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Kenya's economy in the 1990s

by Elisabeth Pape

Kenya has enjoyed rare political stability since independence in 1963. It is one of the most famous holiday destinations in Africa, with abundant wildlife, fine beaches and stunning scenery. But despite having the most advanced economy in East Africa, it is still one of the world's poorest countries. Over 11 million Kenyans live below the poverty line. But better times may be ahead. The Government has embarked on an ambitious reform programme which promises to lay the foundations for strong growth.

The early 1990s marked the worst time in Kenyan history, in economic development terms. Real GDP growth dropped from 4.3% in 1990 to 2.1% in 1991 and was almost zero in 1992 and 1993. This poor performance was due to drought, structural rigidities, lack of monetary discipline, non-enforcement of banking regulations, and reduced donor assistance. While Kenya was used to receiving substantial foreign aid inflows, the present decade began with growing tensions between Government and donors. In the new post-Cold War atmosphere, the latter wanted to see political and economic reforms, and in November 1991 they decided to halt guick-disbursing aid.

Multi-party elections in December 1992 did not immediately restore relations with the donors, in particular as they were accompanied by a lack of fiscal and monetary discipline whose effects threatened economic ruin. Monetary expansion was fuelled, among other things, by discretionary exemptions to Banking Act provisions, which enabled over-borrowing by certain 'political' banks from the Central Bank. In early 1993, things came to a head. Foreign currency reserves were down to just a few weeks of imports, the banking system was on the verge of collapse, and consumer prices had shot up. Against this background, the Government went for a comprehensive, IMF-supported structural adjustment programme.

A number of far-reaching reforms were implemented with unprecedented speed. Exchange restrictions were removed, import licensing was ended, import procedures were made easier and tariffs were reduced. The export license requirement was also lifted and price controls were abolished. In March 1993, the Central Bank (CBK) began to tighten monetary policy. By issuing large amounts of treasury bills, it soaked up most of the excess liquidity which had been injected the previous year. There was also stricter bank supervision and a number of weak financial institutions were closed.

Structural reforms

The Government began structural reforms aimed at reducing its own role in the economy in favour of the private sector. The privatisation programme, begun in 1991, was accelerated. By the end of 1995, the authorities had divested more than half of the 211 non-strategic parastatals-though critics complained the process often lacked transparency. The Government also substantially reduced its fiscal deficit through, above all, an improved revenue policy. The deficit fell from 11.4% of GDP in 1992/93 to 2.5% in 1994/95. The number of civil servants was reduced, mainly through voluntary early retirement, so that, by the end of 1995, the service had been trimmed by more than 30 000 (10% of the payroll).

In 1995, the reform programme lost momentum as proponents of the old and the new systems locked horns. Vested interests stood in the way of more radical reforms. Temporary import bans on maize and sugar were reimposed, key parastatal reforms were delayed and expensive but economically dubious projects were approved outside normal budgetary procedures. These included an international airport in Eldoret, a presidential jet and an identity card project. These further delayed the resumption of balance of payments support by the Bretton Woods Institutions and contributed to the frustration of efforts to improve relations with donors.

The economic crisis peaked in early 1993 and the shilling was sharply devalued. The official rate went from about KSh 36 to the dollar at the end of 1992 to KSh 60 in April 1993. On the market, the currency was being traded at a premium of more than 30% and that continued until July-i.e. about two months after the removal of exchange restrictions. The market premium then started to decline and the two rates converged in mid-October when the shilling stood at 69 to the dollar.

The high interest rate on treasury bills under the liberalised foreign exchange regime was the main reason behind strong currency inflows which began in October 1993. Other factors, whose exact impact is difficult to gauge, included capital flight from neighbouring crisis-torn countries, the international money laundering one normally finds in places with newly liberalised foreign exchange regimes, and a surplus in the current account position. The shilling then started to rise, despite the CBK's massive currency purchases which led to a build up of reserves to the equivalent of six months of imports. The appreciation continued up to October 1994: indeed, at one point, the shilling reached a high of 35 to the dollar.

That was the turning point. Strong import demand, fuelled in particular by a surge in oil imports in the wake of petroleum market liberalisation, and an outflow of portfolio investments due to lower interest rates, weakened the currency. By mid-1995, after two sharp falls, it reached a rate of 56 to the dollar. Since then, it has been relatively stable.

