reform aims to reduce entities from close to 300 to 187 and create a Government Investment Corporation and a National and County Agencies Oversight Office.
- Stress-test outcomes and risks:
  - Standard stress tests do not breach indicative thresholds; largest negative shock is lower real GDP growth.
  - Under a one-time 30 percent nominal depreciation in 2014 and worse loan terms, PV debt-to-GDP increases but remains under thresholds.
  - Staff probability that PV gross debt percent of GDP exceeds 50 percent during 2021/2023 remains low (5 percent).
- Staff recommendations:
  - Maintain efforts to reduce the primary deficit consistent with EAMU convergence criteria by 2021.
  - Set up a sinking fund for eventual Eurobond repayment (government plan).
  - Assess contingent liabilities from PPPs and ensure Debt Management Department evaluates contingent liabilities with World Bank assistance.

### Financial sector, inclusion, and mobile-banking innovations
- Banking and credit developments:
  - NPL-to-total loans ratio: 5.6 percent in May 2014 (from 4.6 percent a year before).
  - Banks expanding domestic credit and operations beyond Kenya.
  - Pickup in credit growth increasingly funded externally via medium-term mostly concessional foreign currency lines.
- Financial inclusion metrics and digital finance:
  - M-Shwari: 7 million customers in its first year of operations.
  - M-Pesa reaches 84 percent of population earning less than US$2 a day.
  - Number of micro accounts (below US$1,200) increased more than 10 times over past 10 years.
  - SME access to credit: 36 percent in 2013 (up from 25 percent six years before).
  - Examples of welfare impact: farmers using M-Pesa repayments, M-Kopa solar panels, mobile-enabled health management systems.
- Regulatory and supervisory measures:
  - KBRR effective July 8, 2014; observed pricing differentials by end-August:
    - Average premium above KBRR on commercial mortgages: 3.05 percent.
    - Average premium above KBRR on corporate loans (1---5 years): 4.09 percent.
  - Prudential capital requirements: from January 2015, minimum capital (Tier II) requirement of 14.5 percent (up from 12 percent); capital conservation buffer of 2.5 percent; minimum core capital to risk weighted assets and total capital to risk weighted assets: 10.5 and 14.5 percent respectively.
  - Recommendation: continue consolidated supervision of systemic groups with cross-border cooperation and resolution procedures.

### Extractive industries, resource discoveries, and governance
- Discoveries and exploration activity:
  - Tullow estimates reserves well above 600 millions of barrels of oil equivalent (mboe).
  - Morgan Stanley estimate: country could become self-sufficient in oil production within 3-5 years (if confirmed).
  - 23 international oil companies conducting exploration in 44 licensed blocks.
  - Companies drilled 15 exploration wells between March 2012 and June 2014 (about 7 wells per year); crude oil found in 7 wells.
- Institutional reforms and policy guidance:
  - Extractive Industry Tax Regime and a new Mining Bill on Parliament’s agenda with FAD and LEG technical assistance.
  - Plans to redesign oil exploration framework, production sharing contract model, and gas contract terms; need for full gas-specific regulatory framework.
  - KEPTAP rolled out with World Bank support to build public-sector capacity.
- Cautions and recommendations:
  - Planned Sovereign Wealth Fund appears premature while fiscal position remains in deficit; any fund must have transparent management rules and full budget integration.
  - Revenue-sharing terms between central government and counties should be decided once volume and timespan for exploitation are known.
  - Authorities emphasize safeguarding most resource revenues for development while ensuring equitable local spending.

### Outlook, risks, and recommended policy priorities
- Growth projections:
  - GDP growth projected to reach 5.8 percent in FY2014/15 from 5.0 percent in the previous year.
  - Medium-term drivers: infrastructure investment in energy and transport, EAC market expansion, devolution reducing social strife, financial inclusion boosting SMEs, higher agricultural productivity from large irrigation projects.
- Upside scenarios:
  - Acceleration of regional integration; marked improvements in security; new discoveries raising oil, gas and mining potential.
- Key risks (from RAM and staff assessment):
  - Return of drought: Relative Likelihood: Medium; Potential Impact: High. Recommended: maintain exchange rate flexibility; use external buffer; guard against second-round inflation effects; targeted cash transfers; continue irrigation and geothermal infrastructure spending.
  - Deterioration in security: Relative Likelihood: Medium; Potential Impact: High. Recommended: reprioritize fiscal spending to accommodate security needs.
  - Implementation risk from devolution: Relative Likelihood: Medium; Potential Impact: Medium. Recommended: maintain fiscal discipline; adhere to PFM Act provisions.
  - Side-effects from global financial conditions: Relative Likelihood: High; Potential Impact: Medium. Recommended: maintain exchange rate flexibility; strengthen financial sector supervision.
  - Protracted slower growth in advanced economies: Relative Likelihood: High; Potential Impact: Medium. Recommended: accelerate reforms to address structural competitiveness weaknesses.
  - Regional geopolitical risks: Relative Likelihood: High; Potential Impact: High. Recommended: maintain exchange rate flexibility; use external buffer; guard against second-round inflation effects.
- Policy priorities:
  - In the immediate horizon: use fiscal space to improve security conditions and manage devolution transition issues.
  - Medium term: contain the wage bill; widen the tax base; improve quality and efficiency of public spending; mobilize domestic revenue; reform government-owned agencies and monitor contingent liabilities.
  - Maintain reserve buffers and exchange rate flexibility; implement TSA and strengthen cash/debt management.

### Data, governance, and technical assistance priorities
- National accounts revision:
  - KNBS revising national accounts for 2006-2013; revised 2013 GDP higher by about 25 percent than the 2001-based GDP, reaching about $55bn.; revised 2013 per capita GDP about $1,325.
  - Revision changes base year from 2001 to 2009; full time series release scheduled for September 2014.
- Data gaps and priorities:
  - Key social indicators only available for 2005/06; balance of payments fails to differentiate short-term from long-term inflows properly.
  - Need improved production indices, labor market information, and international investment position (private debt).
- Technical assistance delivered (selected):
  - FAD, MCM, LEG, STA, Research Department missions across 2011–2014 on PFM, monetary policy, AML/CFT, national accounts, GFS, price statistics, and financial supervision.
- Governance and audit:
  - Temporary governance gaps of the Board and Audit Committee identified in 2011 have been rectified; external auditor issued an unqualified audit opinion for 2011.
  - Authorities committed to submit revisions to the CBK Act to the National Assembly.
- Staff recommendation:
  - Give higher priority to data quality improvement as Kenya transitions toward emerging market status.

*Source: IMF staff report excerpt — "_cr14302" (PDF content provided).*

### 1. Kenya’s Debut Eurobond Sale ___________________________________________________________________ 6

### 1. Kenya’s Debut Eurobond Sale

### Background and macroeconomic context
- Kenya is poised to reap the rewards of extensive institutional reforms and prudent macroeconomic policy in a market-friendly environment.
- Drivers supporting higher economic activity:
  - A surge in public investment in infrastructure.
  - Renewed interest of foreign investors in domestic and regional opportunities using Nairobi as a hub.
  - Lower transaction costs helped by improvements in information technology.
- Convergence of interbank rates toward the central bank policy rate and stability of the market-determined exchange rate reflect a positive impact of macroeconomic policies on credibility and expectations.

### Growth, inflation, and monetary policy
- Non-agriculture growth remained robust while agriculture stayed subdued because of poor rains.
  - Non-agriculture growth: 5.1 percent in January-March 2014.
  - Agriculture growth: 2.0 percent in January-March 2014.
- Headline inflation:
  - 7.7 percent in July (2014).
  - 8.4 percent in August (2014).
  - Monetary policy target: 5 ± 2.5 percent.
  - Central bank policy rate (CBR): 8.5 percent (unchanged since May 2013).
- Concerns highlighted:
  - Potential impact of the recent spike in food and energy prices and rapid credit growth on inflation expectations.
  - Interest rate volatility induced by government cash management problems, despite money market interest rates remaining close to the CBR.

### External current account and capital flows
- External current account deficit: 7.7 percent in 2013/14.
  - Reflects strong capital-goods imports and a decline in agricultural exports.
  - Sizable imports of equipment for oil exploration (largely self-financed).
- Service exports (notably transportation services) to the rest of the East African Community (EAC) have continued accelerating.
- Official BoP statistics underreport financing from FDI and portfolio inflows (Figure note).

### Kenya’s debut Eurobond issuance (Box 1)
- Issuance details:
  - Total size: US$2.0 billion.
  - Oversubscription: more than four times.
  - Use of proceeds:
    - US$600 million used to repay a syndicated loan contracted in 2012.
    - Remaining proceeds to substitute for domestic financing of energy and infrastructure projects.
  - Government also signed a loan with China in May 2014 for the Mombasa-Nairobi standard gauge railway: US$3.6bn, expected to start in October 2014 and to be implemented in around 5 years.
- Tranches and yields:
  - Five-year US$500 million bond at a yield of 5.875 percent.
  - Ten-year US$1.5 billion bond at a yield of 6.875 percent.
- Investor composition:
  - Demand from US investors: 68 percent of total placement.
  - British investors: 25 percent of total placement.
- Contractual law clause:
  - According to the Eurobond prospectus, the Agency Agreements, the Deeds of Covenant and the Notes are governed by, and will be construed in accordance with, English law.
- Additional loan detail (Chinese loan package):
  - The contract comprises two loans: a 15-year US$2 billion loan from Eximbank China at Libor plus 3.6 percent, and a 20-year US$1.6 billion loan from the Chinese government at 2 percent.
  - Repayment sources: Kenya Railways dividends and proceeds from the 1.5 percent railway levy on imports already in place.
- Market reaction:
  - The favorable terms reflect Kenya’s unique position relative to other frontier markets: Nairobi as a hub, issuance justified by infrastructure projects, sound policies and strong tax base, and conscientious preparation including legislative adaptations and assuming minor liabilities previously in litigation.
  - Following issuance, the bond yield in the secondary market declined below comparable securities such as Zambia’s and Ghana’s (chart note).

### Fiscal situation and devolution
- Fiscal deficit in 2013/14 remained unchanged from the previous year.
  - This reflects higher revenue offset by sizeable transfers to counties and a larger-than-envisaged wage bill.
- County development budget execution was low due to capacity constraints faced by counties during the first year of devolution.
  - As a result, the general government fiscal balance is more favorable than that of the central government in 2013/14 (staff estimate based on county fiscal outturns for the first three quarters).
- Devolution rollout (FY2013/14):
  - New counties established in line with the 2010 Constitution.
  - Reporting framework on budget execution by counties introduced via detailed quarterly reports published by the Office of the Controller of the Budget.
  - Fast-track rollout introduced strains in government cash management, inducing interest rate volatility, and complicated enforcement of the public financial management (PFM) framework.
  - Risks if left unaddressed: wage and payroll issues, debt inherited from previous local authorities, and unfavorable spending composition.
  - Authorities’ agreed mitigation steps: revamping the cash management framework and staffing the Intergovernmental Fiscal Relations Department to support capacity building at the county level.

### Devolution and poverty (Box 2)
- Poverty trends:
  - Poverty rate declined from 46.6 percent in 2005/06 to 45.2 percent in 2009.
  - Urban poverty ratio in 2009: 33.5 percent (about 3.9 million individuals).
  - Rural poverty ratio in 2009: 50.5 percent (about 13.1 million individuals).
  - World Bank estimate (cited): reduction in poverty rate to 39 percent in 2012/13 (reference to World Bank report).
- Revenue sharing and transfers:
  - New revenue sharing arrangement involves no less than 15 percent of national revenues.
  - Transfers intend to increase per capita transfers to poorer counties (Northern, Eastern and Coastal parts of Kenya).
- Expected outcomes of devolution:
  - Empower county governments to improve delivery of key services including education and health.
  - Invest in social and infrastructure spending.
  - Reduce inequality across counties over time if central government transfers are used efficiently with appropriate accountability.
  - Raising own revenues at the local level will further increase room for higher social and infrastructure spending.
- Resources to counties:
  - Total available resources to counties as percent of total central government expenditures increased over time (chart note).

