82380 A ENY K $ Walking on a Tightrope Rebalancing Kenya’s economy with a special focus on regional integration Walking on a Tightrope Rebalancing Kenya’s economy with a special focus on regional integration TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS i FOREWORD ii ACKNOWLEDGEMENTS iii MAIN MESSAGES AND KEY RECOMMENDATIONS iv EXECUTIVE SUMMARY v THE STATE OF KENYA’S ECONOMY 1 1. Stabilizing but vulnerable 2 1.1 Economic performance in 2011 2 1.2 The Monetary sector: At the center of the stabilization effort 4 1.3 Responsive fiscal Consolidation 5 1.4 External Account remains out of balance 9 2. Growth Prospects for 2012 and 2013 11 2.1 Growth prospects 11 2.2 Risks to the outlook 13 3. Rebalancing the economy 15 3.1 From short term stabilization to sustained Growth 15 3.2 Leveraging the EAC Customs Union 16 SPECIAL FOCUS: DEEPENING KENYA’S INTEGRATION IN THE EAST AFRICAN COMMUNITY (EAC) 19 4. The EAC – A dynamic economic community 20 4.1 Fast growth and a shift towards regional trade 20 4.2 Regional integration can bring substantive benefits 22 5. Challenges for Advancing the Regional Integration Agenda in East Africa 25 5.1 Non-tariffs barriers (NTBs) 25 5.2 Poor export growth and limited diversification 26 6. Lowering Costs and Increasing Trade - Reducing Kenya's Non-Tariff Barriers 28 6.1 Rules and regulations 28 6.2 Stabilizing food prices in Kenya 29 6.3 Institutional failures 31 7. Growing and Diversifying Kenya’s Exports – Services Matter 37 7.1 Kenya’s promising service sector 37 7.2 Unleashing Kenya’s services 38 8. Policy Recommendations 41 ANNEXES Annex 1: Map of EAC 45 Annex 1.1: GDP Growth rates, Kenya and Sub Saharan Africa 46 Annex 1.2: Key Macro-economic indicators low case, baseline and high case scenario 46 Annex 1.3: Kenya’s GDP per capita 47 Annex 1.4: Sectoral Growth rates 47 Annex 1.5: GDP growth rate of other African countries 47 Annex 1.6: Kenya’s Inflation 48 Annex 1.7: Kenya’s foreign exchange rates 48 Annex 1.8: Capital markets indices 49 Annex 1.9: Interest rates 49 Annex 1.10: Credit distribution to the private sector 50 Annex 1.11: Oil price movements 2011 51 Annex 1.12: Kenya’s Fiscal position 51 Annex 1.13: Simulating the effects of crude oil price increase on the Current Account 52 Annex 1.14: Balance of Payment (2009-2011) 53 Annex 1.15: Maize production 2009 and 2011 54 Annex 1.16: Price Comparison Selected Commodities 54 Annex 1.17: Inflation April 2012 54 Annex 2: Number of products covered by at least one non-tariff measure 55 Annex 3: Sectoral Distribution of non-tariff measures in Kenya 55 Annex 4: Estimated price raising effect of non-tariff measures by product, country comparison (%) 56 Annex 5: EAC Time-Bound Programme for Elimination of NTBs – 2008 57 Annex 6: Elimination of NTBs – 2008-2010 61 Annex 7: Elimination of NTBs – 2010-2011 62 Annex 8: Case Study - Truck Drivers journey along the Northern Corridor 63 LIST OF TABLES Table 1.1: Fiscal consolidation as a result of shocks in 2011 (percent of GDP) 7 Table 2.1: Fiscal consolidation as a result of shocks in 2011 (percent of GDP) 12 Table 4.1: Dynamic intra-regional exports in East Africa gained in the last decade 21 Table 4.2: Top 15 products traded between the EAC countries 22 Table 6.1: Existing NTBs in the food sector – Identified in the EAC NTB Report 32 Table 7.1: Kenya has a revealed comparative advantage in services shown in bold (2010) 38 Table 7.2: Kenyan Supermarkets with EAC Presence 39 LIST OF FIGURES Figure 1: Kenya’s economy in 2012: stabilizing but still vulnerable vi Figure 2: Kenya's trade Balance has deteriorated despite strong service exports vi Figure 3: EAC trading more with itself than other regions – which was not the case in 2008 vii Figure 4: Kenya and Uganda’s trade barriers are among the highest in Africai viii Figure 1.1: Growth remained resilient in all sectors and all quarters 2 Figure 1.2: Kenya’s growth tails in the EAC region ……and lags behind the average for SSA 3 Figure 1.3: Tea and coffee earnings increased but production contracted 3 Figure 1.4: Inflationary pressure easing …as high interest rates rose 4 Figure 1.5: Lending to private sector contracted by 10.3 percent... except for non tradable sector 5 Figure 1.6: Fiscal consolidation in 2011 demonstrates commitment to fiscal discipline 7 Figure 1.7: Recurrent and Development Spending 8 Figure 1.8: Trends in Public Debt 8 Figure 1.9: Kenya can sustain a debt to GDP ratio at 45 percent 8 Figure 1.10: On per capita basis the CRA consultation formula is skewed in favour of countys 9 with low population density Figure 1.11: FDI and short term inflows financed the current account deficit 10 Figure 1.12: The Shilling has appreciated sharply 10 Figure 2.1: Growth will be moderate at 5.0 percent in 2012 and 5.0 percent in 2013 11 Figure 2.2: The current account deficit could reach 15 percent of GDP if the oil price stays 13 above US$100 Figure 2.3: Inflation has declined but any reduction in interest rates should be gradual 14 Figure 2.4: Slow growth of “narrow” money, rises in “broad” money 14 Figure 3.1: High growth episodes have been driven by consumption…excess domestic 15 consumption is met through imports Figure 3.2: Kenya needs to cut back consumption and increase savings 17 Figure 3.3: The trade gap is widening …import cover ratios have declined as oil prices have risen 17 Figure 3.4: The EAC market is growing fast …so is intra regional trade 18 Figure 3.5: Exports have increased …but markets and products have become concentrated 18 Figure 4.1: Average GDP growth in the EAC has been far ahead of most other economic blocks 20 Figure 4.2: EAC partner states now export more goods within the EAC region than to any 21 other region – which was not the case in 2008 Figure 4.3: Kenya exports mostly manufactured goods, chemicals and machinery to EAC partner 21 states (2009) Figure 5.1: Rules and regulations which can become NTBs 25 Figure 5.2: Tariff reduction in the EAC 26 Figure 5.3: Kenya under exports to Tanzania, Uganda and the BRICS 26 Figure 5.4: Sectoral composition of exports - Since 2005 there has been little export 27 diversification in Kenya Figure 6.1: Kenya imposes a large number of rules and regulations, particularly against 28 EAC partner states Figure 6.2: Kenya and Uganda impose a wide variety of rules and regulations 29 Figure 6.3: Kenya’s sectors with the most rules and regulations – metals, machinery 29 and…food products Figure 6.4: Significant price-raising effect of SPS on food types in Kenya and Uganda 30 Figure 6.5: Food surplus and deficit countries in the EAC 30 Figure 6.6: Restricted trade resulted in a recent lose-lose for Tanzania producers and 30 Kenyan consumers Figure 6.7: Lower income groups are hurt more by inflation 31 Figure 6.8: Price-raising effect (%) of (SPS) measures hurt low-income groups the most 31 Figure 6.9: More and more NTBs identified, but more and more time given for removal 34 Figure 7.1: Service exports have increased for all EAC countries, but particularly Kenya 37 Figure 7.2: Kenya is exporting more services than ever before, and the gap between service 38 exports and imports is growing Figure 7.3: Kenya can export professional services to Uganda and Rwanda 40 LIST OF BOXES Box 1.1: The case of interest rate controls in Kenya: why it was a bad idea, and 6 alternative options Box 3.1: Making Oil work for Kenya: Oil Management Challenges 16 Box 4.1: Regional integration and the EAC 23 Box 5.1: In contrast to NTBs, tariffs in the EAC have been reduced significantly 26 Box 5.2: Regional backdrop – Underdeveloped infrastructure, unreliable power and poor 27 business environment Box 6.1: Openness to regional trade can be a win-win…….East Africa can feed itself 30 Box 6.2: Case Study – NTBs affecting maize, who’s capturing the rents? 34 Box 6.3: Case Study – Harmonized EAC dairy standards are a potential NTB 35 Box 6.4: What really happens along the northern transit corridor? Things you need to know… 36 Box 7.1: Knowledge sharing for service sectors 40 ABBREVIATIONS AND ACRONYMS APR Annual Percentage Rate ASEAN Association of Southeast Asian Nations ATM Automated Teller Machine BPO Business Process Outsourcing BPS Budget Policy Statement BRIC Brazil, Russia, India, China CAGR Compound Annual Growth Rates CBK Central Bank of Kenya CBR Central Bank Rate CES Common Economic Space CET Common External Tariff CFS Container Freight Station CRA Commission on Revenue Allocation EAC East African Community EAPP East Africa Power Pool EEA European Economic Area EITI Extractive Industries Transparency Initiative EMU Economic and Monetary Union EPC Export Promotion Council ERS Economic Recovery Strategy EUCU European Union Customs Union FDI Foreign Direct Investment GDP Gross Domestic Product ICT Information and Communication Technology IDF Import Declaration Form KCB Kenya Commercial Bank KES Kenya Shillings KEPHIS Kenya Plant Health Inspectorate Service KEU Kenya Economic Update KNBS Kenya National Bureau of Statistics KRA Kenya Revenue Authority LIBOR London Interbank Offered Rate MRA Mutual Recognition Agreement NCPB National Cereals and Produce Board NEER Nominal Effective Exchange Rate NMC National Monitoring Committee NTBs Non-Tariff Barriers PIP Plant Import Permit REER Real Effective Exchange Rate SACU Southern African Customs Union SPS Sanitary and Phytosanitary SSA Sub-Saharan Africa TBT Technical Barriers to Trade WDI World Development Indicators WITS World Integrated Trade Solution i June 2012 | Edition No. 6 FOREWORD I t is my pleasure to present to you here the sixth edition of the World Bank’s Kenya Economic Update. Following economic turbulence at the end of 2011, the Government of Kenya raised interest rates, and reduced public spending, to help stabilize the economy in 2012. Inflation is now declining, and the exchange rate is more stable. Even so, the outlook for 2012 remains mixed, as macroeconomic instability tends to increase around elections, and the crisis in the Euro zone is clouding the international economic outlook. This is why we chose as the title of this report “Walking on a Tightrope”. This report has three main messages. First, Kenya’s economy is stabilizing, although it remains vulnerable to domestic and external shocks. After sailing through rough waters in 2011, the World Bank projects growth of 5.0 percent for 2012 and 2013, providing shocks are avoided. Second, Kenya’s high and widening current account deficit can be interpreted to mean that the country is living beyond its means. To address this issue, it is time to rebalance the economy by increasing savings for investment—and also increasing exports. Third, the East African Community (EAC) presents many opportunities for Kenya, but non-tariff barriers to trade remain considerable. Kenya can lead the way to deeper EAC integration, by helping to lift non-tariff barriers, and so unlocking regional trade. This would help to reduce Kenya’s trade deficit, as well as its domestic food prices. The World Bank remains committed to helping Kenya to walk the tightrope successfully, and to rebalance the economy through regional integration. The Bank’s series of Economic Updates, which we publish in a new edition every six months, have become our leading vehicle to analyze development trends in Kenya, and to contribute to the implementation of the Bank's strategy for Sub-Saharan Africa—a strategy that puts a special emphasis on knowledge and partnerships. With these reports, we aim to support all those who want to improve the economic management of Kenya. As in the past, we are proud to have worked with many key Kenyan stakeholders during the preparation of this report. We hope that you too will join us in debating policy issues that are topical in Kenya today, and in making your contribution to helping Kenya to grow, and to achieve a permanent reduction in poverty. Johannes Zutt Country Director for Kenya World Bank June 2012 | Edition No. 6 ii ACKNOWLEDGEMENTS This sixth edition of the Kenya Economic Update was prepared by a team led by Jane Kiringai together with John Randa, Nora Carina Dihel, Ian Mills and Peter Warutere with supervision from Wolfgang Fengler. The core team consisted of Betty Maina, Allen Dennis, Catherine Ngumbau, Caroline Wambugu, and Lucy Wariara. The team acknowledges contributions from Andrew Roberts, Geoff Handley, Aurelien Kruse, Miriam Omolo, Olivier Cadot, Julien Gourdon, Laban Maiyo, Fred Wamalwa, and Roger Sullivan. The report benefitted from insights of several peer reviewers including Nehemiah Ng’eno, Mombert Hoppe and Paul Brenton. Humberto Lopez and Johannes Zutt provided overall guidance to the team. Partnership with key Kenyan policy makers was instrumental in the production of this report. On May 30, 2012, a draft of the report was presented at the Quarterly Economic Roundtable. The meeting was attended by senior officials from the Ministry of Finance, the Kenya National Bureau of Statistics, the Kenya Institute of Public Policy and Research Analysis, the Kenya Revenue Authority, the International Monetary Fund, the National Economic and Social Council, and Office of the Prime Minister. Special appreciation goes to Mart Logistics, for conducting a truck drivers’ survey along the northern corridor. iii June 2012 | Edition No. 6 MAIN MESSAGES AND KEY RECOMMENDATIONS Main Messages • Kenya’s economy is stabilizing but still vulnerable. At the end of 2011, the government increased interest rates and lowered the fiscal deficit by curbing expenditures, temporarily stabilizing the economy. Inflation declined, the exchange rate stabilized, and economic growth slowed in 2011 to 4.4 percent. The outlook for 2012 is mixed. With economic stability and good rains, growth could reach 5 percent in 2012 and 2013. However, another series of shocks (increased oil prices, a poor harvest, the euro zone crisis, or domestic instability) could easily create renewed economic turbulence, and slow down economic growth to 4.1 percent. • The current account deficit has increased and Kenya remains vulnerable to external shocks. High oil prices and weak exports have widened Kenya’s trade deficit, and this has contributed to a current account deficit of 13.1 percent of GDP, a record high for Kenya and amongst the highest external deficits in the world. Kenya’s exports remain few (tea, tourism, horticulture) and its import bill remains vulnerable to high oil price increases. • Kenya can improve its trade balance, lower prices and improve food security by reducing non-tariff barriers to trade. The EAC now trades more with itself than with any other region of the World. However, Kenya imposes numerous rules and regulations across a wide variety of sectors on imports, particularly from EAC partner states. Where these rules and regulations are poorly designed or implemented, they become non-tariff barriers. In the food sector, if Kenya were to reduce non-tariff barriers it would ease domestic food prices, help the poor and enable the EAC market to boost production in food surplus countries – which is win-win for both EAC producers and Kenyan consumers. • Kenya is in an excellent position to benefit from EAC integration and expand its trade in services. Kenya is a net importer of goods but a net exporter of services. Kenya’s services have experienced dynamic growth and the sector has further potential for expansion. However, regulatory