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DE RUEHNR #2641/01 1781417
ZNR UUUUU ZZH
R 271417Z JUN 07
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC 0639
INFO RUEHDS/AMEMBASSY ADDIS ABABA 9395
RUEHAE/AMEMBASSY ASMARA 4962
RUEHJB/AMEMBASSY BUJUMBURA 0161
RUEHDR/AMEMBASSY DAR ES SALAAM 5349
RUEHDJ/AMEMBASSY DJIBOUTI 4759
RUEHKM/AMEMBASSY KAMPALA 2123
RUEHKH/AMEMBASSY KHARTOUM 1258
RUEHLGB/AMEMBASSY KIGALI 4852
RUEHLO/AMEMBASSY LONDON 2297
RUEHFR/AMEMBASSY PARIS 2248
RUEHRO/AMEMBASSY ROME 5163
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS NAIROBI 002641 
 
SIPDIS 
 
STATE ALSO FOR AF/E, AF/EPS, AND AF/RSA 
 
STATE PASS TO USTR FOR BILL JACKSON 
 
TREASURY FOR VIRGINIA BRANDON 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN EINV ELAB ETRD PGOV EAGR KE
SUBJECT: GOK'S FY08 BUDGET - AN ATTEMPT TO WOO VOTERS OR BEGIN 
KENYA'S CLIMB TO MIDDLE INCOME STATUS BY 2030? 
 
REF: NAIROBI 1981 
 
¶1.  (U) Sensitive but Unclassified.  Please protect accordingly. 
 
¶2.  (SBU) Summary: On June 14, Kenya's Finance Minister Amos Kimunya 
presented the Kibaki government's budget for FY08 (July 1, 2007-June 
30, 2008) to Parliament under the theme "Vision 2030 -- Working 
Together, on the Path to Prosperity."  Proponents hail the 
expansionary budget's focus on development expenditure, its pro-poor 
proposals, and its structural reforms designed to improve the 
business environment and promote regional integration, while critics 
contend it is a thinly disguised ploy to woo voters during an 
election year with its programs likely to trigger inflation and 
deficit spending.  End Summary. 
 
------------------------------------------ 
Increased shift to Development Expenditure 
------------------------------------------ 
 
¶3.  (U) On June 14, Finance Minister Amos Kimunya presented to 
Parliament the Kibaki government's FY08 budget under the theme 
"Vision 2030--Working Together, on the Path to Prosperity."  Based 
on the gains made under the Economic Recovery Strategy (ERS) 
launched in 2003, the FY08 budget is the first stage of the 
government's ambitious Vision 2030 program intended to bring Kenya 
into middle-income nation status (reftel).  It is the most 
expansionary budget in Kenya's 44-year history as an independent 
nation.  Its projected outlays total Ksh 693.6 billion (US$9.9 
billion), marking a hefty 36.4% increase from FY07.  Premised on 
Vision 2030, the budget is intended to define the path for building 
a strong economy and reduce poverty.  Assuming an economic growth 
rate of 6.5%-7% in 2007, the Government of Kenya (GOK) will allocate 
Ksh 201.7 billion (about US$2.9 billion), a 41.6% increase over the 
FY07, to infrastructure development, a major shift from the past. 
Recurrent expenditures for FY8 amount to Ksh491.9 billion (about 
US$7.0 billion), which is 70.3% of the total budget compared to 
74.8% in FY 2006-07. 
 
