Nairobi, July 12, 2000

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street NW
Washington, D.C. 20431

Dear Mr. Köhler:

1. The attached memorandum outlines the policies and reforms that the government of Kenya plans to adopt during 2000-03. The main goals of our medium-term policies and reforms are to reduce poverty and to increase economic growth. In support of these policies and reforms, the government of Kenya requests a three-year arrangement supported under the Poverty Reduction and Growth Facility in an amount equivalent to SDR 150 million.

2. The government of Kenya is preparing a poverty reduction strategy paper (PRSP) that will involve close consultation with the poor, civil society, the private sector, and development partners. Under this process, the medium-term policy framework will be fully developed. In the meantime, an interim PRSP, with a preliminary policy framework for poverty reduction and a timeline and process for preparing the full PRSP, has been prepared and sent to the Fund and the World Bank.

3. A first program review will be completed by December 15, 2000 on the basis of amendments to the draft bill on the code of conduct for public officials that would be submitted during the October 2000 parliamentary session, and to help monitor closely the program during its first six months. Subsequent reviews will follow the standard semiannual pattern. Specifically, the midterm review of the first-year program will be completed by March 2001, and will consider, inter alia, the budgetary policy framework for 2001/02 (July-June) and progress in addressing governance problems. The government of Kenya will provide the Fund with such information as the Fund requests in connection with Kenya's progress in implementing the economic and financial policies and achieving the objectives of the program.

4. The government of Kenya believes that the policies set forth in the attached memorandum of economic and financial policies are adequate to achieve the objectives of the program. During the arrangement period, the government of Kenya stands ready to take additional measures that may become appropriate for this purpose. We will consult with the Managing Director of the Fund on the adoption of any measures that may be appropriate, at the initiative of the government of Kenya or whenever the Managing Director requests such consultation. Moreover, after the period of the arrangement and while Kenya has outstanding financial obligations arising from loans under the arrangement, Kenya will consult with the Fund from time to time at the initiative of the government or whenever the Managing Director requests consultation on Kenya's economic and financial policies.

Very truly yours,

Attachments

Memorandum of Economic and Financial Policies of the
Government of Kenya, 2000-03

1. Kenya's socioeconomic conditions have deteriorated since the early 1990s, mainly because of a failure to sustain prudent macroeconomic policies, slow progress in structural reform, and pervasive governance problems. This weak performance has been characterized by periodic financial instability, loss of confidence, a rapid buildup of short-term domestic debt, and very high real interest rates. These factors, together with other high costs of doing business—on account of poor infrastructure and services provided by public enterprises, inefficient allocation of public resources, deteriorating security, and constraining government regulations (especially in agriculture)—have reduced the level and quality of investment. As a consequence, economic growth has dwindled and unemployment has risen, which, combined with declines in access to essential services by the poor, has contributed to significant increases in poverty.

2. The most recent household survey (1997) shows an increase in the population living in poverty to about 52 percent of the total. While most of the poor live in rural areas, this increase is also evident in the urban areas as a consequence of rising unemployment. A decline in the gross primary enrollment ratio from 94 percent in 1993 to 83 percent in 1998 and an erosion in the capacity to provide basic health services are two indicators of the deterioration in living standards. This deterioration is compounded by the heavy toll taken by the HIV/AIDS epidemic, which in part is reflected in the estimated decline of life expectancy from 60 years in 1993 to 57 years in 1998.¹

3. Since 1998, the government of Kenya has been taking steps to address some of the socioeconomic ills confronting the country. Macroeconomic policies have been appropriately tightened, leading to a marked decline in inflation and real interest rates. In 1999/2000 (July-June), the government has maintained prudent macroeconomic policies, notwithstanding weak revenue performance and a large increase in external debt amortization. The government deficit (on a commitment basis and before grants) is 0.6 percent of GDP, compared with 0.7  percent in 1998/99, and monetary policy has been conservative; as a result, inflation has remained under control, and net international reserves have been rebuilt. The government has initiated key structural reforms in the areas of privatization and public service (including civil service retrenchment); since mid-1999, it has also taken important steps to address governance problems. However, real GDP growth is estimated to have declined from 1.8 percent in 1998 to 1.4 percent in 1999, reflecting the constraints noted in paragraph 1.

4. The government is committed to intensifying the reforms mentioned above, since considerably more needs to be done over the near and medium term to help increase economic growth and reduce poverty. To this end, it has prepared an interim poverty reduction strategy paper (PRSP) that outlines a preliminary policy framework, which will be fully developed in the context of the full PRSP, scheduled to be finalized by May 2001. The interim PRSP—which has been made public and distributed to the IMF, the World Bank, and donors—has benefited from inputs received from representatives of the poor, the private sector, civil society, and development partners in the context of a wide-ranging consultative process that was launched in March 2000. A recently introduced medium-term expenditure framework (MTEF) was used to prioritize the policies contained in the interim PRSP and is the basis for the 2000/01 fiscal program. The implementation of these policies, as well as those to be developed in the subsequent full PRSP, will help achieve the objectives of the National Poverty Eradication Plan (NPEP) for the period 1999-2015. The plan, which was prepared in the context of a participatory poverty assessment, aims at reducing the number of the poor by one-half by 2015, and stresses the need to provide better coverage of basic services, particularly education, health, and water and sanitation, as well as the need for broad-based economic growth.

5. The primary development goal of the government is to achieve sustained poverty reduction through the pursuit of policies and reforms that would increase economic growth to high and sustainable levels, and through key reforms in social areas, including well-targeted poverty reduction measures. The government's program for the next three years aims at (i) progressively increasing real GDP growth to 5.5 percent by 2003, which is consistent with modest increases in real per capita GDP; (ii) keeping inflation below 5 percent; and (iii) gradually raising the import reserve cover to about four months to help limit the impact of adverse external shocks, while maintaining the current account deficit at sustainable levels.