barriers restrict services, particularly in the banking, professional and business sectors. Services trade liberalization and regulatory reform are needed to enable Kenya to benefit fully from EAC integration. Key Recommendations for Economic Management • Keeping inflation low remains vital for Kenya’s economic recovery. Tight monetary and fiscal policies in 2012 have helped Kenya to regain macroeconomic credibility. Any reduction in interest rates should be gradual to maintain macroeconomic stability and not endanger external financial inflows currently supporting the shilling. Similarly, fiscal consolidation should continue but now needs to strike the right balance between budget cuts and priority investments for growth especially in transport, electricity and water. • As the economy stabilizes, it is time to change gear from short-term stabilization to structural reforms for sustained growth. Kenya’s competitiveness in some sectors has declined (as domestic prices, including food, energy and transport, remain elevated) and this is putting pressure on exporters’ margins as well as on overall competitiveness. As a result, non-tradable sectors, especially services and construction, are driving growth while the share of tradable sectors, especially manufacturing, is declining. It is time to address these imbalances and to promote exports. • Kenya needs to increase public and private savings. Kenya’s growth is mainly driven by consumption. Domestic savings have been declining and the excess of investments over savings is increasing the current account deficit. In short, Kenya is living beyond its means. Tax and expenditure policies can be used to cut back consumption and create incentives to increase savings and investments. Key Recommendations for Regional Integration • Establish a trade regulatory committee and consult stakeholders. The trade regulatory committee should review existing rules and regulations - removing those that cannot be justified - and inform the design and implementation of new rules in the least trade-restrictive manner, without compromising legitimate public policy objectives. It has been shown in the past that an inclusive and transparent process with stakeholders is crucial for successful regional integration. • Develop an effective monitoring mechanism with possible sanctions for non-compliance. The COMESA-EAC-SADC Tripartite online reporting and resolution system is showing signs of encouraging progress and good practice. The binding dispute settlement processes of the WTO, and the experience of the EU in establishing a legally binding mechanism with sanctions for non-compliance, provide additional relevant models for the EAC to consider. • Eliminate regulatory barriers, and disseminate market opportunities, in trade in services. Reforms should focus on aligning regulatory frameworks in financial services and mutually recognizing professional qualifications. Collaboration should be encouraged between universities and professional associations to address skills-shortages and support given to the Export Promotion Council to expand dissemination of market information on services to Kenyan firms. EXECUTIVE SUMMARY I n 2012, Kenya’s economy has been on a tightrope. Policy makers have had to walk a fine line between stabilizing the economy and maintaining the growth momentum. While inflation has declined, the exchange rate stabilized, and the fiscal position improved, fundamental economic imbalances continue to make Kenya vulnerable to shocks. In the absence of economic and social turbulence, Kenya should grow at 5 percent in 2012 and 2013, which would still be substantially below its neighbors. Kenya has been benefitting from the integration and growth momentum in the East African Community (EAC), which has become one of the most vibrant economic regions in the world. However, despite impressive increases in trade between the five EAC partners in recent years, there is still a large untapped potential. EAC trade could increase several-fold if unnecessary restrictions in the trade of goods and services –particularly non- tariff barriers- were removed. Kenya’s Economy: Stable But Vulnerable the world. Such strong performance is to the benefit of all countries in the region. Even with growth at 5 K enya’s economy is stabilizing gradually. After sailing through rough waters in 2011, the economy is back on track to achieve 5 percent growth in 2012. percent, Kenya’s per-capita income is now exceeding US$800 for the first time, and the country is firmly on the path to Middle Income status. Three main factors underpinned stabilization. First, the Government’s determined action to increase Debt levels have returned to below 45 percent of interest rates during the third quarter of 2011 and GDP: if Kenya were part of the European Union, it prudent fiscal policies sent important signals to the would be one of its least-indebted members. With markets and this also helped to stabilize the exchange rate. Second, inflation has started to decline sharply, relatively low levels of debt, a stable exchange rate thanks to lower international food and energy prices. and declining inflation, Kenya again has the space to Third, Kenya’s service sector continued to expand run slightly higher fiscal deficits to maintain public strongly, with very good results in tourism. investment programs, especially in infrastructure. In the medium-term, Kenya will also need additional The return of macroeconomic stability gives hope fiscal resources to manage the transition to a system for 2012 and 2013. While inflation was close to 20 of devolved government. percent at the beginning of 2012, it is expected to remain below 10 percent during the second half of Kenya has avoided a severe economic downturn, but 2012 — a mirror image of 2011. With lower inflation, structural weaknesses remain and they make the interest rates may fall, which will allow the exchange country vulnerable to renewed instability. Kenya’s rate to return to more competitive levels and overall economy is out of balance and the external position spur economic activity. has become even more vulnerable as the country’s current account deficit has skyrocketed and could However, Kenya’s growth remains below the African reach 15 percent of GDP in 2012 (see figure 1). This is average and substantially below that of its EAC among the worst external balances in the world and partners. Sub-Saharan Africa is expected to grow poses a significant risk to Kenya’s economic stability. at 5.3 percent in 2012 and 5.6 percent in 2013, and An additional external shock, especially a sharp rise the EAC continues to outperform the region, with in oil prices, would trigger severe economic stress, average growth likely exceeding 6 percent in both especially if accompanied by capital outflows. years, making it one of the best performing regions in v June 2012 | Edition No. 6 Executive Summary Over the last decade, Kenya’s imports have grown medium-term, policies in both sectors will have an faster than its exports. Since mid-2011, Kenya’s important impact on the macro-economy: earnings from its top four exports have not been • Food. Over the last year, Kenyans paid almost double sufficient topay for its oil imports. While earnings the global price for maize and triple the global price from traditional exports have grown (especially tea for sugar. This is hurting the poor disproportionately and coffee) thanks to higher global prices, the import as they spend a large share of their income on bill has in recent years has grown even faster, on food. It is also increasing Kenya’s macro-economy account of high oil prices. In 2011 alone, the import vulnerability by increasing inflation. bill rose by 23 percent. This has widened the current account deficit, threatening macroeconomic stability. • Energy. Kenya remains heavily-dependent on hydropower, and electricity shortages are frequent Kenya has great potential to increase its exports, when rains are uneven. As a result, Kenya has had both in goods and services. For goods, there is to make increasing use of fuel-powered thermal potential is in new markets —notably the BRICs— and plants, and therefore to import more oil at the new products, especially light manufacturing. Kenya’s very time when oil prices were rising sharply. services exports are already doing well: Kenya’s net The ballooning oil import bill has in turn caused trade in services generated a surplus of US$ 2.35 Kenya’s current account deficit to widen. Kenya billion in 2011 and there is potential for further has embarked upon a major investment program expansion. Kenya’s wide current account deficit is and expansion in geo-thermal energy, which will driven by the deficit in goods, which reached US$ 9 bring multiple benefits to the country, not just for billion in 2011 (see figure 2). Therefore the challenge industry and the environment, but also for the for Kenya is to strengthen its services sector further, macro-economy in reducing the oil import bill. while acting to develop its embryonic manufacturing base. Food and energy are two sectors where Kenya and its partners can benefit greatly from regional Kenya continues to face enormous challenges in integration. While Kenya is facing a structural food food and energy. Both sectors are critical for Kenya’s deficit, Tanzania and Uganda produce a surplus, economic prospects and for the country’s agricultural especially in maize. Expanding the food trade within and industrial transformation. In the short-to the EAC would enable Kenyan consumers to pay less for food while also allowing Tanzanian and Ugandan Figure 1: Kenya’s economy in 2012: stabilizing Figure 2: Kenya's trade Balance has deteriorated but still vulnerable despite strong service exports 25 105 20 Inflation 100 Net trade in goods and Services 15 95 10 Services In ation % 10 90 5 US$/Ksh US$/Ksh 5 85 0 Percent of GDP 0 80 2000 2002 2004 2006 2008 2010 2011 -5 Current Account , % of GDP -5 75 -10 -10 70 Trade balance -15 -15 65 -20 Goods -20 60 Nov Nov Apr Jul Aug Dec Apr Jul Aug Feb Feb Dec Feb April May Sep May Sep May Mar Jun Oct Jan Mar Jun Oct Jan Mar -25 -30 2010 2011 2012 -35 Source: World Bank computations based on KNBS and CBK data. Source: World Bank computations based CBK data. June 2012 | Edition No. 6 vi Executive Summary farmers to earn moreby selling their produce to the external vulnerability. Deepening Kenya’s intra- Kenyan market. In energy, a “regional power pool” EAC trade would help reduce its widening current would enable Ethiopia to earn revenues from selling account deficit, cushion it against global turbulence power to energy-deficit countries such as Kenya, and open the economy to more FDI, which has Tanzania, Uganda and Rwanda. already increased threefold in the EAC this decade. Increasing intra-EAC trade would contribute to better The Promise of Regional Integration food security in Kenya, develop regional production chains in food and manufacturing that would create T he East African Community is one of the fastest growing regions in the world. Over the last decade, the region has experienced average employment, and open up new markets in services and increase efficiency in existing ones. growth of 5.8 percent, the second-highest of any The EAC is now trading more with itself than with economic block in the world, just below ASEAN other regions of the world. Over the last decade, (which grew at 6.1 percent). The EAC’s growth has trade with other African countries has been been fueled by rapidly growing trade between the expanding rapidly and it now accounts for about half EAC countries, which tripled in value over the last of Kenya’s total trade. Trade within the EAC has also decade and could increase further. The EAC has also risen importantly, including in manufactured goods experienced unprecedented demographic growth, such as food products, beverages, tobacco, and as the population has grown more than 30 percent cement. Kenya’s trade with its EAC partners has now over the last decade, from 110 million people in 2002 overtaken trade with Europe (see figure 3). to 145 million people in 2012. By 2030, the five EAC countries will be home to an important market with a Figure 3: EAC trading more with itself than other population of about 200 million. regions – which was not the case in 2008 EAC Exports to... Global and regional integration are complements, 2.5 not alternatives. Many European, American and Asian 2 countries benefitted simultaneously from global and regional integration (into the EU, ASEAN and NAFTA). 1.5 US$ Billion The EAC countries can also use regional integration 1 as a stepping stone for competing globally. 0.5 Regional integration is a win-win strategy for growth 0 and poverty reduction in East Africa. Tanzania and Intra - EAC Europe Rest of Africa South and East Asia Rest of World Uganda have relatively robust agriculture sectors 2008 2010 and their mining sectors have been benefitting from rising commodity prices. Kenya has a vibrant service Source: World Bank compulations based on WITS data. industry and Nairobi is increasingly serving as a hub for global companies seeking to expand into Africa. Tariffs have declined markedly, but the business So far, Kenya has been riding the wave of Africa’s climate is still poor in most EAC countries. In the growth momentum. Now is the time for Kenya to last two decades, EAC countries have reduced their become East Africa’s growth engine again: it is best tariffs sharply, from an average of 26 percent in 1994 placed to kick-start manufacturing, which remains to 10 percent in 2011. However, most EAC countries East Africa’s Achilles heel. are still struggling to implement critical business reforms. So, while there have been many positive Kenya can also leverage regional integration to developments over recent years, the full potential of rebalance its economy. Strong regional growth the EAC remains untapped. presents opportunities for Kenya to mitigate its own vii June 2012 | Edition No. 6 Executive Summary Non-tariff barriers continue to hamper trade and hit amongst countries compared (see figure 4). Kenya the poor. A reduction in non-tariff barriers would give is also the only country (in this comparison) which all EAC countries a major boost. EAC countries have imposes more measuresrules and regulations on made progress on reducing quotas and restrictive imports from its regional partners than from the rest import licensing requirements, but still need to make of the world (while other SSA countries impose less headway on other of rules and regulations - namely measuresrules and regulations on imports from their health and safety regulations, technical barriers regional partners than from the rest of the world). to trade (which arise when standards, regulations and assessments systems are Kenya imposes non-tariff not applied uniformly), inspections, and restrictions across a variety of quantity controls. Non-tariff barriers sectors, including food. These raise prices in domestic markets and, Kenya is currently measures restrict the free flow when they affect food products, hurt the imposing more rules of trade across many sectors, poor most. and regulations on particularly metals, machinery and imports than do many food. Even in food, where Kenya Despite Kenya’s good intentions in other African countries. has a major deficit, the country is fostering regional integration, it remains imposing too many restrictions, a major hindrance for growing trade which end up raising domestic within the EAC. Kenya is currently imposing more prices and hurting consumers. As a result, Kenya now rules and regulations on imports than do many has a maize deficit of 1.13 million metric tons, which other African countries – it is close to the bottom explains why the EAC as a whole also entered into a food deficit in 2010. Figure 4: Kenya and Uganda’s trade barriers are among the highest in Africa The potential for trade in services remains large. 