------------------ 
Funding the Budget 
------------------ 
 
¶4.  (SBU) The Kibaki Administration's expenditure proposals will 
leave a huge deficit to finance its activities.  The Finance 
Ministry projects revenue collection for FY08 at 20.8% of GDP 
equivalent to Ksh428.8 billion (about US$6.1 billion), which is an 
increase of 14% over the past fiscal year.  The overall budget 
deficit including grants amounts to Ksh109.8 billion (about US$1.6 
billion) equivalent to 5.3% of GDP.  After factoring net external 
financing of 1.9% of GDP equivalent to Ksh39.8 billion (US$568.6 
million) to the budget, the anticipated deficit is Ksh70 billion 
(about US$1.0 billion) or 3.4% of the GDP.  According to Minister 
Kimunya, the deficit will be largely financed by privatization 
receipts of Ksh41.9 billion (about US$598.6 million) and domestic 
borrowing of Ksh34 billion (about US$485.7 million).  Planned for 
privatization is Telkom Kenya, the country's monopoly landline 
telephone parastal.  The GOK also plans on floating additional 
shares of Kenya Electricity Generating Company (KenGen), selling 
part of its GOK shares in the mobile company Safaricom through an 
Initial Public Offer (IPO) on the Nairobi Stock Exchange (NSE), and 
selling part of the GOK's National Social Security Fund (NSSF) 
shares in National Bank of Kenya (NBK).  To ensure transparency and 
accountability in the privatization process, the GOK is to make 
operational the Privatization Commission before year's end. (Note: A 
close scrutiny of the revenue estimates and the FY08 Financial 
Statement reveals privatization receipts of Ksh44.9 billion (about 
US$641.4 million), leaving unexplained a variance of Ksh3 billion 
(about US$42.9 million). End note.)  Net FY08 domestic borrowing is 
1.6% of the GDP, which is lower than last year's.  The funds raised 
from privatization and domestic borrowing are to finance development 
expenditures.  (Comment: However, the GOK will likely have to borrow 
 
from the domestic market to meet its expansionary expenditures since 
we question whether the privatization proceeds' target will be met. 
  End Comment.) 
 
----------------------------------- 
Expansionary Budget for Development 
----------------------------------- 
 
¶5.  (SBU) The GOK's expansionary budget is re-oriented towards 
development, targeting growth and poverty-reducing programs in the 
areas of infrastructure, health, and education, which are expected 
to lay the foundation for achieving Vision 2030.  Although Kimunya 
acknowledged challenges, including implementation delays, weak links 
between actual spending and policy priorities in key line 
ministries, expenditure leakages, and low absorption of funds, he 
increased domestically financed expenditures to 4.1% of GDP from 
3.0% in FY07.  In line with Vision 2030 aspirations, Kimunya 
identified six priority sectors as having the highest potential for 
economic growth and job creation: tourism, agriculture, 
manufacturing, wholesale and retail trade, business processing 
outsourcing, and financial services.  Appropriations, which are 
intended to bolster these sectors, include: 
 
-- infrastructure development, Ksh166.8 billion (US$2.4 billion), up 
by 113% from Ksh78.3 billion (US$1.1 billion) in FY07; 
-- road infrastructure development, Ksh62.1 billion (about US$887.1 
million) an increase of 46% from Ksh42.5 billion (about US$589.5 
million) in 2006-07; 
-- supply of electricity, Ksh8 billion (about US$114.3 million); 
-- ICT infrastructure expansion through investment in an undersea 
fiber optic cable and the development of a "National Fiber Optic 
Network," Kshs1.0 billion (about US$14.3 million) towards The East 
African Marine System (TEAMS) project; 
-- education sector, Ksh119.5 billion (about US$1.7 billion) up by 
11% from FY07, with Ksh8.1 billion (US$115.7 million) for free 
primary education, Ksh7.3 billion (about US$104.3 million) for 
teachers salary adjustment, Ksh2.5 billion (about US$35.7 million) 
to recruit an additional 11,000 teachers, and Ksh2.9 billion 
(US$41.4 million), effective from January 2008, to cover all tuition 
fees for secondary school students countrywide; 
-- health sector, Ksh.34.4 billion (about US$491.4 million); 
-- agriculture sector, Ksh29.8 billion (about US$425.7 million) up 
20% from Ksh24.9 billion (about US$345.4 million) in FY07. 
 
--------------------------------------------- -- 
Goodies to the Voters or Addressing Real Needs? 
--------------------------------------------- -- 
 
¶6.  (U) In addition, the finance minister announced new social 
spending for disadvantaged groups, saying the appropriations are 
needed to respond to real social needs.  The GOK will allocate 
Ksh1.3 billion (about US$18.6 million) for acquiring land to settle 
squatters who are internally displaced to improve their living 
standards and increase food safety.  To empower young adults, 
Kimunya earmarked an additional Ksh250 million (about US$3.6 
million) for the Youth Enterprise Fund, thus raising it to Kshs.1.25 
billion (about US$17.9 million).  In addition, he said the 
government would establish a Kshs2.0 billion (about US$28.6 million) 
"Women Enterprise Development Fund" (WEDF), with an initial outlay 
of KShs1.0 billion (about US$14.3 million). 
 