### Financial sector, inclusion, and mobile banking (Box 3)
- Banking sector expansion:
  - Banks are expanding by raising domestic credit, providing access to new borrowers, and increasing operations beyond Kenyan borders.
  - Non-performing loans (NPL)-to-total loans ratio: 5.6 percent in May 2014 (from 4.6 percent a year before).
  - Pickup in credit growth increasingly funded externally via medium-term mostly concessional foreign currency lines for SME project financing and increased credit limits by international banks to their subsidiaries.
- Financial inclusion progress:
  - Mobile-banking loans and deposits driven by M-Shwari: 7 million customers in its first year of operations.
  - Financial inclusion charts indicate substantial increases in formal financial access between 2006, 2009, and 2013 (chart notes).
- Impact of M-Pesa and related innovations:
  - M-Pesa introduced in 2007 as a means to transfer money via mobile phones.
  - M-Pesa reaches 84 percent of population earning less than US$2 a day.
  - Number of micro accounts (deposit accounts below US$1,200) in formal financial institutions increased more than 10 times over the past 10 years (chart note).
  - M-Shwari: deposit-lending facility tailored to the poor with 7 million active customers in over a year of operations.
  - Product examples and welfare impacts:
    - Farmers acquiring equipment like water pumps with repayments via M-Pesa.
    - M-Kopa enabling use of solar panels with repayments in small installments.
    - Small scale health care management systems tracking procedures, lab tests, drug inventories via mobile phone devices.
- SME access to credit:
  - Access to credit by SMEs increased to 36 percent in 2013 from 25 percent six years before.
  - World Bank Enterprise Surveys show Kenyan SMEs are more competitive, innovative and more labor intensive than average SSA countries and LICs (chart notes).

### Outlook and risks
- Growth projections and drivers:
  - GDP growth projected to reach 5.8 percent in FY2014/15 from 5.0 percent in the previous year.
  - Medium-term drivers include:
    - Improved business conditions from rising infrastructure investment in energy and transportation.
    - Expansion of the EAC market owing to regional integration.
    - Reduced social strife due to devolution.
    - A more dynamic SME sector from financial inclusion.
    - Higher agricultural productivity and reduced medium-term vulnerability to weather shocks from large irrigation projects.
  - A boost in investor confidence following the successful Eurobond issuance could further improve the outlook.
- Upside scenarios:
  - Acceleration of regional integration beyond baseline assumptions.
  - Marked improvements in security conditions.
  - Possible new discoveries raising oil, gas and mining potential.
- Policy priorities noted:
  - In the immediate horizon, fiscal space should be used to improve security conditions, still complicated by terrorist threats.
  - Devolution needs careful management to overcome transitional problems.
  - In the medium term, decisive action in containing the wage bill and widening the tax base would further increase room for much needed priority social and infrastructure spending.
- External buffers and regional convergence:
  - Kenya’s external buffers and the fiscal plans outlined in the Budget Policy Statement are consistent with meeting the EAMU convergence criteria by 2021.
  - Kenya’s foreign reserves have continued to increase despite the large current account deficit and appear broadly adequate.

*Source: IMF staff report excerpt — "1. Kenya’s Debut Eurobond Sale" (PDF content provided).*

### 12.      Nevertheless, the Kenyan economy remains vulnerable to risks affecting the external

### _cr14302 - 12.      Nevertheless, the Kenyan economy remains vulnerable to risks affecting the external

### External and fiscal vulnerabilities — key risks and staff assessment
- Near-term risks identified:
  - "potential further deterioration of security conditions"
  - "new weather-related shocks following poor rains"
  - "additional difficulties in implementing devolution that could complicate PFM"
- Conditional vulnerabilities:
  - Weather-related shock vulnerability would remain high if infrastructure investments in geothermal energy and irrigation do not progress as planned.
  - Rising private medium-term foreign currency liabilities could increase corporate sector vulnerability to sharp movements in the exchange rate.
  - Protracted slow growth in advanced and emerging economies may constrain remittances and foreign demand for Kenyan exports.
- Capital flows: vulnerability to capital flow reversals appears limited; excluding the Eurobond, portfolio inflows have been mostly equity-based.

### Risk Assessment Matrix (RAM) — selected entries and recommended responses
- Return of drought conditions
  - Relative Likelihood: Medium
  - Potential Impact: High
  - Recommended Policy Response:
    - Maintain exchange rate flexibility.
    - Use external buffer.
    - Guard against second-round effects on inflation.
    - Use targeted cash transfers to vulnerable groups and reprioritize spending.
    - Continue infrastructure spending (irrigation and geothermal).
- Deterioration in security situation
  - Relative Likelihood: Medium
  - Potential Impact: High
  - Recommended Policy Response:
    - Reprioritize fiscal spending to accommodate security needs.
- Implementation risk from devolution
  - Relative Likelihood: Medium
  - Potential Impact: Medium
  - Recommended Policy Response:
    - Maintain fiscal discipline.
    - Adhere to PFM Act provisions.
- Side-effects from global financial conditions
  - Relative Likelihood: High
  - Potential Impact: Medium
  - Recommended Policy Response:
    - Maintain exchange rate flexibility.
    - Strengthen financial sector supervision.
- Protracted slower growth in advanced economies
  - Relative Likelihood: High
  - Potential Impact: Medium
  - Recommended Policy Response:
    - Accelerate reforms to address structural weaknesses affecting competitiveness.
- Regional geopolitical risks (financial flows, commodity prices, and supply chains)
  - Relative Likelihood: High
  - Potential Impact: High
  - Recommended Policy Response:
    - Maintain exchange rate flexibility.
    - Use external buffer.
    - Guard against second-round effects on inflation.

### Fiscal policy and medium-term strategy
- Central objective: maintain gross public debt below Kenya’s strategic ceiling (40 percent of GDP in present value (PV) terms), consistent with the EAMU convergence criterion (50 percent of GDP in PV terms).
- Fiscal trajectory:
  - After initial boost in project spending in FY2014/15, pace of deficit reduction is consistent with meeting the EAMU convergence criteria by 2021 (ceiling on fiscal deficit including grants of 3 percent of GDP).
  - Debt expected to rise in percent of GDP in the near term mainly because of the Eurobond placement and the large loan from China to finance the Standard Gauge Railway.
  - The government plans to set up a sinking fund to build up resources for the eventual repayment of the Eurobond.
- Revenue measures in the 2014/15 budget:
  - Revision of the Excise and Income Tax Acts (with LEG technical assistance).
  - Higher duties on iron and steel products.
  - Improved tax administration, especially VAT (by implementing LEG and FAD recommendations).
  - Amendments to the Income Tax Act to address tax avoidance by multinationals.
  - Incorporation of landlords into the tax base.
  - Expected yield: about 1.3 percent of GDP in 2014/15.
- Exemptions with limited revenue impact were also introduced (e.g., imports of inputs for processing and preservation of seeds, and for the generation of wind and solar energy).

### Wage bill, payroll reform, and fiscal space
- Observations:
  - The general government wage bill has been rising in recent years due to higher-than-projected wage spending by counties and increases in the central government wage bill.
  - Rising wage bill is crowding out priority infrastructure spending.
- Measures:
  - Hiring freeze for this fiscal year and start of a rationalization process to contain the wage bill.
  - Planned payroll audits and streamlining allowances to reduce disparities in gross pay between the private and public sector.
  - Process of staff rationalization to encompass county governments, to be based on a wage grid allowing comparability with private sector wages.
  - Reforms to be implemented gradually with a clear timetable and in the context of a social dialogue.

### Social programs, development spending, and PPPs
- Poverty reduction priorities:
  - 2014/15 budget increased allocation for social programs by about 11 percent in real terms to finance well-targeted cash transfer programs benefiting the elderly, the disabled, and orphaned children.
  - Devolution seen as an opportunity to alleviate poverty and inequality through county-level social and development programs.
- Development expenditure:
  - Authorities prioritize accelerating development expenditure, improving absorption capacity (especially in geo-thermal power generation), and recomposing counties’ spending to increase the share of development spending.
- Public-Private Partnerships (PPPs):
  - New PPP framework to be fully in place this fiscal year with forthcoming regulations and an implementation framework to assess contingent liabilities (under preparation with support from the World Bank).
  - A list of 47 national-priority PPP projects identified in sectors including health, transport, electricity and ports.
  - All contingent liabilities from existing and new PPPs need assessment by the Department of Debt Management of the National Treasury; an assessment framework will be established with World Bank technical assistance.

### Cash, debt management, and public financial management (PFM) challenges
- Treasury Single Account (TSA):
  - Introduction of the TSA will contribute to more efficient cash and debt management.
  - Importance of an effective TSA ensuring a cash management system with clear accountability, closely coordinated with debt management functions.
- Other measures to improve budget efficiency:
  - Introduction of the procurement module of IFMIS to help reduce risk of inflated prices in public contracts.
  - Creation of the Digital Government Payment Gateway to link spending with service delivery online.
- Devolution implementation challenges and recommended steps:
  - Controller of the Budget recommended counties to boost own revenue, put in place budget execution systems, have annual financial statements audited, empower county assemblies, settle payroll management problems, and fully use IFMIS.
  - Staff recommended: adequately staffing the Intergovernmental Fiscal Relations Department; enhancing accountability using the PFM framework; revising the revenue allocation formula to give more weight to fiscal performance and accountability; properly identifying and verifying county assets and liabilities inherited from former local authorities.
  - Authorities committed to enforcing procedures for controlling borrowing by counties, including government-approved guarantees channeled through the Debt Management Department and the Intergovernmental Budget and Economic Council.

### Fiscal risks, contingent liabilities, and state-owned entities — Box 4 highlights
- Macroeconomic shocks:
  - A prolonged decline in baseline growth under adverse macro-conditions would worsen debt dynamics; probability that the PV of gross debt in percent of GDP over the next 10 years would exceed the 50 percent EAMU ceiling during 2021/2023 remains low (5 percent).
- Oil and gas discoveries:
  - Fiscal position could deteriorate if expenditures rise on expectations for high oil and gas revenues that do not materialize; current medium-term budget envelope does not include potential revenues from these sources.
- Liabilities of sub-national governments:
  - Existing debt of previous local authorities has yet to be verified and is being disputed by some counties; some counties (e.g., Nairobi) have inherited relatively large pending bills that may pose risks to fiscal sustainability.
  - New borrowing by counties can only occur with a central government guarantee; National Treasury developing guidelines and a county financial database to assess fiscal capacity and debt sustainability.
- Contingent liabilities:
  - Guaranteed loans to various public entities have reached KSh43.5bn (1 percent of GDP), of which 15 percent have been called to date.
- State corporations:
  - Transfers to SOEs reached KSh354.3bn (8 percent of GDP) in 2013/14, of which 66 percent for development spending.
  - Government reform aims to reduce number of entities (from close to 300 to 187) and introduce new structures: a Government Investment Corporation for commercial entities and a National and County Agencies Oversight Office for other agencies; these institutions’ financial operations should be fully incorporated into the budget.
- Wage bill challenges reiterated:
  - Public wages are high and rising, crowding out social and infrastructure spending; wage setting by counties could magnify this problem. Government has embarked on comprehensive payroll rationalization.

*Source: IMF staff and Kenyan authorities, as presented in the provided content.*

### 22.      The government has initiated institutional and legal reforms for extractive industries.

### 22.      The government has initiated institutional and legal reforms for extractive industries.

### Reforms under way
- The Extractive Industry Tax Regime and a new Mining Bill, incorporating inputs from FAD and LEG technical assistance, are on Parliament’s agenda.
- The government plans to redesign:
  - the framework for oil exploration;
  - the model for production sharing contracts; and
  - the model for terms for natural gas contracts,
  with FAD and LEG technical assistance.
- The petroleum regulatory and fiscal regime dates from 1986 and is in need of modernization.
- The production-sharing scheme for oil does not reflect properly costs, prices, and production volumes, and needs to be revised.
- New production-sharing terms for gas need to be specified; a full gas-specific regulatory framework is needed for the medium term.
- The Kenya Petroleum Technical Assistance Program (KEPTAP), with World Bank support, has been rolled out to build public-sector capacity (geotechnical data acquisition; environmental, social and health and safety standards).

### Natural resource discoveries and implications (Box 5)
- Tullow estimates reserves to be well above the 600 millions of barrels of oil equivalent (mboe), comparable to Equatorial Guinea and the Republic of Congo.
- If confirmed, these reserves could bring Kenya’s external current account to surplus soon after exploitation starts.
- Morgan Stanley estimates that the country could become self-sufficient in oil production within 3-5 years.
- Overall, 23 international oil companies are conducting exploration activities in all 44 blocks currently licensed.
- Companies have been drilling 15 exploration wells between March 2012 and June 2014, an average drilling rate of about 7 wells per year.
- Crude oil has been found in 7 wells (Tullow Oil with Africa Oil as Joint Venture Partner); natural gas and oil were found in onshore and offshore blocks (Apache and British Gas Group).