100 Kenya is competitive in transportation, communication % of imports affected by ≥1 rule & regulation 90 and financial services, and Kenya-based banks are 80 now leading regional integration in the EAC banking 70 sector. Kenyan companies have started to position 60 themselves in neighboring countries (for instance in 50 retail) and the country is exporting more and more 40 30 services to EAC countries (especially Uganda), which 20 are benefitting from better and more affordable 10 services. If Kenya’s non-tariff barriers were reduced, 0 the service exports sector could expand further and SEN MDG MUS NAM KEN UGA contribute to strengthening the current account. World Region Source: Cadot and Gourdon, World Bank 2012. June 2012 | Edition No. 6 viii The State of Kenya’s Economy 1. Stabilizing but vulnerable I n 2012, Kenya’s economy returned to a more stable path. Inflation is declining and is below 10 percent; the exchange rate has stabilized and low fiscal deficits have brought debt levels to below 45 percent. While Kenya’s economic growth slowed in 2011 to 4.4 percent, it is now back on track, with economic stability and good rains, and is projected to reach 5 percent in 2012 and 2013. At the same time, Kenya’s economy is more vulnerable than ever to shocks, due to a large and widening current account deficit, which could reach 15 percent of GDP in 2012. Another oil price shock, poor harvest, or an episode of domestic instability, could easily create renewed economic turbulence. Kenya’s exports continue to be driven by traditional products, and are sold to traditional markets. At a global level, Kenya’s exports remain few (tea, tourism, and horticulture) and are recording modest growth. However, in Africa, especially East Africa, trade has been expanding rapidly, which demonstrates the potential of regional integration for Kenya. 1.1 Economic performance in 2011 years. Industry experienced tepid growth in 2011 at 2.8 percent, a significant decline from 5.3 percent in In an environment of global turbulence and domestic shocks, Kenya recorded moderate growth of 4.4 percent in 2011. For the second 2010 (see figure 1.1 for details). Kenya’s growth for the last four years has been consecutive year, the economy experienced positive relatively modest. Since the 2008 crisis, Kenya has growth across all quarters and sectors, even though agriculture performed poorly. The agriculture sector been growing at an average of 3.5 percent per year, growth declined from 6.4 percent in 2010, to 1.6 well below the average for Sub-Saharan Africa (5.5 percent in 2011. This is attributed to dry weather percent, excluding South Africa) and significantly conditions in 2011. However, in terms of total value, slower than the East African Community (EAC) Kenya’s export crops benefited from favorable global countries, some of which are among the fastest prices, which compensated for reduced output and growing developing countries in the world. For explained the increased export earnings. Growth in example, Rwanda grew at 7.9 percent, Uganda 7.2 the services sector remained robust, at 5.1 percent, percent, and Tanzania 6.7 percent during the 2008- though this was at a slower pace than in previous 2011 period (see figure 1.2). Figure 1.1: Growth remained resilient in all sectors and all quarters Sectoral growth rates Quarterly GDP 8 7.0 6.3 5.9 7 6.0 5.5 5.1 5.0 4.6 6 4.0 5 2.7 2.8 Percent 3.0 Percent 4 2.0 1.6 3 1.0 0.0 2 -1.0 2009 2010 2011 1 -2.0 0 -3.0 -2.5 1 2 3 4 1 2 3 4 1 2 3 4 Agriculture Industry Services 2009 2010 2011 Source: World Bank Computations based on KNBS data. June 2012 | Edition No. 6 2 The State of Kenya’s Economy Figure 1.2: Kenya’s growth tails in the EAC region ……and lags behind the average for SSA Average growth rate in EAC 2008-11 GDP Growth 2008-2011 9 7 8 SSA (excl South Africa) 6 7 6 5 Percent growth Kenya GDP growth (%) 5 4 4 3 3 2 2 1 1 0 0 Rwanda Uganda Tanzania SSA (Excl SA) Burundi Kenya Avg 98 -07 2008 2009 2010 2011 Source: World Development Indictors. Revenue from tea and coffee increased substantially subsector benefitted from high global prices and – but only due to high prices, not volumes (which a weak shilling for part of the year, as earnings declined). Tea, coffee and horticulture—Kenya’s increased by 17 percent; main export crops—all saw a decline in production • Coffee production also declined in 2011 compared in 2011 compared to 2010 levels (see figure 1.3); with 2010, but coffee farmers emerged the real but the global commodity price rally was strong winners in 2011, as global prices increased by 50 enough, which enabled the value of Kenya’s export percent; and commodities to actually increased in 2011 compared to 2010. However, potential gains for Kenya from • Agricultural growth remained modest, due to the higher export prices, were eroded by the higher oil dry weather conditions. The 2011 drought was concentrated in Kenya’s arid and semi-arid regions, prices which Kenya had to pay. which affected pastoralist’s livelihoods, especially livestock, but impacted agricultural production Some of the highlights of the economy in 2011 only mildly. The food sub-sector cereal production include: increased by 5 percent and horticulture production • Tea production contracted by about 5 percent in declined, but prices increased thus earnings 2011, but domestic currency earnings from the remained stable in 2011. Figure 1.3: Tea and coffee earnings increased but production contracted Export Volume Unit Prices 450 9.0 400 8.0 350 7.0 Coffee '000 Metric Tonnes 300 6.0 250 5.0 $/Kg 200 4.0 Tea 150 3.0 100 2.0 50 1.0 0 - Apr Apr Apr Apr Jul Jul Jul Jul Oct Oct Oct Oct Jan Jan Jan Jan Jan Jul Apr Oct Jan 2007 2008 2009 2010 2011 Coffee Tea Horticulture 2007 2008 2009 2010 2011 2012 Source: World Bank Computations based on KNBS. 3 June 2012 | Edition No. 6 The State of Kenya’s Economy A decline in hydropower generation negatively inflation and to stabilize the exchange rate. High affected industry. Low water levels, resulting from interest rates are attracting foreign exchange inflows, the drought in 2011, led to a decline in hydropower which have strengthened the financial account, and generation and a shift towards emergency diesel financed a widening current account deficit, which generated power. As global oil prices peaked, the cost remains vulnerable to high oil prices (see discussion of diesel generated power increased, raising the costs on the external account). By raising the Central Bank of production for industry. Furthermore, interruptions Rate (CBR), all interest rates in the money market in electricity supply have costed businesses in Kenya increased and private sector credit growth slowed. some 7 percent of their annual sales revenue, which As a result, the shilling stabilized against the major also explains the decline in manufacturing growth to currencies, overall, inflation declined, and core 3.3 in 2011 (from 4.5 percent in 2010). Since other inflation leveled off. sectors grew faster than manufacturing, the sector’s share in GDP declined from 9.9 percent in 2010 to 9.4 The Central Bank increased interest rates to stabilize in 2011. the economy. Specifically, it tightened monetary policy in October 2011, by increasing its policy rate The services sector sustained robust performance to 18 percent from 7 percent, previously. As a result, in 2011. Tourism continued to experience a boost, money market interest rates increased, with the recording higher tourist arrivals than 2007, which repo and the interbank market rates also increasing had been a record year. Kenya has been attracting sharply by 13 and 7 percentage points, respectively, significant numbers of tourists from new markets, in the same month. with substantial growth from the Middle East (42 percent) as well as Asia (25 percent), compared to The Central Bank measures resulted in an increase 2010. This could be as a result of new flight routes in both deposit and lending rates. In response to which Kenya Airways has inaugurated to the Far East. tighter monetary policy, commercial banks increased The tourism market from Europe recorded relatively both their lending and deposit rates. Average lower growth of 11 percent, when compared to lending rates of commercial banks increased by 525 previous years and to other markets. basis points, from 14.8 percent in October, to 20 percent in December; deposit rates increased by 1.2 The Monetary sector: At the center of the 278 basis points, from 4.2 to 7.0 in the same period. stabilization effort The interest rate spread widened from 11 to 13 T he strong intervention of the Central Bank during the third quarter of 2011, has helped to ease percentage points, as lending rates remained high (see figure 1.4). In response to public outrage against Figure 1.4: Inflationary pressure easing …as high interest rates rose 30 25 25.0 Monthly Inflation yoy % change 20 20.0 15 15.0 Lending rates Percent 10 10.0 5 CBR 5.0 0 0.0 Mar Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Apr May Mar Jul Oct Jun Aug Nov Mar Mar Jan Jan Jul Oct Aug Nov Feb Apr May Sep Dec Feb Apr May Jun Sep Dec Jan Apr Feb 2010 2011 2012 Food Transport Core Overall 2010 2011 2012 Source: World Bank Computations based on KNBS and CBK data. June 2012 | Edition No. 6 4 The State of Kenya’s Economy commercial bank lending rates, there have been Financial markets have welcomed the government’s attempts to curb interest rates on loans, through decision not to cap lending rates. Recent sharp legislative amendments to the Finance Bill tabled increases in interest rates have been painful for in parliament, but these have been successfully many Kenyans. However, these interest rate hikes resisted by the executive. Had the amended Finance were necessary to stabilize the economy, and cool Bill passed, it would have threatened all the gains off aggregate demand; which would have hurt the made during the last decade, in economy even more, and for a longer deepening both Kenya’s financial period. In addition, there is a perception markets and financial inclusion that banks are charging an undue high (see Box 1.1). “mark-up” for loans, also called the The slowdown in “spread” between deposits and lending lending growth has Lending to the private sector rates. These perceptions drove some has contracted in response to mainly impacted private legislators to propose a legislative interest- high interest rates. Growth in households. rate cap. lending to the private sector has declined from a peak growth rate of 36.3 percent in 1.3 Responsive fiscal Consolidation T September 2011, to 26.0 percent in February 2012. he government adopted a prudent fiscal The contraction affected all sectors, except building response to the 2011 shocks, demonstrating and construction, transport and communication, and its commitment to fiscal discipline. As revenue real estate (see figure 1.5). The slowdown in lending and domestic borrowing underperformed, growth has mainly impacted private households the government rationalized its expenditures. (-3.4 percent contraction), trade (-2.5 percent), and Government expenditures were cut from the budgeted manufacturing (-2.4 percent). While the significant drop in credit to households is desirable to contain 33.6 percent of GDP, to 30.3 percent in 2011/12. inflation, a decline in credit growth to trade, and This fiscal consolidation resulted in a reduction of manufacturing harms growth. However, credit domestic borrowing by about 2 percentage points growth continued in building and construction, from 3.8, to 1.9 percent of GDP. As a result, public transport and communication, real estate. Building, debt as a share of GDP declined from 48.8 percent construction and real estate are non-tradable sectors in 2010/11, to 43.11 percent in 2011/12 (see figures with high import content, which remain profitable 1.6 and 1.8). Revenue performance remained strong even when the real exchange rate is overvalued. at 24.0 percent of GDP and government contained Figure 1.5: Lending to private sector contracted by 10.3 percent... except for non tradable sector Growth in credit to the private sector 0.7 Building & construction 0.5 Real estate Government increased policy rate 0.4 Transport & communication 40.0 0.0 Finance & insurance 35.0 -0.3 Mining & quarrying 30.0 -0.4 Business services 25.0 Percent -0.5 Other activities 20.0 -0.9 Agriculture 15.0 -1.2 Consumer durables 10.0 -2.4 Manufacturing 5.0 -2.5 Trade 0.0 -3.4 Private households Nov Mar Oct Jan Apr Jun Jan Aug May Jul Sep Dec Feb Feb -4.0 -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 2011 2012 Growth in Credit, February - September 2011 (% Weighted growth) Source: World Bank computations based on CBK data. 1 This ratio excludes the recent syndicate loan of US$ 600m. 5 June 2012 | Edition No. 6 The State of Kenya’s Economy Box 1.1: The case of interest rate controls in Kenya: why it was a bad idea, and alternative options Evidence around the world demonstrates that attempts to control prices, especially interest rates, almost always backfire, often leading to higher interest rates and usually hurting the poor most. There are three main reasons for these unintended outcomes. First, any interest rate ceiling means that credit has to be rationed, in which case there is no guarantee that the most productive investment receives the credit. Often credit is rationed on political grounds and the banks that give out these loans often don’t get repaid, putting their balance sheets in jeopardy. Kenya already has a number of painful experiences: in the mid 1980s 11 banks collapsed and in the 1990s 23 banks became insolvent, some of which were put under receivership and merged under consolidated institutions. Second, with interest rate caps, there emerges a “curb market” in credit, with lenders charging exorbitant interest rates to (typically poor) people who have no other option than to borrow in these parallel markets. Third, in the longer run, interest rate ceilings make people reluctant to put their money in banks, leading to slower financial development, which in turn hampers growth. Alternative ways to bring interest rates down include: (i) Promote competition and transparency. The CBK could direct commercial banks to adopt the Annual Percentage Rate (APR) framework, which would facilitate full disclosure on the cost of borrowing to customers. The APR is the effective interest rate that a borrower pays on a loan. Currently, there are too many hidden charges. In addition, the CBK could ensure that the weighted average lending and deposit rates for every commercial bank and deposit taking micro-finance Institution are posted on the CBK website each month by type