- The authorities have implemented all the governance measures that had not been undertaken under the previous arrangement.
- They have prepared a paper on a three-year programme of Economic Reform Strategy for Wealth and Employment Creation (ERSWEC) that incorporates a medium-term economic strategy to drive the economic recovery process, and later convert into a full PRSP after detailed discussions and after undertaking the consultative process.
- The main elements of the new programme to tackle poverty include a reform of the agricultural sector, the growth of medium and small scale enterprises, rehabilitation of rural health facilities, and the expansion of the role and capacity of local governments. There are also other far-reaching policies to address vulnerabilities in fiscal consolidation, monetary management, and international competitiveness, including incentives for private sector participation.
- To implement the economic programme effectively, the Kenyan economy will need increased assistance from donors to bridge the financing gap in the external sector.
My Kenyan authorities express their appreciation to the Management and staff of the Fund for their understanding and support in their efforts to establish a realistic and sustainable economic policy framework that will reverse the many years of low growth and rising poverty. In particular, they acknowledge the invaluable contributions of staff towards the preparation of the Economic Recovery Strategy for Wealth and Employment Creation paper, which forms the basis for the current economic development programme and the medium-term strategies.
The Kenyan authorities have implemented all the governance measures that had not been undertaken under the previous arrangement, in addition to the prior actions in the relevant areas identified in the last Article IV staff report.
- They have also prepared and began to implement a three-year development strategy in the form of an Economic Recovery Strategy for Wealth and Employment Creation (ERSWEC), which outlines a broad-based agenda consistent with their memorandum of economic and financial policies (MEFP) to tackle Kenya’s deep-seated economic problems.
- This strategy will later be expanded into a full PRSP after a detailed discussion of the various dimensions of poverty, the medium-term expenditure framework and the consultative process.
- The macroeconomic framework contained in the programme is consistent with the measures and policies underpinning the proposed PRGF-supported programme.
With these efforts, the authorities hope that their request for the PRGF-supported programme will be favourably considered.
2. Recent Economic Development
The GDP growth rate for 2003 is projected at about 1.0 per cent, owing to many delimiting factors faced by the authorities in implementing economic development programmes during the year. These include the negative impact on tourism, of the recent terrorism-related incidents. Tourism is one of the major sources of revenue for the economy. Consequently, government revenue fell sharply, the overall deficit before grants widened, and domestic borrowing remained high.
However, the external current account deficit (before grants) narrowed significantly, while inflation rate fell from 5.9 per cent to 2.7 per cent, resulting in a decline in the treasury bill rate. There are indications that the horticultural and manufacturing exports, which grew at annual averages of 23 per cent and 36 per cent, respectively, in the three years up to 2002 will continue to perform well and remain competitive. In the meantime, the 2003/04 budget, which was passed in August 2003, is consistent with the macroeconomic framework of the new programme.
3. Reforms Undertaken
The authorities have continued to enhance their reform programme and to place governance, and particularly, the anticorruption strategy at the top of their reform agenda. In this regard, they have embarked on major strengthening of governance and anti-corruption institutions. The following are the additional measures that have been undertaken since the last staff mission:
- implementation of Public Officer Ethics Act under which all public officials, including the executive and legislative arms of government and the military were to complete the declaration of their assets and those of their families by Dec 2003;
- seminars and workshops on corruption prevention are being organised for civil servants at all levels;
- the police force has been reorganised, while an action plan has been initiated with the assistance of the World Bank and other donor agencies to strengthen the judiciary under a newly appointed Chief Justice;
- a draft listing of pro-poor expenditures for both recurrent and development expenditures has been completed, which contains priority progrmmes per sector, and linked to their budget codes to facilitate the tracking of the key programmes. Since early this year, the government has embarked on monitoring, on a quarterly basis, a set of these core poverty programmes;
- comprehensive programme of public finance reforms that will incorporate the recommendations made by the 2003 public expenditure management mission has been prepared, while a variety of measures are being designed to improve customs clearing system and the efficiency of customs administration in order to facilitate trade;
- a committee has been set up to advise on new mechanisms for determining the wages of civil servants;
- a Privatisation Commission has been established to accelerate the privatisation process and manage the divesture programme;
- the Central Bank of Kenya has made notable progress in strengthening its operations since the Dec 2000 safeguards assessment. The bank has improved on the internal audit function and has adopted an external audit rotation policy by appointing a new external audit firm to replace the old one. The pending issues on government transactions and on regularising frozen government loan accounts have also been resolved.
4. Main Elements of the Economic Reform Strategy for Wealth and Employment Creation (ERSWEC)
The Kenyan authorities’ development strategy as outlined in the ERSWEC, is part of a broader economic agenda that is supported by donors and development agencies, including the World Bank. The programme contains a package of policy measures that will address the identified economic problems of low growth, low savings and investment, poor public service, large domestic debt, distortions in the financial system, unemployment, and poverty. Embedded in the programme are core poverty expenditures, which are derived from specific development targets that include, among other measures, improving access to primary education, providing safety nets such as training programmes for urban unemployed youths.
