“After recovering in 2010, the Kenyan economy has faced a number of challenges in 2011, including the severe drought in the Horn of Africa and high international commodity prices that have affected both the urban and the rural poor. Despite these significant challenges, the growth momentum has been preserved, driven by rapidly expanding credit to the private sector. The combination of external shocks and strong domestic demand has led to sharp inflationary pressures, a widening of the current account deficit, and the depreciation of the shilling.
“Program implementation during the first half of 2011 was in line with objectives. All targets for June 2011 have been met. In particular, the fiscal position at end-June was significantly better than expected, thanks to strong revenue performance and strict expenditure control. Structural reforms have also moved forward and the benchmark on the submission of the value added tax (VAT) law is set to be met before the end of the year.
“Gross Domestic Product (GDP) growth is projected to slow to 5 percent in 2011, largely because of the impact of the drought and power rationing. With the return of more favorable weather conditions, continued investments to boost the country’s medium-term prospects, and sustained efforts to ensure a smooth and effective implementation of the new Constitution, economic expansion is projected to accelerate next year, with GDP growth reaching about 5.5 percent. The implementation of tight monetary and fiscal policies to contain domestic demand pressures should also allow for a steady decline in inflation to 7 percent by end-2012.
“The authorities and the mission reached understandings, ad referendum, on economic policies and reforms to maintain macroeconomic stability and promote growth prospects while ensuring debt sustainability. In particular, they concurred that in the near term, high inflation poses a threat to the economic outlook that needs to be resolutely addressed. More specifically:
- Monetary policy will be tightened to bring down the rate of expansion of credit to the private sector to levels that can be sustained and to reduce the demand for foreign exchange.
- The floating exchange rate regime has helped the country cope with adverse shocks and will be maintained. Once the shilling stabilizes, the CBK will resume the gradual accumulation of international reserves to reach the medium term objective of reserve coverage of four months of prospective imports.
- Fiscal policy in 2011 and 2012 will be geared towards rationalizing non–priority expenditure and reducing the demand for imports, while expanding targeted policies to shield the poor from the impact of higher prices. This will help contain the primary fiscal deficit and reduce the public debt-to-GDP ratio to below 45 percent by end 2012/13.
- Preparations for fiscal decentralization will focus on strengthening transparency and expenditure control at both central and county government levels through the adoption and implementation of new public financial management legislation.
- Financial sector reforms will aim at strengthening cross border supervision and enhancing risk management through stress testing, while deepening the sector to transform it into a regional hub for financial services.
“The mission will recommend that the IMF Executive Board complete the second program review and approve the authorities’ request for higher Fund financing, bringing overall support under the ECF arrangement to about $750 million, up from around $500 million at present. The Board is expected to take up the review, the request for higher financing, and the Article IV Consultation, in December 2011.”