KENYA'S BUDGET: MORE SPENDING, BUT BETTER FOCUSED

UNCLAS SECTION 01 OF 03 NAIROBI 002691

SIPDIS

SENSITIVE

DEPT FOR AF/E, AF/EPS, AF/PD, EB/IFD, EB/ODF
USAID FOR AFR/EA
LONDON AND PARIS FOR AFRICA WATCHERS
TREASURY FOR ANN ALIKONIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV EAID KMCA KE
SUBJECT: KENYA'S BUDGET: MORE SPENDING, BUT BETTER FOCUSED
ON DEVELOMENT NEEDS

REF: A) NAIROBI 2651, B) NAIROBI 1756

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


1. (U) This is a joint State-USAID cable


2. (SBU) Summary: Kenya's new budget for the fiscal year
beginning July 1 foresees a 34% nominal increase in
spending, but proposes to spend proportionally more money
in areas deemed crucial to economic development and poverty
reduction, namely health and infrastructure. Estimated
revenues will fall short of total spending, producing a
budget deficit of around $2.4 billion. However, budget
planners prudently excluded anticipated (but not firm)
revenues from donor projects; should these come on line
later in the year, they would represent a budget windfall.
The new budget is a positive step forward both in terms of
an improved planning process, and in the resulting
incremental realignment of spending towards priority areas.
But the trick to making it really work will be in the
implementation. End Summary.

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BUDGET BY THE NUMBERS
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3. (U) Kenya's budget for FY 2005-06 (which begins July 1)
was presented to Parliament June 8 by Finance Minister
David Mwiraria. The budget as presented forecasts a record
KSh 508.5 billion ($6.6 billion) in total spending, a
nominal increase of 18% over the revised budget estimates
for the fiscal year ending June 30. On the other side of
the ledger, total revenues will reach KSh 326 billion ($4.3
billion),a 10.5% increase over the latest estimates for
revenue collection in the current fiscal year. This leaves
a deficit before grants of KSh 182.5 billion ($2.4
billion),which is more than a third larger than the
deficit forecast for the present fiscal year.

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SPENDING MORE ON DEVELOPMENT AND POVERTY REDUCTION
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4. (U) In keeping with the theme of the budget speech -
"Reorienting Expenditure to Achieve Rapid Economic Growth
and Poverty Reduction" - the budget boosts development
spending by 45% to KSh 104.2 billion ($1.4 billion).
Recurrent spending, on the other hand, grew a more modest
25%, while still constituting just under 80% of total
expenditure. Development spending still lags with a 20%
share of total spending, but this is up from 17% last year.


5. (U) Along the same lines, those ministries deemed
essential to poverty reduction and economic development get
bigger budget increases this year, driven in large part by
large increases in their development budgets. Budget
standouts include:

-- Health: Total allocation up 37.2%; development budget up
123%; total share of spending up to 5.9% from 5.1% last
year.

-- Roads and Public Works: Total allocation up 47.3%;
development budget up 95%; total share of spending up to
5.6% from 4.5% last year.

-- Water and Irrigation: Total allocation up 57%;
development budget up 82.3%; total share of spending up to
2% from 1.2% last year.


6. (U) Education saw its budget allocation rise by 14%, or
by less than the increase in overall spending. But the
Education Ministry already dwarfs all others in total
spending, with a 19% share of the budget, essentially flat
from last year. Its development allocation increased by
43%, however, while budgeted recurrent expenditures rose by
only 12%.


7. (U) Nearly all ministerial and agency line items in the
new budget received larger allocations this year,
reflecting that fact that spending is nearly a third higher
than last year across-the-board. The Office of the
President (OP) and the Defense Ministry, for example, are
big spenders generally, taking up nearly 7% and 5.5% of all
spending respectively. The OP budget is larger than last
year, but grows by only 6.8%. Defense is up 25%, which is
still less than the increase in overall spending. These
increases, however, have still generated criticism and
debate in both Parliament and the press over whether the
government is providing enough resources to core poverty
reduction programs, despite the big increases in health,
infrastructure, and education.