of loan. This would allow consumers to effectively evaluate their lending and borrowing options. (ii) Improve efficiency in the banking industry. Even though Kenya has adopted IT systems which will have brought down operating costs for commercial banks (e.g. ATMs, fewer back-office operations and front office operations), these lower costs have not been passed on to customers: banking charges are still very high in Kenya when compared to other countries. The CBK and Kenya Bankers Association need to further review the interconnectivity of bank platforms, as a way of bringing down operations costs of banks. (iii) Sharing both positive and negative customer information via a credit bureau would reduce non-performing loans. Parliament should pass laws to force banks to share both positive and negative customer information. When banks reward good borrowers with lower rates and punish those with negative ratings by charging higher rates, both the share of non-performing loans and the cost of borrowing will decline. (iv) Improving efficiency of commercial banks by encouraging them to lend to each other in the horizontal repurchase market. Banks are hesitant to provide such lending since the master-repurchase agreement does not guarantee them collateralized assets in the event of default. The CBK should amend the master-repurchase agreement to enable banks holding government securities as collateral to realize it upon debtor default. (v) Addressing the need for a comprehensive consumer protection policy for financial services is a cornerstone for a vibrant financial market as consumers are encouraged to take greater responsibility in their financial decision-making. This will include tightening consumer laws to protect bank customers. (vi) Reduce overall costs for customers. The authorities need to cap legal fees on discharging/charging securities, eliminate stamp duty on debentures/charges, and allow sharing of securities. Source: World Bank staff. expenditures. By the end of 2011/12 the overall or CDF). The development budget has grown fiscal balance including grants is projected to decline considerably, from 4.7 percent of GDP in 2006/07, to to -4.9 percent of GDP, 2.5 percent below the initial 7.9 percent of GDP in 2010/11 (see figure 1.7). The budget figure of -7.4 percent. medium-term outlook will see a further increase to about 10 percent of GDP, a third of total spending. A larger share of total spending is allocated to the Meanwhile, recurrent spending was constrained at or development budget. The government has devoted below 21 percent of GDP over 2009/10 to 2011/12. a larger share of its budget towards development spending on a significant number of infrastructure Fiscal consolidation was achieved at a cost, but it projects both at national and constituency level was necessary to contain inflation. Although the (through the Constituencies Development Fund budgetary allocation for development expenditure June 2012 | Edition No. 6 6 The State of Kenya’s Economy Figure 1.6: Fiscal consolidation in 2011 demonstrates commitment to fiscal discipline Public Debt Primary Defict 0 50 2011/12** 2012/13** 2013/14** 49 -1 48 Policy target of 45% -2 Percent of GDP 47 Percent of GDP Fiscal position 46 Oct 2011 -3 45 Fiscal position June 2011 -4 44 43 -5 42 Fiscal position April 2012 -6 41 40 -7 2008/09 2009/10 2010/11* 2011/12** 2012/13** 2013/14** Fiscal Position June2011 Fiscal Position Oct2011 Fiscal Position April2012 Source: Ministry of Finance, Budget Policy Statement 2012. has increased, the cut back in domestic borrowing of borrowing (interest rates on government paper), ultimately translated into reduced development and created a liquidity crunch, as borrowing from the spending in 2011/12. The pre-crisis budget allocations CBK discount window was restricted. For the first time called for development spending to increase to 12.5 since 2003, the government found it difficult to fund percent of GDP, but this had to be scaled back to 9.6 the budget, by borrowing in the domestic market. percent. The Kenyan budget is structured so that Monetary tightening forced commercial banks (the domestic revenues finance the recurrent budget, main holders of government security), to hold onto while domestic borrowing and foreign financing their funds, as the Central Bank increased the reserve support the development budget. Short falls in requirements, and limited activities at the discount revenues also resulted in reductions in recurrent window. The lack of liquidity in the market pushed spending, for operations and maintenance. Revenue interest rates from 6.4 percent in mid-2011, to 21.8 collection was under budget by about 1 percentage percent at year end. The government borrowed US$ point of GDP, which was reflected in a similar cutback 600 million in foreign denominated debt from a in recurrent spending. syndicate of foreign commercial banks, to plug the fiscal gap in the 2011/12 budget. This loan eased The government has resorted to external borrowing, the pressure on domestic money and exchange to ease pressure in domestic money markets and rate markets, and yields on government debt have complement monetary policy. Monetary tightening declined. affected government borrowing through higher costs Table 1.1: Fiscal consolidation as a result of shocks in 2011 ( percent of GDP) 2009/10 2010/11 2011/12 2011/12 BPS 2011/12 Budget Consolidation Revenue 22.3 24.1 24.9 24.0 -0.9 Expenditure and net lending 29.5 29.3 33.6 30.3 -3.3 Recurrent 20.5 21.1 20.9 20.5 -0.4 Development 8.7 7.9 12.5 9.6 -2.9 Fiscal Deficit -6.4 -4.5 -7.4 -4.9 2.5 Public debt 36.2 48.8 45.9 43.1 -2.8 Source: MoF Budget Policy Statement 2012. 7 June 2012 | Edition No. 6 The State of Kenya’s Economy Figure 1.7: Recurrent and Development Spending energy. Our projections show that Kenya could sustain a slightly higher deficit than planned, to enable both Public Expenditure 25 a reasonable level of infrastructure investment, and a Recurrent debt-to-GDP ratio of 45 percent (see figure 1.9). spending 20 The first budget under the new constitution will Percent of GDP 15 allocate 26 percent of ‘shareable’ revenue to 10 devolved government units – including any funds Development spending spent through the CDF – according to the Budget 5 Policy Statement (BPS). The Constitution (Article 187) provides that finance follows functions. Using 0 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 this provision, the central government has earmarked KES. 139 billion for devolved functions , plus KES. 21 Source: MoF Quarterly Economic and Budgetary Review, various and billion for the CDF, which is 26 percent of audited Budget Review and Outlook Paper, December 2011. Revenues (2010/11), and 16 percent of total estimated There is potential to expand the primary deficit revenue and grants in the 2012/13 BPS. The largest over the medium-term, if growth increases in line share of the revenue is allocated for infrastructure, with expectations. If Kenya continues to grow at 4.3 followed by health, public administration and social percent in the next three years, it can run an average protection (see figure 1.10). The Commission on primary deficit of 3.0 percent of GDP. However, if Revenue Allocation (CRA) has proposed a formula for Kenya grows at 5 to 6 percent in the next three years, consultation to allocate the county equitable share it would have room to increase its fiscal deficit to an among the 47 counties: which assigns a 60 percent average of 5.5 percent of GDP, to sustain a debt-to- weight to population; 20 percent for a basic equal GDP ratio at 45 percent. In our view, Kenya still needs share; 12 percent to poverty levels, 6 percent to land significant investment in infrastructure, in order to area; and, 2 percent to county fiscal responsibility increase potential output, and minimize underlying (see figure 1.10).2 structural supply constraints, like the high cost of Figure 1.9: Kenya can sustain a debt to GDP ratio Figure 1.8: Trends in Public Debt at 45 percent Public Debt 60 -1.1 2007/08 2008/09 2009/10 2010/11 2011/12e 2012/13f 2013/14f 2014/15f 48.8 -1.6 50 43.1 44.3 43.6 Primary Balance, % of GDP -2.1 40 36.2 Percent of GDP -2.6 30 -3.1 20 -3.6 10 -4.1 0 -4.6 2009/10 2010/11 2011/12 2012/13 2013/14 -5.1 Domestic Foreign Total Debt 4.3 % growth rate 5 % growth rate 6.0 % growth rate Source: MoF Budget Review and Outlook Paper, December 2011. Source: World Bank simulations. 2 For more insights into Kenya’s devolution process, especially fiscal decentralization, see the forthcoming World Bank report “Devolution without Disruption - Pathways to a successful new Kenya” [title TBC]. June 2012 | Edition No. 6 8 The State of Kenya’s Economy Figure 1.10: On per capita basis the CRA consultation points in August 2011, to a peak of 700 basis points formula is skewed in favour of countys with low in October 2011, before falling to 473 basis points in population density March 2012. As a result, net inflows into the financial 6 County Share account increased by 68 percent in 2011 to US$ 4.2 billion (mainly short-term inflows). Net short-term 5 flows increased by 45 percent from US$ 1.1 billion 4 in 2010, to US$ 1.7 billion in 2011. Net Errors and Omissions increased by US$ 1.5 billion from US$ 0.85 Percent 3 billion in 2010, to US$ 2.4 billion in 2011, which also helped finance the current account deficit. 2 1 0 Short term inflows have increased the supply of foreign currency and stabilized the exchange Wajir Laikipia Baringo Kwale Busia Vihiga Nyamira Machakos Lamu Migori Kitui Makueni Embu Nyandarua Bomet Kajiado Nandi Narok Nyeri Kilifi Siaya Kisii Isiolo Marsabit Samburu Turkana Garissa Trans Nzoia Tharaka Nithi Mandera Kirinyaga Mombasa Murang'a Kisumu Bungoma Nakuru West Pokot Kericho Tana River Homa Bay Uasin Gishu Kakamega Meru Elgeyo-Marakwet Taita Taveta rate. Significant increases in net short term foreign Source: World Bank currency flows (mainly portfolio flows) increased the supply of dollars in the market, which stabilized the exchange rate – at least for the moment. By early 1.4 External Account remains out of balance 2012, the shilling had recovered the nominal losses In 2011, the current account deficit nearly doubled to 13.1 percent of GDP.3 Imports grew by almost 20 percent, while exports only increased by 10 percent. experienced in 2011. During the first four months of 2012, the shilling appreciated against the US dollar (to 82.9 from 101.3), the UK pound (to 131.2 from 159.4) Import growth was mainly driven by oil imports, and the Euro (to 109.6 from 138.9). This represents which accounted for 27.6 percent of the total import a nominal appreciation of about 18 percent against bill in 2011, jumping from US$ 2.7 billion (8.9 percent these major currencies, since October 2011. Going of GDP) in 2010, to US$ 4.1 billion (11.6 percent of forward, any reduction in interest rates should be GDP) in 2011. The growth in oil imports reflects a 33 gradual, so as to maintain macroeconomic stability, percent increase in oil prices (from US$ 79.5/bbl to and not endanger external financial inflows, which 106) during 2011, coupled with a 12 percent increase are stabilizing the exchange rate. in volume (from 3.2 to 3.6 million metric tons), which was due to the need to expand thermal power, A strong shilling and high domestic prices have as hydropower operated below potential. With resulted in a real exchange rate appreciation, factor income and transfers roughly constant, the negatively affecting exports. The recent appreciation deterioration in the trade balance was also apparent of the shilling, coupled with high inflation, wiped off in the current account balance. any competitive advantage Kenyan exporters might have gained through a weaker exchange rate in 2011. The widening current account deficit also pulled the The trade weighted real exchange rate appreciated overall balance into negative territory. The current by 17.2 percent, between October and December account deficit was mainly financed by short term 2011, and the trade weighted nominal exchange rate flows, which were attracted by high interest rates. appreciated by 15.5 percent during the same period. The interest rate differential between domestic rates The appreciation in the real effective exchange rate and those in the international markets (LIBOR), after reflects the impact of high domestic prices, and controlling for inflation, increased from 26 basis reduction of earnings of Kenyan exporters. 3 KNBS numbers report a current account of Kshs 296 billion and Nominal GDP of Kshs 2.5 trillion. 9 June 2012 | Edition No. 6 The State of Kenya’s Economy Figure 1.11: FDI and short term inflows financed the current account deficit Balance of Payments Financing of Balance of Payments 6.0 5 4.5 5.0 5 4.0 4.0 4 3.5 Months of Import cover 4 3.0 US$ Billions 3.0 US$ Billions 3 2.0 2.5 3 1.0 2.0 2 0.0 1.5 2 short term May May Sept May May Mar Mar Mar Mar Nov Nov Nov Nov Sep Sep Sep Jan Jan Jan Jan Jan Jul Jul Jul Jul 1 flows 1.0 -1.0 1 0.5 -2.0 2008 2009 2010 2011 2012 0 0.0 -3.0 2008 2009 2010 2011 -4.0 Capital Account Investment Assets and Liabilities Short Term flows Net Errors and Omissions -5.0 Capital & financial Account Overall Balance Current Account Gross Reserves Source: Central Bank of Kenya. Figure 1.12: The Shilling has appreciated sharply Exchange Rates Real Exchange Rates 180 140 130 NEER 160 120 Normalized 2005 Jan=100 140 Sterling pound 110 120 100 Euro Ksh 90 REER 100 US$ 80 80 70 60 60 May May May Nov Nov Mar Mar Mar Aug Aug Dec Dec Apr Apr Apr Sep Feb Feb Sep Feb Apr Apr Oct Jan Apr Apr Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Jul Oct Jan Jul Oct Oct Jan Apr Jul Oct Jan Jul Oct Jan Jul Jun Jun Jan Jan Jan Jul Jul 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: World Bank calculations based on Central Bank of Kenya. Notes: 1) NEER (nominal effective exchange rate) is the trade weighted exchange rate; 2) REER (real effective exchange rate) is the trade weighted exchange rate but also takes into account domestic and foreign price differentials. June 2012 | Edition No. 6 10 The State of Kenya’s Economy 2. Growth Prospects for 2012 and 2013 T he World Bank projects an average GDP growth rate of 5.0 percent in the medium-term. Macro stability has been restored but remains fragile. The prevailing conditions through the first half of 2012, call for a cautious approach to monetary and fiscal policy management. It may be too early to relax monetary policy, but high interest rates will nevertheless slow down investment. The two most significant downside risks to the growth outlook are: (i) the rising oil prices; and, (ii) the crisis in the euro zone, which could push the current account deficit to over 15 percent of GDP. The war in Somalia, preparations for general elections, and the roll-out of devolved government, are likely to increase fiscal pressure which is likely to be managed through cut backs in development spending. 