US embassy cable - 05NAIROBI1756

UNCLAS SECTION 01 OF 05 NAIROBI 001756 
 
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 ALEX SEVERENS 
 
LONDON AND PARIS FOR AFRICA WATCHERS 
 
E.O. 12958:  N/A 
TAGS: ECON, EAID, EFIN, KCOR, PGOV, KE 
SUBJECT:  BUDGET REFORM:  A KEY TO BETTER GOVERNANCE IN KENYA 
 
Refs:  A.  Nairobi 001593, B. Nairobi 000514 
 
Sensitive-but-unclassified.  Not for release outside USG 
channels. 
 
1.  (U) This is a joint State-USAID cable. 
 
2.  (SBU) Summary: Kenya's system for allocating its scarce 
national resources though the national budget process is 
broken and has long been a factor in the country's slow 
economic decline.  Recognizing this, the government, 
spearheaded by the Ministry of Finance with help from 
donors, is rolling out badly needed reforms of the budget 
planning and public expenditure management systems.   These 
multifaceted efforts center on improving the planning 
process to ensure that the country's annual budget actually 
reflects its strategic economic priorities, such as "pro- 
poor" spending on health and education programs aimed at 
reducing poverty.  On the spending side of the budget coin 
are related initiatives to monitor public expenditures to 
ensure that monies allocated for priority programs are 
actually utilized for these purposes, and to identify and 
eliminate spending bottlenecks in order to accelerate 
utilization of budgeted funds. 
 
3.  (SBU) While there has been great progress over the past 
year, Kenya's budget reforms are still in their infancy and 
are constrained by inertia, human capacity limitations, and 
resistance to change from a bloated bureaucracy dependent 
on the status quo for jobs and influence.  But should 
transparent and more accountable budget systems become 
firmed rooted over the next 2-3 years, the resulting 
benefits would be enormous.  Better budget planning would 
generate efficiency gains across the entire economy, and 
better public expenditure management would reduce the scope 
for pervasive graft.  In short, un-sexy though the topic 
may be, successful budget reform holds one of the keys to 
improving governance and strengthening democracy in Kenya. 
End summary. 
 
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The Budget: At the Nexus of Economic Reform in Kenya 
--------------------------------------------- ------- 
 
4.  (U) The Government of Kenya's (GOK) Economic Recovery 
Strategy (ERS) was published by the reformist National 
Rainbow Coalition (NARC) administration in early 2003, just 
after it came to power.   Ambitious and articulate, it maps 
out in broad brushstrokes a plethora of inter-related 
economic and governance reforms designed to jumpstart 
economic growth and reduce poverty in a country which has 
grown steadily poorer over the course of the past ten years 
(ref B).  One set of intended reforms is the overhaul of 
the processes by which the country formulates and 
implements its national budget.  Such an overhaul, 
important in its own right as a purely fiscal measure, is 
also a prerequisite for the success of other, more profound 
structural reforms and development goals detailed in the 
ERS.  These include civil service reform, privatization, 
the elimination of corruption, and poverty reduction.  Dry 
though the topic may be, budget reform thus sits at the 
nexus of economic development and improved governance in 
Kenya. 
 
--------------------------------------------- ---- 
Broken System, Squandered Resources, Poor Country 
--------------------------------------------- ---- 
 
5.  (U) It was clear well before the NARC administration 
came to power that Kenya's budget processes were broken and 
badly in need of radical surgery.  During the previous era 
of rampant corruption under President Daniel arap Moi, the 
budgeting, accounting and performance monitoring processes 
in Kenya had been systematically undermined in order to 
facilitate resource allocation based on personal enrichment 
and political patronage, as opposed to the achievement of 
national development objectives.  Despite several periods 
of budget reform in the 1970s, '80s, and '90s, Kenya's 
budget process was (and still is) characterized by a number 
of inter-related flaws that continue to contribute 
materially to the country's economic decline.  First and 
foremost, the process has suffered from inadequate-to- 
nonexistent institutional linkages between the planning and 
budgeting processes, as well as between budgeting and 
actual budget implementation. 
 
