Kenya’s DEVELOPMENT PARADIGM AND Cooperation with EMERGING ECONOMIES

1. Kenya’s DEVELOPMENT PARADIGM AND Cooperation with EMERGING ECONOMIES A Presentation to UNCTAD on: South-South Cooperation and the New Forms of Development Partnerships by Njuguna Ndung’u Governor, Central Bank of Kenya September 17, 2010

2. Kenya’s Development Paradigm 2 • Kenya’s Development Paradigm is outlined in its Vision 2030 strategy covering the period 2008 to 2030. It aims to transform Kenya into a “newly industrializing middle-income country” by the year 2030. • The Vision is underpinned by a program of strategic investments in public capital, skills and education, supported by a responsive and accountable political system. • The Vision 2030 foresees an economy in which prosperity emerges from the successful exploitation of its strategic location both as a prime tourist destination and a major exporter of high-value agricultural and manufactured goods to the region, Europe, the Middle East and Asia. • Its three pillars namely; economic, social and political are anchored on macroeconomic stability; continuity in governance reforms; enhanced equity and wealth creation opportunities for the poor; infrastructure; energy; among others.

3. Kenya’s Development Paradigm… • The growth strategy aims at achieving an average annual growth rate of 10% over the next two decades. • According to the Commission on Growth and Development (2006) countries that had sustained growth rates in excess of 7% had five common characteristics: • Good Leadership and governance • Openness: imports of Knowledge and exports to the world markets • Market allocation • Macro stability, including sustainable public finances • Future orientation of the Government to long term development • These strategies are achievable under the new constitutional dispensation and Vision 2030. However, short-term challenges might arise from investment and human capacity shortfalls.

4. Kenya’s Development Paradigm… • To generate this growth requires tremendous increase in the level and productivity of investment from about 15-20 percentage share of GDP to levels in excess of 30 percent. • For extra investment to be externally financed would require large increases in either foreign aid or FDI • The growth paradigm (and a target of 10% growth) requires Kenya to focus on what are the important spin-offs: • Identifying the growth diagnostics and binding constraints to growth • Raising the capacity for growth – through public investments that are complementary to private investment • Identifying the endogenous factors of growth especially being an important member of the East African Common market

5. Kenya’s Development Paradigm… • Reducing Binding Constraints to Growth • Easing Infrastructure constraints such as high costs in the telecommunication, energy and transport sectors and Mombasa Port inefficiencies would reduce a big share of business costs and increase private investment, thus growth. • Expansion of cities and their infrastructure. • Easing constraints to private appropriability (corruption, crime, and political instability) which seem to be holding back private investment would boost growth. • Even though not identified as a binding constraint, Kenya will need specialized human skills to meet human capacity requirements to implement Vision 2030. • Kenya’s population growth rate is among the highest in the world. The demographic transition and constraints it imposes on investment and consumption patterns means that the population growth rates need to be checked.

6. Trade: key to Kenya’s Development Agenda • The Vision identifies trade as key to Kenya’s development agenda: • Deepening regional integration within the East African Community (EAC) is critical to Kenya’s growth. Kenya is already a major supplier of FDI to Tanzania, Uganda and Rwanda • Expanding trade with middle- and high-income countries in its efforts to secure access to markets outside the region, particularly in Asia, is key • Identifying manufacturing, high-valued services based on Internet, and tourism as sectors of focus could prove useful • Maintaining a competitive real exchange rate through an improvement in productivity in the services sector through reduction of costs would help maintain competitiveness. To support this competitive path, further trade liberalization would help through increased imports.

7. Kenya: Direction of Trade 7 • Kenya’s trade with developing countries increased from Ksh 559bn (68.6% of total) in 2005 to Ksh 820bn (72.4% of total trade) in 2009. • Trading with the Far East increased from Ksh 148bn in 2005 to Ksh 333bn in 2009 while trading with EU increased from Ksh 156bn to Ksh 229bn in the same period. Trading with other African states increased from Ksh 183bn to Ksh 267bn in the same period. • At the same time Kenya’s trading with China and India increased from Ksh24bn and Ksh 29bn in 2005 to Ksh 77bn and Ksh 88bn, respectively.

8. Kenya: Direction of Exports (2005-2009) 8 Source: Kenya Economic Survey 2010 • Kenya’s export growth between 2005 and 2009 was 8 percent. This was driven primarily by exports to Africa and the EU. • Exports to new markets of the Middle East and China grew sharply by 29% and 24%, respectively, in the past 5 years.

9. Kenya: Imports and Direction of Imports (2005 - 2009) (Ksh Bn) 9 • Imports growth between 2005-2009 averaged 19% with imports from EU and America declining while those to Far East, China and India increasing faster. • Average growth of imports to the Far East was 37% compared to 13% from EU and America. China and India imports to Kenya grew at an average of 56% and 60%. respectively.

