IMF BRIEFS DONORS ON KENYA'S ECONOMY AND PRGF

UNCLAS NAIROBI 004599

SIPDIS

SENSITIVE

SIPDIS

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 PGOV EAID EFIN KCOR KE
SUBJECT: IMF BRIEFS DONORS ON KENYA'S ECONOMY AND PRGF
PROGRESS

Ref: Nairobi 3129 and previous

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


1. (SBU) SUMMARY: IMF Mission Chief for Kenya Godfrey
Kalinga briefed donors on the results of a 10-day IMF
mission examining Kenya's progress on the second review of
its three-year $326.7 million Poverty Reduction and Growth
Facility (PRGF). Kalinga was generally optimistic on
Kenya's near-term economic performance and on progress made
in meeting the second review's performance criteria and
benchmarks. He noted that sustained growth rates and
progress on meeting the Millennium Development Goals (MDGs)
will require improvements in Kenya's infrastructure and
better budget management. Kalinga assured the donors that
the IMF remains concerned about governance, but is willing
to work around the unfinished business of verification of
public officer asset declarations in order to have a
successful Executive Board Meeting, likely on December 21.
We remain worried that Kenya's budget spending will become
increasingly politicized in the run-up to the November 21
constitutional referendum and the subsequent presidential
election. We also hope Kenya will focus its economic
policies towards sound, pro-growth initiatives, and not
simply target the MDGs. END SUMMARY.

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Economic Developments
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2. (SBU) IMF Mission Chief for Kenya Godfrey Kalinga
briefed donors on October 28 on the results of a 10-day IMF
mission on the second review of Kenya's three-year $326.7
million Poverty Reduction and Growth Facility (PRGF).
Kalinga said the IMF Executive Board is currently planning
to meet on the Kenya program December 21, when it is likely
to give a passing grade and authorize disbursement of the
next US$ 72.6 million tranche of the credit.


3. (SBU) Kalinga confirmed the IMF's previous estimate of
at least 5% GDP growth for Kenya in 2005. The economy is
performing better than anticipated one year ago, partly
because growth is spreading to a broader range of sectors.
He was also guardedly complimentary of the GOK's fiscal
management for both revenues and expenditures. With
revenues exceeding projections, the expected budget deficit
will likely not occur. Due largely to favorable weather
conditions leading to lower food prices, inflation has
receded during the past few months. At the same time, for
Kenya to achieve significant transformational economic
performance, it needs growth rates considerably higher than
5%.


4. (SBU) The medium term outlook is also brightening,
particularly because of improved security in Southern
Sudan, resulting in increased economic activity for Kenyan
goods and service suppliers. Kalinga cautioned that Kenyan
companies and authorities still needed to "take advantage
of these opportunities."


5. (SBU) When asked, Kalinga admitted that there remains a
significant "ceiling" on medium-to-long term growth, most
notably from a lack of investment in Kenya's deteriorating
infrastructure. Despite recent upturns in manufacturing
and trade, even 5% growth might not be possible beyond
FY2005/6. At the same time, Kalinga cited some important
initiatives that should pay economic dividends, including a
World Bank funded (and USAID/REDSO-supported) program to
improve the Northern Transit Corridor, the recent joint
Kenya-Uganda private contract for managing rail freight, a
proposal to accelerate telecom reform, a more flexible
approach to water management, and a proposal for
privatizing container handling at the Port of Mombasa.

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Pushing Good Governance
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6. (SBU) Kalinga assured the donors that the IMF remains
concerned about governance issues, saying, "it is a key
issue for all of us." He sees some progress in the GOK's
ability to investigate and prosecute corruption cases, but
sees a need for additional capacity in these areas to deal

with an "expected increase in cases." [Note: USAID/Kenya
is providing support to strengthen the performance of the
Department of Public Prosecutions. End note.] He also
expressed concern for Kenya's underperforming parliament,
and explained that without passage of the Miscellaneous
Amendments Act, enabling legislation will not be in place
for verifying senior GOK officials' asset declarations,
which is a prior action for this second review. Since
parliament is unlikely to be in session again before the
board meeting, Kalinga said that the IMF is working with
the GOK on "substituting some other actions that will
enable us to meet this requirement." Specifically, the IMF
has asked the GOK to develop an enhanced code of conduct
for government officers, for both their official activities
and private business interests.


7. (SBU) Prior to the board meeting, Kalinga hopes to see
additional GOK efforts to improve fiscal "soundness,"
including more progress creating a robust expenditure
monitoring system. Looking further out, Kalinga
highlighted the need to supplement the legislative
framework in the fight against corruption, including, he
hopes, passage of anti-money laundering legislation next
year, and enhanced parastatal reform to include regular
account audits.