### Staff observations and policy recommendations
- Caution on the timing and design of a Sovereign Wealth Fund:
  - The planned Sovereign Wealth Fund proposed by the Task Force on Parastatal Reform appears premature as long as the fiscal position is projected to remain in deficit.
  - Its eventual introduction would require provisions fully consistent with transparent management rules and resources fully integrated into the budget.
- Recommendation on revenue-sharing design:
  - The terms of sharing of revenues from natural resource exploitation between the central government and counties should be decided once the volume and expected timespan for the exploitation of available resources are known.
- Authorities’ stance:
  - The authorities recognize these concerns and underscore the importance of safeguarding most natural resource revenues for development purposes, while balancing the need for infrastructure and social spending at the local level to ensure equitable sharing of natural wealth.

*Source: IMF staff report excerpt (section 22 and Box 5).*

### 34.      The authorities intend to take measures to upgrade the business environment and

### _cr14302 - 34.      The authorities intend to take measures to upgrade the business environment and

### Business environment and security
- Authorities plan measures to upgrade the business environment and improve security conditions, including:
  - simplifying regulations;
  - rationalizing procedures;
  - removing barriers to entry; and
  - improving the delivery of government services to business.
- Government announcements include establishment of:
  - (a) an investors relations office;
  - (b) a one-stop investment shop; and
  - (c) expansion of one-stop public-service centers (Huduma centers) to lighten the bureaucratic burden on firms.
- Security modernization program (started last year) includes:
  - expansion of the police force; and
  - upgrade of police equipment.

### Data compilation, quality, and priority gaps
- Compilation and dissemination of economic information is high, but data quality in some key sectors is low.
- Authorities are taking steps to address limitations; a major step was the national accounts revision that lifts nominal GDP by 20-25 percent.
- Key data availability gaps:
  - key social indicators are only available for 2005/06 (the year of the last household survey);
  - balance of payments data fail to differentiate short-term from long-term inflows properly (see annex in Staff Report for the Sixth Review under the ECF).
- Further areas for improvement:
  - availability and timeliness of production indices;
  - labor market information; and
  - international investment position, especially private debt information.

### Box 7 — National Accounts Revision (highlights)
- KNBS is revising Kenya’s national accounts for the period 2006-2013; release of a full time series consistent with this revision is scheduled for September 2014.
- Revision supported by STA technical assistance under the Enhanced Data Dissemination Initiative.
- Based on KNBS 2014 Economic Survey (May 2014), estimates used in this report take into account:
  - The revised 2013 GDP will be higher by about 25 percent than the 2001-based GDP, reaching about $55bn.;
  - The revised 2013 per capita GDP would reach about $1,325, closer to middle-income status.
- Revision changes the base year from 2001 to 2009.
- Improved coverage and upgraded sources of information lead to:
  - upward revision of value added for agriculture, financial activities and the informal sector;
  - reduction in the contribution of wholesale and retail trade due to more appropriate measurement.

### East African integration steps
- Kenya has taken important steps to support East African integration:
  - Customs revenue collection for some EAC members (Rwanda, Uganda) already takes place in Mombasa, with preliminary indicators showing improved revenue for Uganda and Rwanda;
  - Delays in border posts are sharply reduced;
  - Government committed to streamline port services in Mombasa, with commitment to specific targets by all entities involved.

### Staff appraisal — macroeconomic assessment and recommendations
- Macroeconomic performance and monetary policy:
  - Kenya’s economy has continued to grow in a broadly stable macroeconomic environment.
  - Credit to the manufacturing sector has picked up and foreign investor interest is growing, notably in the extractive industries.
  - Headline inflation has risen above the upper band of the inflation range in recent months; further food price shocks in the context of rapid credit growth may fuel inflation expectations.
  - Recommendation: The CBK should stand ready to tighten monetary policy to keep inflation expectations anchored around the mid-point of the target band.
  - The market determined exchange rate has remained stable.
  - A successful sovereign bond issue and recent exit from the FATF’s monitoring process attest to progress in establishing Kenya as a robust financial center.

- Risks and external buffers:
  - Kenya faces a positive outlook but remains vulnerable to important risks: domestic risks related to devolution and security; weather-related shocks; and a potential renewed downturn in advanced and emerging economies.
  - Recommendation: Maintain a strong foreign exchange reserves position with exchange rate flexibility to cushion potential shocks.
  - Improve liquidity forecasting to support prudent monetary policy and anticipate changes in inflation expectations.

- Fiscal policy and contingent liabilities:
  - Kenya’s debt remains sustainable, but rising contingent liabilities are a fiscal risk.
  - Recommendation: Maintain a prudent fiscal stance consistent with Kenya’s medium-term debt target while shifting expenditure composition toward development priorities.
  - Priority: Control the wage bill at both national and county level.
  - Recommendation: Improve quality and efficiency of public spending to create fiscal space for targeted social programs and increased infrastructure investment.
  - Continue efforts to mobilize domestic revenue.
  - Reform of government-owned agencies to reduce contingent liabilities is welcome; implementation should remain consistent with the overall PFM framework.

- Devolution and public financial management:
  - Devolution holds promise for inclusive growth and improved social conditions; considerable progress made during the first year.
  - Weaknesses to address: accountability, compliance with legal framework, and implementation capacity.
  - Priority areas:
    - adoption of the PFM Act regulations;
    - a formal agreement between the central government and counties on outstanding liabilities;
    - stronger oversight on the use of public resources;
    - make the Intergovernmental Fiscal Relations Department fully operational;
    - strengthen capacity-building in public financial management.

- Treasury Single Account (TSA) and cash management:
  - Launching the TSA provides an opportunity to overhaul government cash management systems.
  - Benefits: avoid undue pressure on payment flows and interest rates; reduce borrowing costs for government and private sector; allow the central bank to focus on monetary operations.

- Natural resource management:
  - Effective management of recent oil and gas discoveries can increase foreign exchange and fiscal resources.
  - If commercially viable, these findings could accelerate growth and reduce drought-related and geopolitical risks.
  - Recommendation: Establish a sound fiscal framework consistent with the PFM Act, with transparent management rules and full integration of these resources into the budget.

- Financial sector and inclusion:
  - Banks expanding regionally while facilitating financial inclusion.
  - Recommendation: Continue consolidated supervision of systemic groups with cross-border cooperation, information sharing, joint prudential oversight and resolution procedures.
  - Domestic financial inclusion expansion creates opportunity to extend credit at more affordable rates to small and medium-sized enterprises.
  - Policy balance: maintain an enabling environment while improving the prudential framework.

- Regional integration:
  - Accelerating regional integration will support investor sentiment and export diversification.
  - Commitment to East African Monetary Union Protocol’s convergence criteria supports integration.
  - Kenya’s role in reducing shipment delays enhances integration benefits.
  - Recommendation: Remove non-tariff barriers to significantly lower the cost of doing business in the region.

- Data priorities reiterated:
  - Data quality improvement should be given higher priority as Kenya transitions toward emerging market status and faces more intensive monitoring by private investors, rating agencies, international banks, and multinational companies.
  - Recommendation: Upgrade quality and scope of information on the balance of payments, social indicators, and the labor market.

*Source: IMF staff report excerpt.*

### 47.      It is proposed that the next Article IV consultation for Kenya takes place within 12

### It is proposed that the next Article IV consultation for Kenya takes place within 12 months, subject to the decision on consultation cycles.

### Consultation timing
- It is proposed that the next Article IV consultation for Kenya takes place within 12 months, subject to the decision on consultation cycles.

### National accounts and prices (selected indicators and projections)
- Nominal GDP (market prices, in billions of Kenya shillings): 4,497; 5,051; 5,734; 6,525; 7,420; 8,416; 9,504
- Real GDP growth (market prices): 4.6; 5.0; 5.8; 6.3; 6.5; 6.5; 6.6 (annual percentage change)
- GDP deflator (average): 6.7; 6.9; 7.2; 7.0; 6.7; 6.4; 5.9
- Consumer price index (annual average): 4.6; 7.1; 6.5; 5.2; 5.0; 5.0; 5.0
- Consumer price index (end of period): 4.9; 7.4; 5.3; 5.0; 5.0; 5.0; 5.0
- Import volume growth, goods: 6.8; 3.6; 8.3; 11.2; 7.6; 8.8; 8.8
- Import value growth, goods: 3.2; 5.0; 11.2; 9.2; 7.8; 8.7; 9.6
- Export volume growth, goods: 8.2; 0.7; 6.2; 10.3; 10.0; 10.6; 10.7
- Export value growth, goods: 2.8; -5.3; 4.1; 9.1; 10.4; 11.1; 11.3
- Terms of trade, goods, and services (Base year 2000): -4.2; -6.2; -1.3; 1.5; 0.6; 1.2; 0.7
- Ksh per US$ exchange rate (end of period): 85.8; 87.6
- Nominal effective exchange rate (- depreciation; end of period): 1.2; -2.7
- Real effective exchange rate (- depreciation; end of period): 3.6; 1.9

### Money, credit, and monetary survey (selected levels and growth)
- M3 (broad money and foreign currency deposits, end period): 14.2; 21.4
- Reserve money: 11.7; 16.0
- Investment (percent of GDP): 18.7; 18.7; 22.3; 22.6; 23.2; 23.1; 22.8
  - Central government: 6.6; 6.2; 8.6; 8.7; 9.0; 8.8; 8.5
  - Other: 12.1; 12.5; 13.7; 14.0; 14.2; 14.3; 14.3
- Gross national saving (percent of GDP): 10.6; 11.0; 13.9; 14.7; 16.1; 16.5; 16.5
- Central government saving (percent of GDP): 0.8; 0.2; 2.1; 2.9; 3.6; 4.0; 4.1
- Selected monetary survey levels (Jun-13 to Jun-15, in billions of Ksh):
  - CBK net foreign assets: 402.1; 432.0; 442.1; 429.7; 461.0; 492.3; 541.2; 590.1
  - Reserve money (end period): 287.4; 320.8; 312.0; 333.3; 346.8; 380.4; 374.7; 399.5
  - M2 plus resident foreign currency deposits (M3): 1,820.9; 1,996.2; 2,060.3; 2,210.4; 2,292.3; 2,376.5; 2,476.5; 2,654.6
  - Annual percent change memorandum items: M1: 0.7; 16.4; 20.4; 23.7; 20.4; 21.1; 20.2; 20.1; M2: 15.6; 13.8; 19.0; 21.9; 21.0; 21.4; 20.2; 20.1; M3: 14.2; 15.6; 17.3; 21.4; 21.6; 19.1; 20.2; 20.1
  - Multiplier (Average M3/RM): 6.2; 6.3; 6.4; 6.5; 6.5; 6.5; 6.5; 6.5