¶7.  (SBU) In a move which drew considerable applause, the finance 
minister exempted pensioners from paying tax while instituting a 3% 
pension increase, payable every two years.  He said the government 
would amend the National Social Security Fund (NSSF) Act to provide 
the monthly 5% of the total wages of casual workers paid by 
employers be declared as surplus benefit to allow casuals and 
self-employed to voluntarily join and benefit from the NSSF.  To 
encourage development of housing and affordable shelter for Kenyans, 
the minister zero-rated taxable goods and taxable services supplied 
to specific projects for the construction of a minimum of 20 units 
 
of houses for the benefit of low income earners.  The Retirement 
Benefit Act (RBA) is to be amended to allow pension benefits as a 
security for accessing housing loans.   (Note: these measures have 
triggered considerable debate with some commentators speculating 
that they are thinly disguised ploys to appeal to voters, especially 
women and young adults, ages 18-35, who comprise major voting blocks 
in an election year.  Others, who accept the allocations are geared 
towards helping disadvantaged groups, especially squatters, point 
out that the government has yet to define who qualifies as "low 
income" or a squatter.  They maintain the GOK should first have 
created a legislative framework to establish the purposes of such 
funds, their mechanisms (rather than relying in taxes as seed 
money), the duration of their existence, and the manner of winding 
them up and assessing their successes. End Note.) 
 
------------------------------------- 
Security, Crime, and Defense Spending 
------------------------------------- 
 
¶8.  (SBU) Acknowledging the monumental challenges of organized crime 
plaguing the country, Minister Kimunya declared the government would 
increase resources to various security agencies.  The budget will 
allocate Ksh13.9 billion (US$198 million) to the Kenya Police 
Department under the Ministry of State for Provincial Administration 
and Internal Security, in part to fund recruitment of an additional 
25,000 police officers.  The GOK will provide an additional Ksh6.8 
billion (about US$97.4 million) a 13.2% increase from FY07, to the 
National Security Intelligence Service (NSIS).  The new budget also 
allocates target funding of Ksh662 million (about US$9.5 million) 
for the Criminal Investigation Department (CID) for community 
policing, and another Ksh708 million (US$10.1 million) for police 
reforms.  To deal with increased poaching, foreign refugees, and 
small arms, the GOK will provide the Ministry of Defence (MOD) with 
Ksh38.9 billion (about US$555 million or 5.6% of its total 
expenditure), an increase of 41.3% from last year's budget.  (Note: 
MOD sources have hinted that the increased military allocation is 
for the purchase of aviation assets, trucks, and other military 
hardware.  Probing the security allocations within the FY08 budget 
reveals that some intelligence and security spending comes under the 
umbrella of the Office of the President and are thus not openly 
available for analysis.  End Note.) 
 
-------------------------- 
Reducing Business Barriers 
-------------------------- 
 
¶9.  (U) Acknowledging the importance of an efficient and predictable 
regulatory business environment, Finance Minister Kimunya said in 
the past year, out of the total 1,325 business licenses, 110 had 
been eliminated and 8 simplified.  He promised the GOK would 
eliminate another 205 licenses and simplify another 371.  He 
revealed that the GOK is working on a "Regulatory Reform Strategy" 
to provide a blue print for future efforts to streamline and improve 
the broader regulatory business environment, and to build regulatory 
reform capacities.  The key aim of the strategy is to cut government 
red tape in priority areas by 25% over the next three years. 
(Comment: Despite the reform process to reduce the regulatory burden 
borne by the private sector, a licensing regime of 1,010 licenses is 
still high, cumbersome and a constraint to efficient setting up of 
enterprises. End comment.) 
 
------------------------- 
Deepening EAC Integration 
------------------------- 
 
¶10.  (U) Following consultations with his Ugandan and Tanzanian 
counterparts, Kimunya reported that the East African Community (EAC) 
finance ministries agreed to reduce the import duty rate from 25% to 
10% on felt material used in the manufacture of oil and air filters 
for motor vehicles.  They also agreed to remove import duty rates on 
textile fabrics and on millstones and grindstones for milling, 
 
grinding or pulping.  They agreed to decrease the Import Declaration 
Fee (IDF) from 2.75% to 2.25% for all goods imported from outside 
the EAC, while no IDF will be charged on goods imported from EAC 
member states.  Other measures geared towards integration include 
treating all EAC citizens who invest in the Nairobi Stock Exchange 
and earn dividend income as Kenyan residents and amending the 
Capital Markets Act to increase the percentage of IPOs reserved for 
Kenyans from 25% to 40% and treating citizens of other East African 
Community partner states as local investors. 
 