2.1 Growth prospects The low growth scenario assumes the risks discussed T in section 2.2 play out. A contagion of the Greek he World Bank maintains its growth forecast of crisis to the rest of the PIGS (Portugal, Italy and Spain) 5.0 percent for 2012 and for 2013, a moderate would see a slowdown in the growth of Kenyan rate that will be driven by consumption. Growth exports and tourism. The resurgence of exchange rate could reach 5.4 percent in a high growth scenario, volatility and high inflation in the domestic market, but it could also dip further to 4.1 percent in the low combined with political uncertainly, would slow case (see figure 2.1). The baseline growth scenario down consumption and investment. The high growth assumes a continuation of appropriate policy vigilance scenario assumes the rally of commodity prices will to sustain prevailing macroeconomic stability, which continue even as oil prices stabilize, see annex A2 for would see a gradual decline in interest rates and details. The baseline scenario is discussed in greater inflation while maintaining exchange rate stability. details in the following sections. Kenya’s growth outlook trends with the average for Sub-Sahara Africa (5.5 percent in 2012, and 5.6 Aggregate demand growth was sluggish in the first percent in 2013) but it is still below its fast growing half of 2012 but will recover during the second half neighbors, Tanzania (6.7), Uganda (6.2), and Rwanda of the year. During the first half of 2012, high inflation (7.6). (and prices) and high lending rates, constrained Figure 2.1: Growth will be moderate at 5.0 percent investment and consumption; in the first six months in 2012 and 5.0 percent in 2013 of 2012, the CBR has been maintained at 18 percent, Growth outlook 2012 -2014 sustaining the pressure on interest rates. Ongoing 7.0 fiscal consolidation will also see a slowdown in public High investment growth. In the second half of 2012, 6.0 5.4 5.1 inflation and interest rate pressure will ease, and 5.0 Baseline 5.0 food prices will decline after the harvest season. As Percent growth 4.0 Low 4.1 the momentum of the political campaign builds, high 3.0 liquidity in the economy will boost consumption. 2.0 Lending to the private sector is expected to pick 1.0 up, as banks try to grow their lending portfolio. The 0.0 syndicate loan by the government will reduce the 2010 2011 2012 2013 2014 government borrowing from the domestic market, crowding out lending to private sector, and help build Source: World Bank. the CBK foreign exchange reserves. 11 June 2012 | Edition No. 6 The State of Kenya’s Economy Table 2.1: Fiscal consolidation as a result of shocks in 2011 ( percent of GDP) Percent growth rates 2007 2008 2009 2010 2011* 2012 2013 GDP 7.0 1.6 2.6 5.6 4.3 5.0 5.1 Private Consumption 7.3 -1.3 3.8 2.8 3.0 3.9 4.1 Government Consumption 4.4 2.3 5.5 4.8 4.5 4.3 4.6 Gross Fixed Investment 13.6 9.5 0.6 7.4 10.2 9.5 11.0 Fiscal Framework (endFY) percent of GDP Total Revenue 22 21.8 22.3 24.1 24.0 24.2 24.4 Total expenditure 27.3 26.6 29.5 29.5 29.3 30.3 29.8 Grants -1.3 0.8 0.8 0.8 0.7 1.4 1.2 Budget Deficit (incl. grants) 4.0 4.0 6.4 6.4 4.5 4.9 4.4 Total debt 34.6 41.7 45.0 36.2 48.1 43.1 44.1 External Account Vol growth Exports, GNFS 7.3 7.5 -7.0 6.1 8.9 6.7 6.7 Imports, GNFS 11.1 6.6 -0.2 3.0 8.6 6.7 6.7 Source: MoF Budget Policy Statement 2012. Demand for Kenya’s exports will remain flat in high travel outcomes will depend on the government’s income countries but rapid growth within the EAC ability to maintain internal security, in the face of countries will provide an expanding market for terrorist threats, and concerns of instability in the goods and services. Globally, growth will remain run-up to the elections. Growth in tourist arrivals subdued at 2.5 percent in 2012, increasing modestly from Europe will be moderate, as a result of conflict to 3.0 percent in 2013. With the deepening euro zone in the region. crisis, growth in high income economies is expected to be only 1.5 percent and 2.0 percent - in 2012 and Pressure on the external trade and current account 2013 respectively. Growth in developing countries balances could continue in 2012. Oil prices have will remain robust, exceeding 5.5 percent in the started rising again in 2012, as a result of uncertainties medium-term. Sub Saharan Africa will be among the in the Middle East (especially Iran and Syria). The fastest growing regions in the world. This will impact World Bank forecasts an average oil price of US$ favorably on Kenya, providing increased export 115 per barrel in 2012, but overall prices are likely opportunities. to remain volatile. Further, trade balance pressure will emanate from imports of heavy equipment for In the real sector, agricultural output is expected to ongoing geothermal projects. be in line with forecasts. The rains arrived later than expected in the first part of 2012, but the current Moderate export growth is expected in 2012. The forecast points to a normal growing season. Frost cost of power is expected to decline as the heavy rains experienced in the early part of the year impacted received in 2012 will boost hydropower generation, tea production, which will likely be 20 to 30 percent thereby improving the competitiveness of Kenya’s lower than in 2011. Industry may record a mixed industrial sector. However, slow economic growth in performance; construction remains robust, as the some of Kenya’s main trading partners will weaken growth in lending to the sector suggests. Growth in demand in key markets, and the current account services will hold, particularly wholesale and retail deficit is expected to widen, as a result. Figure 2.2 trade as consumption picks up. However, tourism and simulates the impact of higher oil prices on the June 2012 | Edition No. 6 12 The State of Kenya’s Economy current account, and the balance of payments based 1. A sharp reduction in interest rates when inflation on the following two scenarios (in both of which the declines, could reverse short term foreign currency overall balance of payments would be in deficit, and inflows, and trigger another cycle of exchange rate put pressure on the exchange rate): volatility. Figure 2.2: The current account deficit could reach 2. The worsening of the crisis in the euro zone, will 15 percent of GDP if the oil price stays above US$100 negatively impact Kenya’s balance of payments position through three main channels: a reduction Current Account and BOP Simulation at different Oil Prices in demand of Kenya’s exports and tourist arrivals 5 Overall Balance from Europe; a reduction in portfolio inflows 0 US$ 106 from the region; and, a reduction in migrant 2012* US$ 120 remittances. 2008 2009 2010 2011 US$ 130 Current Account -5 Balance 3. Tensions in the wider Middle East region could lead % of GDP -10 to a potential surge in oil prices. Already, in March -15 Trade Balance US$ 106 2012 oil prices reached US$ 120 per barrel, and these could increase further, if conflict actually US$ 120 US$ 130 -20 US$ 106 US$ 120 materializes, worsening Kenya’s current account deficit. US$ 130 -25 Source: World Bank. 4. Government’s possible pursuit of a tight fiscal policy, could choke off public investment, through huge cut backs in development spending, • In a scenario where the price of oil remains at dampening growth prospects. US$ 120 throughout 2012, the oil import bill will increase by US$ 1.3 billion in 2012, and the current 5. Fiscal expansion to accommodate demands for account balance will worsen by US$ 2.0 billion (1.7 higher expenditures by newly created departments percent of GDP), increasing the overall current (most notably expansion in personnel spending account deficit to 14.9 percent of GDP, and; resulting from devolution), higher wages for teachers and other professional, as well as • In a more extreme scenario, an average price of elections related expenses, could jeopardize US$ 130 per barrel in 2012, would see the current macroeconomic stability. account deficit deteriorate further, to 16.8 percent of GDP. 6. Political risk associated with the forthcoming general elections, and ICC trials of major political 2.2 Risks to the outlook figures, might discourage both public and private investment and growth prospects. O ur key assumption is that Kenya’s economy is stabilizing but remains vulnerable to shocks, and will grow at 5 percent in 2012 and 2013. It The risk remains that the exchange rate will continue to be volatile if current account pressure is is presumed that there will be a continuation of not reduced. Kenya’s weak external position makes appropriate policy vigilance to sustain prevailing it vulnerable to further macroeconomic instability in macroeconomic stability, which would see a 2012. The high oil prices, weak external environment gradual decline in interest rates and inflation, in Europe (one of Kenya’s main export destinations while maintaining exchange rate stability. However, and tourist sources), may trigger intense pressure on there are significant downside risks to this growth the currency. Any sharp reduction of interest rates in projection, with any of these developments, having 2012 by the monetary authorities; when inflationary significant adverse effects on Kenya’s economy. The pressure subsides, could trigger another cycle of immediate risks are: exchange rate volatility. 13 June 2012 | Edition No. 6 The State of Kenya’s Economy Skilled policy balancing will be required foreign currency deposits + narrow to maintain stability. Our simulations money) increased by 18.6 percent, show that inflation has declined, and a A premature reduction and narrow money (currency in gap is emerging between the simulated in interest rates, could circulation and quasi money or M2) (notional) CBR, and the actual CBR reverse the gains in recorded a growth of 16.4 percent. (see figure 2.3). However, a premature demand management, The growth of narrow money (M2) reduction in interest rates, could reverse which could take time slowed down to 13.9 in 2011, the gains in demand management, which to contain as happened compared to 20.8 in 2010, while the could take time to contain as happened in 2011. average growth for foreign currency in 2011. For instance our analysis shows deposits accelerated to 5.1 percent that monetary policy actions take up to 11 months in 2011, compared to 2.4 percent in 2010. The to have an impact in the market, and that the impact slowdown in the growth of narrow money explains can last up to two years.4 why commercial banks have been complaining of “lack of liquidity in the market.” However, measuring Figure 2.3: Inflation has declined but any reduction liquidity through broad money (M3) would signal in interest rates should be gradual the need for further tightening, while M2 signals 25.00 the “true” liquidity position in the market. Further Overall Inflation tightening can lead to a vicious cycle of high interest 20.00 rates, growth in foreign currency deposits, growth 15.00 Actual CBR movements did in broad money, and contraction in narrow money; not reflect upside risk to inflation which would tax economic activity. This scenario 10.00 explains the under subscriptions in the Treasury bill market in the first six months of the 2011/12 fiscal 5.00 year, and higher and volatile interbank rates in the Notional CBR which reflects Inflationary Pressure and domestic capacity utilization money market. 0.00 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 2010 2011 2012 Figure 2.4: Slow growth of “narrow” money, rises in “broad” money Source: World Bank simulations. 30.0 25.0 Tight monetary policy has slowed down growth of 20.0 narrow money, but foreign currency inflows are Percent 15.0 driving growth of broad money. The market response to the high interest rate policy has seen a degree of 10.0 currency substitution, from local to foreign currency 5.0 deposits, which is keeping liquidity high. The inflows 0.0 of foreign currency deposits kept the growth of broad Aug Aug Jul Nov Jul Nov Apr Dec Feb Feb Apr Dec May Sep May Sep Mar Oct Oct Jun Mar Jun Jan Jan Jan money high, even as the CBK strained to contain the 2010 2011 2012 growth of the money supply through high interest Wieghted growth FCD Weighted growth M2 Growth M3 rates (see figure 2.4). In 2011, broad money (M3 = Source: World Bank. 4 IMF “Kenya: 2011 Article IV Consultation”. June 2012 | Edition No. 6 14 The State of Kenya’s Economy 3. Rebalancing the economy T he rising current account deficit can be interpreted to mean that Kenya is living beyond its means. For Kenya to achieve and sustain a high growth rates it needs to rebalance the economy by increasing savings for investment—and also increasing exports. As Kenya seeks to diversify exports products and markets, regional integration would help to reduce the trade deficit as well as its domestic food prices. 3.1 From Short term stabilization to Kenya’s high current account deficit problem in sustained growth 2011 was driven by high private consumption, and T huge imports of machinery for public infrastructural he slowdown in GDP growth in 2011 was as a projects. As noted above, the current account result of Kenya’s underlying macroeconomic deficit is a reflection of the savings investment gap, imbalances. Aggregate domestic absorption slowed which in part is driven by the fiscal deficit to finance down as inflation constrained private consumption, infrastructural projects worsened the current account interest rates constrained investment, and fiscal in 2011. Low savings indicate that consumption consolidation curtailed growth in public spending. expenditure is high, relative to investment in the In Kenya, private consumption accounts for over Kenyan economy, where development assistance 70 percent of GDP and a combination of high (grants) is minimal. High interest rates would attract domestic prices, a weak shilling and high interest foreign savings to finance the current account rates, constrained private consumption in 2011. Investment slowed down as government cut back Kenya needs to undertake structural reforms to on development spending (see fiscal section), and establish the foundation for long term growth. growth in credit to the private sector contracted The decline of Kenya’s external balance (high during the second half of 2011, in response to higher and widening current account deficit and real interest rates. The deficit in the external account appreciation of the shilling), has been accompanied widened, acting as a further drag on growth (for by growing tensions from internal imbalances, which more details refer to section on external account). have created the 2011 economic instability (high Figure 3.1: High growth episodes have been driven by Inflation, low savings, and high unemployment). This consumption…excess domestic consumption is met calls for structural reforms to shift incentives away through imports from heavy investments in non-tradable goods (i.e. building and construction, and real estate) towards Contribution to Growth 8.0 the production of goods and services for export markets. 