By ANDREW KANYEGIRIRE, IMF’s Press Officer
A staff team from the International Monetary Fund (IMF) led by Mary Goodman conducted virtual missions to Kenya from December 9 to 17, 2020 and from February 4 to 15, 2021 to undertake negotiations on a combined 38-month program under the Extended Fund Facility (EFF) and Extended Credit Facility (ECF) arrangements.
At the end of the mission, Ms. Goodman made the following statement: “I am pleased to announce that the Kenyan authorities and the IMF mission team have reached agreement on economic and structural policies that would underpin a 38-month program under the EFF and ECF arrangements for about US$2.4 billion. The staff-level agreement is subject to IMF management approval and Executive Board consideration, which is expected in the coming weeks. The program will support the next phase of the country’s COVID-19 response and the authorities’ plans for a strong multi-year effort to stabilize and begin reducing debt levels relative to GDP, laying the ground for durable and inclusive growth over the years to come.
Kenya was hard hit at the onset of the COVID-19 crisis, but growth has been recovering since mid-2020 and heading into 2021.
The authorities’ forceful early actions cushioned the pandemic’s economic impact, and real GDP growth is projected to have contracted by just -0.1 percent in 2020. Inflation remained within the central bank’s target band, reaching 5.7 percent in January, while financial sector vulnerabilities have been contained and the banking system remains well capitalized overall. The external sector proved resilient against the backdrop of the shock, with horticultural exports and remittances performing well. The reopening of schools and removal of pandemic containment measures are expected to underpin a growth rebound to 7.6 percent in 2021, even as some sectors of the economy face continuing headwinds.
The Kenyan authorities have begun to roll back some of their extraordinary economic support measures. With the pickup in activity, the earlier temporary personal and corporate income tax cuts as well as the reduced VAT rate were discontinued at end-December, shoring up tax revenues. To maintain the cushion for the low income earners and for Micro, Small and Medium Enterprises (MSMEs), the Authorities did not reverse the personal relief on income tax and the lower turnover tax (1%) for small businesses introduced in April 2020. Many households and businesses continue to benefit from the temporary debt relief agreements reached with their banks, and borrowers accounting for a total of 54.2 percent of loans had entered such rescheduling agreements by end-2020. Overall, the authorities’ decision to pause fiscal adjustment this year will allow accommodating health, social, and development spending to support the recovery, complemented by accommodative monetary policy.
The mission team agreed with the authorities on a program to support the next phase of their COVID-19 response. The authorities’ program aims at reducing debt vulnerabilities through a multi-year fiscal consolidation effort, centered on raising tax revenues and tight control of spending, which would safeguard resources to protect vulnerable groups. It would also advance the structural reform and governance agenda, including by addressing weaknesses in some SOEs and ongoing efforts to strengthen transparency and accountability through the anticorruption framework. Finally, it would strengthen the monetary policy framework and support financial stability.
The program charts a clear path to reduce the vulnerabilities crystallized by the COVID-19 shock. Building on steps the authorities have already taken, the strong multi-year consolidation effort will deliver a primary balance that would stabilize debt as a share of GDP and put it firmly on a downward path over the course of the program. This will free up resources for private investment, setting a strong footing for durable growth coming out of this global shock. The program will also form a strong basis for support from other development partners.
COVID-19 continues to pose risks for the global economy and for Kenya. Risks generally remain to the downside, and projections are subject to extraordinary uncertainty. Accordingly, the program incorporates flexibility, including by recognizing near term uncertainties about tax yields due to challenges from the COVID-19 shock in key sectors like hospitality. As the authorities evaluate risks in the SOE sector, the program will support their plans over time to develop a strategy to address weaknesses in vulnerable SOEs within the scope of the limited available fiscal space. The team looks forward to close engagement with the authorities to evaluate the evolving landscape over the course of this year and achieve the program’s goals.
The mission team is grateful to the authorities for the candid and constructive discussions and their strong efforts to ensure success of the upcoming program.