### Central government fiscal operations (levels, 2012/13–2018/19, in billions Ksh)
- Revenues and grants: 868.2; 1,106.2; 994.4; 1,238.4; 1,204.8; 1,363.8; 1,555.8; 1,785.2; 2,016.4
- Revenue: 847.2; 1,028.5; 969.2; 1,180.5; 1,175.5; 1,335.5; 1,529.5; 1,758.5; 1,986.3
- Tax revenue: 701.2; 862.9; 851.8; 1,006.5; 1,006.5; 1,145.9; 1,313.7; 1,508.7; 1,703.2
  - Income tax: 373.4; 459.0; 449.6; 541.9; 541.9; 619.8; 712.0; 812.5; 917.5
  - Import duty (net): 57.7; 69.0; 67.6; 77.7; 77.7; 89.6; 102.4; 116.4; 134.7
  - Excise duty: 85.5; 113.1; 102.0; 119.8; 119.8; 132.5; 151.8; 177.1; 203.4
  - Value-added tax: 184.6; 221.8; 232.6; 267.1; 267.1; 304.0; 347.5; 402.7; 447.5
- Nontax revenue: 146.1; 165.6; 117.4; 174.0; 169.0; 189.6; 215.8; 249.9; 283.1
  - Investment income: 15.3; 17.7; 10.2; 17.4; 17.4; 19.8; 22.5; 25.5; 28.8
  - Ministerial and Departmental Fees (AIA): 49.7; 67.3; 30.5; 71.2; 66.2; 72.3; 82.3; 93.3; 105.4
- Grants: 21.0; 77.7; 25.3; 57.9; 29.3; 28.3; 26.3; 26.7; 30.2
- Total expenditure and net lending: 1,117.0; 1,439.7; 1,281.2; 1,581.0; 1,559.4; 1,719.5; 1,936.6; 2,172.2; 2,408.8
  - Recurrent expenditure: 808.3; 990.6; 965.9; 1,102.8; 1,054.8; 1,145.8; 1,256.2; 1,418.4; 1,591.2
    - Interest payments: 121.2; 120.5; 134.1; 147.4; 142.1; 162.8; 183.4; 203.9; 230.4
    - Wages and benefits (civil service): 274.4; 263.0; 288.5; 302.4; 303.3; 338.0; 368.9; 416.3; 468.8
  - Development and net lending: 298.9; 439.1; 315.3; 478.5; 496.2; 568.1; 673.9; 746.4; 809.3
    - Domestically financed: 201.8; 196.1; 214.6; 289.2; 336.0; 371.0; 441.4; 519.7; 562.8
    - Foreign financed: 94.7; 240.6; 98.4; 187.2; 157.3; 194.1; 229.2; 222.9; 242.1
- Balance (commitment basis, excluding grants): -269.8; -411.2; -312.0; -400.5; -383.8; -384.1; -407.1; -413.7; -422.5
- Balance (commitment basis, including grants): -248.8; -333.5; -286.7; -342.6; -354.6; -355.7; -380.8; -387.0; -392.3
- Balance (cash basis, including grants): -232.4; -333.5; -286.7; -342.6; -354.6; -355.7; -380.8; -387.0; -392.3
- Financing (total): 232.4; 333.5; 286.7; 342.6; 354.6; 355.7; 380.8; 387.0; 392.3
  - Net foreign financing: 62.7; 226.3; 83.7; 149.8; 198.7; 173.2; 201.2; 199.0; 251.5
    - Disbursements: 86.2; 314.9; 165.3; 177.3; 227.5; 208.1; 240.2; 244.8; 305.2
    - Repayments due: -24.0; -88.6; -82.8; -27.5; -29.3; -34.8; -39.0; -45.8; -53.7
  - Net domestic financing: 169.8; 106.7; 203.0; 190.8; 155.9; 182.5; 179.6; 188.0; 140.8

### Public debt (selected ratios)
- Total public debt, gross (percent of GDP): 42.1; 42.2; 45.8; 45.5; 45.4; 45.0; 44.3
  - Of which: external debt (percent of GDP): 18.8; 19.4; 19.0; 19.3; 19.7; 19.7; 20.1
  - Of which: domestic debt, gross (percent of GDP): 23.4; 22.8; 26.8; 26.8; 26.2; 25.7; 25.2
- Total public debt, net of deposits (percent of GDP): 37.6; 38.2; 40.7; 41.3; 41.4; 41.1; 40.5
- Memorandum: Total gross public debt, gross (in 2013/14 levels table): 1,856.5; 2,180.5; 2,130.8; 2,370.3; 2,624.3; 2,971.7; 3,371.6; 3,784.7; 4,213.3
  - of which: external debt: 805.9; 962.3; 977.6; 1,153.3; 1,088.3; 1,261.6; 1,462.7; 1,661.8; 1,913.3
  - of which: domestic debt: 1,050.6; 1,097.0; 1,153.1; 1,217.0; 1,536.0; 1,710.1; 1,908.9; 2,122.9; 2,300.0

### Balance of payments and external sector (selected levels and projections, in millions of US$)
- Current account balance: -4,240.3; -4,504.3; -5,371.8; -5,718.1; -5,672.7; -5,786.4; -6,158.7
- Exports, f.o.b.: 6,018.2; 5,823.3; 6,039.3; 6,586.9; 7,270.0; 8,075.1; 8,985.8
  - Coffee: 230.1; 216.4; 248.5; 265.1; 292.5; 323.6; 351.5
  - Tea: 1,207.1; 1,124.7; 1,069.4; 1,155.2; 1,286.1; 1,453.7; 1,641.5
  - Horticulture: 717.8; 770.3; 825.2; 882.3; 963.1; 1,070.5; 1,190.7
- Imports, f.o.b.: -15,568.0; -16,308.2; -18,168.3; -19,829.4; -21,391.2; -23,244.9; -25,487.8
  - Oil: -3,776.5; -3,899.4; -4,338.0; -4,577.2; -4,807.7; -5,172.8; -5,666.0
  - Other private: -11,610.6; -12,293.3; -13,707.9; -15,122.8; -16,441.3; -17,915.5; -19,649.5
- Balance on goods: -9,549.8; -10,484.9; -12,129.1; -13,242.5; -14,121.3; -15,169.8; -16,502.0
- Balance on services: 2,563.1; 2,823.4; 3,090.7; 3,391.1; 3,749.0; 4,172.6; 4,653.8
- Balance on goods and services: -6,986.7; -7,661.5; -9,038.3; -9,851.4; -10,372.3; -10,997.2; -11,848.1
- Income (net): -226.7; -364.9; -412.5; -284.8; -100.0; -26.5; -6.1
- Current transfers (net): 2,973.1; 3,522.1; 4,079.0; 4,418.1; 4,799.6; 5,237.4; 5,695.5
  - Private (net): 2,765.5; 3,391.7; 4,021.6; 4,386.4; 4,805.4; 5,262.5; 5,720.5
    - Remittances: 2,088.7; 2,409.8; 2,651.6; 2,905.1; 3,202.2; 3,527.4; 3,842.8
- Capital and financial account: 4,838.2; 5,166.6; 6,654.3; 6,886.6; 6,752.9; 7,086.8; 7,634.4
  - Net FDI: 375.7; 802.5; 1,242.8; 1,399.1; 1,505.7; 1,706.0; 1,884.6
  - Net portfolio investment: 105.8; 2,101.9; 160.2; 372.4; 379.0; 441.2; 1,238.3
  - Net other investment: 3,453.7; 2,610.8; 3,971.7; 4,861.3; 4,589.6; 4,641.5; 4,548.5
- Errors and omissions: 732.3; 471.7; 0.0; 0.0; 0.0; 0.0; 0.0
- Overall balance: 872.6; 937.0; 1,282.5; 1,168.5; 1,080.3; 1,300.4; 1,475.7
- Reserve assets (gross, end of period, in millions US$): 6,222.0; 7,475.0; 8,275.0; 9,325.0; 10,325.0; 11,209.7; 12,484.7
  - In months of next year imports: 4.0; 4.3; 4.4; 4.6; 4.6; 4.6; 4.6
- Import volume growth, goods and services (percent): 6.1; 2.4; 8.9; 11.6; 8.2; 9.1; 8.8
- Export volume growth, goods and services (percent): 5.6; 4.2; 9.7; 11.3; 10.8; 11.0; 10.6
- Change in the terms of trade (goods and services, percent): -4.2; -6.2; -1.3; 1.5; 0.6; 1.2; 0.7

### Financial soundness indicators (selected, 2009–2013)
- Regulatory Capital to Risk-Weighted Assets: 19.6 (2009); 20.8 (2010); 19.4 (2011); 21.9 (2012); 23.2 (2013)
- Non-performing Loans to Total Gross Loans: 7.9 (2009); 6.3 (2010); 4.4 (2011); 4.5 (2012); 5.0 (2013)
- Bank Provisions to Non-performing Loans: 66.3 (2009); 75.3 (2010); 82.2 (2011); 80.9 (2012); 70.7 (2013)
- Return on Assets: 2.3 (2009); 3.7 (2010); 3.3 (2011); 3.8 (2012); 3.6 (2013)
- Return on Equity: 20.1 (2009); 30.7 (2010); 32.2 (2011); 34.2 (2012); 28.9 (2013)
- Liquid Assets to Total Assets: 36.0 (2009); 38.4 (2010); 33.3 (2011); 35.2 (2012); 34.3 (2013)
- Total Loans to Total Deposits: 72.4 (2009); 72.5 (2010); 77.5 (2011); 76.9 (2012); 80.4 (2013)
- Foreign-Currency-Denominated Assets to Total assets: 8.1 (2009); 10.6 (2010); 11.8 (2011); 13.2 (2012); 13.7 (2013)

*Sources: Kenyan authorities and IMF staff estimates and projections.*

### Annex I. Devolution: Recent Developments, Transitional

### Annex I. Devolution: Recent Developments, Transitional Challenges, and the Medium-Term Outlook

### Background and recent developments
- County budgets for FY 2013/14 amount to KSh261bn, or 5.2 percent of Kenya’s GDP.
- County budgets are financed by:
  - equitable share transfers from the national government: 74 percent of total county budgets;
  - conditional grants: 1 percent of total;
  - own-source revenue collections: 25 percent of total.
- Counties allocated around 63 percent of their budgets to current spending and the remaining to development spending.
- Counties are entitled to receive a minimum of 15 percent of nationally raised revenues; the current allocation significantly exceeds this number due to a fast-track approach to devolution.

### Own-source revenue collection and absorption capacity
- Counties projected local revenue collections of KSh68bn during the current fiscal year.
- Actual local revenue collections amounted to around KSh19.1bn during the first three quarters of the fiscal year.
- Revenue collections improved during the third quarter; expected revenues at end of fiscal year: around KSh24bn (an increase from KSh19.7bn collected by defunct local authorities in 2012/13).
- Counties received KSh133.3bn during the first three quarters of the fiscal year (KSh110.1bn in national transfers and the remaining in local revenue collections), but spent only KSh106.6bn (including wage spending on devolved staff initially paid on their behalf by the central government).
- Total spending is expected to rise to around KSh169bn by the end of the fiscal year.
- Based on projected transfers and local revenue collections for the full fiscal year, counties would still accumulate around KSh50bn in bank deposits because of under-spending (about 1 percent of GDP).

### Composition of spending: current vs development
- Development spending is far below the envisaged goal of 30 percent of total expenditure.
- During the first three quarters of FY 2013/14, current spending amounted to 86.1 percent of total county spending.
- Development spending absorption rate has been gradually improving and is expected to continue improving over time, with exceptions in a few large counties facing structural high costs inherited from previous local authorities (noted counties: Nairobi, Mombasa, Kisumu, and Nakuru).

### Wage bill, staffing, and related fiscal pressures
- Counties spent more than half of their resources during the first three quarters of 2013/14 on wages, including wages paid to devolved staff on their behalf by the central government.
- Factors contributing to a high wage bill:
  - large number of staff inherited from previous local governments;
  - new recruitment by counties;
  - wage increases;
  - high salaries of county assembly support staff.
- FAD TA report findings cited:
  - around 4,200 new staff (legislative officials and county executives) may be added to the 2,600 staff already in place.
- Some former local authority staff and members of county assemblies awarded themselves substantial wage increases during 2013/14.
- Risk: these devolution-related wage bill issues could create significant pressures on general government finances in the medium term unless the national government adopts clear wage and remuneration policies and guidelines, ideally in the context of a rationalization program.
- The Public Service Commission has approved recruitment of the top three officials for the Intergovernmental Fiscal Relations Department.

### Legacy debt, liabilities, and county borrowing
- County debt repayments of inherited debt from previous local authorities during the first three quarters of 2013/14 amounted to around KSh3bn (3 percent of total expenditure).
- The attorney-general issued a legal opinion that county governments are the successors of former local authorities and bear the obligations of the defunct local authorities.
- The Transition Authority is expected to verify assets and quantify all liabilities by end-December 2014.
- Current constitutional requirements: borrowing by counties requires government guarantees and should only be used to finance development projects.
- National Treasury stance: provide guarantees to counties only after they develop adequate capacity to monitor fiscal risks, with resources made available in line with counties’ capacity to repay and debt sustainability.
- Recommendation: formalize the approach to guarantees to avoid potential impact on fiscal sustainability if these guarantees are de-facto called.

### Accountability, governance, and fiscal distortions
- Some counties recorded expenditures higher than actual funds released to their accounts, implying they may have spent resources from local revenues without seeking required authorization from the Office of the Controller of the Budget.
- Note: spending outside funds released to operational accounts does not imply an accumulation of arrears since budgets are on a cash basis.
- Distortions from the allocation formula:
  - county budgets were adopted before specific functions were transferred to the counties;
  - some functions remained within the national government even though funds had been transferred to counties;
  - these distortions create pressures on central government finances.
- Current spending includes non-negligible allocations to domestic and foreign travel, purchase of motor vehicles, and MCA allowances to members of county assemblies with unclear justification.
- Accountability should be strengthened by county assemblies, the Kenya Audit Office and the Parliament.