Economic recovery

Real GDP grew by 3% in 1994 and an estimated 5% in 1995. Good weather certainly helped, but the economy also benefited from the Government's reforms. Agriculture, the mainstay, grew by 2.8% in 1994 and by more than 5% in 1995. This compares with negative growth rates in 1992-93, when the sector was hard hit by bad weather. Elsewhere, the trends were more mixed. Many producers for the local market were affected by trade liberalisation and, in 1994, by the strong shilling. The former created a highly competitive environment almost overnight-after years of cosy protectionism. For cloth manufacturers, the liberalisation of imports of second-hand clothing further aggravated the problem. In 1994, the clothing sector's output dropped 35%. Tourism, the main foreign exchange earner, fared quite well in volume terms in 1994 despite the strong shilling. But while turnover may have gone up, it is likely that many operators did not earn enough extra to cover their increased local currency costs. In 1995, visitor arrivals fell by 20% to the lowest figure since 1988. In consequence, tourism earnings fell by a quarter.

As intended, liberalisation led to higher trade volumes. In 1994, exports ( + 16%) rose by more than imports ( + 13%) in value terms, but the position was reversed in 1995 when the latter jumped by 35% while the former were 14% lower. One good sign was that the highest import growth was in industrial supplies and machinery (60% up) but the fact that the deficit almost doubled to reach record levels was obviously a cause for concern.

A major revolution has also taken place in trade flows. In 1994, for the first time, Uganda overtook the UK as the biggest importer of Kenyan goods. In the same year, the value of Kenya's exports to African countries moved ahead of its combined exports to Europe and North America.

During 1994, the Nairobi Stock Exchange proved to be one of the worid's best-performing stock markets, the value of shares rising by 80%.1995 was disappointing, however. Although foreigners were allowed to invest for the first time, the index nonetheless fell by 25%.

Fighting inflation has been the CBK's main objective since 1993 and a tight monetary policy has brought the problem under control. Inflation dropped from 46% in 1993 to 29% in 1994 and to below 2% in 1995. Recently, however, an upward trend has bean observed. This follows a money supply increase far in excess of the expansion of economic activity, and is mainly due to a substitution of treasury bills for borrowing from the Central Bank since the end of 1994. If inflation is to remain within the 5% target for 1996-which already seemed highly unlikely by the middle of the year - the trend needs to be speedily reversed.

Initially, the main way of mopping up excess liquidity was through the sale of treasury bills. When the sales began in March 1993, there was a huge liquidity overhang and high interest rates had to be offered to take money out of the market quickly. The rate earned on 90-day bills-which became the lead interest rate in the economy- rose from 17% to 80% between March and July 1993. It then declined steadily, reaching 18% at the end of 1994. This prompted an outflow of short-term capital, leading to currency depreciation and lower foreign reserves. Since mid 1995, treasury bill rates have been back above 20% and this seems to have stabilised the foreign exchange situation. It is generally believed that the high prevailing real interest rates are a major obstacle to investment and economic growth.

Interest on domestic debt is still a big item in the state budget, although, the situation is much improved, thanks to the reduction in the stock of treasury bills and lower interest rates. In fiscal year 1993/94, interest payments on domestic debt alone swallowed one third of total gavernnnent expenditure.

The agriculture sector employs 70% of the total labour force and generates more than a quarter of Kenya's GDP. Much of industry is linked to agricultural processing, and tea, coffee and horticultural products are Kenya's major foreign exchange earners after tourism. The marketing of key farm products is dominated by large parastatals and cooperatives which are often run like parastatals. Most marketing organisations have been hard hit by the liberalisation, which brought both inefficiency and corruption to light. Tea growers have complained about improprieties at the Kenya Tea Development Authority. Imported sugar flooded the local market, often without paying import duties, leaving the mills with huge stocks. This, in turn, created severe cash flow problems. Most sugar farmers have not been paid for months. Kenya Cooperative Creameries was not able to pay farmers for milk deliveries for up to half a year, and could only start servicing the arrears when the Government came to its rescue with KSh 800 million in January 1996.

Formidable challenges

Kenya's labour force, around 12.5 million in 1996, is growing at more than 4% a year. This means that at least half a million people enter the job market annually. The challenge of absorbing the new workers is formidable. Studies show that any strategy to deal with this must be based on three pillars: smallholder agriculture (to absorb most of the growth in the rural labour force), continuing substantial job creation in the informal sector, and high real GDP growth (+8% per year is needed to ensure that the modem sector absorbs a significant number of workers).

Informal sector employment has risen rapidly (up by 15-20% a year since 1991). By 1994, for the first time, there were more people working here than in the modern economy. The informal sector covers semi-organised and unregulated activities largely under taken by self-employed people or employers with just a few workers. Typically, they do not comply fully with tax, registration, and licensing rules, and this sometimes leads to conflict with the authorities. Workers are often paid below the minimum wage and have no social security. For many, the informal sector is, therefore, an 'employer' of last resort.