6. To achieve these objectives, key elements of the government's policy framework include the consolidation of macroeconomic stability, a necessary condition for achieving the desired economic growth; a comprehensive and systematic set of measures to improve governance, so as to reduce corruption and ensure that public resources are effectively allocated to priority areas such as health, education, infrastructure, and security; and wide-ranging reforms to remove structural constraints. The proposed program, including the envisaged acceleration of structural reforms, would improve the enabling environment for private sector investment, raising investor confidence and reducing the costs of doing business in Kenya and thus strengthening Kenya's external competitiveness. On macroeconomic policies, the medium-term fiscal objectives in the MTEF during 2000/01-2002/03 are to gradually and credibly reduce fiscal deficits (after an initial modest increase to accommodate higher expenditure in priority areas) and to bring down the domestic debt burden in order to rebuild private sector confidence and lower real interest rates. To improve the quality of service delivery, the government will reduce the size of the civil service in line with identified core government functions. The fiscal strategy is consistent with the need to keep the external current account deficit at sustainable levels and envisages a gradual reduction in the tax burden. Monetary policy will continue to be geared toward maintaining low inflation and gradually raising international reserves.

7. The government will accelerate and broaden the scope of privatization of key public enterprises; reduce the regulatory constraints affecting economic activity, particularly in the agriculture sector where most of the poor derive their income; review the regulatory framework in the labor market to remove possible impediments to the creation of employment opportunities; and rationalize the import duty regime to render it more predictable and transparent.

8. While higher economic growth is a necessary condition for increasing employment and reducing poverty, specific policies and measures are needed to ensure that the benefits of growth will reach all parts of society, especially the poor. Some of these policies and measures, in the areas of education, health, water and sanitation, rural infrastructure, and agriculture sector reform, are already reflected in the government's program, but more needs to be done. During the preparation of the full PRSP—which will involve close and wide-ranging consultations between the government and the poor, the private sector, civil society, and development partners—the government expects to continue to gain a deeper understanding of the nature and determinants of poverty, and of the type of policies and programs that would be more effective in reducing poverty. As a result, the MTEF will be refined to ensure that adequate resources are provided to such programs, including the reallocation of expenditure away from lower-priority areas. At the same time, the government will fully develop input and outcome social indicators and monitoring mechanisms to gauge the effectiveness of these programs in achieving established objectives. The government will ensure that these policies and programs are consistent with and will promote high real GDP growth and macroeconomic stability.

III. Economic Program for 2000/01

9. Good governance is a fundamental building block of a just and economically prosperous society and, therefore, is an essential component of the action plan to reduce poverty. Since mid-1999, the government of Kenya has made significant progress in addressing governance problems. This progress includes increased transparency of the procurement system, improved budget planning and expenditure management, and the gradual strengthening of the Kenya Anti-Corruption Authority (KACA) and the Office of the Controller and Auditor General (C&AG). The government is determined to maintain the present momentum in governance reforms and has, therefore, adopted a comprehensive set of measures and an implementation timetable (Appendix VI) based on a systematic approach to addressing the problem. The approach has focused on (i) enhancing accountability and transparency; (ii) strengthening oversight bodies; (iii) strengthening budget planning and execution; (iv) changing the incentive structures faced by potential participants in corruption; and (v) removing rent-seeking opportunities. Some of the measures will constitute performance criteria or benchmarks under the program, as indicated in Table 1. To enhance the transparency of the governance reform program and establish broad public support for it, the government added the list of these measures as an annex to the interim PRSP, and submitted to parliament its governance program.

10. The government has by end-June 2000: (i) published in the official gazette, a bill containing a code of ethics for all holders of public offices that provides for clear sanctions against actions contrary to the code, and that requires holders of public office to declare their assets and liabilities upon appointment and every three years thereafter or upon leaving the service;² (ii) provided adequate support to KACA and the C&AG under the 2000/01 fiscal program; (iii) reissued accounting officers' letters of appointment to emphasize their responsibility in strengthening expenditure control and the sanctions to be applied for failure to uphold these responsibilities; and (iv) adopted a concrete plan to strengthen expenditure management (see paragraph 16). In the case of the submitted bill containing the code of ethics, the government intends to amend it inter alia to strengthen the independence of the Public Service Committee examining alleged infractions of the code, to broaden the categories of family members required to declare assets and liabilities, and to broaden the definition of the types of assets and liabilities to be declared. The government understands that the introduction of these amendments constitutes a condition for the completion of the first review of the program by December 15, 2000. Furthermore, the government is committed to publish in the official gazette, not later than 30 days after the determination (i.e., completion of the discussion) by parliament on the Report of the Select Committee of Parliament on Anti-Corruption, an Anti-Corruption and Economic Crimes legislation that is essentially similar to the bill annexed to that report. The government understands that the relevant review of the first-year program is contingent on the fulfillment of this commitment. The bill aims, inter alia, at increasing the accountability of public officials and strengthening the ability of KACA to investigate and prosecute cases of misuse of public resources. The government expects that the legislation will be enacted by year's end.

11. In line with the medium-term objectives outlined in paragraphs 5–8, the program for 2000/01 (July-June) aims at (i) accelerating economic growth from 1.5 percent in 2000 to 3 percent in 2001; (ii) maintaining inflation at 5 percent; and (iii) increasing gross reserves by June 2001 to the equivalent of 2.9 months of the following year's imports of goods and nonfactor services.