6.0 4.0 The recent oil discovery in Turkana, if commercially 2.0 viable, will improve Kenya’s trade balance. But for oil 0.0 to catalyze development, Kenya will have to avoid the 2009 2010 2011* -2.0 special macroeconomic and governance challenges -4.0 associated with natural resources. Kenya can use the -6.0 lead time to production, to lay the right foundations Consumption Investment Net exports for a successful oil economy. This should include a strong focus on diversifying the economy, to make Source: Computation from Economic Survey. other export sectors more competitive. Countries as 15 June 2012 | Edition No. 6 The State of Kenya’s Economy diverse as Botswana, Chile, and Norway have shown become more pronounced, as the frequency of global that natural resources can be a blessing, but this shocks increases. For instance, Kenya’s merchandise requires hard work and sound institutions - see Box exports can only pay for just over one third of her 1.2 for a discussion of the challenges. imports, having declined from 65 percent of imports in 2003, to about 38 percent in 2011. The widening 3.2 Leveraging the EAC Customs Union current account deficit is worrying, and could reach A ll the key indicators of Kenya’s external 15 percent in 2012, in light of the recent oil price competitiveness have followed a worrying surge (see figure 3.1). Kenya’s grain deficit has also trend. As emphasized in previous publications, Kenya widened, as agricultural productivity declines, and remains vulnerable to external shocks, and this has the population increases. Box 3.1: Making Oil work for Kenya: Oil Management Challenges Avoiding “Dutch disease”: The oil sector has limited linkages with other sectors of the economy. A big resource boom will increase the demand for labor, drive up wages and thereby prices for non export sectors such as services and real estate. This leads to a real appreciation and thus hurts the export sector and import-competing sector. In the extreme it could lead to a deindustrialization of the country – the so called “Dutch disease”. The Arab uprising has demonstrated the dangers of jobless growth. Strong policy and legal framework to embed transparency in oil revenue management: A strong legal framework will be required to ensure there is an open and transparent system for the management and use of oil revenues. Kenya can leverage good practice to start on sound footing: • Kenya can learn from Ghana’s Petroleum Revenue Management Act, which is hailed as a world class piece of legislation, providing for the collection, allocation and management of upstream petroleum revenue, and defining a strong and transparent mechanism for monitoring oil receipts and for spending those revenues. • Kenya can participate in the Extractive Industries Transparency Initiative (EITI). The EITI emphasizes that governments should provide up to date and credible information to citizens on revenues collected, oil reserves, production and prices and fiscal regimes for private investors. The reports are then audited and made publicly available on a regular basis. For instance, in Nigeria the EITI audited accounts for 1999 – 2004 revealed huge discrepancies, with the government found to be owed US$5 billion, the largest part of which was owed by the state-owned oil company. Smoothing oil revenues over both the short- and long-term: In the short-term, the sheer volatility of international oil prices makes planning and budgeting for oil revenues a huge challenge. Having an oil revenue stabilization account can help to provide a buffer against short-term price fluctuations. In the long-term, Kenya can maximize the economic returns from oil by investing oil revenues in education, health and infrastructure and by saving for the future instead of spending it all at once. Sharing the benefits with communities and counties: Several elements are important in the design of sharing systems. It is important not to undermine the efficiency and transparency of revenue reporting: this should continue to be a national responsibility. It is important to maintain simplicity and transparency in revenue sharing: if rules are clear, well-designed, and seen as acceptable by key stakeholders there will be fewer grounds for mistrust between national and sub-national actors. The draft Mining and Minerals Bill proposes 5 percent of royalties go to local communities and 15 percent to counties: the windfall of significant additional revenues for counties benefitting from a share of royalties should be factored into to calculation of the county’s other fiscal transfers to avoid undermining the inter-governmental revenue sharing arrangements. Also, the policy framework should ensure that short-term volatility of oil revenues is not passed down to counties that receive a share, as they will find it far harder to manage. Building systems for improved absorptive capacity in beneficiary counties is also key. Avoid populist policies such as fuel subsidies: No matter how high oil prices will go and no matter how tempting it would be for the government to establish price ceilings or to introduce energy subsidies, the negative impacts would be dramatic. Research has shown that oil subsidies benefit the rich disproportionately because they own cars, often big ones. Nigeria is currently struggling to cut back its inequitable fuel subsidies. Kenya should avoid this. Source: World Bank staff. June 2012 | Edition No. 6 16 The State of Kenya’s Economy Deepening intra-EAC trade is a low hanging fruit diversification and growth. For example, despite the that member states can exploit in order to reduce large increase in Kenya’s services trade during the vulnerability to external shocks. The EAC is one last decade, there is still a widespread misconception of the leading export markets that Kenya’s comparative advantage lies for Kenya, but non-tariff barriers solely in the export of manufactured (NTBs) in the EAC, constrains trade goods. growth. The importance of exports Kenya’s merchandise to EAC economies, has significantly exports can only pay Regional integration can play a crucial increased in the last decade. Exports for just over one role in export diversification. Growth earning increased from about US$ 6 third of her imports, in exports over the last decade has billion in 2002, to US$ 20 billion in having declined from typically been fueled by a small number 2010. However this strong growth 65 percent of imports of mineral and primary products (see was in the major EAC countries, in 2003, to about 38 figure 3.5), with limited impact on the Kenya, Uganda and Tanzania while percent in 2011. wider economy. Currently, the impact export growth stagnated in Rwanda on unemployment and poverty is and Burundi (see figure 3.2). disappointing, and the formal sector remains small in many EAC countries. Deeper regional integration can Services offer new dynamic opportunities for reduce transaction costs and provide a regulatory exports. Opening up economies to imports of services environment, in which goods and services can flow and foreign direct investment is a key mechanism freely, and cross-border production networks can for increasing competition, and ultimately providing begin to flourish. It can also relax the constraints more efficient and competitive services in the faced by many firms in accessing the essential services domestic economy. Lower prices, higher quality, and skills that are needed, to boost productivity and and wider access to services, raises productivity and diversify into higher-value added production and improves competitiveness across all sectors, including trade. The integration agenda needs to cover services, agriculture and manufacturing. Kenya needs to be as well as goods, given the important role of services aware about the important role of services for export as intermediate inputs in almost all activities. Figure 3.2: Kenya needs to cut back consumption Figure 3.3: The trade gap is widening …import cover ratios and increase savings have declined as oil prices have risen Import cover ratio Oil prices US$/bbl Savings and Investments 70% 64% 120 US$106 per Barrel 22 60% 100 Investment 20 50% 80 Percent of GDP 18 40% 39% 60 16 30% US$ 24 per Barrel 40 20% 14 Savings 10% 20 12 0% 0 2000 2006 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 10 2007 2008 2009 2010 2011 Import cover Oil Price Source: World Bank. Source: World Bank. 17 June 2012 | Edition No. 6 The State of Kenya’s Economy Figure 3.4: The EAC market is growing fast Figure 3.5: Exports have increased …but markets and …so is intra regional trade products have become concentrated Exports of Goods and Services Sources of Kenya's Export Growth 1.00 10.0 0.874 9.0 0.80 8.0 0.60 US$ Billion 7.0 6.0 0.40 5.0 0.27 4.0 0.20 3.0 0.007 0 2.0 0.00 1.0 -0.073 -0.077 -0.20 0.0 Traditional Traditional Traditional new products Products & Value 2002 2003 2004 2005 2006 2007 2008 2009 2010 products to products to markets new to new markets market Death contraction in traditional new markets products existing markets markets Kenya Uganda Rwanda Burundi Tanzania Source: World Bank based on WDI 2012 data. Source: World Bank. Non export sectors like construction and real estate are recording robust growth .. the share of exportable sectors in GDP is declining June 2012 | Edition No. 6 18 The State of Kenya’s Economy Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 4. The EAC – A dynamic economic community T he EAC is a vibrant economic community, which now trades more with itself than with any other region of the World. Kenya can improve its trade balance, lower prices for a variety of goods and services and create jobs by reducing non-tariff barriers to trade and strengthening exports, particularly services. Although Kenya’s export performance has improved over the last decade, its imports have grown much faster. Kenya’s service sector has experienced recent growth, and there is room for further expansion. Kenya is in an excellent position to benefit from regional integration, and address the non- tariff barrier and regulatory reform agenda at both the national and regional levels. 4.1 Fast growth and a shift towards regional trade Although each EAC country grew in the last decade, T growth was unevenly distributed. Tanzania, Uganda he EAC is one of the fastest growing economic and Rwanda grew at an average of over 7 percent communities in the world. It has grown faster per year between 2002 and 2010, compared to than all other economic communities in the last Kenya and Burundi which grew at 3 and 4 percent decade, except for ASEAN, which grew at 6.1 percent. respectively. Kenya is the largest economy with a GDP The EAC grew at an average of 5.8 percent per year, of approximately US$ 32 billion in 2010, followed by between 2001-2009 (see figure 4.1) and over the Tanzania, Uganda and Rwanda, and finally Burundi last decade, each EAC country more than doubled its with a GDP of only US$ 1.6 billion in 2010. Between own GDP. The EAC also experienced unprecedented 2002 and 2010, GDP per capita increased at an population growth – the region grew by 25 percent average of 112 percent across the region, and now from 110 million people in 2002, to 138 million ranges from over US$ 800 in Kenya, to under US$ people in 2010. The region’s high population growth 200 in Burundi. To reach middle-income status (GDP has been close to 3 percent per year over the last per capita of US$ 1,000) by 2020 – the ambition of two decades, compared to the Sub-Saharan Africa’s most EAC countries – the region would have to grow average of 2.6 percent. The population in Kenya at an average of 8.5 percent per year, for the rest of alone doubled over the last twenty-five years, and the decade. Rwanda, Tanzania and Uganda, with rapid population growth is set to continue. per capita income somewhat behind the regional Figure 4.1: Average GDP growth in the EAC has been far average, would have to grow at 10 percent per year, ahead of most other economic blocks in order to meet that goal, individually5. 6 EAC partner states now export more within the EAC 5 region than to any other region. Total goods and 4 services exports from EAC partner states more than tripled over the last decade from US$ 6 billion in 2002 % Annual 3 to US$ 19.5 billion in 2010. In 2010, goods exports 2 comprised of US$ 12 million and service exports US$ 1 7.5 million. The share of total EAC exports traded within the region increased from US$ 1.8 billion in 0 ASEAN EAC Arab League UNASUR SACU EU 2008, to US$ 2.2 billion in 2010; surpassing Europe as the region’s main trading block (see figure 4.2). Source: World Bank computation based on WDI 2012 data. 5 Excluding Burundi from forecast, Regional Economic Outlook, IMF 2011. June 2012 | Edition No. 6 20 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) In addition, there was a large increase in EAC trade EAC goods exports are mostly simple manufactured with Asia – as expected, given ASEAN’s strong growth products. Unlike EAC exports outside the region, record over the past decade. The trend in EAC which are mainly commodities, the bulk of intra- exports is reflected in the compound annual growth regional exports are manufactured goods (food rates (CAGR), where intra-EAC exports exceed those products, beverages, tobacco, cement) and oil re- of EAC exports to the rest of the world (see table 4.1). exports. There has been limited variation between Kenya, Tanzania, and Uganda (the founding members 2000 and 2009, with the basket of top traded goods of the EAC) are the main sources of such intra-regional within the region remaining broadly the same (see export growth. Over the next few years, Rwanda and table 1.2). Although a noticeable change is the Burundi are expected to increase their exports to EAC reduction in the amount of oil traded between EAC countries (albeit from relatively low levels), and both countries, which comprised of 41 percent of the top countries are expected to see export growth exceed 15 products in 2000 compared to only 11 percent in import growth from 2015 onwards (East Africa 2009. This is likely to change once investments in Corridor Diagnostic Study, 2011). the recent oil discoveries in Kenya begin to come on- stream. Kenyan exports to the EAC have consisted Figure 4.2: EAC partner states now export more goods mostly of manufactured goods, chemicals and within the EAC region than to any other region – which was not the case in 2008 machinery (see figure 4.3). The value of Kenya’s top three products exported to Tanzania and Uganda 2.5 EAC exports goods to... doubled during 2000-2010, from US$ 97m to US$ 175m, and US$ 31 to US$ 73m, respectively. These 2 consisted of oil, plastics, construction materials, and soaps. 