VZCZCXYZ0001
PP RUEHWEB

DE RUEHNR #3068/01 1941340
ZNR UUUUU ZZH
P 131340Z JUL 06
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC PRIORITY 3036
INFO RUEHXR/RWANDA COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS NAIROBI 003068 
 
SIPDIS 
 
 
DEPT FOR AF/E, AF/RSA 
DEPT ALSO PASS TO USTR FOR BILL JACKSON 
TREASURY FOR LUKAS KOHLER 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: ELAB AGOA ECON ETRD PHUM PGOV KE
SUBJECT: Optimistic GOK Budget Focuses on Development, But 
Implementation is Real Challenge 
 
REF: 
 
¶1. (SBU) Summary:  In an effort to address popular 
frustration at the slow pace of economic development and 
poverty reduction, Finance Minister Kimunya's presentation 
of the GOK's budget for FY 2006-07 stressed social spending 
and tax relief provisions targeted to assist the poor and 
vulnerable.  Kimunya also announced structural reforms 
designed to encourage investment and growth, but cut the 
budget of anti-corruption agencies.  The budget assumption 
of 5.8% GDP growth in 2006 is reasonable.  The fiscal 
deficit is likely to be greater than the $400 million 
forecasted, and will require continued domestic borrowing, 
but the GOK believes it can keep inflation down to 5%. 
Kimunya tried to walk a fine line between demonstrating 
nationalist defiance of donors' aid conditions and 
reassuring international financial markets of continued 
macroeconomic stability.  The budget's provisions look 
promising, but they lack governance mechanisms and are open 
to abuse.  The NARC administration has not so far 
demonstrated the discipline needed to transform budget 
promises into results, and the political jockeying in the 
runup to the 2007 annual general election will create 
further distraction.  End summary 
 
¶2. (U) Finance Minister Amos Kimunya presented the GOK's 
budget to Parliament on June 15 for Fiscal Year (FY) 2006- 
07 (July 1, 2006 - June 30, 2007). Presented under the 
theme "Frameworks for the future, laying the building 
blocks", the Minister boasted of the NARC government's 
achievement of 5.8% economic growth in 2005 and predicted 
GDP would also grow 5.8% in 2006. Despite painting a rosy 
picture on economic performance, Kimunya was quick to add 
that more needs to be done to reduce poverty and the gap 
between the rich and the poor in Kenya. 
 
Income Projection Seems Optimistic 
---------------------------------- 
 
¶3. (U) The FY 2006-07 budget assumed receipts will rise 
16.8% to Ksh403.8 billion (US$5.5 billion), equivalent to 
21.4% of GDP, with tax revenues rising 21.5% to Ksh375.4 
billion (US$5.1 billion).  Although tax revenues rose 8.5% 
in FY 2005-06 to Ksh257.7 billion, collections fell well 
below the Ksh309 billion target set in the budget, casting 
some doubt on the realism of the revenue projection. 
Kimunya tried to demonstrate independence from donor 
conditions by claiming he excluded external budgetary 
support, but close scrutiny of the budget revenues reveals 
he included Ksh58.6 billion (US$799.5 billion) in 
development assistance, consisting of project grants of 
Ksh28.4 billion (US$387.4 million), and project and 
concessionary loans of Ksh30.2 billion (US$412 million). 
The budget also assumed other inflows whose source and/or 
reliability are uncertain: privatization proceeds of 
Ksh18.2 billion (US$248 million), refinancing bank 
restructuring at Ksh20 billion (US$272 million), domestic 
debt rollover at Ksh51.9 billion (US$706 million), 
repayment of arrears at Ksh4 billion (US$54.5 million) and 
administrative recoveries at Ksh500 million (US$6.8 
million). 
 
Rising Expenditures, Deficit and Domestic Borrowing 
--------------------------------------------- ----- 
 
¶4. (U) The budget increased total expenditures 11.7% to 
Ksh550.1 billion (US$7.5 billion), creating an overall 
budget deficit of Ksh29.5 billion (US$402 million), and a 
1.7% deficit/GDP ratio.  In FY 2005-06, GOK expenditures 
went beyond the budgeted level to fund emergency drought 
relief efforts, the costs of office remodeling and luxury 
cars for the expanded Cabinet, and increased salaries and 
allowances for Members of Parliament (MPs).  The GOK 
therefore increased net domestic borrowing in FY 2005-06 
from the budgeted Ksh25.3 billion (US$345.2 million) 
deficit to Ksh36.3 billion (US$495.2 million) and the GOK's 
total domestic debt increased 14.8% to Ksh362.3 billion by 
June 2006.  The rise in the debt stock is expected to 
continue as the GOK plans to rely on the domestic market to 
fund the fiscal deficit.  Kimunya claimed interest rates 
(currently at 15% and expensive to investors) would not 
increase, and that inflation would be kept at 5%.  Banks 
are flush with cash, reluctant to risk loans to the private 
sector, and anxious to buy GOK Treasury bonds, so increased 
GOK borrowing may not drive interest rates any higher. 
 