Fiscal policy

12. Kenya's fiscal framework for  2000/01 reflects the policy reprioritization described above, and aims at reducing the government's domestic debt (which will help to sustainably lower treasury bill rates, the benchmark for lending rates in Kenya) and help keeping inflation and the external current account deficit under control. To this end, the fiscal program for 2000/01 envisages an overall deficit (on a commitment basis and before grants) of K Sh 12,266 billion, or 1.5 percent of GDP, compared with 0.6 percent in 1999/2000.³ At the same time, given the need to intensify the efforts to reduce poverty, the program allows for a maximum of K Sh 4 billion (0.5 percent of GDP) in additional outlays in the priority areas of education, health, water and sanitation, and rural infrastructure over and above those included in the fiscal program, provided that additional concessional foreign financing is forthcoming on a sustainable basis. Before committing any additional expenditure in these areas and correspondingly raising the overall government deficit, the government will consult with the staffs of the Fund and the World Bank. Appropriate performance criteria and benchmarks on fiscal performance during 2000/01 are contained in Table 1. The technical memorandum of understanding (Annex II) defines those variables and actions that will be subject to these and other performance criteria and benchmarks.

13. The fiscal program envisages a modest rise in the ratio of revenue to GDP from 23.9 percent in 1999/2000 to 24.8 percent in 2000/01. An increase in the value-added tax (VAT) rate from 15 percent to 18 percent⁴ will offset the loss of revenue arising from (i) cuts in import duties (see paragraph 22) and the excise on beer; (ii) the full-fiscal-year impact of a cut in income tax rates and bracket adjustment made on January 1, 2000; and (iii) further adjustments in brackets and the personal tax allowance (exemption) that are to take place on January 1, 2001. The adjustments in income taxes are mainly aimed at relieving the tax burden on the lower-income groups. In support of its revenue targets, the government will continue to strengthen tax administration in 2000/01 by, inter alia, transferring stamp duties and civil aviation revenues to the Kenya Revenue Authority (KRA) for collection, and reducing fraud associated with traffic licenses. These measures have been in place since July 1, 2000. The government also intends to transfer the collection of the catering and training levy to the KRA during 2000/01. To help improve tax and customs administration, the government will seek technical assistance from its development partners.

14. As a result of the MTEF exercise and the progress made in the governance area, the efficiency and effectiveness of government spending is expected to improve considerably. But there is also a need for a modest increase in such spending. Accordingly, total expenditure is targeted to rise by 1.8 percent of GDP to 26.3 percent in 2000/01, mainly reflecting the impact of the costs of the civil service reform (see paragraph 28), as well as increases in other recurrent expenditure. Personnel costs (excluding retrenchment costs) will increase by about 11 percent—after adjusting the base by nearly K Sh 3 billion savings because of the retrenchment—owing to a wage drift of 2 percent and an increase in the housing allowance for civil servants and teachers; a wage increase to the lowest-paid civil servants to bring their wages to the legal minimum wage; and salary increases for the security forces that had been promised four years ago but postponed for lack of funds. These increases could not be delayed further without undermining the motivation and discipline in the security forces and desired improvements in service delivery in the public sector. Other recurrent expenditure (excluding retrenchment costs) would increase from 10.7 percent of GDP in 1999/2000 to 11.7 percent in 2000/01 on account of higher nonwage expenditure in road maintenance, water and sanitation, and security (for the latter, see paragraph 24), as well as larger transfers to local authorities. Development expenditure and net-lending is expected to rise marginally from 3.5 percent GDP to 3.6 percent, reflecting government efforts to improve the quality of projects, which has deteriorated significantly in recent years.

15. Consistent with the objective of reducing the domestic debt burden, the fiscal program envisages the repayment of K Sh 6.7 billion of government securities on a net basis and the elimination of pending bills (see paragraph 17). This would be facilitated by the considerable increases expected in privatization proceeds and in external financing, including US$167 million expected from the rescheduling of outstanding arrears and of part of the external debt service falling due in 2000/01 that Kenya intends to request soon from its creditors.

16. The government will strengthen its expenditure management systems to help prevent a new accumulation of pending bills. In this context, it reissued on July 11, 2000 accounting officers' letters of appointment highlighting their financial responsibilities and the sanctions to be applied for failure to uphold these responsibilities. Furthermore, it will shift the supervision of district treasury offices from the Office of the President to the Ministry of Finance by December 2000. Moreover, during 2000/01, the government will (i) place financial officers at the apex of line ministry financial management, clarify their reporting channels and responsibilities, and provide them with sufficient independence by requiring that their annual performance review be finalized by the Ministry of Finance; (ii) revise the format of the vote book and expenditure returns to incorporate information on expenditure arrears; (iii) develop, with technical assistance from the IMF, a system to strengthen expenditure commitment controls, including in the districts; and (iv) clarify the roles and responsibilities (including those regarding financial reporting) of the various treasury departments involved in the budget preparation and execution process. In addition to these measures, the government has provided sufficient funding to the C&AG to enable it to complete the auditing of the 1998/99 and 1999/2000 central government accounts by the end of June 2001. To aid in the implementation of this reform plan, the government has requested technical assistance in expenditure management and budgeting from the IMF. The government is also requesting technical assistance from the IMF to review the internal audit system, with the aim of developing concrete reforms to strengthen it.