1.5 $ Billion Figure 4.3: Kenya exports mostly manufactured goods, 1 chemicals and machinery to EAC partner states (2009) 0.5 Kenya's Exports to East African Countries Commodities and transactions not classified 1039556 0 0% Intra - EAC Europe Rest of South and Rest of Miscellaneous manufactured Africa East Asia World articles Food and Live animals 75158300 67914320 2008 2010 9% 8% Beverages and tobacco Source: World Bank illustration based on Comtrade data. 53059548 6% Machinery and transport equipment 129889784 Crude materials, inedible, Table 4.1: Dynamic intra-regional exports in East Africa 16% except fuels 34786439 gained in the last decade 4% Compound annual growth rates Mineral fuels, lubricants and related materials (CAGR) (percent) 12194178 2% 2000-4 2004-9 2000-9 Animal and vegetable oils, fats and waxes EAC exports to the 13 10 11 13745948 2% world Chemicals and related EAC exports to the 11 16 14 Manufactured goods classified chiefly by material products, n.e.s. 175918626 254015994 EAC 31% 22% Source: World Bank calculation based on WITS data. Source: World Bank compulation based on WITS data. 21 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Table 4.2: Top 15 products traded between the EAC countries 2000 2009 Product USD 1,000 Percent Product USD 1,000 Percent 1. Petroleum oils 186,603 41.4 1. Petroleum oils 160,451 11.2 2. Cement and construction material 14,664 3.3 2. Cement and construction material 115,678 8.1 3. Vegetable oil 12,372 2.7 3. Paper 52,574 3.7 4. Medicaments including veterinary 11,986 2.7 4. Manufactured fertilizers 47,037 3.3 5. Flat-rolled products of iron 11,738 2.6 5. Medicaments including veterinary 44,692 3.1 6. Other crude minerals 11,185 2.5 6. Soaps/cleansers/polishes 37,727 2.6 7. Paper 9,884 2.2 7. Alcoholic beverages 36,296 2.5 8. Articles of plastics) 8,903 2.0 8. Made-up textile articles 34,286 2.4 9. Soaps/cleansers/polishes 8,144 1.8 9. Road motor vehicles 33,396 2.3 10. Cut paper/paperboard and 6,295 1.4 10. Flat-rolled products of iron, clad, 32,789 2.3 related articles plated or coated 11. Maize except sweet corn 6,071 1.3 11. Crude vegetable oil 32,065 2.2 12. Rubber tyres 6,037 1.3 12. Other crude minerals 28,638 2.0 13. Glassware 5,945 1.3 13. Cut paper/paperboard and 25,283 1.8 related articles 14. Flour/meal wheat/meslin 5,191 1.2 14. Iron and steel bars/rods/etc. 24,164 1.7 15. Edible products 5,122 1.1 15. Articles of plastics 23,441 1.6 Total Trade 450,993 100 Total Trade 1,430,290 100 Source: World Bank computation based on Comtrade/WITS data. Although still at low levels, there has been a notable place structures for intra-regional FDI. Furthermore, increase in foreign direct investment in the EAC. On deepening regional integrated would attract more average, FDI flows to the EAC (2.5 percent of GDP FDI inflows (much of which is likely to come to Kenya), in 2009) are below the SSA average (4.3 percent of reducing the importance of short-term capital flows GDP in 2009)6. However, FDI flows to the EAC have for Kenya in offsetting its current account deficit. increased by threefold, from approximately US$ 590 million in 2000 to approximately US$ 1.7 billion in 4.2 Regional integration can bring substantive 2010. A recent FDI survey7 by Ernst and Young shows benefits8 I that Kenya topped the list of East African countries, ntra-EAC trade can lead to lower prices for with the highest growth in new investment projects consumers and create more jobs for EAC citizens. between 2003 and 2011. Most FDI inflows have Gains are expected from both traditional sources (e.g. been directed towards natural resource sectors. In economies of scale, increased and more diversified Tanzania, gold exports already account for more trade and investment), and non-traditional sources than a third of total exports of goods and services, (e.g. commitment for domestic reforms, benefits in Uganda oil production is expected to account for from access to regional public goods, and increased close to 10 percent of GDP, and in Kenya recent oil bargaining power in wider trade negotiations). EAC discoveries have been made. A challenge for the EAC integration will also contribute to greater regional is to stimulate investments beyond natural resources, food security. The stages, history and current status generate linkages in their economies, and put in of EAC integration is explained in box 4.1. 6 FDI for ���� and ���� are approximately the same at US$ 1.7 billion, with investments in Uganda and Tanzania helping to prevent a regional downturn. 7 Ernst & Young, Building Bridges in Africa Survey, 2012. 8 This section is based on World Bank, Defragmenting Africa, 2012. June 2012 | Edition No. 6 22 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) More intra-EAC trade in agriculture would contribute barriers are currently limiting such opportunities to food security. The production of food staples for through increasing production and transport growing urban markets and food deficit rural areas, costs. Similarly, prospects for regional production represents the largest growth opportunity for regional chains driven by trade in parts and components farmers. Given that there is population growth and (“trade in tasks”), remain limited due to trade and increased urbanization, Africa’s demand for food regulatory barriers, which raise transaction costs and staples will grow dramatically in the coming decade. increase uncertainty. The removal of such barriers Indeed, demand in Africa is expected to double by would encourage vertical specialization, and the 2020, primarily in cities. But agricultural resources are emergence of regional production chains, that create not allocated equally across EAC countries, or even employment and promote export diversification. within them, so borders often artificially demarcate food surplus areas, from food deficit ones. Regional Intra-EAC trade in services can have significant trade integration can have a substantial impact by economy-wide benefits for all EAC countries. Trade better linking farmers to consumers across borders, in services is particularly important for maintaining and in ameliorating the effects of periodic national the competitiveness of landlocked countries and food shortages, and increasing global food prices. At Uganda is now exporting education services to East this stage, however, regional trade in food staples Africa and beyond. Over the past 10 years, exports of remains far from free, despite efforts for policy and services from non-oil exporting land-locked countries regulatory harmonization. The arbitrary and erratic in Africa have increased at a rate more than three imposition of barriers undermines private sector times their exports of goods. For Kenya, firms have confidence to invest, and distorts incentives towards become successful exporters of business, financial cash crop production away from food staples. and distribution services to the EAC region. Services are important for other sectors (agriculture and Intra-EAC trade in basic manufactured goods manufacturing), as services provide critical inputs and regional production chains can reduce for most economic activities. Opening up services unemployment. Trade in basic manufactured goods sectors, through liberalization and reform, improves such as plastics, chemicals, paints and cosmetics, efficiency and helps attract greater levels of foreign construction materials and pharmaceuticals is direct investment. beginning to materialize in East Africa, but non-tariff 23 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Box 4.1: Regional integration and the EAC What’s meant by regional integration? There are four common stages of regional integration: • A Customs Union is an agreement between governments to remove regional barriers to trade to form a duty-free trade area. The governments agree upon a common external tariff whereby partner states impose identical rates of tariff on goods imported from foreign countries. The intention is to increase regional economic efficiency, and establish closer ties between partner states. Examples include the European Union Customs Union (EUCU), and the Southern African Customs Union (SACU). • A Common Market is a market established by governments where there is a free movement of capital, labour and goods. The intention is for partner states to be able to access factors of production without physical or regulatory constraints, and to improve resource allocation. Examples include the European Economic Area (EEA), and Common Economic Space (CES). • A Monetary Union is an agreement between governments to use the same currency. The intention of a monetary union is often to reduce exchange rate risk and price variability, along with associated benefits of political union. Examples include the CFA Franc (West and Central Africa) and the Economic and Monetary Union (EMU) of the European Union. • A Political Federation is an agreement between governments to operate under a centralized government recognized internationally as a single political entity. Article 5 of the EAC Treaty sets out the intention to form a political federation, but does not provide for its composition or structure. Examples of political unions include the United States of America and African Union. A long history of EAC integration efforts Kenya, Tanzania and Uganda have a long history of successive regional integration arrangements: • 1927: Customs Union between Kenya, Tanzania and Uganda • 1948-1961: East African High Commission • 1961-1967: East African Common Services Organization • 1967-1977: East African Community • 1993-2000: East African Co-operation • 1993: East African Co-operation • 2000: East African Community • 2005: East African Community Customs Union • 2010: East African Community Common Market Protocol The EAC Treaty establishing the community was signed on 30 November 1999 and entered into force on 7 July 2000 following its ratification by the original three partner states – Kenya, Tanzania and Uganda. Burundi and Rwanda acceded to the EAC Treaty on 18 June 2007. The EAC today is a regional intergovernmental organization of Kenya, Tanzania, Uganda, Rwanda and Burundi, with a headquarters and Secretariat in Arusha, Tanzania. South Sudan has made an application to join the EAC. EAC collapse in 1977 and lessons learnt The collapse of the EAC in 1977 can be attributed to a number of reasons; including governance challenges, economic imbalances (in part arising from the socialist system in Tanzania and capitalist system in Kenya), political disagreements, and an extremely limited dissemination of information. Two reasons stand out, first, the relatively low engagement of stakeholders in civil society, the private sector and amongst EAC citizens, in the decision-making and management processes of community integration. And, second, a lack of a dispute resolution process for sharing the costs and benefits arising out of EAC integration. Since 1977, steps have been taken to address some of these problems, including a Mediation Agreement (1984) for determining and diving EAC assets and liabilities, and an agreement for the establishment of the Permanent Tripartite Commission for East African Cooperation (1993). Nonetheless, citizen engagement, knowledge sharing and consensus building are, and will continue to be, key components for successful integration. The EAC today: good progress but much remains to be done Out of the four planned stages of EAC integration – Customs Union, Common Market, Monetary Union and Political Federation – the first two stages are currently in effect. The Customs Union protocol established a duty-free trade between the partner states (with the successful reduction of intra-regional tariffs), common customs procedures between the partner states and a common external tariff whereby an identical rate of tariff is imposed on goods imported from foreign countries. The next stage – the Common Market protocol - established a single market allowing the free movement of goods, capital and labour within the region. Partner states have been required to review domestic rules and regulations and ensure compliance with the protocol, in order to harmonize policies and regulations within the region. This involves the removal of restrictions on the free movement of factors of production, and on the right of establishment, and to pursue mutual recognition of academic and professional qualifications. The implementation of the Common Market protocol is still taking effect, with the free movement of goods, capital and labour across all partner states not an every-day reality for many EAC citizens. The third stage – Monetary Union – would bring a single currency to the region, and agreement on the Monetary Union protocol was planned for this year but is behind schedule. The fourth stage – Political Federation – would likely bring a centralized president and parliament, and is planned for 2015, but is perceived by many as too ambitious. Given delays in implementation of both the Customs Union and Common Market, it is expected that the Monetary Union and Political Federation protocols, might be postponed further. Source: EAC Integration Process & Enabling Peace and Security, Hon. Beatrice B. Kiraso (2009) and EAC Secretariat. June 2012 | Edition No. 6 24 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 5. Challenges for Advancing the Regional Integration Agenda in East Africa A lthough EAC integration offers Kenya many opportunities, two key challenges remain: non-tariff barriers – rules and regulations that unduly restrict trade, continue to neutralize the impact from successful tariff reductions; and poor export growth and limited diversification – Kenya’s imports continue to outgrow Kenya’s exports, despite Kenya’s promising service sector. These challenges are set against a regional backdrop of physical infrastructure constraints that hinder competitiveness. 5.1 Non-tariffs barriers (NTBs) circumstances, rules and regulations can act as NTBs N to trade (see figure 5.1). TBs protect domestic markets. Some of the most cited NTBs which impede regional trade of goods in East Africa are: import and export bans; NTBs in Kenya and partner states – across a high multiple roadblocks; numerous weighbridges and number of products – limit regional trade. The corruption along the Northern Corridor (see box 6.4); EAC Secretariat produced a report entitled the EAC burdensome import licensing requirements; lack of Timebound Programme for Elimination of NTBs harmonization in regulations related to standards; (the “EAC NTB Report”) in which it identified for and, rules of origin. There can be legitimate reasons elimination, approximately 33 NTBs in 2008, and for governments to introduce rules and regulations, 47 NTBs in 2010. However, majority of these NTBs however, such measures can also be imposed to were not eliminated by the EAC partner states within protect domestic markets (as substitutes to tariffs) the agreed timeframe (see section 6 and annexes instead. Moreover, even without protectionist intent, 5-7 for details). NTBs which were not eliminated private-sector surveys have repeatedly shown that predominately concern “soft” rules and regulations, unduly restrictive or poorly implemented rules and rather than “hard” infrastructure, and range from regulations can raise trade costs, divert managerial charges on food products, non-recognition of health attention, and penalize small-exporters and those and safety standards, lack of harmonized import/ in low-income countries, especially where access to export documentation and procedures, and delays regulatory information is difficult to obtain. In these in transit bonds cancellation. In contrast to the Figure 5.1: Rules and regulations which can become NTBs Export measures Source: UNCTAD Multi-Agency Support Team (MAST) Report on Non-Tariff Barriers 2009 25 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Box 5.1: In contrast to NTBs, tariffs in the EAC have been reduced significantly In preparation for EAC integration, as well as in response Figure 5.2: Tariff reduction in the EAC to the Customs Union protocol, intra-regional tariffs in the EAC have been reduced dramatically. In the last two 50 decades, the EAC partner states reduced the number 45 of tariffs from approximately 26 percent in 1994, to 10 40 percent in 2011 (see figure 5.2). However, the Customs 35 Union protocols calls for tariff-free trade amongst partner 30 Percent states, and it is clear that there is more to be done, until 25 20 all intra-regional tariffs are removed. 