10. Resource gaps to achieve growth targets • Kenya’s domestic savings rate is relatively low at 15 to 16 percent of GDP. This is not adequate to finance and sustain the growth target of 10 percent. • Domestic resource mobilization and new instruments for financing public investment are required: • Mobilizing higher national savings through financial inclusion (leverage on mobile phone financial services technology) • Tapping long term sources of finance using new instruments to attract funds from pension and insurance companies to finance Infrastructural projects (e.g. Infrastructure bonds) • Promoting public private partnerships • In addition, foreign aid and foreign direct investment are critical to attain Vision 2030 objectives: Attract More FDI and concessional financing (aid).

11. Aid has been minimal but needs fiscal space to finance development 11 Foreign aid to Kenya has been minimal. Share of foreign aid to GNI has been less than 5 percent. This is in sharp contrast to EAC states where Aid/GNI is above 20 percent. Kenya has not been dependent on aid More than 95 percent of the total budget is financed through domestic revenue collection. Public expenditure reforms and cutting of government waste undertaken between 2003 to 2007 reduced public debt (both domestic and external) from 60 percent of GDP to 40 percent without HIPC support, thus creating fiscal space which can be used to finance Vision 2030 targeted projects. Most foreign aid is concessional in nature but goes to finance projects in infrastructure.

12. Source: World Bank WDI FDI to Kenya is Minimal • For Kenya to achieve the Vision 2030 growth rate would require that the country draws upon both FDI and concessional finance in a big way. • FDI flows to Kenya have been miniscule: much lower than neighboring Rwanda, Uganda and Tanzania. However, Kenya is among the largest sources of FDI to the region. • Experience elsewhere shows that FDI flows respond the most to the size of the domestic market. • Future FDI flows targeting EAC will create a footprint in Kenya. This means that FDI flows will respond somewhat to increased demand for Kenyan products in the expanding regional market and may become important. FDI to Kenya is less than remittances from Kenyans in the diaspora who bring back an average of US$50m per month (US$600m per year).

13. The Increasing Role of China • Since 2005, Kenya has nurtured a close relationship with China: • Kenya’s Development Cooperation with China is currently anchored on the Forum for China Africa Cooperation (FOCAC) Action Plan 2010 – 2012. • Volume of Chinese ODA = Ksh 42.2bn (US$ 527m) • Grants - Ksh 1.93bn (US$ 24m) • Loans - Ksh 40.3bn (US$ 503m) • Further funding from Export-Import Bank of China =US$4.5bn • Imports from China have tripled from Ksh 23bn to Ksh 75bn. These imports comprise furniture, palm oil, machinery/transport equipment and textiles. • Exports to China doubled fromKsh 1bn to Ksh 2bn. Main exports include scrap metals (copper and aluminum waste) black tea, sisal fiber, leather, raw hides and skins and fish. • Civil engineering and contractors plant and machinery was Ksh 3.9bn in 2009 (mostly infrastructural projects such as roads to enhance road network nationally and regionally and facilitate trade expansion).

14. The Increasing Role of China…. 14 • Currently, there are 73 Chinese companies in Kenya representing a sizeable Chinese FDI portfolio in Kenya. • China Investment Promotion Authority and Kenya Investment Authority are in negotiation that will culminate in bilateral investment agreement to foster investment from Chinese companies. • Investment opportunities in Kenya which are encouraging Chinese firms include: Agro and food-processing, tourism, air transport and construction, machinery and equipment, medical products and equipment, power generation, infrastructure, etc. • With the establishment of the EAC Common Market, Kenya has become a gateway to the hinterland nations in Eastern and Central region of Africa. Kenya is seeking Chinese investment that would transfer Chinese production capacity of some of their key exports to Kenya. These include basic telecommunications equipment, electrical machinery, building material, clothing and textile and motor vehicle assembly, especially of motor cycles.

15. The Increasing Role of China…. 15 • Among the key projects being undertaken by China grants and concessions by Chinese firms are: • The building of the second main port in Lamu and the South Sudan Rail Link (US$ 1bn partly financed by the Chinese Government). • Thika Highway (US$132m) – has changed the way road network construction will take place in EAC in future. • Modernization of Jomo Kenyatta International Airport. • Drilling of Geothermal Field Production Wells (US$93m).

16. Summary: Unlocking Kenya’s Potential of Vision 2030 • The success of Kenya’s development paradigm is predicated on implementing its growth strategy and looking for new partnerships with the BRICs. This involves, among other things: • Easing the Infrastructural constraints which have been identified as among the binding constraints to private investment and growth. • Taking advantage of the country’s coastal location to promote a manufacturing-led export strategy and prime tourism destination. Such strategy requires targeted public investment in physical infrastructure that lowers the cost of doing business which will also attract other large scale investors along the coastal strip. • Given the rate of investment required to deliver the growth targets, external orientation both in terms of trade and external resources (FDI and AID) is key. Cooperation with the BRICs and other emerging countries is essential in terms of FDI, technological transfer and new markets for Kenyan goods. • Financial inclusion and reducing the costs of doing business: new institutions like Credit Reference Bureaus and new initiatives like agent banking: access to finance is pro-poor.

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