17. In an effort to gradually eliminate outstanding pending bills (domestic arrears), the government issued by June 2000 bonds amounting to K Sh 3.4 billion to cancel most of those pending bills that have been properly verified. This leaves the stock of outstanding pending bills at K Sh 8.5 billion, of which K Sh 5.5 billion is being disputed by the government; the remaining K Sh 3 billion will be securitized by December 2000, of which K Sh 1.7 billion is still to be properly verified. The government will develop by December 2000 a strategy to prevent the further accumulation of pending bills by other public sector institutions, and to eliminate the outstanding pending bills after appropriate verification. In the interim, the accounting officers supervising these institutions will exercise expenditure control and take disciplinary measures on managers incurring commitments outside the approved fiscal program.

18. The government has terminated all nonpriority extrabudgetary projects and has brought the highest-priority extrabudgetary projects into the 2000/01 fiscal program, in line with the MTEF exercise, and has made provisions in the fiscal program for the termination costs of others that were clearly deemed not to warrant completion. The government has also made provisions in the fiscal program for interest and penalties caused by some stalled projects. All the remaining stalled projects will be reassessed by December 2000 as to whether they will be sold or completed by 2001/02 and beyond. The proposed strengthening of expenditure management will help prevent the reemergence of the extrabudgetary transactions in the future. To further bolster progress in this area and improve the selection, appraisal, and overall management of the development expenditure, the government intends to seek technical assistance from the World Bank.

Monetary policy

19. The monetary program for 2000/01 aims at achieving the inflation and net foreign assets targets of the program, while providing room for an adequate increase in credit to the private sector so as to help achieve the real GDP growth objective. This policy is consistent with a rate of growth of about 8 percent for broad monetary aggregates, taking into account, inter alia, the planned reduction in domestic government debt. The conduct of monetary policy will continue to be based on indirect monetary control instruments. Appropriate performance criteria and benchmarks on monetary performance for 2000/01, including on international reserves of the Central Bank of Kenya (CBK), are contained in Table 1. Regarding the external value of the shilling, the central bank will continue to maintain exchange rate flexibility. CBK intervention in the exchange markets will be guided by the need to achieve the program's net foreign assets targets.

20. Consistent with its privatization strategy (see below), and to help strengthen the financial system, the government is committed to selling the government's shares in the Kenya Commercial Bank (KCB). The offer for sale is scheduled for September 2000, and the transaction is expected to be completed by March 2001. The restructuring of the National Bank of Kenya (NBK) will be accelerated, including by intensifying efforts to collect or restructure nonperforming loans, and the bank will be privatized as soon as possible. The loan recovery effort will be supported by a substantial increase in the number of judges during 2000 to handle debt recovery in the courts and general banking litigation. To strengthen further the role of the Banking Supervision Department (BSD) of the CBK, the following measures have been or will be adopted: (i) in July 2000, the CBK will issue regulations establishing minimum capital adequacy ratios, and the amount of risk banks may incur in foreign exchange open positions, and it will clarify the reporting requirements of banks to the CBK; (ii) in July 2000, the CBK Board will adopt (and publicize widely) a written policy for prompt, progressive intervention (including through monetary penalties) for noncompliance by banks and their managements with statutes and regulations; (iii) by September 2000, the CBK will issue prudential regulations and policies, including, inter alia, on the amount of risk that banks may incur in lending operations, with a view to clarifying and expanding on prohibited activities; and (iv) by March 31, 2001, comprehensive amendments will be submitted to the Banking Act and the Building Society Act regarding the role of CBK in, inter alia, supervising all institutions involved in banking activities.

21. The current account deficit is expected to reach 6.4 percent of GDP in 2000/01, mainly on account of an expected pickup of imports in the energy and airline sectors. However, the projected improvement in the financial account—mainly on account of higher expected capital inflows—should allow reserve coverage of the following year's imports to increase to 2.9 months by June 2001. After tentatively identified program financing has been taken into account, a residual gap of about US$167 million remains; in order to close this gap, it is expected that Kenya will seek a rescheduling with the Paris Club of its eligible external arrears and some of the maturities falling due on eligible debt.

22. The government is committed to simplifying the trade regime so as to make it more transparent and predictable. Under the 2000/01 fiscal program, the government replaced existing suspended duties with constant tariffs⁵ and at the same time reduced the number of resultant tariff bands, excluding sugar, from 13 to 9. Import duties applied to raw materials, such as rubber, vegetable oils, pulp, and crude minerals, have been reduced. The government intends to prepare a program to rationalize and lower import duties in line with Kenya's commitment under the Cross-Border Initiative and to facilitate achievement of the common external tariff structure under the Common Market for Eastern and Southern Africa (COMESA) and the East African Cooperation (EAC).⁶ The government, in consultation with the staffs of the IMF and World Bank, will develop this program by March 2001, with a view to initiating its implementation in July 2001. It is also committed to further restricting the scope of import duty exemptions. In 2000/01, donated passenger vehicles will no longer qualify for duty exemptions, and in 2001/02 major import exemptions awarded to the public sector will be discontinued.

23. The government has reviewed its external debt records and has captured all outstanding commitments. To help prevent the reemergence of debt-management problems, the government has simplified debt-management procedures—all debt approval and monitoring now pass through the debt-management division of the Ministry of Finance—and these have been codified in a ministerial circular. Furthermore, the debt-management division and the external resources department has started in June 2000 preparing quarterly reconciliations with the Accountant General's records.

24. Physical security in various parts of the country has deteriorated considerably, reflecting partly the continued instability in bordering countries and the worsening poverty situation in Kenya. Crime, especially in urban areas, is also becoming increasingly serious. As part of its effort to address these problems, the government is taking steps to strengthen security and police forces. These include (i) taking stock of existing training and the state of equipment and facilities in the police force in order to come up with improvements; (ii) increasing pay and housing provisions for security forces to reduce corruption and improve their conditions of living; (iii) providing training, including on human rights practices; and (iv) developing a code of ethics for law enforcement officials.

