Kenya at a Glance: 2002-03

COUNTRY REPORT

Kenya Kenya at a glance: 2002-03

OVERVIEW Political stability in Kenya is not expected to improve during the forecast period because electoral pressures will intensify conflicts within the ruling Kenya African National Union (KANU) and the opposition parties. Inter- tribal violence is likely to increase as the elections, which must be held by end-2002, approach. Relations with the IMF will remain difficult, and the government’s hope for a resumption of donor support is unlikely to be fulfilled in 2001. Although economic reforms will continue to shape policy, divestment of state assets and retrenchment of the public sector will proceed slowly, if at all. Key changes from last month Political outlook • A major cabinet reshuffle will take place towards the end of this year in which the old guard, including the vice-president, George Saitoti, are likely to be casualties. Although the appointment of National Development Party members to government and the move towards a full merger between the two parties has fuelled speculation that President Moi does not intend to relinquish power when he completes his last constitutional term in office at the end of 2002, recent events suggest that Mr Moi will not seek to run as president. Mr Moi will, however, keep the leading contenders waiting as long as possible before engineering the succession within KANU. Economic policy outlook • The need to restore IMF support and other donor funding will continue to dominate the government’s economic policy in the coming months. Economic forecast • Real GDP is estimated to rise by 1.6% in 2001, owing to a recovery of both agriculture and manufacturing. The continued recovery of tourism in 2001 will also have a positive effect on economic growth. Provided that donor funding is resumed, the Kenyan economy is forecast to recover more strongly in the forecast period; real GDP is expected to grow by 2.5% in 2002 and by 3.3 % in 2003.

October 2001

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Outlook for 2002-03

Political outlook

Domestic politics It is clear that the general election at the end of 2002 and the attendant succession battle will dominate President Daniel arap Moi’s agenda over most of the forecast period rather than the need for structural reform and economic recovery. The imminent merger between the ruling Kenya African National Union (KANU) and the National Development Party (NDP) has gained momentum following a decision by KANU’s National Executive Council, chaired by Mr Moi, to create nine new posts within the ruling party. The expansion of the structure of the ruling party—and its merger with the NDP— was agreed at a meeting of KANU and NDP national delegates in late August. It is clear that the next joint KANU-NDP national delegate meeting will both ratify and fill all the positions. With the exception of the post of national chairman, which is reserved for Mr Moi, the other positions will be hotly contested. The positions will not only be divided between the two parties, but are expected to reflect a realignment in which “young Turks” will succeed the old guard in a number of key positions. The coveted position of secretary- general is expected to change hands from Joseph Kamotho to Uhuru Kenyatta, the son of the late President Jomo Kenyatta. In a further move targeting the vast Kenneth Matiba constituency in Muranga and the Kikuyu diaspora, President Moi has appointed Raymond Matiba, the eldest son of his bitter political adversary, to head the Kenya Tourist Board—a position previously occupied by Uhuru Kenyatta. It is clear that both Mr Kenyatta and Mr Matiba junior have little substantive experience and achievement to show from their previous posts and are unlikely to inspire much confidence in the political arena.

These changes are expected to be followed by a major cabinet reshuffle towards the end of 2001, in which the old guard, including the vice-president, George Saitoti, are likely to be casualties and the “young Turks” are likely to gain key leadership positions. Although the appointment of NDP members to government and the move towards a full merger between the two parties has fuelled speculation that President Moi does not intend to relinquish power when he completes his last constitutional term in office at the end of 2002, recent evidence suggests that Mr Moi will not seek to run as president in 2002. Mr Moi is likely to step down from the presidency in any of the three following scenarios. First, he may retire following the formalisation of the KANU-NDP merger, using the constitutional review process to push through constitutional amendments that will result in a considerably weakened presidency and the devolution of power from the central government. Second, he may step down after ensuring that the combined team at the helm—probably NDP members and the KANU “young Turks”—will accommodate and protect his interests after retirement. The third scenario is that Mr Moi will remain chairman of the new KANU, a position that will give him the power to continue determining the political agenda and the direction of the ruling party. However, there is no clear pattern emerging in the Moi succession saga although there are obvious

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competing interests. First, there are the key proponents of the KANU-NDP merger including Raila Odinga. Then there are the KANU “young Turks” including Musalia Mudavadi, Julius Sunkuli, Uhuru Kenyatta and Kalonzo Musyoka. Finally, there is the old-guard represented by the president himself, Mr Saitoti, Nicholas Biwott and Joseph Kamotho. The president will keep the leading contenders waiting as long as possible before engineering the succession within KANU.