 
¶5. (U) The overall ratio of budgeted expenditure to GDP in 
FY 2006-07 is 31%, exceeding the Medium Term Expenditure 
Framework target of 25.9%.  The budget identifies Ksh412.5 
billion (US$5.6 billion) in recurrent expenditure, a 3% 
rise over last year and Ksh137.6 billion (US1.9 billion) in 
development spending, an increase of almost 50% over the 
same period in FY 2005-06.  The ratio of recurrent to 
development expenditure fell from 4:1 in 2005-06 to 3:1 in 
2006-07. 
 
Budget Focuses on Development and Poverty Reduction 
--------------------------------------------- ------ 
 
¶6. (U) The GOK increased the budget allocation to health, 
education, agriculture, rural development and 
infrastructure from 60.7% of total expenditure in FY 2005- 
06 to 62.7% in the FY 2006-07 budget, and it expects to 
reach 66.5% by FY 2008-09. In addition, the Minister 
allocated 4% of the GDP (Ksh86 billion or US$1.2 billion) 
to "core poverty" programs, a 10.6% increase from the FY 
2005-06 level. 
 
¶7. (U) The government's budgeted wage bill of Ksh129.3 
billion (US$1.8 billion) represents 38.2% of recurring 
expenditures, and is equivalent to 8.4% 1of Kenya's GDP. 
Specifically, the budget allots: 
 
-- The education sector Ksh99 billion (US$1.4 billion), 27% 
of total expenditure.  Ksh71 billion (US$0.97 billion) is 
for teachers salaries. 
-- The health sector Ksh33.3 billion (US$454.3 million), 
6.1% of expenditures, and is projected to increase to Ksh43 
billion (US$587 million) in FY 2008-09. 
-- The agriculture sector Ksh10.2 billion (US$139.9 
million), 1.9% of expenditures and is projected to increase 
to Ksh33.5 billion (US$457 million) in FY 2008-09. 
-- To infrastructure development Ksh58.5 billion (US$798.1 
million), an increase of 42%, and is projected to increase 
to Ksh126 billion (US$1.7 billion) or 21.6% of total 
expenditure by FY 2008-09. 
-- To the road sub-sector within infrastructure Ksh46 
billion (US$627.5 million), 8.4% of total expenditures. 
-- The highly abused Constituency Development Fund (CDF) 
Ksh10 billion (US$136.4 million) up 39% from Ksh7.2 billion 
(US$98.2 million). 
-- The Defense Ministry Ksh27.5 billion (US$375 million), 
5% of expenditures 
-- Provincial administration Ksh29.2 billion (US$398 
million), 5.3% of expenditures. 
-- The Finance Ministry Ksh51.4 billion (US$701 million), 
9.3% of expenditures. 
 
 
GOK Seeks Votes With Targeted Budget Provisions 
--------------------------------------------- --- 
 
¶8. (U) To appeal to the young and general public in the 
December 2007 general elections, the GOK allocated in the 
budget: 
 
-- Ksh1.0 billion (US$13.6 million) for the establishment 
of a Youth Enterprise Fund to provide credit to start small 
and medium scale business; 
-- Ksh105 million (US$1.4 million) for rehabilitation of at 
least one polytechnic in each of the 210 constituencies; 
-- Ksh150 million (US$2.0 million) for the National Youth 
Council; 
-- Ksh50 million (US$0.68 million) for funding innovative 
youth projects; 
-- Ksh400 million (US$5.5 million) to buy land to resettle 
victims of tribal clashes and those removed from forests 
and other water catchment areas; and, 
-- Ksh250 million (US$3.4 million) for the National Youth 
Service. 
 
