US embassy cable - 05NAIROBI4599

UNCLAS NAIROBI 004599 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
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, PGOV, EAID, EFIN, KCOR, KE 
SUBJECT:  IMF BRIEFS DONORS ON KENYA'S ECONOMY AND PRGF 
PROGRESS 
 
Ref:  Nairobi 3129 and previous 
 
Sensitive-but-unclassified.  Not for release outside USG 
channels. 
 
1.  (SBU) SUMMARY:  IMF Mission Chief for Kenya Godfrey 
Kalinga briefed donors on the results of a 10-day IMF 
mission examining Kenya's progress on the second review of 
its three-year $326.7 million Poverty Reduction and Growth 
Facility (PRGF).  Kalinga was generally optimistic on 
Kenya's near-term economic performance and on progress made 
in meeting the second review's performance criteria and 
benchmarks.  He noted that sustained growth rates and 
progress on meeting the Millennium Development Goals (MDGs) 
will require improvements in Kenya's infrastructure and 
better budget management.  Kalinga assured the donors that 
the IMF remains concerned about governance, but is willing 
to work around the unfinished business of verification of 
public officer asset declarations in order to have a 
successful Executive Board Meeting, likely on December 21. 
We remain worried that Kenya's budget spending will become 
increasingly politicized in the run-up to the November 21 
constitutional referendum and the subsequent presidential 
election.  We also hope Kenya will focus its economic 
policies towards sound, pro-growth initiatives, and not 
simply target the MDGs.  END SUMMARY. 
 
--------------------- 
Economic Developments 
--------------------- 
2.  (SBU) IMF Mission Chief for Kenya Godfrey Kalinga 
briefed donors on October 28 on the results of a 10-day IMF 
mission on the second review of Kenya's three-year $326.7 
million Poverty Reduction and Growth Facility (PRGF). 
Kalinga said the IMF Executive Board is currently planning 
to meet on the Kenya program December 21, when it is likely 
to give a passing grade and authorize disbursement of the 
next US$ 72.6 million tranche of the credit. 
 
3.  (SBU) Kalinga confirmed the IMF's previous estimate of 
at least 5% GDP growth for Kenya in 2005.  The economy is 
performing better than anticipated one year ago, partly 
because growth is spreading to a broader range of sectors. 
He was also guardedly complimentary of the GOK's fiscal 
management for both revenues and expenditures.  With 
revenues exceeding projections, the expected budget deficit 
will likely not occur.  Due largely to favorable weather 
conditions leading to lower food prices, inflation has 
receded during the past few months.  At the same time, for 
Kenya to achieve significant transformational economic 
performance, it needs growth rates considerably higher than 
5%. 
 
4.  (SBU) The medium term outlook is also brightening, 
particularly because of improved security in Southern 
Sudan, resulting in increased economic activity for Kenyan 
goods and service suppliers.  Kalinga cautioned that Kenyan 
companies and authorities still needed to "take advantage 
of these opportunities." 
 
5.  (SBU) When asked, Kalinga admitted that there remains a 
significant "ceiling" on medium-to-long term growth, most 
notably from a lack of investment in Kenya's deteriorating 
infrastructure.  Despite recent upturns in manufacturing 
and trade, even 5% growth might not be possible beyond 
FY2005/6.  At the same time, Kalinga cited some important 
initiatives that should pay economic dividends, including a 
World Bank funded (and USAID/REDSO-supported) program to 
improve the Northern Transit Corridor, the recent joint 
Kenya-Uganda private contract for managing rail freight, a 
proposal to accelerate telecom reform, a more flexible 
approach to water management, and a proposal for 
privatizing container handling at the Port of Mombasa. 
 
----------------------- 
Pushing Good Governance 
----------------------- 
6.  (SBU) Kalinga assured the donors that the IMF remains 
concerned about governance issues, saying, "it is a key 
issue for all of us."  He sees some progress in the GOK's 
ability to investigate and prosecute corruption cases, but 
sees a need for additional capacity in these areas to deal 
 
with an "expected increase in cases."  [Note:  USAID/Kenya 
is providing support to strengthen the performance of the 
Department of Public Prosecutions.  End note.]  He also 
expressed concern for Kenya's underperforming parliament, 
and explained that without passage of the Miscellaneous 
Amendments Act, enabling legislation will not be in place 
for verifying senior GOK officials' asset declarations, 
which is a prior action for this second review.  Since 
parliament is unlikely to be in session again before the 
board meeting, Kalinga said that the IMF is working with 
the GOK on "substituting some other actions that will 
enable us to meet this requirement."  Specifically, the IMF 
has asked the GOK to develop an enhanced code of conduct 
for government officers, for both their official activities 
and private business interests. 
 
7.  (SBU) Prior to the board meeting, Kalinga hopes to see 
additional GOK efforts to improve fiscal "soundness," 
including more progress creating a robust expenditure 
monitoring system.  Looking further out, Kalinga 
highlighted the need to supplement the legislative 
framework in the fight against corruption, including, he 
hopes, passage of anti-money laundering legislation next 
year, and enhanced parastatal reform to include regular 
account audits. 
 