The KANU-NDP parliamentary partnership will also be closely involved in the constitutional review process. The constitution, to be produced by the Constitution of Kenya Review Commission, led by Professor Yash Pal Ghai, is therefore likely to be favourable to the KANU-NDP succession agenda. KANU- NDP are already putting forward proposals for constitutional amendments to create the positions of two vice-presidents and a prime minister. Although constitutional reform is expected to remain at the forefront of political debate in Kenya, progress is expected to be slow, and any moves towards political liberalisation will be minor and largely cosmetic. The government remains determined to retain tight political control even if the measures taken provoke international criticism. KANU hardliners within the government will block any constitutional reforms that might threaten their party’s dominant position at the next election. The opposition will remain weak and unable to pose a serious threat to KANU and President Moi, and the allegiance of the state institutions, such as the army, is not expected to change.

Pre-election tension As the opposition will remain weak and unable to challenge the ruling party, there is a clear risk of street violence should Mr Moi try to stand again. Foreign businesses will not be directly targeted, but both staff and premises may come under threat. Before both the 1992 and 1997 elections there was an upsurge in inter-tribal violence. This is widely thought to have been an attempt by KANU to drive potential opposition voters out of marginal constituencies, but there are genuine ethnic tensions too—in September, for example, at least 18 people were killed in clashes between the Wardey and Pokomo communities in the east of the country. Further clashes are almost inevitable, and tension will increase as the elections, which must be held by end-2002, approach.

International relations The recent terrorist attacks in the US will inevitably lead companies to reassess the risk of operations throughout the world, and Kenya is likely to be high on the list. In 1998 Nairobi was the site of one of the most serious attacks on American interests outside the US itself, when almost 250 people, most of them Kenyans, were killed in a car bomb attack on the US embassy. Since at least two of those suspected of organising the Nairobi bombing have yet to be apprehended and owing to reports that Osama Bin Laden, who allegedly directed both the Kenyan and US attacks, has visited both Kenya and neighbouring Somalia, there is bound to be concern that foreign interests in Kenya are vulnerable to further terrorist attack. Kenyan foreign policy will also be concerned with regional issues. These include efforts to promote greater regional integration through the recently launched East African Community, and the problem of political instability in the Horn of Africa, which is causing

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bandit activity and an influx of refugees in north-eastern Kenya. However, progress towards resolving both these issues will be slow.

Economic policy outlook

Policy trends The need to restore IMF support and other donor funds will dominate the government’s economic policy in the coming months. However, following the government’s failure in parliament on August 14th to push through an anti- corruption bill—a crucial prerequisite for the resumption of IMF-World Bank support—the current impasse between the IMF and World Bank and the Kenyan government is not expected to be resolved before the end of 2001. A World Bank and IMF visit to Kenya in late August was dissatisfied with the progress made towards attaining the critical performance criteria agreed in 2000, particularly over the main contentious issues, namely the two anti- corruption bills and the sale of Telkom Kenya. It is clear that the whole programme is in danger of falling apart if the government does not take serious action on governance issues and demonstrate its commitment to economic reform. Since most of the outstanding issues, except the privatisation of Telkom Kenya, relate to legislation on economic governance and must therefore be dealt with by parliament, progress is expected to be slow. The Economist Intelligence Unit considers the resumption of IMF lending to be crucial to Kenya’s economic prospects. Our baseline scenario assumes that the government recognises the importance of retaining multilateral approval of its economic policies, that it will broadly follow the commitments it made to secure an IMF poverty reduction and growth facility (PRGF) in the second half of 2001, and that donor support will resume in the first half of 2002.

