Optimistic GOK Budget Focuses on Development, But

UNCLAS NAIROBI 003068 SIPDIS DEPT FOR AF/E, AF/RSA DEPT ALSO PASS TO USTR FOR BILL JACKSON TREASURY FOR LUKAS KOHLER SIPDIS E.O. 12958: N/A TAGS: ELAB AGOA ECON ETRD PHUM PGOV KE SUBJECT: Optimistic GOK Budget Focuses on Development, But Implementation is Real Challenge REF: ¶1. (SBU) Summary: In an effort to address popular frustration at the slow pace of economic development and poverty reduction, Finance Minister Kimunya's presentation of the GOK's budget for FY 2006-07 stressed social spending and tax relief provisions targeted to assist the poor and vulnerable. Kimunya also announced structural reforms designed to encourage investment and growth, but cut the budget of anti-corruption agencies. The budget assumption of 5.8% GDP growth in 2006 is reasonable. The fiscal deficit is likely to be greater than the $400 million forecasted, and will require continued domestic borrowing, but the GOK believes it can keep inflation down to 5%. Kimunya tried to walk a fine line between demonstrating nationalist defiance of donors' aid conditions and reassuring international financial markets of continued macroeconomic stability. The budget's provisions look promising, but they lack governance mechanisms and are open to abuse. The NARC administration has not so far demonstrated the discipline needed to transform budget promises into results, and the political jockeying in the runup to the 2007 annual general election will create further distraction. End summary ¶2. (U) Finance Minister Amos Kimunya presented the GOK's budget to Parliament on June 15 for Fiscal Year (FY) 2006- 07 (July 1, 2006 - June 30, 2007). Presented under the theme "Frameworks for the future, laying the building blocks", the Minister boasted of the NARC government's achievement of 5.8% economic growth in 2005 and predicted GDP would also grow 5.8% in 2006. Despite painting a rosy picture on economic performance, Kimunya was quick to add that more needs to be done to reduce poverty and the gap between the rich and the poor in Kenya. Income Projection Seems Optimistic -------------- ¶3. (U) The FY 2006-07 budget assumed receipts will rise 16.8% to Ksh403.8 billion (US$5.5 billion),equivalent to 21.4% of GDP, with tax revenues rising 21.5% to Ksh375.4 billion (US$5.1 billion). Although tax revenues rose 8.5% in FY 2005-06 to Ksh257.7 billion, collections fell well below the Ksh309 billion target set in the budget, casting some doubt on the realism of the revenue projection. �0A;Kimunya tried to demonstrate independence from donor conditions by claiming he excluded external budgetary support, but close scrutiny of the budget revenues reveals he included Ksh58.6 billion (US$799.5 billion) in development assistance, consisting of project grants of Ksh28.4 billion (US$387.4 million),and project and concessionary loans of Ksh30.2 billion (US$412 million). The budget also assumed other inflows whose source and/or reliability are uncertain: privatization proceeds of Ksh18.2 billion (US$248 million),refinancing bank restructuring at Ksh20 billion (US$272 million),domestic debt rollover at Ksh51.9 billion (US$706 million), repayment of arrears at Ksh4 billion (US$54.5 million) and administrative recoveries at Ksh500 million (US$6.8 million). Rising Expenditures, Deficit and Domestic Borrowing -------------- -------------- ¶4. (U) The budget increased total expenditures 11.7% to Ksh550.1 billion (US$7.5 billion),creating an overall budget deficit of Ksh29.5 billion (US$402 million),and a 1.7% deficit/GDP ratio. In FY 2005-06, GOK expenditures went beyond the budgeted level to fund emergency drought relief efforts, the costs of office remodeling and luxury cars for the expanded Cabinet, and increased salaries and allowances for Members of Parliament (MPs). The GOK therefore increased net domestic borrowing in FY 2005-06 from the budgeted Ksh25.3 billion (US$345.2 million) deficit to Ksh36.3 billion (US$495.2 million) and the GOK's total domestic debt increased 14.8% to Ksh362.3 billion by June 2006. The rise in the debt stock is expected to continue as the GOK plans to rely on the domestic market to fund the fiscal deficit. Kimunya claimed interest rates (currently at 15% and expensive to investors) would not increase, and that inflation would be kept at 5%. Banks are flush with cash, reluctant to risk loans to the private sector, and anxious to buy GOK Treasury bonds, so increased GOK borrowing may not drive interest rates any higher. ¶5. (U) The overall ratio of budgeted expenditure to GDP in FY 2006-07 is 31%, exceeding the Medium Term Expenditure Framework target of 25.9%. The budget identifies Ksh412.5 billion (US$5.6 billion) in recurrent expenditure, a 3% rise over last year and Ksh137.6 billion (US1.9 billion) in development spending, an increase of almost 50% over the same period in FY 2005-06. The ratio of recurrent to development expenditure fell from 4:1 in 2005-06 to 3:1 in 2006-07. Budget Focuses on Development and Poverty Reduction -------------- -------------- ¶6. (U) The GOK increased the budget allocation to health, education, agriculture, rural development and infrastructure from 60.7% of total expenditure in FY 2005- 06 to 62.7% in the FY 2006-07 budget, and it expects to reach 66.5% by FY 2008-09. In addition, the Minister allocated 4% of the GDP (Ksh86 billion or US$1.2 billion) to "core poverty" programs, a 10.6% increase from the FY 2005-06 level. ¶7. (U) The government's budgeted wage bill of Ksh129.3 billion (US$1.8 billion) represents 38.2% of recurring expenditures, and is equivalent to 8.4% 1of Kenya's GDP. Specifically, the budget allots: -- The education sector Ksh99 billion (US$1.4 billion),27% of total expenditure. Ksh71 billion (US$0.97 billion) is for teachers salaries. -- The health sector Ksh33.3 billion (US$454.3 million), 6.1% of expenditures, and is projected to increase to Ksh43 billion (US$587 million) in FY 2008-09. -- The agriculture sector Ksh10.2 billion (US$139.9 million),1.9% of expenditures and is projected to increase to Ksh33.5 billion (US$457 million) in FY 2008-09. -- To infrastructure development Ksh58.5 billion (US$798.1 million),an increase of 42%, and is projected