25. Serious and repeated deterioration in weather conditions has resulted in large shortages of staple food items, especially in certain parts of the country. International food relief has been helpful, but much remains to be done. In the fiscal program for 2000/01, the government has provided K Sh 1.5 billion for food relief in the form of maize purchases; the situation will be kept under review.

26. As in the case of domestic food supply, hydroelectric power supply is also being seriously undermined by recurrent drought conditions. As a result, severe power rationing has now been introduced. The shortage of hydroelectric power will last at least six months, and then will depend on the extent of the rains expected in November and December. Arrangements for limited off-peak power imports from Uganda have been concluded, and a fossil fuel plant is being rehabilitated. The government is investigating all options to minimize the adverse impact of power shortages on production and living conditions. In the short run, these options include increases in domestic prices to ration power, the use of emergency generators, and tax breaks to encourage private sector production and to reduce the costs of incremental fossil fuel usage. Discussions with donors are being held to seek both technical advice and financial assistance. For the medium term, least-cost strategies for stabilizing the power supply are being reviewed, including linking Kenya into the southern Africa grid.

27. In the period 2000/01-2002/03, the government of Kenya will accelerate and broaden the scope of structural reforms, which are essential for enhancing the economy's growth potential and reducing poverty. Priority areas include public service reform, reprioritization of government expenditure, the acceleration of the privatization of key state-owned utilities and transportation enterprises, and the removal of other structural constraints, especially in agriculture.

28. The government completed its preliminary functional review of ministries and departments and has defined core government functions, which are consistent with the objective of establishing an efficient and affordable public service. Accordingly, the size of the civil service (excluding teachers) will be reduced by 32,348 (15.5 percent of the total) during 2000/01-2001/02; of that total, 25,783 civil servants will be removed from the payroll by September 2000. In addition, the civil service will be reduced by about 8,800 employees over the two years through national attrition. The retrenched civil servants will be provided with adequate severance pay, in accordance with a plan developed with the assistance of the World Bank staff and donors. In addition to the expected improvement in the efficiency of the public service, this reform will allow the government to increase the allocation of resources to priority areas, and to gradually improve the civil service pay structure. Furthermore, under the same retrenchment program, about 7,000 employees of the public universities, the Kenya Revenue Authority, an agricultural research institute, and the Catering and Training Levy Trust will also be separated.

29. Under the first phase of the privatization program, which was initiated in 1992, the government privatized a large number of small and medium-sized enterprises, but progress in privatizing key utilities and transportation enterprises has been slow. In 2000/01, the government will accelerate the second phase of its privatization program on the basis of a new privatization strategy that emphasizes limiting the role of government in commercial activities, putting in place an appropriate regulatory framework, and using competitive bidding and other modalities to ensure transparency and fairness. This is being done with assistance from the World Bank. The Kenya Posts and Telecommunications Corporation has been split into TELKOM and the Postal Authority, and a regulatory body has also been created. Moreover, a license was provided to a second cellular telephone operator to increase competition in the sector. In this context, the government has offered for sale 49 percent of the government's share in TELKOM. The separation of Kenya Power and Lighting Company into power generation (KenGen) and power distribution (KPLC) is well advanced and will pave the way for the restructuring and privatization of both companies. Regarding Kenya Railways, the government decided to offer unitary concessions to private sector operators. The government's short-term strategy for the Kenya Port Authority is to improve the availability and reliability of container terminal handling equipment by refurbishment and replacement, while partly privatizing certain services of the port, including the container terminal, through a strategic partner.

30. Over the medium term, in close collaboration with the World Bank, the government plans to improve the provision to the poor of basic social services, such as preventive health care, primary and secondary education, and water and sanitation. This will be achieved by shifting resources from wage to nonwage expenditure, improving the targeting of subsidies, as well as by improving the efficiency of service delivery. The development of appropriate monitoring and evaluation mechanisms will, however, only emerge from the full PRSP process. The 2000/01 program thus focuses on a few key poverty reduction measures. In line with the National Health Strategic Plan, the program envisages a reallocation of resources spent in curative services to primary care in rural areas. In this context, starting in 2000/01, fiscal expenditure allocations will be shifted from centralized hospital care to decentralized, preventive health care. Combating the HIV/AIDS epidemic is an essential element of the government's strategy in the health sector, and the government will provide more resources for this endeavor starting in 2000/01, including for education programs, with particular focus on local levels. The government will provide adequate resources to the National AIDS Coordination Council to combat the HIV/AIDS epidemic and assist its victims, especially orphans.

31. In the education sector, the emphasis is on increasing enrollment by lowering parents' high cost of primary and secondary schools, reflecting too many subjects, and a low student- teacher ratio. In this regard, the 2000/01 fiscal program provides for an increase of 22 percent for nonwage expenditure in primary schools, which will be mainly for well-targeted subsidies, such as scholarships and books, to the poor communities. These resources will be supplemented by financial assistance from development partners. Other steps in this area will include a reduction in the number of subjects taught in primary and secondary schools and other curriculum reforms, a more equitable distribution of teachers across districts, and other measures to improve the efficiency of the education system, including strengthening school- level managers and parent participation in education policy.

32. On water and sanitation, the government has significantly increased fiscal resources to this important sector in 2000/01 in order to increase access by the poor to these facilities. The bulk of the resources will be allocated to rural areas, where most of the poor are concentrated. Moreover, the government's program in water and sanitation focuses on strengthening community management in the delivery of these services.