6.  (SBU) Without such linkages, Kenya's budget - both as 
planned and as implemented - has perennially failed to 
truly reflect the country's development priorities, which 
at best are only integrated into the budget process on an 
inconsistent, ad hoc basis.  Even today, Kenya's planning 
and budget processes are undertaken by two separate 
bureaucracies - the Ministry of Planning and National 
Development, and the Ministry of Finance.  (Note: This 
division of responsibilities impeded program and policy 
implementation during the initial eighteen months of the 
NARC government.  However, over the past year, modalities 
of coordination between the two Ministries have greatly 
improved.  End note). 
 
7.  (U) Second, with the absence of effective linkages 
between planning and budgeting came a still-prevalent 
dichotomy between recurrent and development spending. 
Thus, and in the face of ever-present resource constraints, 
Kenya's budget process has tended to heavily favor 
recurrent spending - the money needed to keep government 
running on a day-to-day basis - at the expense of spending 
on multi-year development projects, even though the latter 
might better reflect the country's longer-term development 
priorities and the needs of its economy.  This bias is 
exacerbated by a budget cycle which has in the past always 
been done on an annual basis, often leading to development 
projects being started when resources are available in year 
one, but then not completed because funding is diverted to 
recurrent needs in the out years.  (Note: This analysis is 
an oversimplification, since the costs of upkeep for many 
development projects, once completed, migrate to the 
recurrent budget and become productive investments.  But 
most observers agree that the development budget is under- 
funded in Kenya, and that the recurrent budget is too high. 
End note). 
 
8.  (U) Fiscal discipline has been another perennial 
problem for Kenya.  The government has tended to put very 
little emphasis on determining a realistic medium-term 
macro-economic and fiscal framework - the basis for the 
"fiscal envelope" of resources available for the budget. 
Resource availability has often been determined on a short- 
term annual basis, with revenue estimates typically being 
overly optimistic and expenditures under-estimated.  The 
lack of hard budget constraints on ministries, combined 
with the lack of overall prioritization and the bias in 
favor of recurrent spending noted above, has typically 
generated large, unplanned budget deficits over the years, 
including a deficit totaling 4.4% of GDP in FY 2003-04. 
This has forced the government to increase its borrowing 
(primarily domestic) time and again, further undermining 
macro economic stability and economic development. 
 
--------------------------------------------- - 
MTEF to the Rescue!  But What the Heck is It?? 
--------------------------------------------- - 
 
9.  (U) In light of these interconnected problems and the 
country's economic regression during the 1990s, Kenya 
signed on in 1999 to a budget reform process known as the 
Medium-Term Expenditure Framework, or MTEF, initially with 
support from the World Bank, and later from other donors, 
as well.  However, the MTEF was not implemented until the 
current budget cycle, after the NARC administration decided 
to make it the centerpiece of its reform of the budget 
planning process.   Easier to explain than to implement, 
the ultimate goal of the MTEF is deceivingly simple: to 
better align the country's development priorities with the 
government's actual spending patterns, or in the words of 
Minister of Finance David Mwiraria, "to make the budgetprocess a more effective 
tool for realizing the 
Government's key strategic objectives." 
 
10.  (U) The MTEF attempts to do so by introducing a 
realistic three-year planning horizon for making medium 
term forecasts of revenues and expenditures.  Within this 
three-year macro and fiscal framework, the MTEF then aims 
to set more predictable expenditure ceilings for each of 
eight sectors (e.g. social services), and these overall 
ceilings in turn are converted into hard budget ceilings 
for line ministries.  Thus, in contrast to the past 
practice of each ministry receiving roughly the same 
increase in printed estimates on an annual, ad hoc basis, 
in theory, the MTEF process should allow GOK planners to re- 
allocate resources over time from lower priority areas to 
those given greater priority in the ERS, such as health and 
education. 
 