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An Improving Budget
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8. (SBU) In response to a question from USAID, Kalinga
noted that improved management of expenditures is necessary
for both Kenya's recurrent and its development budgets.
However, with the recurrent expenditures dropping slightly
to 20% of GDP and development funding increasing from 2% to
7% of GDP in recent years, the GOK needs to improve its
development processes and absorptive capacity. With
development resources coming from donor programs at
approximately 4% of GDP, the GOK is hindered by the
multiplicity of negotiations and funding conditions by the
various donor organizations. Kalinga agreed that even the
recurrent budget is bogged down by the huge number of
regulations and implementation instruments required by
Kenya's vast bureaucracy. President Kibaki needs to lead
the way on more clearly-elaborating policy priorities,
allowing the bureaucracy to be more proactive, rather than
having "everything decided by the cabinet" which meets
infrequently. Kalinga is hopeful that the implementation
of the Public Procurement Act, which was recently signed by
Kibaki, will improve budget management for both development
and recurrent spending. [Note: Another component of this
effort is Kenya's Public Financial Management Reform
Program, which the GOK hopes will be partially funded
through its not-yet approved MCC Threshold program. End
Note.]


9. (SBU) When asked if he has confidence in the GOK's
handling of expenses related to the current constitutional
referendum campaign, Kalinga replied that there were clear
line-items for additional referendum-related security
measures, but that it is not possible to track all the
funds. In part, this is because Kenya needs more time to
finish implementing its new system for allocating and
monitoring expenditures. He admitted not having a complete
picture of how the budget is passing through the
ministries, but hopes that will become clearer by mid-
January. Kalinga opined that he would like to see more
effective parliamentary oversight of the budget, but that
is "outside the scope" of the IMF mission. [Note:
USAID/Kenya's support for Parliament Strengthening provides
assistance to budget oversight committees to enhance their
capacity in this area. End note.]

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How About the MDGs?
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10. (SBU) Asked if Kenya's budget was on the right track
for meeting the Millennium Development Goals (MDGs),
Kalinga responded that Kenya needs to target around 4% of
GDP to the MDGs to make real progress (and will require
higher than 5% GDP growth),but this is not currently
possible. He also noted that the GOK needs to continue
reducing some budget areas, such as defense spending and

overseas diplomatic missions in order to create "fiscal
space," and the ability to quickly address pressing needs,
but, the country is still 2-3 years away from making this
happen. Also, according to Kalinga, Kenya's expenditure
process is too inflexible to effectively address the MDGs.
He feels that government decisions on allocations for key
areas take much too long.


11. (SBU) Kalinga said that Kenya will also require more
donor funds. He elaborated that the current problem with
absorptive capacity is not a significant concern if the aid
is addressing areas that can utilize significant increases,
like education and healthcare, and as long as the
bureaucracy does not have to deal with too many separate
administrative requirements. He estimates that Kenya can
manage additional donor contributions up to 7-8% of GDP,
especially if some of that is managed by contractors.


12. (SBU) Kalinga admitted that the second review's
performance criteria for new wage guidelines continues to
slip, but that Kenya would be granted a waiver. In what is
a slight restatement of this criterion, he added that
stabilization of the wage bill is the goal, not substantive
cuts, since much of Kenya's development objectives are
"labor intensive."

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Exchange-Rate Angst
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13. (SBU) When asked about the current strength of the
Kenya Shilling (currently trading at about 73 to the
dollar, as opposed to a more historical level of
78/dollar),Kalinga noted that he is supposed to report to
the IMF on what's happening with the shilling's exchange-
rate, but that the dynamics are not entirely clear. He
added that a stronger shilling is harming key export
sectors, including horticulture and textiles, and does not
compliment Kenya's overall development objectives. Kalinga
credits the Central Bank of Kenya for at least espousing an
exchange-rate neutral position, notionally free from
political interference. The shilling's enhanced value is
likely due to a combination of factors, including increased
capital inflows from donors and NGOs (again, the Southern
Sudan factor),increased remittances, and weak demand for
investment funds domestically.

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Comment
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14. (SBU) Kalinga appeared to be torn between an upbeat
message on Kenya's progress and concerns about problematic
foundations, including governance. As with Kalinga's
previous exchange, the donors expressed on-going worries
about governance, security, and the GOK's seriousness to
pursue real reform. Ambassador Bellamy voiced our concern
that President Kibaki and his pro-draft constitution's
current policy of trying to buy votes by handing out title
deeds, salary increases, and jobs is only a precursor for
what will happen in the subsequent Presidential campaign.
The likely consequence is that donors will be asked or
required to take on more of the responsibility for meeting
Kenya's basic needs during the next two years as the
country's minimal development budget is further
politicized.


15. (SBU) More immediately, we hope the IMF will be firm
with Kenya in its discussions leading up to the December
board meeting. On verifying asset declarations, it is
important to have a public GOK commitment to whatever
interim agreement is hammered out. Also, in outlining
Kenya's budget framework and management, the IMF should
push for policies that encourage sustainable economic
growth and not allow the GOK to focus solely on meeting MDG
criteria.

BELLAMY