### Role of the Intergovernmental Fiscal Relations Department and policy actions
- Staffing the Intergovernmental Fiscal Relations Department is crucial and should be done as early as possible.
- Once staffed, the Department will:
  - provide fiscal oversight over county budgets, fiscal reporting and fiscal policy;
  - develop a repository of fiscal data for counties;
  - help improve accountability of counties for public resources.
- Complementary policy actions should cover:
  - wage bill sustainability;
  - composition of spending (current vs development);
  - legacy debt resolution;
  - potential borrowing by counties and contingent liabilities.
- The National Treasury has proposed a structure to provide financial oversight of counties.
- This Department’s role will be especially significant when counties start applying for loan guarantees.

*Source: Annex I. Devolution: Recent Developments, Transitional Challenges, and the Medium-Term Outlook (excerpts) from the IMF staff report.*

### 2011. The assessment found that the temporary governance gaps of the Board and Audit Committee

### _cr14302 - 2011. The assessment found that the temporary governance gaps of the Board and Audit Committee

### Governance and Audit Findings
- The temporary governance gaps of the Board and Audit Committee identified in the 2011 assessment have been rectified.
- Oversight bodies have been fully restored to support effective discipline and responsibility.
- The Audit Committee concluded satisfactorily on its ex-post assessment of the gaps.
- The external auditor issued an unqualified audit opinion for 2011.
- The assessment recommended adopting an action plan to resolve the large stock of pending audit recommendations.
- Aside from amending the CBK Act, almost all recommendations of the earlier assessment have been implemented on schedule.
- The authorities have committed to submit revisions to the CBK Act to the National Assembly.
- Internal audit has resumed certifying reconciliations supporting the monetary data reporting to the Fund.

### Exchange Rate Arrangement
- Currency: Kenyan Shilling.
- De jure exchange rate arrangement: free floating.
- De facto exchange rate arrangement: classified as floating.
- The official exchange rate (set at the previous day’s average market rate) applies only to government and government-guaranteed external debt-service payments and to government imports for which there is a specific budget allocation.
- On August 28, 2014, the exchange rate was KSh88.3786=US$1.00.
- Kenya accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF Articles of Agreement with effect from June 30, 1994, and maintains an exchange system free of restrictions on payments and transfers for current international transactions, other than restrictions notified to the Fund under Decision No. 144 (52/51).

### Article IV Consultation
- The last Article IV consultation with Kenya concluded on November 23, 2011.
- The next Article IV consultation with Kenya is expected to take place on a 12-month cycle.

### FSAP Participation
- A joint IMF/World Bank mission assessed Kenya’s financial sector as part of the FSAP update during September 2009.
- The staff report on the Financial Sector Stability Assessment was issued to the Executive Board concurrently with the 2009 Article IV Consultation Staff Report.

### Technical Assistance (selected entries and years of delivery)
- Fiscal Affairs Department (FAD):
  - AFRITAC East: Several PFM review missions — 2014
  - AFRITAC East: Harmonizing PFM among EAC partners — 2014
  - Workshop on medium-term budget frameworks — 2014
  - Fiscal decentralization support — 2013
  - Workshop on FARI model — 2013
  - Revenue administration — 2013
  - Natural resource management — 2013
  - AFRITAC East: Improving efficiency in customs — 2013
  - Workshop on public sector wages — 2013
  - AFRITAC East: Several PFM review missions — 2012
  - PFM Act implementation — 2012
  - Pension reform — 2011
  - Tax Administration/VAT — 2011
  - Several PFM review missions — 2011
- Monetary and Capital Markets Department (MCM):
  - AFRITAC East: ICAAP/SREP implementation — 2014
  - Inflation targeting — 2014
  - Pensions supervision — 2014
  - Enhancing CMA’s investigative techniques and enforcing capacity — 2013
  - Bank stress testing — 2013
  - Monetary operations and Instruments — 2012
  - AFRITAC East: Several missions on consolidated supervision — 2012
  - Insurance stress testing/Early warning system — 2012
  - AFRITAC East: Several missions to CBK on liquidity forecasting — 2012
  - AFRITAC East: Strengthening surveillance systems — 2011
  - Bank stress testing — 2011
  - Conducting onsite inspection and consolidated supervision — 2011
  - Insurance and pension supervision — 2011
- Legal Department (LEG):
  - Strengthening AML/CFT regime — 2013-14
  - VAT regulations, excise law and regulations, tax procedures — 2013
  - Natural Resources Law — 2013
  - Central Bank Law — 2013
  - Tax legislation — 2011
- Research Department:
  - Modernizing Monetary Policy by developing an FPAS — 2012-14
- Statistics Department (STA):
  - Several missions on National Accounts — 2014
  - AFRITAC East: GFS mission — 2014
  - Price Statistics (XMPIs, PPI, construction) — 2013
  - National Accounts — 2013
  - Government Finance Statistics — 2012
  - National Accounts — 2012
  - Price Statistics (CPI) — 2011
  - Government Finance Statistics Mission — 2011
  - AFRITAC East Mission on Quarterly National Accounts — 2011
  - DFID III follow-up GFS to implement — 2011

### Resident Representative
- Mr. Ragnar Gudmundsson, since August 2010.

### Statistical Issues — Assessment of Data Adequacy for Surveillance
- General:
  - Data provision has some shortcomings because of capacity constraints, but is broadly adequate for surveillance and program monitoring.
  - Further improvements in the methodology of compiling real, fiscal, and external sector statistics would be desirable.
- National Accounts:
  - KNBS has made significant efforts to enhance national statistics compilation.
  - Major constraints: limited funding for data collection activities, lack of a long-term funding strategy, and a lack of trained staff.
  - East AFRITAC statistics advisor is assisting with rebasing annual and quarterly national accounts estimates at current and constant (from 2001 to 2009) prices, and developing 2009 supply and use tables (SUTs).
  - Improved source data and balancing via SUTs expected to increase estimated levels of measured GDP.
  - KNBS participates in the Quarterly National Accounts (QNA) Statistics Module of the IMF-U.K. DFID.
- Price Statistics:
  - KNBS faces significant challenges in compilation and dissemination of CPI series at a detailed historical level.
  - Three East AFRITAC TA missions in 2010—2013 advised on improvements to all KNBS price statistics.
  - KNBS released rebased export and import price indexes (XMPIs) using Customs unit value trade data in May 2012 (previously compiled on a base year of 1982).
  - Recommendations made for improving methodology and a major rebase of the construction price index (currently 1972).
  - KNBS commenced dissemination of a new quarterly producer price index for mining and quarrying, manufacturing and utilities from October 2012.
- Government Finance Statistics (GFS):
  - A GFS TA mission under the EDDI project (DFID-funded) visited Nairobi in October 2011 and made multiple recommendations, including:
    - Set up a tripartite technical working group (MOF, CBK, and KNBS) to determine institutional coverage of general government and subsectors.
    - Disseminate monthly budget outturn on MOF’s website and report regularly to STA for IFS publication.
    - Reconcile monthly, quarterly, and annual fiscal statistics regularly.
    - Investigate causes of large discrepancy between net lending and financing.
    - Compile and disseminate fiscal statistics for budgetary central government following GFSM 2001 classifications and tables, and gradually expand coverage to major extra-budgetary units and social security funds.
    - Prepare a migration plan with a detailed timetable for gradual migration to the GFSM 2001 methodology.
  - An October 2012 follow-up GFS TA mission found some progress and assisted further implementation.
  - East AFRITAC (AFE) is collaborating with the EAC Secretariat to improve GFS based on GFSM 2014 to meet EAMU Protocol fiscal data requirements.
- Monetary and Financial Statistics:
  - Progress in compilation of monetary data; Kenya benefited from monetary statistics module in Phase II of the DFID Project.
  - Objectives included adoption of MFSM methodologies and establishment of an Integrated Monetary Database (IMD).
  - Kenya’s MFS do not include data on other financial corporations, a growing sector.
  - Kenya does not participate in the IMF’s CDIS and CPIS.
  - Kenya reports 11 core FSIs and 10 encouraged FSIs for deposit takers and reports household debt to GDP ratio; FSIs for other financial corporations and nonfinancial corporations are not available.
- External Sector Statistics:
  - KNBS compiles annual balance of payments statistics in Kenya shillings and regularly reports to STA.
  - CBK compiles a complete set of annual balance of payments statistics in U.S. dollars, reported to AFR and used for programming and surveillance.
  - The two datasets are not entirely consistent; Fund staff have strongly encouraged reconciliation.
  - Trade data quality may be reasonably good, but data for other current account and many financial account transactions are rather weak.
  - The financial account is largely drawn from ITRS, which suffers from a large and growing element of unclassified inflows and outflows that might include settlements of current account transactions.
  - Kenya participates in phase II of the external sector module of the DFID Project. Four TA missions under this project undertook a comprehensive enterprise survey of cross-border financial flows and stocks on an annual basis to improve BOP and compile IIP statistics.
  - During 2013, KNBS completed its second Foreign Investment Survey (FIS); it is expected this survey could be undertaken on an annual basis.
  - KNBS and CBK analyze large differences between the FIS results and financial account data from the ITRS to explain expected revisions and to develop an IIP statement consistent with the revised balance of payments.

### Data Standards, Reporting, and Publication
- Kenya participates in the Fund’s GDDS and the EDDI project for Anglophone Africa.
- A Data ROSC was conducted in October 2005.
- Reporting to STA:
  - Budgetary central government data submitted for publication in the GFS Yearbook have been reported in GFSM 2001 format, albeit with a significant lag.
  - Monthly and quarterly GFS data are regularly reported for inclusion in the International Financial Statistics (IFS).
  - Monetary data for the central bank and ODCs are regularly reported for inclusion in the IFS.
  - Annual balance of payments data, following BPM5 classifications, are regularly reported to STA.

### Table of Common Indicators — Selected dates and frequencies (as of July 31, 2014)
- Exchange rate: Date of latest observation 8/28/14; Date received 8/28/14; Frequency of Data D; Frequency of Reporting D; Frequency of Publication M.
- Reserve/Base Money: Date of latest observation 8/28/14; Date received 8/28/14; Frequency of Data D; Frequency of Reporting D; Frequency of Publication M; Data Quality – Methodological soundness: LO, LO, LO, LO; Data Quality – Accuracy and reliability: LO, LO, O, O, NO.
- Broad Money: Date of latest observation 6/30/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Central Bank Balance Sheet: Date of latest observation 7/15/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Consolidated Balance Sheet of the Banking System: Date of latest observation 6/30/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Interest Rates: Date of latest observation 8/28/14; Date received 8/28/14; Frequency of Data D; Frequency of Reporting D; Frequency of Publication M.
- Consumer Price Index: Date of latest observation 7/30/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation 6/31/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation 5/31/2014; Date received 7/25/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- External Current Account Balance: Date of latest observation 5/31/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Exports and Imports of Goods and Services: Date of latest observation 5/31/14; Date received 7/31/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- GDP/GNP: Date of latest observation 31/12/13 (A); Quarterly: 31/3/14 (Q) and 5/14/14; Date received 6/30/14; Frequency Q,A; Frequency of Reporting Q,A; Frequency of Publication Q,A.
- Gross External Debt: Date of latest observation 5/31/14; Date received 7/25/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- International Investment Position: Date of latest observation 31/12/12; Date received ...; Frequency NA; Frequency of Reporting NA; Frequency of Publication NA.

*IMF staff report content (PDF): _cr14302 - 2011. The assessment found that the temporary governance gaps of the Board and Audit Committee*

### 1. Assessment of key infrastructure projects

### 1. Assessment of key infrastructure projects

### Background
- At end-2013, gross public debt totaled 41 percent of GDP and has remained stable at around 41–42 percent of GDP since 2010.
- A little under half of Kenya’s public debt is owed to external creditors.
- Nominal public external debt at end-2013 was USD 10 billion, equivalent to 18 percent of GDP.
- Multilateral creditors accounted for more than 60 percent of external credit to Kenya at end-2013.
- Major 2014 financing and commitments:
  - USD 2 billion sovereign bond issuance in June 2014: USD 500 million 5-year bond and USD 1.5 billion 10-year bond.
  - Two-year syndicated commercial loan in 2012 of about USD 600 million.
  - Agreement with China in May 2014 featuring USD 3.8 billion in semi-concessional loans for a regional railway, expected to be disbursed over the next four years.
- Kenya did not seek debt relief under either the HIPC or MDRI initiatives.
- Gross domestic public debt was around 23 percent of GDP at end-2013.
  - Domestic debt composition: Treasury bonds 68 percent; Treasury bills 27 percent.
  - Holders of domestic debt: commercial banks 47 percent; nonbanks 47 percent; central bank holds most of the remainder.
  - Average maturity of domestic debt was 5 years at end-2013, down from 5.8 years in June 2011.