-------------------------------- 
2004/05: A Year of Real Progress 
-------------------------------- 
 
11.  (U) In practice, Kenya has made a great deal of 
progress in making the MTEF an effective new format for 
allocating public resources.  After a review of the MTEF to 
date in early 2004, the GOK appointed a new team of senior 
technocrats at the Finance Ministry which is spearheading a 
number of improvements to the current planning cycle.  A 
key change begun last year is pushing the entire timetable 
for the MTEF process to earlier in the year to better 
include cabinet ministries and (in theory) Parliament in 
the planning process.  During the current cycle for the FY 
2005-06 budget (to be presented to Parliamant in June), the 
GOK achieved several important milestones.  First, in 
December, it kicked off the planning process by publishing 
its first-ever Budget Outlook Paper. The paper reiterates 
the GOK's development strategy articulated in the ERS, 
provides realistic medium-term resource estimates, and lays 
down annual performance targets derived from the ERS for 
line ministries. 
 
12.  (U) Used as guide for line ministries in the initial 
stages of formulating their own budget plans, the paper was 
followed in early April by a second innovation, the GOK's 
Budget Strategy Paper (BSP), also a first.  Like the 
Outlook Paper, the BSP provides a realistic medium-term 
"resource envelope" expected to be available for recurrent 
and development budgets for fiscal years 2005-2008.  It 
also includes a strategy on how the GOK will restructure 
spending to patterns more in line with ERS development 
priorities.  In this respect, it goes beyond the Outlook 
Paper in providing specific guidance to line ministries on 
aligning their spending patterns with stated national 
priorities.  It calls, for example, for a 15% average 
annual increase in "core poverty programs", a shift which 
will change the ratio of such programs from the current 
4.8% of GDP to 5.7% by 2007/08.   Overall, spending on 
economic and social sectors is planned to increase from 
59.3% of total spending now to 60.9% by 2007/08. 
 
--------------------------------------------- ---------- 
The Other Side of the Coin: Actually Spending the Money 
--------------------------------------------- ---------- 
 
13.  (U) The BSP is one side of the budgetary coin in that 
it helps determine how national resources are allocated. 
It does not speak, however, to budget outcomes, i.e. how 
the money allocated is actually spent.  As such, an 
integral and parallel reform within the MTEF process is 
Public Expenditure Review (PER).  PERs have been carried 
out in Kenya in 1997, 2003, 2004, and 2005, and are meant 
to reveal to policymakers whether the money allocated to 
ministries for specific purposes is actually spent, and 
spent for those purposes.  As such, PERs also reveal which 
units of government are overspending their budgeted 
allocations, and which are underspending.  In so doing, 
PERs constitute a "diagnostic expose of any mismatches" 
between "the desired policy ideal as stated in the printed 
budget and actual spending outcomes." 
 
14.  (U) Kenya's 2003 and 2004 PERs revealed that the 
overall budget reform process still has a long way to go in 
achieving its goals.  While the variance between the 
printed budget and overall spending is small on an 
aggregate basis, the variances at the ministry level are 
often quite large, with government units not directly 
involved in service delivery or poverty reduction (e.g. the 
Defense and Home Affairs Ministries, State House, and 
Parliament) typically overspending their budget allotments 
by a wide margin, while those in theory directly involved 
in providing public services (e.g public works, water, and 
agriculture) underspending their allotments.  Moreover, 
across ministries, allocated recurrent budgets are 
typically fully spent (or overspent), while budgets for 
development programs are underspent, suggesting that the 
GOK is having institutional problems utilizing available 
funds for this purpose.  These deviations collectively 
point to long-standing structural problems, alluded to in 
paras 3-5 above, which the GOK hopes to address as the MTEF 
process continues to be pushed down to line ministries. 
PERs themselves are forcing line ministries to improve 
fiscal discipline and improve public expenditure management 
systems. 
 