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REVENUES AND FINANCING THE DEFICIT
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8. (U) The Kenya Revenue Authority (KRA) outdid itself
during the past fiscal year, raking in KSh 293.4 billion
($3.8 billion),13% more than originally anticipated.
Recognizing that some of last year's growth came from one-
time-only gains, including a tax amnesty, the new budget
anticipates only a 10.5% increase in revenue over last
year, not enough to balance the budget. The Finance
Minister plans to plug the $2.4 billion budget gap through
external assistance in the form of grants ($372 million),
new external borrowing ($514 million),privatization
proceeds and bank restructuring proceeds ($220 million),
other items ($1.1 billion),finally, new domestic borrowing
of KSh 25.4 billion ($338 million).


9. (U) As such, the budget as presented foresees a
substantial increase in the stock of domestic debt.
However, in drafting the budget, the Finance Ministry
consciously exercised fiscal prudence by including only
firm commitments from donors, and excluding conditional
offers of assistance. As such, should the government meet
the conditions for upcoming World Bank and bilateral
credits and grants during the course of the year, the
revenue will constitute a windfall which can be used to
increase spending in priority areas, or to reduce domestic
borrowing.

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TAX AND TARIFF CHANGES
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10. (U) In keeping with the "pro-poor" budget theme,
Mwiraria also announced a number of tax changes designed to
lower living costs for the poor. Some of the highlights
include:

-- Tariffs on imported used hand clothing will drop to 45%
of ad valorem or $0.30 per kilo (from 70% or $0.60 per kilo
previously).

-- Tariffs on imported pharmaceuticals will return to being
zero rated after being raised to 20% on January 1 upon
formation of the East Africa Customs Union.

-- Tariffs on diapers, sanitary pads, cooking gas, coal and
media containing software zero rated.

-- VAT on sanitary towels, LPG, maize flour, milk and
kerosene all zero-rated.

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COMMENT
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11. (SBU) The new budget is good news in two respects:
first, the process by which it was formulated was a big
improvement over past practice (see ref B) in terms of
discipline, transparency and buy-in from line ministries.
Second, and in large part as a result of improved budget
planning, the content of the budget has succeeded in more
closely aligning planned spending with areas considered
priorities under the country's economic development
blueprint, the Economic Development Strategy. An IMF team
visited Kenya just after the budget was presented, and has
incorporated it "lock, stock and barrel" into the
performance criteria for the next review period under
Kenya's IMF program. The World Bank commented at a recent
donor coordination meeting that the new budget represented
a "huge move forward" both in terms of process and results,
and noted that Kenya is likely to realize unbudgeted
revenues from donors which the Bank is confident will be
used to fund priority development projects.

12. (SBU) The trick, however, will be in implementation,
especially at the line ministry level, where past practice
has shown wide divergences between the budget forecast and
the actual outturn, both in terms of overspending in some
areas and under-spending in others (ref B again). The
Roads Ministry, for example, is slated to receive another
major boost in funding this year to build roads. This is
fully justified given the urgent need for better roads in
Kenya as a way to maintain and accelerate economic growth.
However, because of human capacity constraints and
cumbersome procurement processes, the Ministry last year
spent less than half the funds allocated to it for this
purpose. Typically, ministries less involved in providing
critical services and infrastructure (e.g. the Office of
the President) overspend their allotments. In short the
Finance Ministry, which deserves the lion's share of the
credit for improving the budget process, still has its work
cut out for it in terms of ensuring discipline as the
budget moves from being just a plan to being money actually
spent.


13. (SBU) Along these same lines, we note that a number of
commentators have asserted that Kenya's new budget lacks
full transparency in terms of destination and use of
allocated monies. This is nothing new, but unlike in past
budgets, when which particular budget lines were specified,
the new system of printed estimates is devoid of details of
where and how the money is to be spent. While these
changes have been introduced to improve pipeline management
and facilitate shift from one ministerial line item to
another in case of either slow disbursement or emergency,
the fact that the actual disbursement decisions will be
left to individual ministers raises the specter of
political manipulation by ministers (who are sitting MPs)
in the run-up to the 2007 general elections. Also, under
the current system, tracking of expenditures can only be
implicitly inferred from budget lines leaving wide scope
for possible financial impropriety and mismanagement.
Again, this in many ways is nothing new, and serves as a
reminder that the ultimate success of the budget will be
more in the implementation than in the planning.
BELLAMY