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 and the opposition. 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. The Economist Intelligence Unit forecasts that the economy will recover strongly in 2002-03, provided that donor funding is resumed. Private-sector activity and investment will also increase as the government makes progress with its long-delayed privatisation programme. Monetary policy will be geared towards maintaining the relative strength of the currency and keeping inflation in check. The current-account deficit is forecast to improve from 2.9% of GDP in 2002 to 2.5% of GDP in 2003, owing to rising exports, net transfers and tourism receipts. Key changes from last month Political outlook • Uncertainty over who will succeed President Daniel arap Moi as president and leader of KANU will impede political effectiveness. Inter-tribal violence is likely to increase as the elections—which are due to be held by the end of 2002—approach. Economic policy outlook • The appointment of a new finance minister, Christopher Obure, is not expected to lead to a change in economic policies over the forecast period. Economic forecast • Real GDP growth for 2001 has been revised slightly downward to 1.3%, from our earlier estimate of 1.8%, in line with recent firm data for the first seven months of the year. • Assuming that donor support is resumed, we forecast real GDP growth of 2.5% in 2002 and 3% in 2003.

December 2001

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The EIU delivers its information in four ways: through our digital portfolio, where our latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7830 1007 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7830 1023 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2001 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the EIU does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-4239

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK. Kenya 1

Outlook for 2002-03

Political outlook

Domestic politics It is clear that the general election due at the end of 2002 and the battle for President Daniel arap Moi’s succession will dominate Kenya’s political agenda over most of the forecast period. 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 President 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. Moreover, Mr Moi formally announced on October 20th (Kenyatta Day) that he would hand over to a younger person “when the time is right”. In the past he has only either alluded to his retirement or his desire to be succeeded by a younger politician; this was the first official announcement that he will retire.

However, there are still a number of unresolved issues surrounding President Moi’s retirement. First, he did not specify when he would step down, only saying that he would do so when the time was right. He also made it clear that after handing over the presidency, he would like to continue serving Kenya in many other capacities, as well as retaining his position as the KANU national chairman. Therefore he obviously intends to remain an important political player behind the scenes. Meanwhile, the motion to allow Mr Moi to stand for a third presidential term has been withdrawn from the agenda of the National Assembly, following a recommendation by the KANU parliamentary group.

The most likely outcome is that President Moi’s current term in office, and that of parliament, will be extended by one or two years, because the constitutional review process will not have been completed by the end of 2002—this will probably have the support of all sides in parliament. This extension of Mr Moi’s current term of office, and the fact that he has committed himself to stepping down, should give him to time to choose his successor (which will give him greater influence from behind the scenes). There is little doubt that the succession battle will take greater precedence than the need for structural reform and economic recovery on Kenya’s political agenda in 2002. It is too early to predict with confidence who will succeed Mr Moi, although the front runner is certainly Musalia Mudavadi—the former finance minister and now the minister for information, transport and communications. Developments over the next few months will give a clearer picture of the succession issue.

Cabinet reshuffle A cabinet reshuffle has resulted in the removal of another Kenyan finance minister, Chris Okemo. Like others before him, Mr Okemo found it difficult to balance the demands of the international financial community and internal politics. For example, having announced a bold budget for 2001-02 guided by a combination of the medium-term expenditure framework and the poverty reduction strategy paper, an end-October speech delivered on Mr Okemo’s behalf stated that the IMF had "coerced" Kenya into misguided economic

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 2 Kenya

policies. The problem for Mr Okemo—and now for his replacement, Chris Obure (formerly the foreign minister)—is twofold. Economic growth, which is forecast to average only 2.9% per year in 2001-05, down from around 6% per year in the latter half of the 1980s, will not recover without a resumption of donor support. However, progress towards improved relations with donors is almost bound to be slow, since most of the contentious issues relate to legislation on economic governance and must therefore be dealt with by parliament. The change of finance minister will not alter the situation, and the current impasse between the Bretton Woods institutions and the Kenyan government is thus highly unlikely to be resolved before the end of 2001. Nevertheless, the Economist Intelligence Unit still believes that the government does recognise the importance of retaining multilateral approval of its economic policies, and that it will broadly follow the commitments it made to secure a poverty reduction and growth facility in 2002. Donor support is, therefore, likely to resume in the first half of 2002.