Fiscal policy Tight fiscal policy, aimed at reducing the budget deficit, will remain an important priority in the 2001/02 financial year (July-June). Guided by a combination of the medium-term expenditure framework and the poverty reduction strategy paper, the finance minister, Chris Okemo, has announced a bold budget for 2001/02. The Kenyan economy is now forecast to grow by an average of only 2.9% per year in 2001-05, down from growth of around 6% per year in the latter half of the 1980s, and the finance minister has acknowledged that new ways must be found to tackle the general government deficit if future deficit-reduction targets are to be met. The 2001/02 fiscal deficit is forecast at 2.5% of GDP, from a modest surplus of 0.4% of GDP in 2000/01. Total expenditure is set at KSh246.9bn (US$3.11bn). In terms of spending, the budget focuses mainly on civil service reform—11,230 public-service workers are expected to be made redundant, at a cost of KSh3bn—education and the HIV/AIDS awareness campaign. The government is unlikely to meet its 2001/02 budget deficit target, particularly as economic growth and fiscal revenue are likely to fall well short of official projections. The fiscal position is made even more uncertain by the government’s reluctance to progress with the sale of state assets, particularly Telkom Kenya. However, the main surprise in the budget was that it was premised on the resumption of IMF funding, and other donor support, from July. We forecast that total revenue will continue to fall short of official targets, and now expect the overall fiscal balance to return to a

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deficit of 3% of GDP in 2001/02, and to remain at that level in 2002/03. Because access to external funds will remain extremely limited, at least for most of the current financial year, the budget deficit will continue to be financed mainly by the issue of Treasury-bills and bonds.

Monetary policy We expect monetary policy to remain geared towards maintaining the relative strength of the currency and keeping inflation in check. Falling US interest rates will be matched by a slight fall in domestic interest rates, but heavy government borrowing in the domestic capital market—to finance the fiscal deficit—will keep interest rates relatively high for the remainder of this year and the first half of 2002. The monetary authorities will need to maintain a cautious stance on interest rate reductions if they are to avoid boosting inflationary pressures or contributing to exchange-rate nervousness.

Economic forecast

International assumptions summary (% unless otherwise indicated) 2000 2001 2002 2003 Real GDP growth World 4.7 2.3 3.0 4.1 OECD 3.7 1.1 1.6 2.9 EU 3.4 1.7 1.8 2.5 Exchange rates (av) ¥:US$ 107.8 121.2 124.0 121.5 US$:¤ 0.924 0.903 0.968 1.015 US$:SDR 1.32 1.28 1.30 1.33 Financial indicators ¤ 3-month interbank rate 4.48 4.28 3.88 4.65 US$ 3-month Libor 6.53 3.83 2.59 5.34 Commodity prices Oil (Brent; US$/b) 28.5 25.4 21.5 20.5 Tea (US$/kg) 1.86 1.58 1.48 1.42 Coffee (Arabica) (US cents/lb) 87.1 61.6 53.3 49.5 Food, feedstuffs & beverages (% change in US$ terms) –6.1 0.8 14.1 10.9 Industrial raw materials (% change in US$ terms) 13.4 –6.9 3.3 12.2

Note. Regional GDP growth rates weighted using purchasing power parity (PPP) exchange rates.

International assumptions The world economy is not only experiencing its most severe slowdown since the 1973-74 oil price shock, it also faces increased uncertainty following the terrorist attacks on the US in September. We now estimate that world economic growth will slow to an average of just 1.4% in 2001 and recover gently to 2% in 2002. Prospects for 2003 are brighter and world growth is expected to recover to 3.3% in line with US performance. Prospects for the prices of Kenya’s main commodity exports will be mixed during the outlook period; the price of arabica coffee is forecast to decline from 87.1 US cents/lb in 2000 to 61.6 US cents/lb in 2002, while tea prices are forecast to fall to US$1.6/kg in 2001 and US$1.5/kg in 2002. Oil prices are also now expected to fall, to US$25.42/barrel

in 2001, US$21.51/b in 2002 and US$20.54/b in 2003. These price reductions will lessen Kenya’s energy import bill.

Economic growth Despite the IMF’s decision in August to continue to withhold funds, Kenya’s real GDP is estimated to grow by 1.6% in 2001, thanks to a recovery in both agriculture and manufacturing. The continued recovery of tourism in 2001 will also have a positive effect on economic growth. In 2002-03, the Kenyan economy is forecast to recover more strongly provided that donor funds are resumed. Real GDP is forecast to grow by 2.5% in 2002 and by 3.3% in 2003. Private-sector activity and investment should also receive a boost as the government makes progress on its long-delayed privatisation programme. The resumption of donor support should lift consumer and business sentiment from mid-2002.