The team met with Cabinet Secretary for the National Treasury and Planning, Mr. Ukur Yatani; Governor of the Central Bank of Kenya (CBK), Dr. Patrick Njoroge; Head of the Public Service, Mr. Joseph Kinyua; the Principal Secretary for the National Treasury, Dr. Julius Muia; Deputy Governor of the CBK, Ms. Sheila M’Mbijjewe; and other senior government and CBK officials. Staff also had productive discussions with representatives of the private sector, civil society organizations, and development partners.
IMF Loan to Support Economic Recovery in Kenya
IMF Country Focus spoke to the IMF mission chief for Kenya, Mary Goodman, who explained that the loan would be used to support the government’s reform plans and help meet financing needs.
What was the impact of the COVID-19 pandemic on Kenya and its economy? And how did the country respond?
Like many other countries around the world, Kenya was hit hard by the COVID-19 shock. The disruption in global trade and travel, and the containment measures put in place to limit the spread of the virus, meant that economic activity contracted sharply in Kenya in the second quarter of 2020.
School closures, curfews, and restrictions on public gatherings transformed daily life. Some lost their jobs, while many more felt the pressure from a loss of income. For the most vulnerable, this pressure translated into real hardship.
Forceful early actions to support the economy in the face of such an unprecedented shock included immediate temporary cuts in personal income taxes and corporate income taxes, a temporary reduction in the rate of the value-added tax from 16 percent to 14 percent, and revisions to the budget to accommodate additional spending on health and social protection.
The Kenyan Central Bank helped cushion the blow with interest rate cuts, and with liquidity injections to ensure the continued smooth functioning of Kenya’s financial system. It also encouraged banks to offer borrowers the chance to postpone loan payments. The temporary elimination of fees for mobile money transactions reduced costs for users and promoted transition from physical exchange of cash to a safer means of payment.
As a result, while the shock was large, the impact on economic growth has been contained. On a year-on year-basis, output growth recovered from -5.5 percent in the second quarter of 2020 to -1.1 percent in the third quarter. Growth in 2020 overall is likely to have been close to zero and it is projected to bounce back strongly in 2021.
While economic activity is picking up, many challenges remain. Public health is still under pressure with the rollout of COVID-19 vaccines just getting started. Higher poverty has set back progress towards Kenya’s development goals. Kenya’s fiscal and debt positions have also worsened, adding to difficulties that existed even before the shock.
The IMF provided emergency pandemic support last May, why is a Fund program needed now when the economy is recovering?
In May, the IMF provided $739 million in the form of an interest-free loan under the Rapid Credit Facility to help Kenya weather the initial shock. This helped to cover the cost of additional spending on health, social protection, and speeding up payments to bolster the economy.
The new program with the IMF will support the next phase of the government’s COVID-19 response. Combining arrangements under the Extended Fund Facility and Extended Credit Facility, it provides for $2.4 billion in low-cost financing over the next three years. Other development partners will also be providing substantial amounts of concessional financing. Without this help, Kenya would have to aggressively cut spending on investment and social programs, making it more difficult to achieve a durable and inclusive recovery.
Does the IMF propose fiscal consolidation for Kenya under the new loan arrangement?
As the pandemic continues to threaten both lives and livelihoods, the authorities are determined to protect vulnerable groups while also setting the stage for a strong recovery. The program enables the health, social, and development spending that is needed. This is being complemented by accommodative monetary policy.
The program also supports the authorities’ plan for fiscal consolidation over the medium term. Kenya is at high risk of debt distress and reducing the fiscal deficit as the COVID-19 shock fades is essential. The government has already begun reversing some of the extraordinary measures introduced at the start of the shock. This includes the temporary tax cuts, which ended at the start of 2021.
The 2021 Budget Policy Statement, which was released recently, gives an overview of Kenya’s priorities and fiscal policy goals. It envisages a multi-year effort through a combination of revenue mobilization and spending rationalization measures that will reduce the fiscal deficit to below 4 percent of GDP by fiscal year 2024/25. This will put the ratio of public debt to GDP firmly on a downward path.
The impact of fiscal consolidation would need to be softened by more efficient spending. Supported by transparent use of funds, this will help ensure that government spending is channeled to the areas where it is most needed. It will also free up resources for private investment. Together these steps will help put in place conditions for durable and inclusive growth, which should allow Kenya to quickly resume progress on its development goals.