to increase to Ksh126 billion (US$1.7 billion) or 21.6% of total expenditure by FY 2008-09. -- To the road sub-sector within infrastructure Ksh46 billion (US$627.5 million),8.4% of total expenditures. -- The highly abused Constituency Development Fund (CDF) Ksh10 billion (US$136.4 million) up 39% from Ksh7.2 billion (US$98.2 million). -- The Defense Ministry Ksh27.5 billion (US$375 million), 5% of expenditures -- Provincial administration Ksh29.2 billion (US$398 million),5.3% of expenditures. -- The Finance Ministry Ksh51.4 billion (US$701 million), 9.3% of expenditures. GOK Seeks Votes With Targeted Budget Provisions -------------- --- ¶8. (U) To appeal to the young and general public in the December 2007 general elections, the GOK allocated in the budget: -- Ksh1.0 billion (US$13.6 million) for the establishment of a Youth Enterprise Fund to provide credit to start small and medium scale business; -- Ksh105 million (US$1.4 million) for rehabilitation of at least one polytechnic in each of the 210 constituencies; -- Ksh150 million (US$2.0 million) for the National Youth Council; -- Ksh50 million (US$0.68 million) for funding innovative youth projects; -- Ksh400 million (US$5.5 million) to buy land to resettle victims of tribal clashes and those removed from forests and other water catchment areas; and, -- Ksh250 million (US$3.4 million) for the National Youth Service. ¶9. (U) The GOK budget also offered a number of appealing tax reductions: -- removing the VAT on wheat flour -- removing the VAT on water supply and treatment materials purchased by local authorities; -- removing the VAT on babies' nappies, napkins, and feeding bottles; -- removing the import duty on kits for bicycles imported by approved local assemblers; -- reducing the import duty on unassembled kits for motorcycles from 25% to 10%; -- removing the import duty on agricultural tractors, semi- trailers for agricultural tractors and tractor tires; -- removing the VAT on transportation fees for unprocessed agricultural and agro-forest produce to reduce farmers' costs; -- removing the VAT on computer equipment, computer parts and accessories (previously 16%); and, -- exempting local sales of Kenyan artists' creations from VAT to promote talented youth. Structural Reforms to Support Investment and Growth -------------- -------------- ¶10. (U) To improve Kenya's creditworthiness and access to international financial markets, Kimunya announced the GOK will hire Standard and Poor's to carry out a credit review and provide Kenya its first sovereign rating. The private sector has for several years called for the review. Kimunya hopes for a positive review that will not only encourage foreign direct investment, but will also stimulate domestic investment through lower interest rates, as cheaper financing from international markets forces banks in Kenya to compete by lowering their rates. Kimunya also tried to walk a fine line between demonstrating nationalist defiance of donor conditions and reassuring international financial markets by reiterating the Government's intention to seek a Policy Support Instrument with the IMF (which does not include financial assistance) upon the expiration of the Poverty Reduction and Growth Facility (PRGF) later this year. ¶11. In his speech, the Minister highlighted the Government's enactment of the Public Procurement and Disposal Law and its ongoing efforts to implement this law through the establishment of an independent procurement authority and implementing regulations. (Note: USAID/Kenya is actively supporting the Government's procurement reform program within the context of the multi-donor supported Strategy for the Revitalization of Public Finance Management, which was formally launched by Kimunya on June 23rd. End note.) ¶12. Acknowledging the impediments to trade and investment created by tedious, lengthy and opaque licensing procedures, requirements and fees, Kimunya announced the immediate elimination of 37 licenses. He also pledged to eliminate 118 more by the end of 2006, and to harmonize a number of local authorities' licenses and permits. Kimunya announced the GOK will table a Business Regulatory Reform Bill in Parliament in July 2006. It would establish a Business Regulatory Unit in the Finance Ministry to review, simplify, consolidate 700 other business licenses and reduce their fees. Less Funding for Anti-Corruption Agencies and Prosecutors -------------- -------------- ¶13. Although Minister Kimunya talked about strengthening the capacity of institutions like the Office of the Attorney General, the Judiciary and KACC, Controller and Auditor General's offices to fight corruption and crime, the budget did not support his statements. The GOK reduced the allocation to all these agencies, the Justice and Constitutional Affairs Ministry by 5%, casting doubt on the GOK's commitment. Comments -------------- ¶14. (SBU) Kenya's skewed wealth distribution, in which the richest 10% control more than 42% of Kenya's wealth, and over half the population lives below the poverty line, is blatantly obvious. Minister Kimunya touted the budget as a "common man's", and a large percentage of the country's vulnerable population could theoretically benefit from the budget's provisions. The budget proposals and structural reforms are good on setting institutions, rules, systems and procedures for public service delivery and resource management in general. The proposals sadly lack governance mechanisms and are open to abuses such as those seen in existing programs like the Constituency Development Fund, but the GOK seems anxious to demonstrate that it will not allow donors to dictate conditions for good governance. ¶15. (SBU) Implementation, coordination and fiscal discipline are critical to actually delivering the budget's promised benefits. In previous years, the NARC administration has been dogged by program implementation mishaps, with many line ministries' actual expenditures well below their development budget allocations. It is doubtful the GOK will effectively deliver on its development promises to Kenyans, especially with everyone already distracted by the political jockeying in the runup to the 2007 general election. ROWE