US embassy cable - 05NAIROBI2651

UNCLAS SECTION 01 OF 03 NAIROBI 002651 
 
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 ANN ALIKONIS 
LONDON AND PARIS FOR AFRICA WATCHERS 
 
E.O. 12958:  N/A 
TAGS: ECON, EAID, EFIN, KCOR, PGOV, KE 
SUBJECT: KENYA'S IMF PROGRAM: PROGRESS HINGES ON 
PROCUREMENT LEGISLATION AND OTHER REFORMS 
 
Ref: 04 Nairobi 5038 
 
Sensitive-but-unclassified.  Not for release outside USG 
channels. 
 
1.  This is a Joint Embassy-USAID message. 
 
2.  (SBU) Summary: Kenya performed reasonably well in 
meeting the quantitative and structural targets of its IMF 
program during the current, second review period, and the 
government and the IMF have reached broad agreement for 
targets in the next review period, which in theory runs 
through June, 2006.  But the IMF is making passage of two 
important reform measures in Parliament -- and in 
particular enactment of the Procurement Bill -- necessary 
"prior actions" that the GOK must achieve now before the 
IMF will approve the next disbursement of funds and thus 
move the program forward.  This new-found toughness will 
likely assist reformers led by the Ministry of Finance in 
pushing through long-overdue procurement and other reforms, 
but it constitutes a bold and somewhat risky move by the 
IMF.  We support the IMF's stance given the importance of 
procurement reform not only to the fate of the IMF program, 
but also to Kenya's broader economic future.  End summary. 
 
3.  (SBU) Acting Director of USAID Kenya and Embassy Econ/C 
attended a June 28 briefing provided by Nairobi IMF 
Resident Representative Jurgen Reitmeier.  Reitmeier 
provided a comprehensive and transparent read-out of the 
results of the June 6-17 visit to Kenya by an IMF team led 
by Godfrey Kalinga meant to complete negotiations for the 
second review of Kenya's three year, $240 million Poverty 
Reduction and Growth Facility (PRGF). 
 
--------------------------------------------- -- 
Performance: Not Perfect, But No Major Problems 
--------------------------------------------- -- 
 
4.  (SBU) In discussing Kenya's performance since the 
completion of the first review of its IMF program in 
December, 2004, Reitmeier said Kenya had met four of six 
quantitative performance criteria.  The missed criteria 
include targets for reserve money and the Government of 
Kenya (GOK) wage bill.  In both cases, however, the margin 
of non-compliance was small (less than two percent), and 
the causes clear.  Staff would recommend waivers in both 
cases, Reitmeier noted. 
 
5.  (SBU) Similarly, in terms of structural performance 
criteria, Kenya met three of five targets.  The two missed 
items include the continued existence of legal controls 
over bank fees and charges, which the GOK has attempted to 
remove unsuccessfully by amending the Banking Act.  The 
other, considered minor, is the failure of the GOK to 
provide new wage guidelines to Kenya's Industrial Court. 
Again, Reitmeier implied that non-compliance in these areas 
would not be considered serious enough to hold up IMF Board 
approval for the next tranche of the PRGF to move forward. 
 
------------------------------------- 
Future Performance: Agreement Reached 
------------------------------------- 
 
6.  (SBU) An even more "positive angle" to the IMF/GOK 
discussions was the establishment of new performance 
criteria and benchmarks for the period running through the 
end of the fiscal year which begins July 1.  Reitmeier did 
not reveal specific details, but did offer the following 
assumptions built into the new quantitative performance 
criteria.  These include: 
 
-- GDP Growth: 4.6% for the fiscal year just ending June 
30; 4.9% for the following fiscal year. 
 
-- Inflation: Targeted to be reduced sharply from 13.6% (12 
month rate for end May 2005) to 5% by the end of June, 
2006.  The key to reducing inflation is tighter monetary 
policy, to be implemented through tighter targets for 
reserve money. 
 
7.  (SBU) On the structural performance side, Reitmeier 
highlighted the following for the next review period: 
 
-- Verification of asset declarations for all senior GOK 
officials, to be carried out by the Kenya Anti-Corruption 
Commission (KACC).  For more on this, see para 8 below. 
 
-- A "sharpening" of the Code of Conduct for senior GOK 
officials. 
 
-- A review of GOK wage and pay policies. 
 
-- GOK cash flow plans to be published quarterly as a way 
to generate greater predictability in financial markets 
concerning the GOK's borrowing needs. 
 
-- Tighter loan loss provisioning guidelines issued by the 
Central Bank. 
 
-- A financial review of the National Social Security Fund 
and 25 other parastatals. 
 