### Underlying assumptions
- Macro assumptions are consistent with the Staff Report for the 2014 Article IV consultation.
- Notable revisions from April 2013 DSA:
  - Real GDP growth: weaker in short term but higher in long term.
  - Primary fiscal deficit: projected to be around 2 percent of GDP wider in the short term due largely to devolution spending needs.
  - GDP deflator: projected higher in the medium term reflecting pass-through from past falls in the terms of trade.
  - Current account deficit: substantially wider when abstracting from upward revision of GDP, reflecting larger historical deficits, oil exploration-related imports, and higher longer-term investment needs.
  - Baseline does not include recent oil discoveries pending confirmation of commercial viability.
  - Discount rate for PV of external debt: unified rate of 5 percent (previously 3 percent), producing a more favorable PV debt profile.
  - Indicative thresholds for debt are higher owing to Kenya’s improved CPIA rating.
- Selected macroeconomic assumptions (fiscal-year basis; authorities expect to release upwardly revised GDP statistics in September 2014):
  - Real GDP Growth (Current DSA): 2012: 4.5, 2013: 4.6, 2014: 5.0, 2015: 5.8, Long term: 7.0
  - Primary Fiscal Deficit (percent of GDP, Current DSA): 2012: 2.8, 2013: 3.5, 2014: 3.2, 2015: 2.3, Long term: 0.9
  - Non-interest Current Account Deficit (percent of GDP, Current DSA): 2012: 8.2, 2013: 8.4, 2014: 7.3, 2015: 8.1, Long term: 5.8

### External Debt Sustainability Analysis
- All external debt indicators remain well below policy-dependent thresholds under the baseline scenario; no thresholds breached under standard stress tests.
- Key external DSA results:
  - NPV of external debt would rise to 16 percent of GDP at end-2014 and stabilize at 16–17 percent thereafter (well below the 50 percent indicative threshold).
  - NPV of debt-to-exports ratio would plateau at 90–95 percent in the medium term (well under the 200 percent indicative threshold).
  - Standard stress tests do not reveal significant vulnerabilities; even largest shocks keep debt below indicative thresholds.
  - Largest stress test impact: one-time 30 percent nominal depreciation of the exchange rate in 2014 and a permanent shock to terms of new public sector loans increases PV debt-to-GDP from 17 to 26 percent in 2033 (still below threshold).
- Resource discovery upside:
  - An oil company reported estimated discovered resources of at least 600 million barrels of oil equivalent.
  - If discoveries are commercially viable, Kenya could become self-sufficient in 3–5 years and a net exporter in 5–10 years.

### Public Debt Sustainability Analysis
- Public debt path under baseline:
  - Public debt projected to rise to 45 percent of GDP in 2014.
  - Sovereign bond issuance and railway loan disbursements lift public debt to around 46 percent of GDP in 2015.
  - With a primary deficit kept to 3 percent of GDP in 2016 and gradually reduced thereafter, public debt eases below 46 percent of GDP by 2018.
  - PV public debt-to-GDP remains around 41–42 percent through end-2018, falling thereafter.
  - PV public debt-to-revenue ratio declines from around 200 percent in 2014–15 to 191 percent in 2018.
- Alternative scenarios and bound tests:
  - All projected debt indicators remain under relevant thresholds.
  - Largest negative shock: real GDP growth one standard deviation below historical average.
    - Under this shock, PV debt-to-GDP reaches 49 percent in 2018 (baseline 41 percent).
    - PV debt-to-revenue rises to 229 percent in 2018 (baseline 191 percent).
    - PV debt service-to-revenue rises to 30 percent in 2018 (baseline 26 percent).
  - An unchanged primary balance from 2013 would yield similar adverse outcomes.
- Devolution-related fiscal risks:
  - Devolution to 47 county governments has produced transitional capacity and coordination challenges.
  - Risks include underspending by counties (near-term lower budget deficit), devolution-related wage bill issues, debt inherited from previous local authorities, and potential county borrowing—any of which could hamper medium-term primary balance reduction.
- Contingent liabilities:
  - Publicly guaranteed debt of public entities reached KSh 43.5 billion (1 percent of GDP) at end-2012/13; about 15 percent of this guaranteed debt has been called.
  - Public Private Partnerships (PPPs), mostly in the energy sector, represent additional contingent liabilities yet to be fully assessed.

### Main findings, conclusions, and policy implications
- Overall assessment:
  - Kenya continues to face low risk of external debt distress.
  - Institutional improvements and a higher discount rate have increased the safety margin between projected debt and indicative thresholds.
  - Upward revisions to GDP time series are lowering debt-to-GDP ratios.
- Stress test implications:
  - Exchange rate shocks and less favorable terms on new public sector loans are the largest upside risks to external debt.
  - Overall public debt would increase most if economic growth is significantly lower than anticipated.
- Triggers for adverse growth scenarios include:
  - A return to drought reducing agricultural production and hydro-power generation, increasing food and oil imports, and widening the current account deficit.
  - A deterioration in security conditions reducing tourism earnings and dampening FDI inflows.
  - A protracted slowdown in trading partner growth (notably the euro area) and declining commodity prices lowering export earnings (e.g., tea, horticulture, coffee), remittances, and FDI inflows.
  - Higher global food and fuel prices raising the import bill and pressuring the current account and exchange rate.
- Policy recommendations and priorities:
  - Maintain efforts to reduce the primary deficit in the medium term, consistent with meeting the fiscal convergence criteria for the East African Community (EAC) monetary union.
  - Address transitional devolution challenges and county capacity constraints to avoid medium-term fiscal pressures.
  - Design appropriate policies to manage potential natural resource revenues should recent discoveries be confirmed commercially viable.

*Prepared by staffs of the International Monetary Fund and the International Development Association; September 8, 2014.*

### 14.      The authorities agree with the conclusions of this DSA. They concur that Kenya is at low risk of

### _cr14302 - 14.      The authorities agree with the conclusions of this DSA. They concur that Kenya is at low risk of

### Authorities' assessment and policy actions
- The authorities agree with the conclusions of this DSA and concur that Kenya is at low risk of external debt distress.
- Kenya’s successful debut sovereign bond issuance in June 2014 is viewed as helping to diversify the country’s funding sources and as a stepping stone toward emerging market status.
- The authorities recognize specific fiscal risks in their medium-term budget policy statement, and have identified and are seeking to address emerging challenges in the devolution process.
- The government has initiated institutional and legal reforms for extractive industries.

### Key external debt and public debt indicators (selected figures from tables)
- External debt (nominal): 33.0 (2014) with projected path 33.9 (2015), 35.3 (2016), 35.7 (2017), 37.1 (2018), 41.8 (Average 2014-18), 43.1 (2023).
- Public and publicly guaranteed (PPG) external debt: 19.5 (2014) and projected 19.7 (2015), 20.3 (2016), 20.7 (2017), 21.1 (2018), 23.3 (Average 2014-18), 22.2 (2023).
- Change in external debt (2014): 2.3.
- Identified net debt-creating flows (2014): 5.2; projected averages 3.9 (2015), 4.1 (2016), 2.1 (2017), 2.7 (2018).
- Non-interest current account deficit (2014): 4.6 percent of GDP; series includes 3.2 (2015), 7.3 (2016), 8.1 (2017), 6.7 (2018), average 6.2 (2014-18), 5.6 (2019-2033 average).
- Exports (percent of GDP): 17.8 (2014), 17.3 (2015), 17.6 (2016), 17.1 (2017), 17.7 (2018), 18.5 (Average 2014-18), 21.0 (2023).
- Imports (percent of GDP): 31.0 (2014), 31.4 (2015), 30.6 (2016), 29.5 (2017), 29.5 (2018), 30.3 (Average 2014-18), 32.0 (2023).
- Net current transfers (negative = inflow): -6.1 (2014); series shows -6.3 (2016), -6.1 (2017), -6.0 (2018), -5.7 (Average 2014-18).
- Net FDI (negative = inflow): -0.5 (2014); series includes -1.8 (2016), -2.0 (2017), -1.9 (2018), average -1.8 (2014-18).
- Endogenous debt dynamics contribution (2014): -0.4; contributions from nominal interest rate (2014): 0.4; from real GDP growth (2014): -0.8; from price and exchange rate changes (2014): -0.1.
- Residual (3-4) (2014): -2.9; residual examples include -3.0 (2015), -2.7 (2016), -1.7 (2017), -1.3 (2018).
- PV of external debt: 29.0 (2015), 29.8 (2016), 30.8 (2017), 30.9 (2018), 32.0 (Average 2014-18), 35.9 (2023), 37.5 (2033).
- PV of PPG external debt: 15.6 (2015), 15.6 (2016), 15.8 (2017), 15.8 (2018), 16.0 (Average 2014-18), 17.5 (2023), 16.5 (2033).
- PV of PPG external debt in percent of exports: 87.4 (2015), 89.9 (2016), 89.7 (2017), 92.8 (2018), 90.7 (Average 2014-18), 94.3 (2023), 78.7 (2033).
- PV of PPG external debt in percent of government revenues: 77.5 (2015), 76.0 (2016), 76.4 (2017), 76.3 (2018), 76.3 (Average 2014-18), 80.9 (2023), 75.9 (2033).
- Debt service-to-exports ratio: 24.9 (2014), 20.9 (2015), 22.1 (2016), 22.7 (2017), 22.7 (2018), 23.1 (Average 2014-18), 23.6 (2023).
- PPG debt service-to-exports ratio: 10.6 (2014), 5.6 (2015), 5.9 (2016), 6.1 (2017), 5.9 (2018), 5.3 (Average 2014-18), 6.3 (2023).
- PPG debt service-to-revenue ratio: 9.4 (2014), 4.7 (2015), 5.1 (2016), 5.0 (2017), 5.0 (2018), 4.6 (Average 2014-18), 6.1 (2023).
- Total gross financing need (Billions of U.S. dollars): 9.3 (2014), 10.4 (2015), 10.9 (2016), 12.1 (2017), 12.8 (2018), 23.2 (Average 2014-18), 70.2 (2033).
- Non-interest current account deficit that stabilizes debt ratio: 5.0 (2014), 7.2 (2015), 5.3 (2016), 5.8 (2017), 4.2 (2018), 4.7 (Average 2014-18), 5.7 (2023).

### Public sector debt metrics (selected)
- Public sector debt (percent of GDP): 44.7 (2014), 46.2 (2015), 46.5 (2016), 46.1 (2017), 45.9 (2018), 42.0 (Average 2014-18), 34.9 (2023).
- Change in public sector debt (2014): 3.8.
- Primary deficit (percent of GDP): 0.9 (2014); projections include 1.6 (2015), 3.4 (2016), 3.3 (2017), 2.8 (2018), average 2.4 (2014-18).
- Revenue and grants (percent of GDP): 20.6 (2014), 21.0 (2015), 21.1 (2016), 21.1 (2017), 21.3 (2018), 21.9 (Average 2014-18).
- Primary (noninterest) expenditure (percent of GDP): 24.0 (2014), 24.2 (2015), 23.9 (2016), 23.5 (2017), 23.2 (2018), 22.7 (Average 2014-18).
- Automatic debt dynamics (2014): -1.6; contribution from interest rate/growth differential (2014): -0.7.
- PV of public sector debt: 40.7 (2015), 42.1 (2016), 42.0 (2017), 41.3 (2018), 40.8 (Average 2014-18), 36.1 (2023), 29.2 (2033).
- Gross financing need (percent of GDP): 16.3 (2014), 15.6 (2015), 15.6 (2016), 14.9 (2017), 14.2 (2018), 10.5 (Average 2014-18), 7.7 (2033).
- PV of public sector debt-to-revenue and grants ratio (percent): 197.9 (2015), 200.6 (2016), 198.9 (2017), 195.6 (2018), 191.4 (Average 2014-18), 164.7 (2023), 132.4 (2033).
- Debt service-to-revenue and grants ratio (percent): 32.4 (2014), 27.4 (2015), 27.3 (2016), 26.6 (2017), 25.9 (2018), 20.2 (2033).

