KENYA'S IMF PROGRAM: PROGRESS HINGES ON

UNCLAS SECTION 01 OF 03 NAIROBI 002651

SIPDIS

SENSITIVE

DEPT FOR AF/E, AF/EPS, EB/IFD/OMA
USAID FOR AFR/DP WADE WARREN, AFR/EA JEFF BORNS AND
JULIA ESCALONA
TREASURY FOR ANN ALIKONIS
LONDON AND PARIS FOR AFRICA WATCHERS

E.O. 12958: N/A
TAGS: ECON EAID EFIN KCOR PGOV KE
SUBJECT: KENYA'S IMF PROGRAM: PROGRESS HINGES ON
PROCUREMENT LEGISLATION AND OTHER REFORMS

Ref: 04 Nairobi 5038

Sensitive-but-unclassified. Not for release outside USG
channels.


1. This is a Joint Embassy-USAID message.


2. (SBU) Summary: Kenya performed reasonably well in
meeting the quantitative and structural targets of its IMF
program during the current, second review period, and the
government and the IMF have reached broad agreement for
targets in the next review period, which in theory runs
through June, 2006. But the IMF is making passage of two
important reform measures in Parliament -- and in
particular enactment of the Procurement Bill -- necessary
"prior actions" that the GOK must achieve now before the
IMF will approve the next disbursement of funds and thus
move the program forward. This new-found toughness will
likely assist reformers led by the Ministry of Finance in
pushing through long-overdue procurement and other reforms,
but it constitutes a bold and somewhat risky move by the
IMF. We support the IMF's stance given the importance of
procurement reform not only to the fate of the IMF program,
but also to Kenya's broader economic future. End summary.


3. (SBU) Acting Director of USAID Kenya and Embassy Econ/C
attended a June 28 briefing provided by Nairobi IMF
Resident Representative Jurgen Reitmeier. Reitmeier
provided a comprehensive and transparent read-out of the
results of the June 6-17 visit to Kenya by an IMF team led
by Godfrey Kalinga meant to complete negotiations for the
second review of Kenya's three year, $240 million Poverty
Reduction and Growth Facility (PRGF).

-------------- --
Performance: Not Perfect, But No Major Problems
-------------- --


4. (SBU) In discussing Kenya's performance since the
completion of the first review of its IMF program in
December, 2004, Reitmeier said Kenya had met four of six
quantitative performance criteria. The missed criteria
include targets for reserve money and the Government of
Kenya (GOK) wage bill. In both cases, however, the margin
of non-compliance was small (less than two percent),and
the causes clear. Staff would recommend waivers in both
cases, Reitmeier noted.


5. (SBU) Similarly, in terms of structural performance
criteria, Kenya met three of five targets. The two missed
items include the continued existence of legal controls
over bank fees and charges, which the GOK has attempted to
remove unsuccessfully by amending the Banking Act. The
other, considered minor, is the failure of the GOK to
provide new wage guidelines to Kenya's Industrial Court.
Again, Reitmeier implied that non-compliance in these areas
would not be considered serious enough to hold up IMF Board
approval for the next tranche of the PRGF to move forward.

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Future Performance: Agreement Reached
--------------


6. (SBU) An even more "positive angle" to the IMF/GOK
discussions was the establishment of new performance
criteria and benchmarks for the period running through the
end of the fiscal year which begins July 1. Reitmeier did
not reveal specific details, but did offer the following
assumptions built into the new quantitative performance
criteria. These include:

-- GDP Growth: 4.6% for the fiscal year just ending June
30; 4.9% for the following fiscal year.

-- Inflation: Targeted to be reduced sharply from 13.6% (12
month rate for end May 2005) to 5% by the end of June,

2006. The key to reducing inflation is tighter monetary
policy, to be implemented through tighter targets for
reserve money.


7. (SBU) On the structural performance side, Reitmeier
highlighted the following for the next review period:

-- Verification of asset declarations for all senior GOK
officials, to be carried out by the Kenya Anti-Corruption
Commission (KACC). For more on this, see para 8 below.

-- A "sharpening" of the Code of Conduct for senior GOK
officials.

-- A review of GOK wage and pay policies.

-- GOK cash flow plans to be published quarterly as a way
to generate greater predictability in financial markets
concerning the GOK's borrowing needs.