---------------------------------- 
Fly in the Ointment: Prior Actions 
---------------------------------- 
 
8.  (U) Reitmeier made clear, however, that all is not 
smooth sailing for Kenya's IMF program.  The area of 
contention is "prior actions" - those actions the GOK must 
achieve in the immediate near-term before the IMF Board 
will even meet to approve the next disbursement under the 
program.  Reitmeier listed four such actions: 
 
-- Enactment of the Public Procurement and Disposal Bill by 
Parliament. 
 
-- Enactment of an amendment to the Public Officers Ethics 
Act to allow for the verification of the asset declarations 
from senior GOK officials by the KACC (see para 7 above). 
 
-- Wage guidelines for the Industrial Court (a holdover 
from the current review period). 
 
-- Curtailment of the GOK's discretionary tax exemption 
authority. 
 
--------------------------------------- 
Why the Procurement Bill is So Critical 
--------------------------------------- 
 
9.  (SBU) Reitmeier focused on the first two actions, and 
in particular passage of the Procurement Bill, as essential 
to keeping Kenya's PRGF on track, and his comments jibed 
with those of Godfrey Kalinga, who told a small group of 
donors on June 10 that for the IMF, passage of this 
legislation is "fundamental to all our efforts" in Kenya. 
 
10.  (SBU) Reitmeier noted that both bills are important 
structural reform measures "necessary for the country and 
for governance."  During other parts of his presentation, 
he made clear why procurement reform is so essential to 
Kenya's development.  The GOK actually under-borrowed and 
under-spent its budget last year, he noted. This phenomenon 
is more a worry than a cause for celebration because it 
results from "dismally low" rates of utilization of 
available project funding in some areas, which in turn is 
caused in part by cumbersome procurement procedures. 
(Note: A Kenyan Treasury official told Econ/C in May that 
the Roads Ministry returned more than half the funds 
allocated to it last year for road building and repair. 
End note).  Making the link to the broader development 
agenda, the IMF has concluded that the current economic 
recovery, even in the 4-5% GDP growth range, is 
unsustainable without a "major push" in improving Kenya's 
infrastructure.  The upshot: While the absolute level of 
resources available to the GOK is one constraint, unless 
Kenya can spend the money that is being made available to 
it now, in part via procurement reform, current 
infrastructural constraints on the economy will make rapid 
economic take-off impossible over the medium- and long- 
term. 
 
--------------------------------------------- ---- 
Procurement Bill's Ripple Effect on Donor Funding 
--------------------------------------------- ---- 
 
11.  (SBU) Reitmeier added that passage of the Procurement 
Bill takes on even greater short-term importance because it 
is a condition of other donor programs which are integral 
to the GOK's fiscal health and to the country's development 
plans.  In particular, at least one World Bank budget 
support credit, along with a three-year $198 million budget 
support grant from the EU (reftel) require passage of the 
Procurement Bill among other pre-conditions.  Reitmeier 
made a point of emphasizing that if these budget support 
credits "slip away," it "effectively prevents us from 
moving forward."  The earliest the IMF Board would meet to 
consider completion of the second review is September, he 
said, and this will be pushed back further if Kenya has not 
completed the prior actions by this time.  He refused to 
speculate on the fate of the IMF program should passage of 
the Procurement Bill and/or other prior actions fail to 
materialize prior to the end of the year. 
 
12. (SBU) In a sidebar conversation at the IMF briefing, 
the EU delegation representative in attendance noted that 
while other conditions of the EU package could be waived if 
they are not met by the GOK, it is unlikely Brussels and EU 
member states would go along with waiving passage of the 
Procurement Bill as a condition.  Further, he noted that 
the EU money dedicated for budget support to Kenya 
"expires" at the end of the 2005 calendar year. 
 
------- 
Comment 
------- 
 
13.  (SBU) The upshot is that despite broad agreement in 
most areas under discussion with the GOK, the IMF has opted 
to play hardball by staking the future of Kenya's program 
on passage of two key governance-related bills now in 
Parliament.  In so doing, the IMF is providing ammunition 
to like-minded reformist officials in the Finance Ministry 
(and ultimately to President Kibaki) to push these bills 
through.  Getting any legislation out of Parliament, 
however, is a tenuous undertaking at best in Kenya and this 
is thus a bold and risky gambit.  But it is absolutely the 
right thing to do.  The IMF has concluded that without 
passage of the Procurement Bill, needed donor flows will 
dry up and likely doom the IMF program in any event.  The 
IMF also appears to realize that the time is right to 
finally get serious about passing reform legislation, and 
is shrewdly holding the GOK's feet to the fire.  We're 
impressed. 
Bellamy