¶9. (U) The GOK budget also offered a number of appealing 
tax reductions: 
 
-- removing the VAT on wheat flour 
-- removing the VAT on water supply and treatment materials 
purchased by local authorities; 
-- removing the VAT on babies' nappies, napkins, and 
feeding bottles; 
-- removing the import duty on kits for bicycles imported 
 
by approved local assemblers; 
-- reducing the import duty on unassembled kits for 
motorcycles from 25% to 10%; 
-- removing the import duty on agricultural tractors, semi- 
trailers for agricultural tractors and tractor tires; 
-- removing the VAT on transportation fees for unprocessed 
agricultural and agro-forest produce to reduce farmers' 
costs; 
-- removing the VAT on computer equipment, computer parts 
and accessories (previously 16%); and, 
-- exempting local sales of Kenyan artists' creations from 
VAT to promote talented youth. 
 
 
Structural Reforms to Support Investment and Growth 
--------------------------------------------- ------- 
 
¶10. (U) To improve Kenya's creditworthiness and access to 
international financial markets, Kimunya announced the GOK 
will hire Standard and Poor's to carry out a credit review 
and provide Kenya its first sovereign rating. The private 
sector has for several years called for the review. 
Kimunya hopes for a positive review that will not only 
encourage foreign direct investment, but will also 
stimulate domestic investment through lower interest rates, 
as cheaper financing from international markets forces 
banks in Kenya to compete by lowering their rates.  Kimunya 
also tried to walk a fine line between demonstrating 
nationalist defiance of donor conditions and reassuring 
international financial markets by reiterating the 
Government's intention to seek a Policy Support Instrument 
with the IMF (which does not include financial assistance) 
upon the expiration of the Poverty Reduction and Growth 
Facility (PRGF) later this year. 
 
¶11.  In his speech, the Minister highlighted the 
Government's enactment of the Public Procurement and 
Disposal Law and its ongoing efforts to implement this law 
through the establishment of an independent procurement 
authority and implementing regulations. (Note: USAID/Kenya 
is actively supporting the Government's procurement reform 
program within the context of the multi-donor supported 
Strategy for the Revitalization of Public Finance 
Management, which was formally launched by Kimunya on June 
23rd. End note.) 
 
¶12. Acknowledging the impediments to trade and investment 
created by tedious, lengthy and opaque licensing 
procedures, requirements and fees, Kimunya announced the 
immediate elimination of 37 licenses.  He also pledged to 
eliminate 118 more by the end of 2006, and to harmonize a 
number of local authorities' licenses and permits. Kimunya 
announced the GOK will table a Business Regulatory Reform 
Bill in Parliament in July 2006.  It would establish a 
Business Regulatory Unit in the Finance Ministry to review, 
simplify, consolidate 700 other business licenses and 
reduce their fees. 
 
Less Funding for Anti-Corruption Agencies and Prosecutors 
--------------------------------------------- ----------- 
 
¶13. Although Minister Kimunya talked about strengthening 
the capacity of institutions like the Office of the 
Attorney General, the Judiciary and KACC, Controller and 
Auditor General's offices to fight corruption and crime, 
the budget did not support his statements.  The GOK reduced 
the allocation to all these agencies, the Justice and 
Constitutional Affairs Ministry by 5%, casting doubt on the 
GOK's commitment. 
 
 
Comments 
-------- 
 
¶14. (SBU) Kenya's skewed wealth distribution, in which the 
richest 10% control more than 42% of Kenya's wealth, and 
over half the population lives below the poverty line, is 
blatantly obvious.  Minister Kimunya touted the budget as a 
"common man's", and a large percentage of the country's 
vulnerable population could theoretically benefit from the 
budget's provisions.  The budget proposals and structural 
reforms are good on setting institutions, rules, systems 
and procedures for public service delivery and resource 
management in general.  The proposals sadly lack governance 
mechanisms and are open to abuses such as those seen in 
 
existing programs like the Constituency Development Fund, 
but the GOK seems anxious to demonstrate that it will not 
allow donors to dictate conditions for good governance. 
 
¶15. (SBU) Implementation, coordination and fiscal 
discipline are critical to actually delivering the budget's 
promised benefits.  In previous years, the NARC 
administration has been dogged by program implementation 
mishaps, with many line ministries' actual expenditures 
well below their development budget allocations.  It is 
doubtful the GOK will effectively deliver on its 
development promises to Kenyans, especially with everyone 
already distracted by the political jockeying in the runup 
to the 2007 general election. 
 
ROWE