### Stress tests, sensitivity analysis and scenarios
- Figures and tables present alternative scenarios and bound tests where the most extreme stress test varies by indicator (examples: One-time depreciation shock, Terms shock, Exports shock).
- Table 1b sensitivity highlights selected projections for PV of debt-to-GDP, PV of debt-to-exports, PV of debt-to-revenue under:
  - Baseline and Historical scenario.
  - A1. Key variables at their historical averages in 2013-2033.
  - A2. New public sector loans on less favorable terms (interest rate on new borrowing assumed 2 percentage points higher than baseline).
  - B1-B6. Bound tests including Real GDP growth shocks, Export value shocks, US dollar GDP deflator shocks, Net non-debt creating flows shocks, combination shocks, and a One-time 30 percent nominal depreciation in 2014.
- Table 2b shows public debt sensitivity under alternative scenarios:
  - A1. Real GDP growth and primary balance at historical averages.
  - A2. Primary balance unchanged from 2013.
  - A3. Permanently lower GDP growth.
  - Bound tests B1-B5 include real depreciation, increases in other debt-creating flows, and combined shocks.
- Memorandum item: Grant element assumed on residual financing is listed as 2 (repeated series).

### External position, reserves, and competitiveness
- Kenya’s external position is broadly stable with built up international reserve buffers and external debt appearing within sustainable bounds.
- The current account deficit is large at around 8 percent of GDP; this is broadly in line with medium-term fundamentals after accounting for capital imports, but suggests vulnerability to external shocks.
- The nominal exchange rate is largely market-determined; the real effective exchange rate has appreciated steadily in recent years.
- Several metrics suggest modest real overvaluation, though results are cautioned due to measurement gaps in external sector and productivity statistics.
- Measures of nonprice competitiveness indicate relatively well developed financial markets and flexible prices and labor markets, but gaps in infrastructure, health and education, and governance.

### Key macroeconomic assumptions (selected)
- Real GDP growth: 8.6 (2010), 7.6 (2011), 1.7 (2012), 7.5 (2013), 5.1 (2014), projections include 3.0 (2015), 2.8 (2016), 8.8 (2017), 4.1 (2018), 8.9 (2023), 4.4 (2033); averages and other projections included across tables.
- GDP deflator in US dollar terms (change in percent): 7.2 (2014), 6.9 (2015), 9.6 (2016), 3.3 (2017), 4.5 (2018), 5.8 (Average 2014-18).
- Effective interest rate (percent): 1.3 (2014), 0.5 (2015), 1.3 (2016), 1.5 (2017), 1.5 (2018), 1.5 (Average 2014-18), 1.6 (2023).
- Growth of exports of G&S (US$ terms, percent): 12.0 (2014), 11.1 (2015), 3.3 (2016), 9.4 (2017), 10.6 (2018), 11.6 (Average 2014-18).
- Growth of imports of G&S (US$ terms, percent): 16.3 (2014), 12.0 (2015), 5.5 (2016), 13.6 (2017), 6.0 (2018), 11.0 (Average 2014-18).
- Grant element of new public sector borrowing (in percent): series includes 32.7 (historical point), 10.3, 30.8, 33.4, 32.9, 32.4, 28.0, 29.3, 24.2, 26.2 (various projection years).
- Government revenues (excluding grants, percent of GDP): 20.1 (2014), 20.5 (2015), 20.7 (2016), 20.8 (2017), 21.0 (2018), 21.6 (Average 2014-18), 21.8 (2023).

*Source: _cr14302 - 14.      The authorities agree with the conclusions of this DSA. They concur that Kenya is at low risk of external debt distress (IMF staff report content provided).*

### 1.      Kenya has been rebuilding its international reserves buffer despite a challenging external

### _cr14302 - 1.      Kenya has been rebuilding its international reserves buffer despite a challenging external

### International reserves: recent rebuilding and adequacy
- Kenya’s gross international reserves increased from USD 4.3 billion (2.9 months of next year’s imports) at end-2011 to USD 6.4 billion (3.9 months of next year’s imports) at end-2013, and further to USD 7.5 billion (4.5 months of imports) at end-June 2014 following the successful inaugural sovereign bond issuance.
- Current account deficit has been around 9 percent of GDP or more for the past three years; terms of trade declined steadily.
- Financial inflows to Kenya have been stable at around 10–11 percent of GDP annually, enabling the Central Bank of Kenya (CBK) to purchase official reserves in the interbank market to reach a desired minimum reserve coverage of 4 months of imports, even allowing for some sales of FX in May 2014.
- Traditional rules of thumb indicate adequacy:
  - Reserves of 4–4½ months of next year’s imports are above the standard adequacy threshold of 3 months.
  - End-2013 reserves were equivalent to 28 percent of broad money, well above the standard adequacy threshold of 20 percent.
  - Authorities report a lengthy average time to maturity on external debt, exceeding 11 years, and a high grant element (short-term external debt data are not available).
- Optimality analysis:
  - A panel probit regression yields a range of “optimal” reserves that depends on the cost of holding reserves. In the case of Kenya, current reserve levels would be close to optimal if the annual cost of holding reserves is around 4 percent per year, and somewhat more than optimal if the cost of holding reserves is higher.
  - Follow-up analysis suggests that LICs face a marginal cost of holding reserves of around 4 to 6 percent, but at the lower end of the range for LICs that have accessed sovereign bond markets.
  - The model suggests reserve needs will be higher in the absence of an IMF-supported program.
- Policy and medium-term considerations:
  - Kenya’s flexible exchange rate regime and gradual transition to an inflation targeting framework mitigate short-to-medium-term reserve needs, subject to risks to balance sheets from a potential exchange rate adjustment remaining contained.
  - In the medium to longer term, Kenya will need to maintain reserve cover of at least 4.5 months of imports to meet macroeconomic convergence criteria in the East African Community Monetary Union protocol.
- Risks to reserves:
  - Staff estimate the stock of portfolio liabilities at around USD 2–2.5 billion at end-2013, mainly in equity and investment fund shares, based on fragmented data sources.
  - In a worst-case scenario, loss of the full stock of portfolio liabilities could bring reserves down below USD 5 billion, or below the standard threshold of 3 months of next year’s imports.
  - An additional uncertainty is the lack of timely information on private sector external debt.

### Exchange rate assessment
- Regime and recent behavior:
  - Kenya maintains a de facto floating nominal exchange rate regime; the nominal exchange rate is largely market-determined, with moderate CBK intervention to build reserves.
  - The Kenyan shilling has remained broadly stable against major currencies since 2012, with seasonal fluctuations.
- Real exchange rate dynamics:
  - The CPI-based real effective exchange rate (REER) appreciated by 17½ percent from December 2010 to July 2014.
  - This pace is faster than the trend real appreciation of about 2½ percent annually since 2000, even abstracting from 2011 crisis-related volatility.
- Fundamentals and competitiveness:
  - The real appreciation is difficult to explain by improved fundamentals: terms of trade declined by some 18 percent from end-2010 to end-June 2014.
  - National accounts data do not provide evidence of productivity growth above that of trading partners (with caveat that data are being revised and may underreport recent services-sector growth).
  - Agricultural productivity through 2012 was flat compared with growth in key export competitor countries (Colombia for coffee, Sri Lanka for tea).
  - Kenya’s REER remains relatively appreciated compared with other countries in the region, with the exception until recently of Zambia.
- Quantitative assessments of misalignment (range of underlying estimates and methodologies):
  - Estimated misalignments range from -1 to 17 percent; underlying estimates need caution and are based on external sector ratios scaled for forthcoming GDP time series revisions.
  - Macroeconomic balance (MB) approach: negligible undervaluation (1 percent); underlying current account deficit projected to narrow to 6½ percent of GDP in the medium term; current account “norms” estimated at around 6½–7½ percent.
  - External sustainability (ES) approach: indicates overvaluation of some 9 percent, but subject to high uncertainty due to data gaps on private external debt and the international investment position. Available time series for net foreign assets (NFA) imply lower current account “norms” of around 4¾–5½ percent of GDP consistent with stabilizing NFA; a norm of 5½ percent would imply a current account gap of around 1½ percentage points of GDP.
  - Equilibrium REER approach: indicates overvaluation of around 10 percent but results are particularly uncertain and excluded from the overall average; sensitive to estimated productivity differentials and recent national accounts rebasing.
  - Purchasing power parity (PPP) approach: suggests overvaluation of 17 percent, calculated as the deviation of the current level of the REER from its long-term historical average.
- Implications:
  - These results do not imply a need to adjust the nominal exchange rate, which has been market-determined, but point to structural bottlenecks that policymakers should address.
  - Upside potential from resource discoveries: if recent oil and gas discoveries are confirmed commercially viable, Kenya’s medium and long-term current account balance could narrow substantially more than the current baseline indicates, reducing current account gaps and implied exchange rate misalignments under the MB and ES methodologies.

### Survey-based indicators of competitiveness
- General findings from international surveys:
  - Survey evidence does not provide evidence of price or wage inflexibility, but points to remaining weaknesses in infrastructure, health and education, and governance.
- Global Competitiveness Index (GCI) 2014–2015:
  - Kenya’s overall rank was 90 out of 144 countries, an improvement from 106 out of 144 in 2012–2013.
  - Kenya’s rankings are better than average compared to other low-income (“factor-driven”) economies and roughly comparable to economies in transition to the next stage of development.
  - Most favorable sub-rankings: financial market development (24) and labor market efficiency (25).
  - Less favorable sub-rankings: higher education and training (95), infrastructure (96), health and primary education (120), and macroeconomic environment (126).
  - GCI respondents identified corruption as the most problematic factor for doing business in Kenya.
- Doing Business (World Bank) 2014:
  - Kenya’s overall ranking was 129 out of 189 economies, above the sub-Saharan Africa average (142) but below some African peers; this represented a decline of 7 places from a rank of 122 out of 185 in 2013.
- Most problematic factors for doing business in Kenya (percent of responses, Global Competitiveness Report, 2014–2015):
  - Corruption 20.0
  - Access to financing 18.1
  - Crime and theft 10.3
  - Inadequate supply of infrastructure 9.9
  - Tax rates 9.9
  - Inefficient government bureaucracy 8.2
  - Inflation 6.8
  - Policy instability 3.5
  - Tax regulations 3.3
  - Restrictive labor regulations 2.9
  - Insufficient capacity to innovate 1.6
  - Poor work ethic in national labor force 1.4
  - Inadequately educated workforce 1.3
  - Poor public health 1.0
  - Foreign currency regulations 0.9
  - Government instability/coups 0.9

*Source: IMF staff estimates.*

### Annex I: Technical Comments on the Exchange Rate

### Annex I: Technical Comments on the Exchange Rate Assessment

### Macroeconomic Balance (MB)
- Methodology:
  - Exchange rate misalignment = current account (CA) “gap” divided by CA elasticity.
  - CA gap = “underlying” CA balance minus “norm” CA balance.
  - Elasticity = percentage point change in the CA balance resulting from a one percentage point change in the real exchange rate.
  - Results depend on: underlying CA time series (historical data and projections); econometric estimates of the CA norm (source: AFR); econometric estimates for export and import elasticity (sources: CGER and Tokarick Working Paper WP/10/180).
- Key coefficient and variable notes (as reported):
  - Old age dependency: -0.132; -0.103; -0.104; 0.014; 0.014
  - Population growth rate (rel. to trading partners): 0.016; -1.947; -1.694; -0.030; -0.026
  - Relative income: -2.254; -0.008; -0.007; 0.018; 0.015
  - Per capita GDP growth (rel. to trading partners): 0.009; -2.709; -2.071; -0.025; -0.019
  - Oil balance: -0.065; 0.197; 0.197; -0.013; -0.013
  - Fiscal balance (rel. to trading partners): -0.026; 0.269; 0.270; -0.007; -0.007
  - Net foreign assets: -0.431; 0.034; 0.031; -0.015; -0.013
  - Aid inflows: 0.026; -0.080; -0.075; -0.002; -0.002
  - Remittance inflows: 0.045; -0.062; -0.026; -0.003; -0.001
  - Foreign direct investment: 0.022; - ; -0.324; - ; -0.007
  - Constant: 1.000; -0.013; -0.006; -0.013; -0.006
- Current account and gap (percent of GDP):
  - Current Account Norm (% of GDP): -7.6; -6.6
  - Underlying Current Account (% of GDP): -6.9; -6.9
  - Current account gap (underlying - norm): 0.7; -0.3
- REER misalignment estimates (’+’ = overvaluation):
  - CGER elasticity = -0.12: -5.8; 2.3
  - Tokarick elasticity = -0.29: -2.5; 1.0
- Note: “All variables are expressed in decimals. The current account norm is converted to percent by multiplying by 100.” Source: IMF staff estimates.