Inevitably, there is also a more political dimension to the cabinet reshuffle. For some time we have been predicting a major cabinet reshuffle in which KANU’S “young Turks” gain leadership positions, and one of the most prominent members of this younger generation of politicians—Uhuru Kenyatta (son on Kenya's first president)—has now been appointed as local government minister. This is hardly a key post, but it will enable Mr Kenyatta to build substantive ministerial experience, and it does send a clear signal about the latest balance of power, since Mr Kenyatta replaces Joseph Kamotho, a high-profile member of the party's “old guard”.

International relations Kenyan foreign policy will be mainly 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 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 is critical. However, following the government’s recent failure 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 in the near future. A World Bank and IMF mission to Kenya at the end of October again expressed dissatisfaction with the progress made towards attaining the performance criteria agreed in 2000, particularly over the main contentious issues, namely the two anti-corruption bills and the sale of Telkom Kenya. The IMF has also blamed the government for a “stop-go” approach to reforms, which demonstrates insufficient commitment to the programme. 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

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Kenya 3

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) into 2002, 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 for the remainder of the 2001/02 financial year (July-June). Total expenditure for the year is set at KSh246.9bn (US$3.11bn). In terms of spending, the 2001/02 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. Recent data for the current fiscal year indicate that the government’s fairly tight fiscal policy has remained in force. During the first two months of the 2001/02 fiscal year, the budget deficit was KSh1.5bn, representing 0.2% of GDP, compared with a deficit of 0.5% of GDP in July-August 2000, owing to improvements in both expenditure and revenue collection.

However, the government is unlikely to meet its 2001/02 budget deficit target, particularly because 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 move forward with the sale of state assets, particularly Telkom Kenya. We forecast that total revenue will continue to fall short of official targets, and now expect the overall fiscal balance to return to a deficit of 2% of GDP in 2001/02, rising to 2.5% of GDP in 2002/03.

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 2001 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 Not only is the world economy experiencing its most severe slowdown since the 1973-74 oil price shock, it also faces increased uncertainty following the terrorist attacks on the US on September 11th. We now estimate that world economic growth will slow to an average of just 2.2% in 2001 and recover gently to 2.7% in 2002. Prospects for 2003 are brighter and world growth is expected to recover to 4.2%, in line with stronger performance in the US and EU. Kenya’s tourist industry, which was experiencing a marked upturn in 2001, will suffer most directly from the aftermath of the attacks on the US during the final three months of 2001, particularly at the upper end of the market which draws its customers mainly from the US. The drop in demand for hotels, restaurants, cafés, bars and taxis will have a substantial effect on the rest of the economy. In addition, the imminent closure of some of the national airlines

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 4 Kenya

will have a negative effect on access to and from Kenya. For instance, if Sabena and Swissair discontinue their flights to Kenya, there will be a shortage of available seats and freight capacity to Europe.

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 52.6 US cents/lb in 2002; tea prices are forecast to fall to US$1.6/kg in 2001 and US$1.4/kg in 2002. Oil prices are also now expected to fall, to US$24.28/barrel in 2001, US$18.26/b in 2002 and US$20.19/b in 2003. The reduced oil price will help to reduce Kenya’s energy import bill.

International assumptions summary (% unless otherwise indicated) 2000 2001 2002 2003 Real GDP growth World 4.7 2.2 2.7 4.2 OECD 3.7 0.8 1.1 2.9 EU 3.3 1.5 1.4 2.6 Exchange rates (av) ¥:US$ 107.8 121.1 124.0 121.5 US$:¤ 0.924 0.898 0.963 1.015 US$:SDR 1.32 1.28 1.30 1.33 Financial indicators ¤ 3-month interbank rate 4.48 4.23 3.13 4.60 US$ 3-month Libor 6.53 3.80 1.64 4.72 Commodity prices Oil (Brent; US$/b) 28.5 24.3 18.3 20.2 Gold (US$/troy oz) 279.3 268.8 255.0 250.0 Tea (US$/kg) 1.9 1.6 1.4 1.3 Coffee (Arabica; US cents/lb) 87.1 61.7 52.6 49.5