---------------------------------------- 
Striving to Meet International Standards 
---------------------------------------- 
 
15.  (U) In a complementary attempt to fix the budget 
planning and public expenditure systems, the Finance 
Ministry is pushing to meet 16 international performance 
benchmarks established in a dialogue with donors under the 
Public Expenditure Management and Assessment Plan (PEMAAP). 
PEMAAP tracks seven benchmarks in budget formulation, four 
in budget execution, and four in budget reporting.   At the 
end of the 2003/04 budget year, only four of the 16 
benchmarks had been met.  Another two have since been met, 
bringing the total to six.  Like the PERs - but on a 
broader scale - the PEMAAP process is both a report card 
and a diagnostic tool for policymakers, allowing them to 
focus reform efforts on clearly identified systemic 
weaknesses, and to work towards tangible, internationally 
recognized benchmarks.  While the GOK currently meets less 
than half of the PEMAAP benchmarks, it now falls within the 
upper range of African countries.  Moreover, the direction 
is positive, and during Consultative Group meetings in mid- 
April (ref A), the GOK committed itself to meeting 13 of 
the benchmarks by June 2006, and all 16 by June 2008. 
 
-------------------------------------- 
Budget Reform in Political Perspective 
-------------------------------------- 
 
16. (SBU) Budget reform is a positive story for Kenya, and 
progress is being made.  But it remains a slow, grinding 
process thanks to general political uncertainty, the need 
for better donor coordination, human capacity constraints, 
and resistance to change throughout the broader civil 
service bureaucracy.  Even in the current budget cycle, 
despite major strides forward, the planning process has 
been fraught with maddening delays and missed deadlines. 
The reforms are still being introduced and internalized. 
They are not yet firmly rooted. 
 
17.  (SBU) Politically, the process is fragile, as well, 
as it amounts in essence to an ambitious effort by the 
Ministry of Finance, backed by donors, to enforce both 
coordination and discipline across all ministries in the 
budget planning and expenditure management process.  This 
flies in the face of the instincts and interests of the 
majority of civil servants, most of whom are not merely 
content with the dilapidated status quo, but dependent upon 
it for their positions and influence.  The reform effort is 
centered very much on a small cadre of dedicated 
technocrats at the Ministry of Finance working under 
Permanent Secretary Joseph Kinyua, and the Ministry of 
Planning and National Development under Permanent Secretary 
David Nalo.  One wonders whether, once the implications of 
budget rationalization become better understood by the line 
ministries, front-line reformers like Kinyua and Nalo will 
be pushed out, particularly in light of the general lack of 
political will at the leadership level of the NARC 
administration to push through painful-but-necessary 
reforms.  It is clear that without sustained leadership, 
commitment, and the requisite expertise, the MTEF process 
would quickly grind to halt in Kenya. 
 
------------------------------ 
Comment: But What if it Works? 
------------------------------ 
 
18.  (SBU) That said, if the various budget and public 
expenditure reforms being rolled out under the MTEF 
actually begin to take root over the next 2-3 years, with 
buy-in from key line ministries, the gains to Kenya would 
be immense.  First, the GOK would be better able to direct 
its scarce public resources toward achieving its strategic 
economic development priorities.  Second, in turn, it wouldalso be able to 
ensure that those resources, once 
allocated, are actually being utilized as planned.  In the 
process, both the planning and expenditure systems would 
become far more transparent and accountable, both in 
political and financial terms.  This would mark a quantum 
leap forward in improving governance, eliminating now- 
pervasive graft, and strengthening democracy in Kenya.  As 
such, and despite the confusing plethora of acronyms and 
technical terms, the USG needs to closely monitor, and 
strongly support, the unfolding budget reform effort in 
Kenya. 
 
BELLAMY