------------------- 
An Improving Budget 
------------------- 
8.  (SBU) In response to a question from USAID, Kalinga 
noted that improved management of expenditures is necessary 
for both Kenya's recurrent and its development budgets. 
However, with the recurrent expenditures dropping slightly 
to 20% of GDP and development funding increasing from 2% to 
7% of GDP in recent years, the GOK needs to improve its 
development processes and absorptive capacity.  With 
development resources coming from donor programs at 
approximately 4% of GDP, the GOK is hindered by the 
multiplicity of negotiations and funding conditions by the 
various donor organizations.  Kalinga agreed that even the 
recurrent budget is bogged down by the huge number of 
regulations and implementation instruments required by 
Kenya's vast bureaucracy.  President Kibaki needs to lead 
the way on more clearly-elaborating policy priorities, 
allowing the bureaucracy to be more proactive, rather than 
having "everything decided by the cabinet" which meets 
infrequently.  Kalinga is hopeful that the implementation 
of the Public Procurement Act, which was recently signed by 
Kibaki, will improve budget management for both development 
and recurrent spending.  [Note:  Another component of this 
effort is Kenya's Public Financial Management Reform 
Program, which the GOK hopes will be partially funded 
through its not-yet approved MCC Threshold program.  End 
Note.] 
 
9.  (SBU) When asked if he has confidence in the GOK's 
handling of expenses related to the current constitutional 
referendum campaign, Kalinga replied that there were clear 
line-items for additional referendum-related security 
measures, but that it is not possible to track all the 
funds.  In part, this is because Kenya needs more time to 
finish implementing its new system for allocating and 
monitoring expenditures.  He admitted not having a complete 
picture of how the budget is passing through the 
ministries, but hopes that will become clearer by mid- 
January.  Kalinga opined that he would like to see more 
effective parliamentary oversight of the budget, but that 
is "outside the scope" of the IMF mission.  [Note: 
USAID/Kenya's support for Parliament Strengthening provides 
assistance to budget oversight committees to enhance their 
capacity in this area.  End note.] 
 
------------------- 
How About the MDGs? 
------------------- 
10.  (SBU) Asked if Kenya's budget was on the right track 
for meeting the Millennium Development Goals (MDGs), 
Kalinga responded that Kenya needs to target around 4% of 
GDP to the MDGs to make real progress (and will require 
higher than 5% GDP growth), but this is not currently 
possible.  He also noted that the GOK needs to continue 
reducing some budget areas, such as defense spending and 
 
overseas diplomatic missions in order to create "fiscal 
space," and the ability to quickly address pressing needs, 
but, the country is still 2-3 years away from making this 
happen.  Also, according to Kalinga, Kenya's expenditure 
process is too inflexible to effectively address the MDGs. 
He feels that government decisions on allocations for key 
areas take much too long. 
 
11.  (SBU) Kalinga said that Kenya will also require more 
donor funds.  He elaborated that the current problem with 
absorptive capacity is not a significant concern if the aid 
is addressing areas that can utilize significant increases, 
like education and healthcare, and as long as the 
bureaucracy does not have to deal with too many separate 
administrative requirements.  He estimates that Kenya can 
manage additional donor contributions up to 7-8% of GDP, 
especially if some of that is managed by contractors. 
 
12.  (SBU) Kalinga admitted that the second review's 
performance criteria for new wage guidelines continues to 
slip, but that Kenya would be granted a waiver.  In what is 
a slight restatement of this criterion, he added that 
stabilization of the wage bill is the goal, not substantive 
cuts, since much of Kenya's development objectives are 
"labor intensive." 
 
------------------- 
Exchange-Rate Angst 
------------------- 
13.  (SBU) When asked about the current strength of the 
Kenya Shilling (currently trading at about 73 to the 
dollar, as opposed to a more historical level of 
78/dollar), Kalinga noted that he is supposed to report to 
the IMF on what's happening with the shilling's exchange- 
rate, but that the dynamics are not entirely clear.  He 
added that a stronger shilling is harming key export 
sectors, including horticulture and textiles, and does not 
compliment Kenya's overall development objectives.  Kalinga 
credits the Central Bank of Kenya for at least espousing an 
exchange-rate neutral position, notionally free from 
political interference.  The shilling's enhanced value is 
likely due to a combination of factors, including increased 
capital inflows from donors and NGOs (again, the Southern 
Sudan factor), increased remittances, and weak demand for 
investment funds domestically. 
 
------- 
Comment 
------- 
14.  (SBU) Kalinga appeared to be torn between an upbeat 
message on Kenya's progress and concerns about problematic 
foundations, including governance.  As with Kalinga's 
previous exchange, the donors expressed on-going worries 
about governance, security, and the GOK's seriousness to 
pursue real reform.  Ambassador Bellamy voiced our concern 
that President Kibaki and his pro-draft constitution's 
current policy of trying to buy votes by handing out title 
deeds, salary increases, and jobs is only a precursor for 
what will happen in the subsequent Presidential campaign. 
The likely consequence is that donors will be asked or 
required to take on more of the responsibility for meeting 
Kenya's basic needs during the next two years as the 
country's minimal development budget is further 
politicized. 
 
15.  (SBU) More immediately, we hope the IMF will be firm 
with Kenya in its discussions leading up to the December 
board meeting.  On verifying asset declarations, it is 
important to have a public GOK commitment to whatever 
interim agreement is hammered out.  Also, in outlining 
Kenya's budget framework and management, the IMF should 
push for policies that encourage sustainable economic 
growth and not allow the GOK to focus solely on meeting MDG 
criteria. 
 
BELLAMY