It is estimated that almost 50% of rural people and 30% of urban residents live in absolute poverty- unable to meet their minimum requirements for food and essential non-food items. While the percentage has remained fairly stable in recent decades, the increase in the number of 'absolute' poor is alarming. So too is the extent of the poverty: the gap between these people's minimum needs and their actual disposable income has reportedly increased over the last ten years. The bulk of the poor live in the central and western parts of the country, which have the best agricultural potential, the rich soils having always attracted settlers. For decades there was enough land to go around, but demographic trends have finally started to take their toll. The size of landholding has declined continuously, in many cases reaching levels which are no longer capable of sustaining a family.

There has been some progress in restructuring parastatals, but much remains to be done. The performance of key parastatals has been unsatisfactory by international standards and this has constrained growth. At Mombasa port, which is managed by the Kenya Ports Authority, handling charges are 50% higher than the global average, while container turnover is three times slower. Rail transport is unreliable, slow and more expensive than road haulage. The Kenya Power and Lighting Company has a shortage of generating capacity which means periodic power cuts. And intervention in the maize market by the National Cereals and Produce Board- at above-market prices-has prevented private sector involvement as well as placing a heavy burden on government finances. The Board has posted annual operating losses of between KSh 1.8bn and KSh 2.5bn each fiscal year since 1992/93.

Corruption, misuse of funds, and the politics of patronage remain endemic and these clearly distort development. Elimination of corruption has been an aim of most reform programmes but it seems that the effect so far has only been to change its form. Trade liberalisation has killed cash cows such as import and foreign exchange licences, and the commercialisation of parastatals has stopped them from doing deals with cronies which were profitable only for the latter. But other forms of non-acceptable wealth accumulation have emerged. In the early 1990s, alleged exports of gold and diamonds are thought to have resulted in a loss of KSh 7 billion of public funds. Land grabbing has also become widespread. This either involves land being sold to individuals or companies with well-established political connections at well below market prices, or the purchase of land by public institutions from the same individuals or companies at inflated prices.

After delays because of political differences, cooperation between the three states of the former East African Community (Uganda, Tanzania and Kenya) was revived in early 1996. The EAC Secretariat, based in Arusha, is headed by a Kenyan, Francis Muthaura, a former ambassador in Brussels. For the three countries, the new cooperation aims at facilitating movements of people, capital and trade within the region, and harmonisation of external tariffs and investment regulations. Currencies will be fully convertible. This revived cooperation is expected to have a major growth impact. The Nairobi Stock Exchange is currently assisting Kampala and Dar es Salaam to set up their own exchanges. And the NSE Chairman, Jimnah Mbaru, sees the future not only in a cross-listing of companies in the three places, but in a regional stock exchange.

Policy framework

The Policy Framework Paper (PFP) for 1996-1998, which was published in February ahead of the donors' Consultative Group (CG) Meeting, was highly applauded for both its content and form. The programme, which the media has dubbed 'the big push', promises finally to crack most of the 'hard nuts' of previous reform agendas, in particular in the parastatal and public sector. It also lays down measures aimed at supporting fiscal and monetary discipline through the next elections. These include cutting the budget deficit to 1.5 % of GDP by 1997/98, a tight monetary policy, and more autonomy for the Central Bank. In addition, it tackles some areas'that have emerged as avenues of corruption in recent years, such as the National Social Security Fund. While previous PFPs were highly confidential, this one was published, and the President appointed a Commission chaired by himself to oversee its implementation. These are seen as important steps in bridging the credibility gap which threatened to open up again in 1995. Donors are prepared to support the reform agenda and are eager to see it implemented speedily. Shortly after the positive outcome of the CG meeting, the IMF approved a three-year Enhanced Structural Adjustment Facility programme for a total of $220m. The World Bank is expected to follow suit with a credit of $85m.

An increasing number of donors, however, have pointed to the link between democratic governance/ human rights issues on the one hand, and aid and investment flows on the other. If Kenya is to meet its ambitious targets and turn into a newly-industrialising country by 2010, foreign inflows will be vital. The point was succinctly put by a delegate to the CG meeting. 'If its (the Government's) economic successes are matched by a commitment to democracy and human rights, Kenya may yet prove that surging economic growth is not just for Asian tigers, but for African lions, too.' The period leading up to the next general election will be the acid test.