33. The agriculture sector accounts for 70 percent of total employment in Kenya, and much of this is on subsistence farms. Accordingly, rural sector development is key to increasing growth and reducing poverty. In this context, the government is committed to removing identified structural constraints, building efficient technology delivery services, and improving rural infrastructure. In the tea sector, the government will have fully liberalized the marketing of tea and abolished the Kenya Tea Development Authority by June 2000. In the coffee sector, recent steps to improve the management of the Coffee Marketing Board will be followed by the enactment of legislation separating the regulatory and marketing arms of the board by December 2000 and establishing a new institution for the marketing of coffee by June 2001. The government will also liberalize the production, processing, and marketing of coffee by December 2000, and at the same time overhaul the cooperative system. To improve rural infrastructure, the government will provide increased fiscal expenditure allocations toward the building and maintenance of feeder roads and the provision of water, and will subcontract maintenance to local communities in areas where labor-intensive techniques are appropriate. The Roads Board Act has been amended to provide an appropriate framework for improving the management of road construction and maintenance, particularly feeder roads.

34. Reflecting the importance of land ownership in Kenya as an issue related to both equity and poverty (particularly in the rural areas), the government established a Land Commission in November 1999 to develop a new land policy and revised land legislation. This step is expected to increase land ownership by women, facilitate the settlement of squatters, and provide little deeds that enable communities' access to credit from the banking system.

35. The government will gradually strengthen the Central Bureau of Statistics, so as improve the socioeconomic statistics needed to formulate and monitor the reform program. In this regard, it will provide adequate support to the bureau to finalize the work on the results of the 1999 census. The government will seek financial and technical assistance from development partners to help improve the quality and timeliness of statistics, as well as to help develop a National Sample Survey and Evaluation Program (NASSEP) based on the 1999 census. The NASSEP is expected to play a key role in filling gaps in the understanding of the nature and determinants of poverty, fully developing input and outcome social indicators, and ensuring the monitoring of poverty dynamics. To monitor social expenditures, the government is committed to developing a program budget classification in time for the 2001/02 fiscal year. In the interim, from the existing administrative and functional classification, a detailed presentation of the relevant social expenditure programs will be prepared to help their monitoring. The government is committed to improving macroeconomic statistics, in line with the recommendations of recent technical assistance from the Fund.

Table 1. Kenya: Financial and Structural Performance Criteria and Benchmarks Under the First Year Program, July 2000-June 2001 1/ (In millions of Kenya shillings, unless otherwise indicated)
		2000			2001
	Mar. 31	Sep. 30	Dec. 31		Mar. 31	Jun. 30
	Act.			Prog.
Financial performance criteria and benchmarks 2/
Performance criteria
Net domestic assets of the central Bank of Kenya (CBK) 3/	...	25,900	26,200		22,500	18,800
Net foreign assets of the CBK 4/	43,592	44,925	49,125		52,125	57,725
Overall fiscal deficit 3/	...	3,900	9,400		14,300	12,700
Stock of external payment arrears (in millions of U.S. dollars) 3/ 5/	100	35	0.0		0.0	0.0
Contracting or guaranteeing nonconcessional external debt 3/5/	...	0.0	0.0		0.0	0.0
Short-term external debt 3/ 5/	...	0.0	0.0		0.0	0.0
Benchmarks
Stock of pending bills 3/ 6/	...	1,722	0.0		0.0	0.0
Memorandum items:
Programmed external budgetary support (cumulative)	...	8,503	22,005		31,894	39,768
Of which: nonproject support	...	5,002	14,448		19,345	21,991
Social expenditure (to be completed)	...	...	...		...	...
Nonbank net holdings of government debt	74,259	71,902	75,651		81,188	74,486
Privatization receipts	...	0.0	0.0		7,572	7,572
Program exchange rate (U.S. dollar per Kenya shilling)	74.8	74.8	74.8		74.8	74.8

Table 1. Kenya: Financial and Structural Performance Criteria and Benchmarks Under the First Year Program, July 2000-June 2001 (concluded)