--------------------- 
Promoting Agriculture 
--------------------- 
 
¶11.  (U) Kimunya unveiled several initiatives to help the 
agricultural sector.  They include value addition in agro 
processing, institutional reforms towards food security and 
governance to support farmers and promotion of storage and 
processing plants and fisheries.  To encourage growth of the dairy 
sub-sector and processing of excess milk into powder, the GOK 
zero-rated milk powder for VAT purposes.  It will also zero-rate 
pyrethrum extract to encourage the manufacture of insecticides using 
local pyrethrum extract, increase the export duty on local hides and 
skins from 20% or Ksh10 per kilo to 40% or Ksh20 per kilo, and 
impose an excise duty of 120% on plastic bags and ban the 
importation and manufacture of thin plastic bags under 30 microns to 
protect the environment. 
 
--------------------- 
Old Ways of Budgeting 
--------------------- 
 
¶12.  (SBU) While many local analysts praise the budget as one that 
lays the foundation for future growth and is friendly to the poor, 
some experts predict it will trigger a rise in inflation.  According 
to Dr David Ndii, an economics lecturer at the University of 
Nairobi, the budget is "highly inflated with a huge deficit that 
only points to a rise in inflationary pressure in the next 12 
months." Ndii said borrowing Ksh34 billion (about US$485.7 million) 
from the domestic market and plans to use debt rollover from the 
current financial year to plug the budget hole is 
a breeding ground for runaway inflation, which would hurt those in 
the low income bracket.  Inflation has been steadily rising in 
recent months helped by turbulence in crude oil prices and 
unpredictable weather patterns that have piled pressure on food 
prices.  Low income bracket earners spend nearly half of their 
income on essential commodities such as paraffin and food compared 
to seven per cent of top income bracket earners in similar items. 
Inflationary pressure is likely to kick off from aggressive 
borrowing from the domestic market in the event that the GOK fails 
to get the proceeds of privatization it has factored in the budget. 
According to Ndii, although the economy will continue to be robust, 
drastic policy interventions may have to be taken in light of the 
strengthening shilling and the possibility of high inflation rates. 
"We are returning to the old ways of budgeting for money that we 
don't have." 
 
¶13.  (SBU) Others fault the budget for failing to define the path 
towards Vision 2030.  Charles Muchene, the country director for 
PricewaterhouseCoopers (PWC), questions the exclusion of the 
implementation plan that is expected to consume massive resources 
from the budget.  Failure to factor it into the budget, he 
maintains, could hamper its initial take off expected to be launched 
in July. 
 
-------- 
Comment 
-------- 
 
¶14. (SBU) Teachers, women, young adults, housing developers, 
farmers, pensioners, and squatters are this budget's biggest 
 
(short-term) beneficiaries, as Finance Minister Amos Kimunya 
seemingly is targeting key voting demographics for the upcoming 
winter 2007 elections.  His budget speech vowed to make Kenya a 
competitive investment destination by among other ways abolishment 
of additional licenses.  Building on the three pillars of Vision 
2030 (reftel), he seemingly has his fiscal and developmental 
priorities and policies well conceived.  Nevertheless, 
implementation, coordination, and fiscal discipline are critical to 
the government actually delivering on its FY08 budget's promised 
benefits.  The budget's provisions do indeed look promising, but 
they lack governance mechanisms and may become prone to 
mismanagement and abuse.  Since the Kibaki Administration took over 
in January 2003, it has been dogged by program implementation 
mishaps, with many line ministries' actual expenditures well below 
their development budget allocations.  Last year's budget theme of 
"reducing poverty and addressing inequality in the country" saw most 
of the minister's proposals not seeing the light of the day when the 
Finance Act was published. 
 
¶15. (SBU) The budget faces various risks including inflation and 
insecurity that could impede the delivery of its planned development 
agenda despite Kenya's current economic recovery.  Additionally, 
inadequate utilization of funds in development expenditure could 
slow infrastructure development.  Unless low absorption capacity 
common in public works, health, water, and transport sectors are 
tackled comprehensively, the huge allocations will end up back to 
the Treasury come FY09.  Although the budget has made generic 
references to governance reforms, it lacks candid actions that would 
improve overall transparency especially on monies allocated to 
popular programs such as youth, women, and squatter settlement.  End 
comment. 
 
Ranneberger