Cablegate: Optimistic Gok Budget Focuses On Development, But


DE RUEHNR #3068/01 1941340
P 131340Z JUL 06





E.O. 12958: N/A
SUBJECT: Optimistic GOK Budget Focuses on Development, But
Implementation is Real Challenge


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

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

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

-- 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
-- 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

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'
-- 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.


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.


© Scoop Media

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