Forecast summary (% unless otherwise indicated) 2000a 2001b 2002c 2003c Real GDP growth –0.3 1.6 2.5 3.3 Industrial production growth –2.5 1.5 2.5 3.5 Gross agricultural production growth –2.4 4.0 5.0 5.5 Consumer price inflation Average 5.8 3.3 3.6 4.0 Year-end 6.0 3.8 4.0 4.3 Short-term interbank rate 22.3 23.0 22.0 20.0 Government balance (% of GDP) 0.4 –3.0 –3.0 –2.0 b Exports of goods fob (US$ bn) 1.7 1.7 1.9 2.0 Imports of goods fob (US$ bn) 3.0b 3.2 3.4 3.6 Current-account balance (US$ bn) –0.2b –0.3 –0.3 –0.2 % of GDP –2.5b –2.8 –3.3 –2.5 External debt (year-end; US$ bn) 6.1b 5.7 5.8 6.0 Exchange rates KSh:US$ (av) 76.18 79.48 84.71 89.47 KSh:¥100 (av) 70.69 65.41 68.86 73.64 KSh:¤ (year-end) 73.27 76.76 89.12 92.88 KSh:SDR (year-end) 101.7 105.9 117.0 122.1

a Actual. b EIU estimates. c EIU forecasts.

Inflation Inflation has continued its steady downward trend so far in 2001, reaching 7.2% in June and yielding an average inflation rate of 2.6% for the first six months of 2001. The low level of inflation has been caused by the slump in food prices, subdued domestic demand and continued tight monetary policy. There is official concern that the recent rise in international fuel prices will feed through into higher inflation, but this effect is likely to be limited. The real test for the monetary authorities will come when the economy starts to recover and supply constraints, such as the country’s poor transport infrastructure, exert renewed upward pressure on prices. In 2002-03 higher domestic demand is likely to increase inflationary pressures but, because the Central Bank of Kenya will continue to use inflation targets to preserve

monetary stability, we expect consumer price inflation to average 3.6% in 2002 and 4% in 2003.

Exchange rates Relations between Kenya and the IMF will remain tense, and it is assumed that the current agreement will remain suspended for the remainder of 2001, in which case the shilling will remain under pressure. The Kenya shilling is expected to depreciate further over the course of the year, although the rate of depreciation will be orderly and will not require heavy intervention by the Central Bank or capital controls. The depreciation pressures will be offset by strong tea and horticultural exports and, to a lesser degree, by tourism receipts. In 2002-03, as financial inflows and export receipts pick up, pressure on the currency should ease. Hence, the shilling is forecast to depreciate gently, averaging KSh79.48:US$1 in 2001, KSh84.71:US$1 in 2002, and KSh89.47:US$1 in 2003.

External sector Forecasts of Kenya’s current-account deficit in 2001-02 remain essentially unchanged. We still expect the deficit to widen from an estimated 2.8% of GDP in 2001 to 3.3% of GDP in 2002, and to improve to 2.5% of GDP in 2003. Export earnings will remain at just US$1.7bn in 2001, on account of the sharp fall in EU demand and the related decline in commodity prices. In the first half of the year, export earnings increased by just 2.5% year on year, whereas imports increased by 4.6% year on year, owing to higher oil prices and rising demand for machinery and transport equipment and food. Weak EU growth and low commodity prices are likely to undermine export demand during the remainder of 2001, and relatively high oil prices will continue to cause imports to rise. In 2002-03 total exports are expected to grow marginally to about US$2bn per year, thanks to a modest upturn in export volumes and in the prices of traditional exports. Imports are also expected to rise in the forecast period, reflecting the recovery of economic activity. On the services account, tourism revenue will provide some relief, although scope for substantial growth is not very promising. Over the forecast period, net transfers will edge up, reflecting the resumption of donor support.

Editors: Pat Thaker (editor); David Cowan (consulting editor) Editorial closing date: October 8th 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule