US embassy cable - 05NAIROBI2691

UNCLAS SECTION 01 OF 03 NAIROBI 002691 
 
SIPDIS 
 
SENSITIVE 
 
DEPT FOR AF/E, AF/EPS, AF/PD, EB/IFD, EB/ODF 
USAID FOR AFR/EA 
LONDON AND PARIS FOR AFRICA WATCHERS 
TREASURY FOR ANN ALIKONIS 
 
E.O. 12958:  N/A 
TAGS: ECON, EFIN, EINV, EAID, KMCA, KE 
SUBJECT:  KENYA'S BUDGET: MORE SPENDING, BUT BETTER FOCUSED 
ON DEVELOMENT NEEDS 
 
REF:  A) NAIROBI 2651, B) NAIROBI 1756 
 
Sensitive-but-unclassified.  Not for release outside USG 
channels. 
 
1.  (U) This is a joint State-USAID cable 
 
2.  (SBU) Summary:  Kenya's new budget for the fiscal year 
beginning July 1 foresees a 34% nominal increase in 
spending, but proposes to spend proportionally more money 
in areas deemed crucial to economic development and poverty 
reduction, namely health and infrastructure.  Estimated 
revenues will fall short of total spending, producing a 
budget deficit of around $2.4 billion.  However, budget 
planners prudently excluded anticipated (but not firm) 
revenues from donor projects; should these come on line 
later in the year, they would represent a budget windfall. 
The new budget is a positive step forward both in terms of 
an improved planning process, and in the resulting 
incremental realignment of spending towards priority areas. 
But the trick to making it really work will be in the 
implementation.  End Summary. 
 
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BUDGET BY THE NUMBERS 
--------------------- 
 
3.  (U) Kenya's budget for FY 2005-06 (which begins July 1) 
was presented to Parliament June 8 by Finance Minister 
David Mwiraria.  The budget as presented forecasts a record 
KSh 508.5 billion ($6.6 billion) in total spending, a 
nominal increase of 18% over the revised budget estimates 
for the fiscal year ending June 30.  On the other side of 
the ledger, total revenues will reach KSh 326 billion ($4.3 
billion), a 10.5% increase over the latest estimates for 
revenue collection in the current fiscal year.  This leaves 
a deficit before grants of KSh 182.5 billion ($2.4 
billion), which is more than a third larger than the 
deficit forecast for the present fiscal year. 
 
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SPENDING MORE ON DEVELOPMENT AND POVERTY REDUCTION 
--------------------------------------------- ----- 
 
4.  (U) In keeping with the theme of the budget speech - 
"Reorienting Expenditure to Achieve Rapid Economic Growth 
and Poverty Reduction" - the budget boosts development 
spending by 45% to KSh 104.2 billion ($1.4 billion). 
Recurrent spending, on the other hand, grew a more modest 
25%, while still constituting just under 80% of total 
expenditure.  Development spending still lags with a 20% 
share of total spending, but this is up from 17% last year. 
 
5. (U) Along the same lines, those ministries deemed 
essential to poverty reduction and economic development get 
bigger budget increases this year, driven in large part by 
large increases in their development budgets.  Budget 
standouts include: 
 
-- Health: Total allocation up 37.2%; development budget up 
123%; total share of spending up to 5.9% from 5.1% last 
year. 
 
-- Roads and Public Works: Total allocation up 47.3%; 
development budget up 95%; total share of spending up to 
5.6% from 4.5% last year. 
 
-- Water and Irrigation: Total allocation up 57%; 
development budget up 82.3%; total share of spending up to 
2% from 1.2% last year. 
 
6.  (U) Education saw its budget allocation rise by 14%, or 
by less than the increase in overall spending.  But the 
Education Ministry already dwarfs all others in total 
spending, with a 19% share of the budget, essentially flat 
from last year.  Its development allocation increased by 
43%, however, while budgeted recurrent expenditures rose by 
only 12%. 
 
7.  (U) Nearly all ministerial and agency line items in the 
new budget received larger allocations this year, 
reflecting that fact that spending is nearly a third higher 
than last year across-the-board.  The Office of the 
President (OP) and the Defense Ministry, for example, are 
big spenders generally, taking up nearly 7% and 5.5% of all 
spending respectively.  The OP budget is larger than last 
year, but grows by only 6.8%.  Defense is up 25%, which is 
still less than the increase in overall spending.  These 
increases, however, have still generated criticism and 
debate in both Parliament and the press over whether the 
government is providing enough resources to core poverty 
reduction programs, despite the big increases in health, 
infrastructure, and education. 
 
