At present, Kenya is grappling with multiple challenges compounded by global conditions impacting economic activities and leading to tightened financial conditions. 

The Kenyan economy is facing multiple challenges as it tries to recover from a prolonged drought and El Nino effects. These challenges include volatility in fuel prices, negative impacts from regional instability, the ongoing Russia-Ukraine conflict, tighter financial conditions, fluctuations in commodity prices, and a difficult external environment for frontier markets. All of these factors are making it challenging for Kenya to manage its balance of payments and fiscal financing requirements. 

The government is in a dilemma on how to reduce the fiscal hit from vast subsidy bills on strained public finances placed by the previous regime and the need for economic reforms amid the risk of rising discontent and social unrest if the economic situation gets worse. 

Additionally, a weakening shilling has also caused pain to importers and consumers, hindering the government’s efforts to rein in the rising cost of living. 

The government is also under pressure from the International Monetary Fund (IMF) and the World Bank to implement an economic reform programme. 

These reforms include fiscal and monetary policy adjustments, public sector reforms, and measures to improve governance and transparency. By implementing these reforms, the government may be able to strengthen the economy, attract further investment and contribute to long-term sustainable development. 

The IMF-backed economic programme under the Extended Fund Facility (EFF) and the Extended Credit Facility (ECF) arrangements, which was approved by the IMF executive board on April 2, 2021, for 38 months and extended by 10 months on July 17, 2023, allow sufficient time to implement the authorities’ reform agenda and to realise the program’s key objectives. 

The program aims to help Kenya reduce its debt vulnerabilities, strengthen its fiscal and external buffers, and address multiple challenges, such as the cost-of-living crisis, the impact of climate change, high levels of poverty and inequality, and exchange rate pressures. 

These objectives are meant to be achieved through a multi-year consolidation strategy that involves progressively raising tax revenues while ensuring equity and fairness, as well as carefully prioritising spending while protecting social and development spending. 

The programme also supports the government’s broader reform and governance agenda by addressing weaknesses in State-Owned Enterprises (SOEs) such as Kenya Power and Lighting Company (KPLC) and Kenya Airways (KQ), strengthening the country’s anti-corruption framework, bolstering the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) legal framework, and improving the efficiency of Central Bank of Kenya (CBK) operations. 

Impact

Human Rights Watch found that in 38 countries where IMF programmes have been approved since the COVID-19 pandemic began, half of these programmes, including in Kenya, seek to increase revenues through value-added taxes, which experts generally agree disproportionately burden people with low incomes.

According to Human Rights Watch, more than half reduce or remove fuel or electricity subsidies, which can lead to sharp price increases. While phasing out fossil fuels is crucial for avoiding the worst impacts of climate change, measures that cause prices of goods such as fuel or electricity to rise should be undertaken together with measures to support people, such as investment in social protection programmes and affordable renewable energy, Human Rights Watch notes.

In addition, the IMF regularly includes “social spending floors”, which typically require governments to spend a minimum amount on social programmes or ministries. 

In Kenya, the social spending floor mandates tiny increases in spending on some health, education, and cash transfer programmes. However, currently, their total represents a mere three percent of GDP, which is lower than when Kenya’s IMF programme was approved in 2021.

This is in line with a “downward trend” in social spending, according to a review of Kenya’s 2022/2023 budget by the UN Office of the High Commissioner of Human Rights. The review found that the total budget allocations for health, education, social protection, and water and sanitation amounted to 6.06 percent of GDP, which is far from meeting international benchmarks. For instance, low- and middle-income countries need to spend at least 6.3 percent of GDP on education alone to provide universal basic education, according to UNESCO. 

In August 2023, the government was forced to tap into a stabilisation fund and reinstated a small subsidy to stabilise retail fuel prices, following public anger over the high cost of living. However, the government clarified that it was not a subsidy but the utilisation of a stabilisation fund. 

“What has been applied is stabilisation, not a subsidy. The Petroleum Development Levy was put in place to, amongst other things, cushion Kenyans from hikes in petroleum pump prices. We have not applied any exchequer funding, which would be a subsidy but simply given back to Kenyans the money which we collected from them in the past. It is within the funds that have been collected and does not need any exchequer support as was the norm in the previous administration, which employed exchequer funds which made it a subsidy,” said Daniel Kiptoo, Energy and Petroleum Regulatory Authority (EPRA) CEO. 

Last month, the IMF hit out at Kenya over the re-introduction of the fuel subsidy scheme on the grounds that lack of funds to pay oil marketers will lead to distortion of the budget. IMF said the government re-introduced the subsidy despite a lack of funds to pay oil marketers, with the National Treasury yet to pay the firms at least Ksh 9 billion ($55.6 million) that has accumulated from last year. 

In September 2022, President William Ruto said his administration would not subsidise retail fuel prices, in line with the conditions to access funds from the IMF and the World Bank. 

IMF review 

At the conclusion of the sixth review of the Extended Arrangements Under the EFF and ECF arrangements and the First Review Under the Resilience and Sustainability Facility Arrangement for Kenya on January 17, 2024, by IMF’s Executive Board, Ms Antoinette Sayeh, Deputy Managing Director and Acting chair, in a statement said Kenya’s performance under the arrangements had been mixed with adherence to quantitative targets being broadly satisfactory. 

She said the authorities have made welcome progress in some key areas, including governance and public financial management, noting that continued implementation of corrective measures to address missed targets and accelerated reforms will be important. 

“The authorities’ commitment to fiscal consolidation while protecting essential social and developmental spending should support efforts to bring down the debt burden toward the new debt anchor of 55 percent of GDP in present value terms by 2029,” she said.

In addition, the IMF notes that implementation of the Medium-Term Revenue Strategy would be key to reversing the erosion in the tax base while promoting equity and fairness in the tax regime and creating more space for spending to improve public services. “Risks to planned fiscal consolidation should be monitored and contingency plans promptly activated as needed.” 

IMF insists that the government should not turn back on these measures aimed at stabilising the economy. “Notwithstanding the elevated downward risks in the near term, the authorities should be resolute in their actions to help keep confidence anchored.”

The Bretton Wood Institution says the reforms on fuel subsidies are, therefore, essential to make better use of budgetary resources for pro-poor and development spending, including for education, health, and social protection. 

It goes on to state that any domestic fuel price stabilisation effort at times of spikes in global prices should be temporary and in line with resources available in the Petroleum Development Fund that is set up for such purposes and financed through a levy. 

IMF notes that the monetary policy has demonstrated its ability to react to inflation shocks and anchor expectations. “CBK should continue to act decisively to ensure that inflation converges firmly to the target”, adding that the strengthening of the monetary policy framework would support price stability and external sustainability. “The exchange rate should be allowed to respond flexibly to market conditions,” the IMF advises. 

And on measures at facilitating greater exchange rate flexibility, IMF says this should help ease foreign exchange market (FX) dysfunction and support a buildup of FX reserves. In the banking sector, the system is generally sound, but emerging vulnerabilities need close monitoring.