More specifically, the following are the policy measures being adopted to achieve the set objectives:
a. Measures to address poverty – The programme identifies that most of the poor live in rural areas, and as a result it focuses on reforming the agricultural sector and encouraging the growth of medium and small scale enterprises, while plans are underway to upgrade microfinance institutions. In addition, there are measures to tackle the high prevalence of HIV/AIDS in rural areas, including the rehabilitation of rural health facilities to positively affect agricultural productivity and rural incomes. Another important element of the rural development strategy and to lay the basis for the implementation of the poverty reduction programme, is that the role of local governments is being expanded, and it is proposed that the proportion of local authorities’ spending will be raised to at least 20 per cent of total expenditure by 2018. Their revenue base and their budget management and programme implementation capacity will also be strengthened.
b. Fiscal programme – Domestic debt restructuring is a central element of the fiscal programme, which aims at debt sustainability and making the government a net contributor of resources to the banking system, without compromising the provision of increased resources for priority poverty reduction spending and for contingent liabilities. To this end, measures at fiscal restructuring and to improve the public expenditure management (PEM) are important elements of the programme. These include, reductions in the wage bill through revised modalities for setting public wages and other entitlements, increasing spending on priority social and economic outlays, reform of all public sector procurement systems, relating the annual budgets to the medium-term expenditure framework and adopting enhanced modalities for monitoring, tracking and reporting of budget operations, particularly poverty spending.
c. International competitiveness – will be addressed through reforms in the utility and telecommunications sectors, in external trade and the labour market, as well as upgrading of infrastructure. Trade reforms in the medium-term will focus on lowering the external tariff from 35 per cent to 15 per cent and the number of tariff bands from 5 to 3, which are consistent with the agreement of the East African Community (EAC) customs union, as well as reducing the current export incentive scheme. It is estimated that improved tax administration under the programme would result in reduction in smuggling and a substantial increase in revenue to facilitate a more ambitious reduction in tariff. The authorities intend to retain the current floating exchange rate regime, and are committed to making full use of the exchange rate flexibility to respond to exogenous shocks.
d. The medium term outlook of the programme – proposes a more broadly based growth, reflecting higher productivity and capital accumulation from reforms in the parastatal and financial sectors and labour markets, as well as from improved terms of trade. Spending on essential social and economic services will rise from 3.4 per cent to 4.6 per cent. Overall, real GDP growth is forecast at 1.9 and 3.9 per cent in 2003/04 and 2005/06, respectively, from the current level of 1.2 per cent
(i) The growth rates are to be driven by increased activities in all the major sectors of the economy, as well as in private sector investment. The underlying inflation will remain at 5 per cent, with a modest buildup in reserves to about 4.0 months of projected import cover by end-June 2006. The inflation objective is to be achieved through reserve money targeting, with broad money as the intermediate target and open market operations as the main instruments. The Central Bank of Kenya will continue to use a broad set of indicators to monitor future inflationary pressures and to gauge the appropriateness of the monetary policy stance.
(ii) The approved budget for 2003/04 envisages an increase in total revenue collection by 1.5 per cent of GDP and aims at a substantial reduction in the domestic borrowing from 5.0 per cent to 3.3 per cent of GDP, consistent with the objective of debt sustainability under the ERSWEC. It is estimated that the increase in revenue will more than offset the revenue losses arising from the reduction in VAT rate from 18 to 16 per cent and excise duty from 15 per cent to 10 per cent Expenditure is projected to rise by 2.0 per cent of GDP during the year, in line with the new programme and consistent with increases in pro-poor social spending and other public outlays, and capital spending.
5. Proposed reforms to facilitate implementation of the ERSWEC
My authorities are aware of the challenges they may face in implementing the programme and they have noted staffs comments and recommendations for addressing them. In this regard, in addition to the reforms already undertaken and those that are ongoing, they have identified and incorporated into the ERSWEC programme, other policy measures that will be needed to pre-empt many of the risks and vulnerabilities. These additional measures would include:
- Transferring financial sector regulatory functions from the Ministry of Finance to the Central Bank of Kenya. In addition, the authorities intend to bring major revisions to the Banking and Central Bank of Kenya Acts before the Parliament by June 2005. There will also be reforms on addressing the major weaknesses in the financial system with focus on banks in distress and a strengthening of the financial system, especially concentrating on the main problems that have given rise to nonperforming loans.
- The authorities will initiate a new anti-money laundering legislation that will reflect all relevant recommendations from the Bank-Fund FSAP assessment report for Kenya
- The Kenya Anti-Corruption Commission (KAC) with five regional offices will be established shortly, following the enactment of the Act in 2003, and the endorsement by Parliament of the KACC Advisory Board.
- A plan has been devised to clear the stock of pending bills and resolve the problem of stalled projects.
- A bill for the transparent privatisation and sale of public assets is already before the Parliament.
- In addition to reforms in customs administration, plans are underway to implement a comprehensive tax reform that will improve tax administration and broaden the tax base, through removal of exemptions and through taxation of larger proportion of informal transactions. The authorities are also planning to institute new modalities for managing the taxation of the petroleum sector.
- On statistics, the authorities are taking appropriate actions, with the assistance of donors, to improve the quality and timeliness of data in the areas of the budget, foreign trade and national accounts.
6. Need for Donor Support
Medium-term projections indicate that there will be external account gaps in implementing the new programme arising from an envisaged pickup in government outlays on social and economic infrastructure and other public investment programmes. These outlays will put substantial pressure on the external current account. The deficit on the external current account is estimated to widen to 4.9 per cent of GDP in 2003/04, with the prospects of rising further to 11,0 per cent of GDP by 2005/006. Consequently, the programme will require a marked increase in donor assistance from 6.5 per cent of GDP to 9.9 per cent in 2005/06 to support its implementation. Total financing needs are projected to average about $1.3 billion per year through 2005/06. Programme support and Paris Club rescheduling are expected to fill the financing gap during the period. The authorities have indicated their intention to seek a rescheduling from the Paris Club and are currently discussing with their key creditors and donors on possible Paris Club rescheduling terms.
My authorities wish to reiterate their strong political will and commitment to revive the Kenyan economy and put it back on the path of sustainable and job creating growth and poverty reduction. They hope they can continue to count on the sustained understanding and support of the Fund and the rest of the international community in the form of timely and adequate financial support, advice and technical assistance in the relevant areas to achieve these objectives.