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REVENUES AND FINANCING THE DEFICIT 
---------------------------------- 
 
8.  (U) The Kenya Revenue Authority (KRA) outdid itself 
during the past fiscal year, raking in KSh 293.4 billion 
($3.8 billion), 13% more than originally anticipated. 
Recognizing that some of last year's growth came from one- 
time-only gains, including a tax amnesty, the new budget 
anticipates only a 10.5% increase in revenue over last 
year, not enough to balance the budget.  The Finance 
Minister plans to plug the $2.4 billion budget gap through 
external assistance in the form of grants ($372 million), 
new external borrowing ($514 million), privatization 
proceeds and bank restructuring proceeds ($220 million), 
other items ($1.1 billion), finally, new domestic borrowing 
of KSh 25.4 billion ($338 million). 
 
9.  (U) As such, the budget as presented foresees a 
substantial increase in the stock of domestic debt. 
However, in drafting the budget, the Finance Ministry 
consciously exercised fiscal prudence by including only 
firm commitments from donors, and excluding conditional 
offers of assistance.  As such, should the government meet 
the conditions for upcoming World Bank and bilateral 
credits and grants during the course of the year, the 
revenue will constitute a windfall which can be used to 
increase spending in priority areas, or to reduce domestic 
borrowing. 
 
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TAX AND TARIFF CHANGES 
---------------------- 
 
10.  (U) In keeping with the "pro-poor" budget theme, 
Mwiraria also announced a number of tax changes designed to 
lower living costs for the poor.  Some of the highlights 
include: 
 
-- Tariffs on imported used hand clothing will drop to 45% 
of ad valorem or $0.30 per kilo (from 70% or $0.60 per kilo 
previously). 
 
-- Tariffs on imported pharmaceuticals will return to being 
zero rated after being raised to 20% on January 1 upon 
formation of the East Africa Customs Union. 
 
-- Tariffs on diapers, sanitary pads, cooking gas, coal and 
media containing software zero rated. 
 
-- VAT on sanitary towels, LPG, maize flour, milk and 
kerosene all zero-rated. 
 
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COMMENT 
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11.  (SBU) The new budget is good news in two respects: 
first, the process by which it was formulated was a big 
improvement over past practice (see ref B) in terms of 
discipline, transparency and buy-in from line ministries. 
Second, and in large part as a result of improved budget 
planning, the content of the budget has succeeded in more 
closely aligning planned spending with areas considered 
priorities under the country's economic development 
blueprint, the Economic Development Strategy.  An IMF team 
visited Kenya just after the budget was presented, and has 
incorporated it "lock, stock and barrel" into the 
performance criteria for the next review period under 
Kenya's IMF program.  The World Bank commented at a recent 
donor coordination meeting that the new budget represented 
a "huge move forward" both in terms of process and results, 
and noted that Kenya is likely to realize unbudgeted 
revenues from donors which the Bank is confident will be 
used to fund priority development projects. 
12.  (SBU) The trick, however, will be in implementation, 
especially at the line ministry level, where past practice 
has shown wide divergences between the budget forecast and 
the actual outturn, both in terms of overspending in some 
areas and under-spending in others (ref B again).  The 
Roads Ministry, for example, is slated to receive another 
major boost in funding this year to build roads.  This is 
fully justified given the urgent need for better roads in 
Kenya as a way to maintain and accelerate economic growth. 
However, because of human capacity constraints and 
cumbersome procurement processes, the Ministry last year 
spent less than half the funds allocated to it for this 
purpose.   Typically, ministries less involved in providing 
critical services and infrastructure (e.g. the Office of 
the President) overspend their allotments.  In short the 
Finance Ministry, which deserves the lion's share of the 
credit for improving the budget process, still has its work 
cut out for it in terms of ensuring discipline as the 
budget moves from being just a plan to being money actually 
spent. 
 
13.  (SBU) Along these same lines, we note that a number of 
commentators have asserted that Kenya's new budget lacks 
full transparency in terms of destination and use of 
allocated monies.  This is nothing new, but unlike in past 
budgets, when which particular budget lines were specified, 
the new system of printed estimates is devoid of details of 
where and how the money is to be spent.  While these 
changes have been introduced to improve pipeline management 
and facilitate shift from one ministerial line item to 
another in case of either slow disbursement or emergency, 
the fact that the actual disbursement decisions will be 
left to individual ministers raises the specter of 
political manipulation by ministers (who are sitting MPs) 
in the run-up to the 2007 general elections.  Also, under 
the current system, tracking of expenditures can only be 
implicitly inferred from budget lines leaving wide scope 
for possible financial impropriety and mismanagement. 
Again, this in many ways is nothing new, and serves as a 
reminder that the ultimate success of the budget will be 
more in the implementation than in the planning. 
BELLAMY