Structural performance criteria and benchmarks Performance criteria Issue a treasury circular to shift by December 31, 2000 the supervision of district treasury officers from the Office of the President to the Ministry of Finance. Issue a treasury circular to bring by December 31, 2000 all financial management units in the line ministries under the control and supervision of the Finance Officer and provide all finance officers with sufficient independence by requiring that their annual performance review be finalized by the Ministry of Finance. Develop by December 31, 2000 terms of service that would allow competitive remuneration of the Controller and Auditor General's staff, on terms comparable to those applicable to the pay structure of the KRA and KACA. Complete the development of a tariff reform program by March 31, 2001, with a view to implementing it under the 2001/02 (July-June) budget. Structural benchmarks Amend by October 2000 the draft bill containing the code of ethics for public officials inter alia to strengthen the independence of the Public Service Committee examining alleged infractions of the code, to extend the requirement to declare assets and liabilities to include immediate families of the officials, and to broaden the definition of the types of assets and liabilities to be declared . 7/ Publish in the official gazette an Anti-Corruption and Economic Crimes bill that is essentally similar to the one annexed to the report of the Select Committee of Parliament on Anti-Corruption not later than 30 days after the determination by parliament on the report. 8/ Offer for sale to a strategic investor (to be identified through a bidding process) by September 30, 2000 at least 26 percent of the Kenya Commercial Bank (KCB) with an announcement that the remaining shares of the KCB will be offered for sale to the market by March 31, 2001. Submit by September 30, 2000 an amendment to the Banking Act to clearly define "reckless lending" and related activities, as well as any other necessary amendment to relevant legislation, applicable to inter alia financial fraud, with a view to enabling the courts to deal more effectively with fraud and realization of security. The CBK will by September 30, 2000 issue prudential regulations and policies, including on the amount of risk that banks may incur in lending operations, with a view to clarifying and expanding on prohibited activities. Set up by December 31, 2000 a system by which the CBK will share debtor information with licensed banking institutions, as provided in the amendment to legislation. Complete by December 31, 2000 a review of operating procedures and methods of the Deposit Protection Fund (DPF) and produce recommendations, with a view to ensuring efficiency and maximizing asset recoveries. Implement these recommendations by June 30, 2001. Submit by March 31, 2001 amendments to the Building Society Act and the Banking Act that will explicitly specify that the CBK is authorized and responsible for supervising and regulating all institutions involved in "banking activities"; require appropriate and specific responses in case a bank is insolvent and formally prohibit directors of restructured problem banks from borrowing from the reopened institution. Revise by December 31, 2000 the format of the "vote book" and expenditure returns to incorporate information on expenditure commitments and pending bills. Develop by December 31, 2000, with technical assistance from the Fund, a system to strengthen expenditure control in the districts. Complete and submit to parliament by June 30, 2001 audited public accounts for fiscal years 1998/99 and 1999/2000. Issue treasury instructions requiring by July 1, 2000 the debt-management division, the external resources department, and the Accountant General Office to prepare quarterly reconciliations of their external debt data. Issue a treasury circular requiring that all noncentral government public institutions develop by December 31, 2000 and subsequently implement a strategy to prevent any further accumulation of pending bills, and to eliminate the outstanding pending bills after appropriate verification. Prepare by March 31, 2001 a plan for the elimination of major import exemptions awarded to the public sector, with a view to implementing the plan under the 2001/02 budget. Develop a plan to reform the internal audit system by December 2000. Implement the reform plan of the internal audit system by March 31, 2001.

1/ The attached Technical Memorandum of Understanding contains definitions and adjustments for the performance criteria and benchmarks. 2/ Performance criteria apply to end-September 2000, end-December 2000 and end-June 2001; for end-March 2001, these are benchmarks. 3/ Ceiling. 4/ Floor. 5/ Continuous. 6/ Excludes about K Sh 5,500 million in pending bills disputed by the government. 7/ This measure constitutes a prior action for the completion of the first review of the program. 8/ This measure constitutes a prior action for the completion of the first, second, or third review (scheduled to be completed by August 2001) of the program, whichever is applicable.

INTERNATIONAL MONETARY FUND

KENYA

Technical Memorandum of Understanding

(July 27, 2000)

1. This memorandum provides the definitions of the quantitative performance criteria and benchmarks for the three-year program expected to be supported by the IMF under the Poverty Reduction and Growth Facility (PRGF). It also sets out the data-reporting requirements for monitoring the program.

I. Quantitative Performance Criteria and Benchmarks (Table 1 of the Memorandum of Economic and Financial Policies (MEFP))

2. Net foreign assets are defined as the difference between the Central Bank of Kenya's (CBK) holdings of gross official reserves (excluding pledged, swapped, or any encumbered reserve assets including but not limited to reserve assets used as collateral or guarantees for third-party external liabilities) and its foreign liabilities (including IMF loans and other short- and long-term liabilities). Exchange rates prevailing on March 31, 2000 will be used to convert the net foreign assets into Kenya shillings. Table 1 shows the floors on net foreign assets, specified in Kenya shillings, for September 30 and December 31, 2000 and for March 31 and June 30, 2001.

3. The net foreign asset floors will be adjusted upward by the difference between any cumulative (from July 1, 2000) excess external budgetary support (EEBS) and the allowable increase in the central government deficit, as defined in paragraph 14. The EEBS is defined as the difference between actual and programmed external budgetary support. Conversions to Kenya shillings will be based on the exchange rates prevailing on March 31, 2000.

4. The net foreign asset floors will be adjusted downward by one-half of any shortfall in non-project-related external budgetary support relative to the programmed amount.

5. The net foreign asset floors will be adjusted upward by any cumulative excess in privatization proceeds 2000/01. Excess proceeds are defined as the difference between actual and programmed proceeds.

Reporting requirement. Data on gross international reserves, encumbered reserves, and foreign liabilities of the CBK will be transmitted to the African Department of the IMF on a weekly basis within five working days of the end of each week. Detailed data on external budgetary support (by donor/creditor, and by currency of denomination) will be transmitted on a weekly basis within five working days of the end of each week.

6. Net domestic assets are defined as the average over the calendar month of the test dates of reserve money, defined as total currency in circulation and reserves of the banking system with the CBK minus the average over the calendar month of the net foreign assets (as defined above) plus encumbered foreign assets. Table 1 of the MEFP shows the ceilings on the net domestic assets for September 30 and December 31, 2000 and for March 31 and June 30, 2001. The authorities will consult with the Managing Director of the Fund on any changes in the ratios of reserve requirements.

7. The ceilings on the net domestic assets will be adjusted upward by one half of any shortfall in non-project-related budgetary support.

8. The ceilings on the net domestic assets will be adjusted downward by any cumulative excess in privatization proceeds during 2000/01. The excess proceeds are defined as the difference between actual and programmed proceeds.

9. The ceilings on the net domestic assets will be adjusted downward (upward) by 12 percent of the excess (shortfall) in the holdings of government debt instruments by the nonbank public over the programmed amounts of K Sh 71,902 million on September 30, 2000; K Sh 75,651 million on December 31, 2000; K Sh 81,188 million on March 31, 2001; and K Sh 74,789 million on June 30, 2001.