-- Tighter loan loss provisioning guidelines issued by the
Central Bank.

-- A financial review of the National Social Security Fund
and 25 other parastatals.

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Fly in the Ointment: Prior Actions
--------------


8. (U) Reitmeier made clear, however, that all is not
smooth sailing for Kenya's IMF program. The area of
contention is "prior actions" - those actions the GOK must
achieve in the immediate near-term before the IMF Board
will even meet to approve the next disbursement under the
program. Reitmeier listed four such actions:

-- Enactment of the Public Procurement and Disposal Bill by
Parliament.

-- Enactment of an amendment to the Public Officers Ethics
Act to allow for the verification of the asset declarations
from senior GOK officials by the KACC (see para 7 above).

-- Wage guidelines for the Industrial Court (a holdover
from the current review period).

-- Curtailment of the GOK's discretionary tax exemption
authority.

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Why the Procurement Bill is So Critical
--------------


9. (SBU) Reitmeier focused on the first two actions, and
in particular passage of the Procurement Bill, as essential
to keeping Kenya's PRGF on track, and his comments jibed
with those of Godfrey Kalinga, who told a small group of
donors on June 10 that for the IMF, passage of this
legislation is "fundamental to all our efforts" in Kenya.


10. (SBU) Reitmeier noted that both bills are important
structural reform measures "necessary for the country and
for governance." During other parts of his presentation,
he made clear why procurement reform is so essential to
Kenya's development. The GOK actually under-borrowed and
under-spent its budget last year, he noted. This phenomenon
is more a worry than a cause for celebration because it
results from "dismally low" rates of utilization of
available project funding in some areas, which in turn is
caused in part by cumbersome procurement procedures.
(Note: A Kenyan Treasury official told Econ/C in May that
the Roads Ministry returned more than half the funds
allocated to it last year for road building and repair.
End note). Making the link to the broader development
agenda, the IMF has concluded that the current economic
recovery, even in the 4-5% GDP growth range, is
unsustainable without a "major push" in improving Kenya's
infrastructure. The upshot: While the absolute level of
resources available to the GOK is one constraint, unless
Kenya can spend the money that is being made available to
it now, in part via procurement reform, current
infrastructural constraints on the economy will make rapid
economic take-off impossible over the medium- and long-
term.

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Procurement Bill's Ripple Effect on Donor Funding
-------------- --------------


11. (SBU) Reitmeier added that passage of the Procurement
Bill takes on even greater short-term importance because it
is a condition of other donor programs which are integral
to the GOK's fiscal health and to the country's development
plans. In particular, at least one World Bank budget
support credit, along with a three-year $198 million budget
support grant from the EU (reftel) require passage of the
Procurement Bill among other pre-conditions. Reitmeier
made a point of emphasizing that if these budget support
credits "slip away," it "effectively prevents us from
moving forward." The earliest the IMF Board would meet to
consider completion of the second review is September, he
said, and this will be pushed back further if Kenya has not
completed the prior actions by this time. He refused to
speculate on the fate of the IMF program should passage of
the Procurement Bill and/or other prior actions fail to
materialize prior to the end of the year.


12. (SBU) In a sidebar conversation at the IMF briefing,
the EU delegation representative in attendance noted that
while other conditions of the EU package could be waived if
they are not met by the GOK, it is unlikely Brussels and EU
member states would go along with waiving passage of the
Procurement Bill as a condition. Further, he noted that
the EU money dedicated for budget support to Kenya
"expires" at the end of the 2005 calendar year.

--------------
Comment
--------------


13. (SBU) The upshot is that despite broad agreement in
most areas under discussion with the GOK, the IMF has opted
to play hardball by staking the future of Kenya's program
on passage of two key governance-related bills now in
Parliament. In so doing, the IMF is providing ammunition
to like-minded reformist officials in the Finance Ministry
(and ultimately to President Kibaki) to push these bills
through. Getting any legislation out of Parliament,
however, is a tenuous undertaking at best in Kenya and this
is thus a bold and risky gambit. But it is absolutely the
right thing to do. The IMF has concluded that without
passage of the Procurement Bill, needed donor flows will
dry up and likely doom the IMF program in any event. The
IMF also appears to realize that the time is right to
finally get serious about passing reform legislation, and
is shrewdly holding the GOK's feet to the fire. We're
impressed.
Bellamy