Cablegate: Gok's Fy08 Budget - an Attempt to Woo Voters or Begin


DE RUEHNR #2641/01 1781417
R 271417Z JUN 07








E.O. 12958: N/A


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.


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


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