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

Economic growth Having only narrowly avoided a contraction in the first six months of 2001, the Kenyan economy faces mixed prospects in the second half of 2001. According to the Central Bank of Kenya’s Monthly Economic Review for October, the economy grew by a modest 0.5% in the 12 months to July 2001. Overall, we still expect the gentle upturn in the economy in the first half of the year to continue during the remainder of 2001. The rate of real GDP growth for 2001 is estimated at 1.3%, which compares favourably with the fall of 0.3% in 2000. However, this growth rate is still far too low to have any real impact on the pressing issues of poverty and unemployment in Kenya, or to stop the decline in income per head. The growth rate is also low in comparison with both Kenya’s historical growth rate and the growth rates of the two other economies in the East African Community: in 2001 real GDP in Tanzania is forecast to expand by 5% and in Uganda it will increase by 5.4%. In 2002-03, the Kenyan economy is forecast to recover more strongly provided that donor funding is resumed. Real GDP is forecast to grow by 2.5% in 2002 and by 3% in 2003. Private-sector activity and investment should also increase as the government makes progress with its long-delayed privatisation programme. The resumption of donor support should boost consumer and business confidence

from mid-2002. The strengthening of the US and European economies in 2002- 03 will also benefit tourism and increase export demand.

Forecast summary (% unless otherwise indicated) 2000a 2001b 2002c 2003c Real GDP growth –0.3 1.3 2.5 3.0 Industrial production growth –2.2 1.0 2.6 3.0 Gross agricultural production growth –2.4 1.6 2.0 3.0 Consumer price inflation Average 5.8 3.3 3.8 4.0 Year-end 6.0 3.8 4.0 4.3 Short-term interbank rate 22.3 23.0 20.0 18.0 Government balance (% of GDP) 0.4 –2.0 –2.5 –2.5 Exports of goods fob (US$ bn) 1.8 1.7 1.8 2.0 Imports of goods fob (US$ bn) 3.0 3.1 3.3 3.5 Current-account balance (US$ bn) –0.2 –0.3 –0.3 –0.2 % of GDP –2.3 –2.7 –2.9 –2.5 External debt (year-end; US$ bn) 6.0 5.6 5.7 5.8 Exchange rates KSh:US$ (av) 76.18 78.79 82.02 86.63 KSh:¥100 (av) 70.69 65.50 67.83 73.12 KSh:¤ (year-end) 73.27 75.39 86.84 92.23 KSh:SDR (year-end) 101.7 105.3 114.3 121.7

a Actual. b EIU estimates. c EIU forecasts.

Inflation Inflation has continued to fall steadily in 2001, to a negative rate of 2.2% in the third quarter, yielding an average inflation rate of 2.5% in the first nine months of 2001. Low inflation has been caused by the slump in food prices, subdued domestic demand and continued tight monetary policy. 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, owing to subdued food and fuel prices, and because the Central Bank will continue to use inflation targets to preserve monetary stability, we expect consumer price inflation to average 3.8% in 2002 and 4% in 2003.

Exchange rate 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 Kenya shilling will be under pressure for the remainder of the year, averaging an estimated KSh78.79:US$1. The depreciation pressures have been 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 KSh82.02:US$1 in 2002 and KSh86.63:US$1 in 2003.

Current-account outlook Kenya’s overall current account returned to a small deficit of US$15m in the second quarter of 2001, following a surplus of US$33m in the first quarter. For

the remainder of 2001 exports will suffer from weak commodity prices and are estimated to show a marginal fall to US$1.74bn for the year. However, imports are expected to edge up slightly to US$3.14bn for the year, mainly because of stronger domestic demand. On the services account, tourism earnings are likely to suffer following the attacks on the US in September and the subsequent downturn in the international tourist market. Overall, the current-account deficit is estimated to rise marginally from 2.3% of GDP in 2000 to 2.7% of GDP in 2001. In 2002-03 total exports are expected to grow marginally to just under US$2bn per year, because of a modest upturn in export volumes and in the prices of traditional exports. Imports are also expected to rise over the forecast period, owing to the recovery of economic activity. On the services account, tourism revenue will provide some relief, but the scope for substantial growth is not promising. Net transfers are forecast to edge up in 2002-03, mainly because of the resumption of donor support. Overall, the current- account deficit is forecast to widen to just under 3% of GDP in 2002 and narrow marginally to 2.5% of GDP in 2003.

Editors: Pat Thaker (editor); David Cowan (consulting editor) Editorial closing date: December 17th 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule