Growth Recovery in Kenya: What Caused it and How Can it be Sustained

1. Growth Recovery in Kenya: What Caused it and How Can it be Sustained Praveen Kumar AFTP1 September 29th, 2008

2. Presentation Outline • Kenya’s Growth experience • Analysis of drivers of recent trends • Constraints to accelerating and sustaining growth • Outline of a growth strategy

3. Overall message • Macro framework reasonably sound, fiscal well-managed • Micro-reforms are working. • Key growth challenges are: • Keeping political risk low • Using fiscal space wisely to scale-up infrastructure services • Reducing micro-risks such as corruption, security

4. Growth bypassed Kenya even as it accelerated in neighboring countries…

5. …but recovered strongly after 2003

6. Recovery was broad-based

7. Annual Percentage Change in Expenditure on GDP (constant 2001 prices) 2003 2004 2005 2006 2007* Government Consumption 6.0 0.6 -0.6 1.5 7.2 Private Consumption 2.2 2.4 6.4 7.6 7.3 Gross fixed Capital Formation -8.0 7.3 27.8 18.5 13.3 Exports of Goods and Services 7.2 12.8 9.7 3.4 6.0 Imports of Goods and Services -0.1 12.3 15.0 18.2 12.7 Source : Economic Survey 2008, KNBS. (*) Provisional Investment grew in an impressive manner…

8. for example, Imports of Machinery and Transport Equipment Increased (% of Gross Domestic Expenditure)

9. TFP also improved

10. Three drivers of positive trends after 2003: • Lagged benefits of liberalization of price, trade, exchange rate & interest rate forced by reduced aid after the Goldenberg scandal uncovered in 1992; • Solid foundation for solvency based on significant revenue collection as a payoff to the reform of tax policy & administration which started in the mid-1990s; & critically; • Declining political risk after the successful 2002 elections fueling an improvement in sovereign creditworthiness & the private investment climate;

11. Driver 1: Economic liberalization in the mid 1990s • Era of price controls ended; • Import licenses abolished, tariff structure simplified – average tariff reduced; • Unified, market-based exchange rate adopted and exchange controls lifted; • KRA established, tax reforms introduced; • Agricultural marketing liberalized; • Major spur for reform was: the need to establish macro credibility in the wake of the Goldenberg scandal, and the reduction of aid.

12. Driver 2: Sustainable trajectory of public debt Debt to GDP ratio

13. What lowered the debt ratio?Debt decomposition

14. Solid foundation for solvency – Revenue mobilization • Significant reforms in tax policy • Improved tax administration

15. Driver 3: Decline in country risk • Cost of domestic borrowing declined • Sovereign risk ratings improved • Reduced perception of risk by firms

16. Driver 3: Decline in country risk:Cost of domestic borrowing

17. Decline in country riskSovereign risk ratings ICRG* Institutional Investor** *Scale 0 to 100, with 100 as lowest risk. **Scale of zero to 100, with 100 representing the least chance of default

18. Reduced perception of risk by firms

19. What can be done to accelerate and sustain growth: Multi-pronged analysis • Growth diagnostics • Cross – country benchmarking • A stylized (real) macro-model (MAMS) • Use of ICA • Sectoral analysis: Tourism, ICT, agriculture

20. Key results from Growth Diagnostics • Cost of finance is not a binding constraint in Kenya currently • Scarcity of human capital is not a binding constraint currently • High cost of infrastructure services - energy, ports etc hurting returns • Macro risk receded, but micro-risks (corruption, security situation) deterring investment

21. Evidence of high business costs from ICA 2007

22. Cross-country benchmarking on deeper determinants of growth • Indicators used by Johnson, Ostry and Subramanian (2007) • Institutions – broad political and economic • Extent of integration into global economy • Two sets of countries • Fast-growing SSA countries that are not resource-rich, not post-conflict • 12 Sustained Growth economies

23. Benchmarking Institutions:Kenya does OK on indicators of broad political and economic institutions Source: Johnson, Ostry, and Subramanian (2007). a. Polity IV database. b. ICRG database. c Normalized Kaufmann-Kraay index. d. WDI database.

24. Benchmarking Institutions:Kenya has high social fractionalization

25. Benchmarking macro and trade policy and outcomes: Kenya looks not bad

26. Benchmarking extent of integration into global economy: Kenya’s low integration

27. Benchmarking extent of integration into global economy: Kenya’s declining competitiveness Shares in World Exports of Goods and Services, High Performing Economies (HPEs) and Kenya, 1975–2005 Source: Staff calculations, based on COMTRADE data. Averaged using SITC2 3-digit classification.

28. Benchmarking sophistication of exports: Low sophistication

29. A stylized (real) macro-model (MAMS) Real Macro Indicators by Simulation (% annual growth from 2006-2030)

30. Outline of growth strategy • Keep political risk low – address issues of social and political cohesion • Sustain macro-stability • Preserve favorable government debt dynamics and use available fiscal space to finance only high-return projects • Strengthen institutional framework for project selection and subject capital projects to systematic economic analysis • Reduce high costs of backbone services: • Logistics costs, particularly of trading across borders • Transportation costs • Telecommunications and energy costs

31. Outline of growth strategy • Improve global integration of Kenyan economy. Towards that: • Deepen regional integration, BUT • Focus on global competitiveness beyond the region: • Use membership of trade groups – EAC and COMESA – to further improve openness • Liberalize unilaterally where possible • Use multilateral route for securing access to protected Asian markets • Maintain a competitive real exchange rate • Proactively provide solutions to government/market failures in key export sectors • Example ICT • Example Tourism