### External Sustainability (ES)
- Methodology:
  - Similar to MB but CA norm is the CA that stabilizes net foreign assets (NFA) at a benchmark level (set as 2018 projected NFA).
  - ES depends on historical and projected NFA series; Kenya’s estimates need caution due to incomplete NFA data (Foreign Investment Survey (FIS) available for 2011 only; no FIS for 2012 or 2013).
  - In absence of timely official statistics, time series to 2011 are extended using flow projections for foreign assets and liabilities (adding change in NFA of commercial banks, less public external debt and net FDI inflows).
- Findings and adjustments:
  - Without adjustment: CA deficit norm implied = 4¾ percent of GDP (arguably low given Kenya’s investment needs and below medium-term projected CA deficits of around 6½ percent of GDP).
  - FIS 2011 confirms substantial underreporting of FDI in BOP statistics.
  - To adjust for underreporting, NFA series beyond 2011 calculated assuming doubled net FDI inflows compared with official statistics.
  - Resulting benchmark NFA implies CA deficit norm = 5½ percent of GDP (used to derive CA gap and estimate of overvaluation).
- Key numerical entries (2017/18):
  - Nominal GDP growth, %: 13
  - Net foreign assets, % GDP: No FDI adj: -43; FDI adj: -49
  - NFA stabilizing CA norm, % GDP: -4.8; -5.5
  - Underlying Current Account (% of GDP): -6.9; -6.9
  - Current account gap (underlying - norm): -2.1; -1.5
  - REER misalignment ('+'=overvaluation):
    - CGER elasticity = -0.12: 18; 12
    - Tokarick elasticity = -0.29: 75
  - ES Average: 139
- Source: IMF staff estimates.

### PPP and Equilibrium REER
- PPP method:
  - Compares current REER to its long-term average, assuming REER stationarity.
  - REER at July 2014 was 17 percent above its average for the previous 10 years.
  - If compared to a long-term average around a secular trend increase (estimated at 3 percent annually), historical deviation is 3 percent.
  - Trend increase could not be explained by fundamentals (terms of trade and/or productivity).
- Equilibrium REER estimation:
  - Estimated using a panel regression with country-specific fixed effects (source: AFR).
  - Most important components: country-specific constant and relative productivity.
  - Negative productivity differential between Kenya and its partners implies a lower equilibrium REER.
  - Overvaluation = gap between current REER and estimated equilibrium value.
- Reported equilibrium regression variables and coefficients:
  - Terms of trade: -0.150; 0.181
  - Relative productivity: -2.482; 0.185
  - Relative government consumption: 0.000; 2.123
  - Initial NFA: -0.431; -0.015
  - Aid inflows: 0.026; -0.035
  - Remittance inflows: 0.045; 0.191
  - Constant: 1.000; 0.649
  - Equilibrium Real Exchange Rate (log): Log(REER)
  - Deviation from Equilibrium %, (+ = overvaluation): -0.03; -0.46; 0.00; 0.01; 0.00; 0.01; 0.65; 0.18; 0.28
- Observation note: Observation for 2014 refers to average of January to July 2014.
- Source: IMF staff estimates.

### Executive Board Assessment and Policy Recommendations (Press Release summary)
- Macroeconomic outlook and recent performance:
  - Growth rose to 5 percent in 2013/14 and expected to gain further momentum in 2014/15 driven by higher domestic and external investment.
  - Inflation moderate but rising food prices and rapid credit growth may fuel inflation expectations.
  - External current account deficit around 8 percent of GDP in 2013/14, reflecting strong capital imports and decline in agricultural exports.
  - Successful first-time Eurobond issue (US$2 billion) in June 2014; international reserves reached some four and a half months of prospective import coverage.
  - 2013/14 central government deficit about 5¾ percent of GDP.
  - Authorities plan gradual fiscal consolidation to meet East African Community Monetary Union Protocol convergence criteria.
- Executive Directors’ key messages and recommended actions:
  - Commended macro stability, market-friendly reforms, and successful Eurobond issuance.
  - Encouraged stronger policy buffers and further structural reforms to strengthen business climate and improve security conditions.
  - Called for continued fiscal discipline during devolution; maintain prudent fiscal stance consistent with medium-term debt target to create space for infrastructure and priority social spending.
  - Supported further revenue mobilization, enhancement of quality and efficiency of public spending, and better control over the public wage.
  - Recommended full implementation of public financial management reforms, especially fiscal devolution and the Treasury Single Account.
  - Supported efforts to reduce fiscal risks by reforming government-owned agencies and monitoring contingent liabilities from state-owned enterprises.
  - In view of rising headline inflation, encouraged monitoring of accelerated credit growth and readiness to tighten monetary conditions to anchor inflation expectations.
  - Recommended strengthening prudential oversight to prevent deterioration in banks’ loan portfolios and modernizing the monetary framework to support inflation targeting.
  - Urged enhanced consolidated supervision of transnational banks and cross-border cooperation with regional supervisors.
  - Welcomed removal from FATF watch list and encouraged sustained improvements in AML/CFT framework.
  - Encouraged continued structural reforms to remove infrastructure bottlenecks and improve competitiveness; put in place an effective framework for natural resource management.
  - Recommended improving quality and scope of balance of payments, social, and labor market statistics.
- Additional macro and fiscal indicators (selection from Main Economic Indicators, 2012/13–2018/19):
  - Nominal GDP (market prices, in billions of Kenya shillings): 4,497; 5,051; 5,734; 6,525; 7,420; 8,416; 9,504
  - Real GDP growth (market prices): 4.6; 5.0; 5.8; 6.3; 6.5; 6.5; 6.6
  - GDP deflator (average): 6.7; 6.9; 7.2; 7.0; 6.7; 6.4; 5.9
  - Consumer price index (annual average): 4.6; 7.1; 6.5; 5.2; 5.0; 5.0; 5.0
  - Investment (percent of GDP): 18.7; 18.7; 22.3; 22.6; 23.2; 23.1; 22.8
  - Gross national saving (percent of GDP): 10.6; 11.0; 13.9; 14.7; 16.1; 16.5; 16.5
  - Total revenue (percent of GDP): 18.8; 19.2; 20.5; 20.5; 20.6; 20.9; 20.9
  - Overall balance excluding grants (percent of GDP): -6.0; -6.2; -6.7; -5.9; -5.5; -4.9; -4.4
  - Current account balance (percent of GDP): -8.1; -7.8; -8.4; -8.0; -7.1; -6.5; -6.3
  - Gross international reserve coverage (end of period, in billions of U.S. dollars): 6.2; 7.5; 8.3; 9.3; 10.3; 11.2; 12.5
  - Gross international reserve coverage (months of next year imports, end of period): 4.0; 4.3; 4.4; 4.6; 4.6; 4.6; 4.6
  - Total public debt, gross (percent of GDP): 42.1; 42.2; 45.8; 45.5; 45.4; 45.0; 44.3
  - Total public debt, net of deposits (percent of GDP): 37.6; 38.2; 40.7; 41.3; 41.4; 41.1; 40.5

- Kenyan authorities’ policy actions reported in the Statement by Mr. Saho (September 22, 2014):
  - Revised 2014 growth estimate to between 5.0-5.5 percent (authorities’ revision reflecting tourism sector weakness).
  - Foreign reserves about 4.2 months of import cover (statement-level figure).
  - FY2013/14 total government revenue surpassed target; tax income contributing 70 percent of revenue.
  - Authorities target to increase revenue collection by 15.5 percent in the current fiscal year.
  - Performance benchmark for absorption of the development budget: at least 80 percent.
  - Fiscal measures and reforms:
    - Deepen tax reforms focusing on excise and income taxes.
    - Revenue Administration Reform and Modernization Program: new online tax system by KRA.
    - Draft Inland Revenue Agency Bill and Customs and Border Services Bill to reorganize KRA (awaiting parliamentary debate).
    - Roll out e-Procurement (Procure-to-Pay module of IFMIS).
    - Capacity Assessment and Rationalization of Public Service (CARPS) initiative; biometric registration of civil servants launched on September 1, 2014.
    - Diversify development financing: debut sovereign bond issuance; Annuity Financing Mechanism for road development.
    - Parastatal reforms: Presidential Task Force proposes reduction of parastatals from 262 to 187; Government Owned Entities Bill 2014 and National Sovereign Wealth Fund Bill 2014 published and awaiting parliamentary debate.
  - Devolution:
    - National government allocating 43 percent of the most recently audited revenues approved by parliament to county governments in the current financial year (Constitution stipulates not less than 15 percent).
    - Division of Revenue Bill and County Allocation Bill assented to, allowing timely disbursement to counties.
  - Monetary and financial policy:
    - Central Bank of Kenya retained CBR at 8.5 percent at MPC meeting on September 3, 2014.
    - CBK pursuing tightening bias through monetary policy operations to anchor inflation expectations.
    - Kenya participating as pilot in IMF project on “Monetary and Exchange rate policies for LICs”; CBK trained on Forecasting and Policy Analysis System (FPAS).
    - Measures to mitigate credit risks from micro-loans: mass education campaign for M-Shwari users; micro-loans under M-Shwari subject to Credit Reference Bureau Regulations.

*Source: _cr14302 - Annex I: Technical Comments on the Exchange Rate (IMF staff estimates and related IMF Article IV staff report excerpts).*

### 2013. Section 50 of the Credit Reference Bureau Regulations (issued as Subsidiary

### 2013. Section 50 of the Credit Reference Bureau Regulations (issued as Subsidiary

### Credit reporting and non-performing loans
- Section 50 provides the timeframe during which all non-performing loans must be reported to the credit bureau for listing.

### Prudential capital requirements and buffers
- Starting January 2015, all banks are required to maintain a minimum capital requirement (Tier II) of 14.5 percent from the current 12 percent.
- CBK issued revised guidelines on prudential capital adequacy ratios in January 2013 to strengthen the regulatory framework for commercial banks.
- Banks are required to hold a capital conservation buffer of 2.5 percent over and above the prevailing minimum ratios.
- This increases the minimum core capital to risk weighted assets and total capital to risk weighted assets requirements to 10.5 and 14.5 percent respectively.
- Policy objective: enable institutions to withstand future periods of stress.
- CBK has indicated intentions to raise the minimum ratios further to make the banking industry move to the level of other markets in the region such as South Africa and Nigeria.

### Kenya Banks’ Reference Rate (KBRR) and loan pricing transparency
- The Kenya Banks’ Reference Rate (KBRR) became effective July 8, 2014.
- CBK and Kenya Bankers Association are monitoring implementation of the KBRR and the Annual Percentage Rate (APR) frameworks by commercial banks.
- Early indications: new and existing loans are benefiting from the KBRR framework.
- Key observed pricing differentials by end August:
  - Average premium above KBRR on commercial mortgages: 3.05 percent.
  - Average premium above KBRR on corporate loans (1---5 years): 4.09 percent.
- Framework aim: improve transparency in credit pricing and promote full disclosure of bank charges on new loans to support an increase in the supply of affordable credit for investment.

### Capital markets and governance
- NSE is now operating as a demutualized entity.
- Significance: demonstrates commitment to transparency and good corporate governance.

### Enhancing the business environment and regional integration
- Authorities are prioritizing enhancing the business environment to strengthen economic activity and create jobs, with a focus on addressing security challenges.
- Security-related actions in the FY2014/15 budget:
  - Recruitment and training of police officers.
  - Security infrastructure development.
  - Housing and medical scheme for security personnel.
- Competitiveness and productivity investments:
  - Modernizing Jomo Kenyatta International Airport.
  - Improving efficiency of Port of Mombasa.
  - Increasing energy production.
  - Widening coverage of road networks.
- Regional integration initiatives:
  - Kenya, Uganda and Rwanda have implemented the single tourist visa and a single customs territory.
  - A standard gauge railway from Mombasa to Kigali and Juba through Kampala is being designed; financing of the first segment has been secured.
  - Kenya National Electronic Single Window System launched to improve Port of Mombasa efficiency.
  - LAPPSET project covering Kenya, Uganda, Rwanda, South Sudan and Ethiopia is expected to foster transport links and give the region a competitive edge in global maritime trade.

### Conclusion and engagement with the Fund
- Authorities value the Fund’s policy advice and technical assistance and will continue to engage with the Fund and seek support from development partners while implementing their economic transformation agenda.
- Authorities are committed to maintaining macroeconomic stability and deepening structural reforms to create a favorable business environment to support strong and inclusive growth.

*Document: _cr14302 - 2013. Section 50 of the Credit Reference Bureau Regulations (issued as Subsidiary*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14302.pdf_