10. Consistent with paragraph 3, the ceilings on the net domestic assets will be adjusted downward by the difference of EEBS over the allowable increase in the central government deficit, as defined in paragraph 14.

Reporting requirement. The daily balance sheets of the CBK will be transmitted on a weekly basis within five working days of the end of each week.

11. Nonconcessional external borrowing (including lease-purchase agreements) is defined as loans with a grant element of less than 35 percent, calculated using currency-specific commercial interest reference rates. Debt rescheduling and debt reorganization are excluded from the limits on nonconcessional external borrowing. Nonconcessional external borrowing will be zero throughout 2000/01.

Reporting requirement. Details of all new external borrowing, including government guarantees indicating terms of loans and creditors, will be provided on a monthly basis within three weeks of the end of each month.

12. Short-term external debt is defined as debt contracted or guaranteed by central government, local governments, and the CBK with contractual maturity of one year or less, excluding normal trade-related credits. There will be no new short-term external debt throughout 2000/01.

Reporting requirement. Data on all new borrowing and guarantees (including terms of loans and creditors) by central government, local governments, and CBK will be transmitted, with detailed description, on a monthly basis within three weeks of the end of each month.

13. The overall fiscal deficit is defined as the sum of the change in total credit to government by the banking system plus net changes in the stock of government debt instruments held by the nonbank public, plus external financing and grants (i.e., disbursements of loans and grants plus rescheduling of external debt service, minus scheduled amortization of external debt falling due in 2000/01, minus outstanding arrears at end-June 2000), plus privatization proceeds, plus any pending bills and external arrears accumulated in 2000/01, minus the change in total deposits of the central government held in the banking system. Table 1 of the MEFP shows the ceilings on the overall fiscal deficit for the periods starting from July 1, 2000 to September 30, 2000, to December 31, 2000, to March 31, 2001, and June 30, 2001.

14. The ceilings on the overall fiscal deficit will be adjusted upward by the excess in programmed social expenditure (EPSE), to the extent that it is fully financed by EEBS. The EPSE is defined as the difference between actual and programmed social expenditure. The adjustment will not exceed K Sh 1 billion by September 30, 2000, K Sh 2 billion by December 31, 2000, K Sh 3 billion by March 31, 2001, and K Sh 4 billion by June 30, 2001.

15. The ceilings on the overall fiscal deficit will be adjusted downward by one-half of any shortfall in non-project-related budgetary support relative to the programmed amount and by the full amount of any shortfall in project-related budgetary support relative to the programmed amount.

16. The net repayment of domestic pending bills is defined as the repayment of outstanding pending bills as of end-June 2000 minus the subsequent accumulation of new pending bills. Pending bills are payments outstanding for longer than the normal commercial grace period. Pending bills will be measured by ministerial reports on pending bills reports and, where necessary, supplemented by special audits by treasury and internal audit staff.

Reporting requirement. Detailed data on repayment of domestic arrears and the remaining previous-year stock of arrears will be transmitted on a monthly basis within four weeks of the end of each month.

17. The stock of pre-cutoff-date of external debt-service arrears at end-June 2000 will remain outstanding until their rescheduling is agreed with creditors; the stock of post-cutoff-date arrears at end-June 2000 will be eliminated by December 2000; and no arrears will be incurred during 2000/01.

18. Public finance data will be required as follows:

• Monthly data on domestic financing (bank and nonbank) of the budget (including treasury bills and government bonds held by the nonbank public) will be transmitted on a monthly basis within three weeks of the end of each month.
  
• Data on the implementation of the development budget, with detailed information on the sources of financing will be transmitted on a quarterly basis within four weeks of the end of each quarter.
  
• Public sector external and domestic scheduled debt service and payments will be transmitted on a monthly basis within three weeks of the end of each month.
  

B. Monetary Sector

19. The following data will be transmitted on a daily/weekly basis within one/five working day of the end each day/week:

• treasury bill rates (weekly); and
  
• interbank interest rates (daily).

20. The following data will be transmitted on a monthly basis or as specified below within four weeks of the end of the month:

• the consolidated balance sheets of deposit money banks, and the individual bank balance sheets as needed;
  
• the monetary survey;
  
• lending and deposit rates;
  
• standard bank supervision indicators for banks and nonbank financial institutions, respectively, and for individual institutions as needed; and
  
• the net foreign assets of commercial banks and nonbank financial institutions broken down by instruments.

C. External Sector

21. The following daily buying, selling, and average exchange rates will be transmitted on a weekly basis within five working days of the end of each week: (i) exchange rates used in interbank transactions among the commercial banks; (ii) the average official exchange rate, quoted daily based on the transactions of the previous day; and (iii) foreign exchange purchases and sales by the CBK on interbank market and other inflows and outflows of foreign exchange to/from the CBK, separately.

22. Other external sector data requirements are as follows:

• Export and import data, including volumes and prices, will be transmitted on a quarterly basis within eight weeks of the end of each quarter.
  
• Other balance of payments data, including the data on services, private transfers, official transfers, and capital account transactions, will be transmitted on a quarterly basis within four weeks of the end of each quarter.

D. Real Sector

23. The following requirements will apply to real sector data:

• Monthly disaggregated consumer price indices for Nairobi (Central Bureau of Statistics) will be transmitted on a monthly basis within four weeks of the end of each month.
  
• Any revisions to the national accounts data will be transmitted within three weeks of the date of revision.
  
• Data on real sector leading indicators will be transmitted within three weeks of the end of each month.

E. Governance and Other Structural Reforms

24. Documentation of all measures undertaken by the government will be transmitted to the IMF's African Department within five working days after the day of implementation.