15 10 The Common External Tariff (CET) 2007 requires partner 5 states to impose identical rates of tariff on goods 0 imported from foreign countries. However, this has not 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 yet been uniformly applied in practice. An example is the Uganda Rwanda Kenya Tanzania preferential tariff treatment given to a list of approximately 135 imports for Uganda, such as paper board products, Source: Winston and Castellanos, IMF 2011. millstone, plastic tubes, cosmetics and cement, which would otherwise be subject to the CET 2007. The preferential treatment was agreed in 1994, following Uganda’s civil war, however, Ugandan exporters are still able to benefit from that duty remission today, enhancing their competitive position vis-a-vis other partner states. The list was meant to end as the EAC region began to implement the Custom Union protocol in 2005, but it has continued in existence fuelling discontent between EAC traders (allAfrica 2011). In addition to the need for uniform application of the CET 2007, the levels of tariff are also reviewed regularly by the partner states. Source: World Bank. experience with NTBs, the EAC partner states have 5.2 Poor export growth and limited diversification K made significant progress in reducing tariffs (see enyan exports are poorly performing. Based on figure 5.2), but the gains have not been felt due to Kenya’s economic size and distance from other the remaining restrictions on trade. markets, it is possible to show both actual and predicted exports (see figure 5.3). Currently Kenya Figure 5.3: Kenya under exports to Tanzania, under exports to Tanzania, Uganda and the BRICs Uganda and the BRICS (and the countries above the diagonal line in figure 14 Kenya: Predicted vs Actual Exports to selected Markets 5.3) and has strong export performance to Rwanda India Tanzania Uganda GBR and Malawi (and the countries below the diagonal 12 China DEU FRA USA line in figure 5.3). While the geographical distance Log of Predicted Exports 10 Brazil Turkey SAU Russia Netherlands between Kenya and the BRICs might explain the ZAF CAN Pakistan below par export performance to those countries, for 8 Thailand Egypt Tanzania and Uganda, NTBs appear to be the binding Rwanda constraints. 6 Malawi 4 Kenya’s imports have grown much faster than 6 8 10 12 14 exports and export composition remains largely Log of Actual Exports the same. As shown in part I, Kenya’s exports have Source: World Bank estimates, Gravity model. expanded but import growth has been faster reflected June 2012 | Edition No. 6 26 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) in the widening current account deficit. The ratio of Figure 5.4: Sectoral composition of exports - Since 2005 there has been little export diversification in Kenya Kenya’s total exports (goods and services) to GDP, fluctuated between 20 to 28 percent over the last 100 decade, whereas Thailand’s ratio increased from 20 90 to 60 percent during the same period. In addition, 80 70 Kenya’s composition of goods exports has changed 60 little over time (see figure 5.4). Export diversification Percent 50 seems to have stalled since 2005, with the relative 40 composition of exports in agriculture and amongst a 30 variety of manufactured goods, remaining largely the 20 10 same. Furthermore, export growth appears to have 0 been driven primarily by existing products, in existing 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 markets, with limited new product/new market OTH MAC MET TEX CHE EXT F&B AGR discovery. Diversification is needed to provide a Source: World Bank illustration based on Comtrade 2012 data. Key: AGR = broader base for sustained export growth, less Agriculture, meat and Dairy, seafood; F&B = Food, beverages, tobacco, wood paper; EXT = Extractive industries; CHE = Chemicals, plastics, rubber; TEX = vulnerability to volatile world prices, and to spread Textiles, apparels leather, footwear; MET= Iron, Steel and other metals; MAC = Machinery, electronics, transportation equipment; OTH= Other Industries. the benefits of trade more widely. See Appendix 1 Table 1 for detailed HS level 2 codes for each category. Box 5.2: Regional backdrop – Underdeveloped infrastructure, unreliable power and poor business environment Increasing demand is exerting great pressure on existing road corridors. In 2009, total traffic on the two corridors (Northern and Central) was estimated at 28.6 million tons, which is likely to almost double to 52.5 million tons, within the next three years. Rail transport lags behind road transport, especially for international traffic, and a process to arrive at a more integrated and balanced system is required. Dar es Salaam and Mombasa ports are characterized by high dwell times, inefficient operations and customs, and represent significant time and cost bottlenecks, in particular for the region’s landlocked countries. Matching capacity with demand in the ports, road and railway sectors will be key challenges to moving forward, if predicted growth rates in the EAC are to be attained. Power remains an important infrastructure challenge in the EAC. In Keny, it is currently estimated9 that unreliable electricity lowers sales revenues of firms by 7 percent, and reduces GDP growth by 1.5 percent annually. The high cost of supplied energy, and the even higher cost of back-up diesel generation has a significant impact on the ability of firms to be competitive. Power demand in the East Africa Power Pool (EAPP) area (comprising of Burundi, DRC, Egypt, Ethiopia, Kenya, Libya, Rwanda, Sudan and Tanzania) is expected to increase by 69 percent over the next ten years. Developing under-exploited hydropower potential in the region, through appropriate regional transmission networks and regulation, will be key to meeting demand, as well as improving security of supply, enhancing environmental quality, and ensuring better economic efficiency. Distances from global markets hinder the movement of goods, people and services. The EAC’s landlocked countries10, which must move goods long distances over land, are particularly reliant on their neighbors’ capacity and willingness, to supply substantial externalities and public goods in form of goods transit policies, regulations, infrastructure, and institutional arrangements. Current divisions associated with the impermeability of borders, and differences and inefficiencies in institutions, regulations, and currencies, exact a major cost on intra-regional trade. For example, it costs US$ 5,000 to transport a container from Mombasa to Bujumbura by road; compared to US$ 1,000 it costs to transport the original container from Japan to Mombasa. Although the EAC business environment improved in 2010 and 2011, the five economies still lag behind globally, in implementing institutional reforms to improve competiveness11. The region’s governments implemented ten regulatory reforms last year, to improve the business environment and encourage entrepreneurship in the region. Rwanda led the way by improving its global ‘doing business’ ranking from position 50 to 45 last year, mostly through improvements for businesses to obtain credit and pay taxes. However, Kenya dropped three places from 106 to 109; Uganda dropped four places, from 119 to 123; Tanzania dropped two places, from 125 to 127; and, Burundi improved eight places to a still dismal 169. As a result, the EAC region as a whole is still struggling in ‘doing business’ reforms. 9 Africa Infrastructure Country Diagnostic, World Bank, 2008. 10 Uganda, Rwanda, Burundi – and, if successful in its bid to join the EAC, South Sudan. 11 Doing Business in the East African Community 2012, World Bank/IFC, 2012. 27 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 6. Lowering Costs and Increasing Trade - Reducing Kenya's Non-Tariff Barriers K enya imposes a large number, and wide variety, of rules and regulations on its imports, particularly from EAC partner states. Where rules and regulations are poorly designed or poorly implemented, they become NTBs. In the food sector, if Kenya were to reduce NTBs it would ease domestic food prices and help the poor. To date, there has been a slow removal of NTBs, and the monitoring committees for NTBs have been largely ineffective. A broad dissemination of the price-raising effect of rules and regulations is needed to inform the review of existing measures, as well as the design and implementation of new rules and regulations. Action is required at both national and regional levels, with effective monitoring, sanctions and appeal mechanisms being put in place. 6.1 Rules and regulations EAC producers and traders. In addition, Kenya is the K only country compared that imposes more rules and enya imposes a large number of rules and regulations on imports from its regional partners (red regulations, compared to other African countries. column) than on imports from the rest of the world The countries chosen were Kenya, Uganda, Namibia, (blue column). Mauritius, Madagascar and Senegal. Kenya and Uganda impose significantly more rules and Kenya and Uganda may be over-regulating their regulations on their regional imports, than do the trade. The frequency12 and coverage13 ratios for five other Sub-Saharan African countries (see figure different categories of rules and regulations were 6.1). As mentioned previously, rules and regulations compared across a selection of SSA countries (see are often imposed for legitimate reasons, such as figure 6.2)14. The categories of rules and regulations, protecting domestic consumers from counterfeits were (i) sanitary and phytosanitary (SPS), (ii) technical and sub-standard products – which are often cited; barriers to trade (TBT), (iii) pre-shipment, (iv) price however, such measures can be overly burdensome controls and (v) quantity controls. For Kenya and in design, or well designed, but poorly implemented, Uganda, the occurrence of pre-shipment measures, unnecessarily constraining the daily operations of SPS measures (intended to protect humans, animals, Figure 6.1: Kenya imposes a large number of rules and and plants from diseases, pests, or contaminants) regulations, particularly against EAC partner states and TBT (which arise when standards, regulations, and assessments systems intended to ensure safety 100 are not applied uniformly), significantly exceeded % of imports affected by ≥1 rule & regulation 90 the levels of other examined African countries. 80 This suggests that Kenya and Uganda may be over- 70 60 regulating, irrespective of how well designed and 50 implemented the rules and regulations are. 40 30 20 Rules and regulations affect a wide variety of 10 sectors in Kenya. Most rules and regulations are 0 imposed upon metals, machinery and food products SENEGAL MADAGASCAR MAURITIUS NAMIBIA KENYA UGANDA (see figure 6.3). For food products, it is somehow World Region expected, since agricultural products which include Source: Cadot and Gourdon, World Bank 2012. food and feed — and their control — is essential 12 The frequency ratio shows the percentage of import transactions covered by a selected group of rules and regulations for an exporting country. It accounts only for the presence or absence of an NTB, without indicating the value of imports covered. 13 The coverage ratio gives the percentage of trade subject to rules and regulations for an exporting country at a desired level of product aggregation. It allows weighting the frequency ratio with the value of imports for the affected tariff lines. 14 Annex 3 sets out the number of products covered by at least one rule or regulation. June 2012 | Edition No. 6 28 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Figure 6.2: Kenya and Uganda impose a wide variety of rules and regulations 100 100 % of imports (weighted with value of imports) 90 90 80 80 covered by rules and regulations % of imports covered by rules & 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Uganda Kenya Mauritius Senegal Madagascar Uganda Kenya Mauritius Senegal Madagascar SPS TBT Pre-Shipment Price Control Quantity Control SPS TBT Pre-Shipment Price Control Quantity Control Key: Sanitary and Phytosanitary (SPS); Technical Barriers to Trade (TBT). Source: Cadot and Gourdon, World Bank 2012. for ensuring health and well being of consumers, 6.2 Stabilizing food prices in Kenya D and protection of the environment. These rules and espite Kenya being a food deficit country, rules regulations are normally sanitary and phytosanitary and regulations are prevalent on food products, (SPS) measures (which cover 75 percent of food thereby deterring food imports, and raising the products in Kenya). However, TBT measures – which price of domestic foods. Kenya’s food sector is result from poor application of rules and regulations mostly affected by SPS, TBT, and inspection rules and – cover 60 percent of food products in Kenya (while regulations (see figure 6.3). SPS and TBT measures usually the average for other countries is 20 percent). raise domestic prices by increasing production costs TBT measures are the most common rules and for domestic and foreign producers. Their price- regulations in Kenya, with prevalence across a wide raising effect is typically a by-product, rather than, range of products (woods, paper, textile, footwear the main objective of the measures, which have non- etc). Common types of TBTs include rules for product trade objectives, such as public health. Because SPS weight, size, and packaging, as well as mandatory measures can be justified by non-trade objectives, labeling, shelf-life restrictions, and import testing. assessing their impact requires a cost-benefit Figure 6.3: Kenya’s sectors with the most rules and analysis. For example, when the price-raising effect regulations – metals, machinery and…food products of a SPS measure is strong, it must bring substantial 250 benefits, in order to be justified. The statistically significant price-raising effects of SPS measures on 200 food categories in both Kenya and Uganda15 is shown Quantity Control in figure 6.4. From this it is clear that the price of 150 rice and bread in Kenya is 42 percent higher, and the Percent Price Control 100 Pre -Shipment price of fresh fruit and vegetables over 30 percent TBT higher, than they would be otherwise16. As a result, 50 SPS Kenyan consumers are significantly losing out and 0 domestic producers benefiting only to the extent of their limited production. e pe s, ar en & ls paood al r ds w t ica et pm e o ot ui hin m w Fo em fo s, se eq ac Ch le tic Ba M xti as Te Pl Source: Cadot and Gourdon, World Bank 2012. 15 Annex 4 sets out in more detail the estimated price-raising effect of NTBs, by product, for Kenya and comparator countries. 16 The estimated “price gaps” refer to the difference between domestic prices and the sample average at the product level. 29 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) In addition to higher food prices, NTBs hamper Poorest households in Kenya are mostly affected by production potential. Farmers in the food surplus rules and regulations on food. The number of rules countries (e.g. Uganda) would benefit from increased and regulations on food products rank a close third sales, as well as consumers in the food deficit after those on metals and machinery. In Kenya, as countries (e.g. Kenya); through lower food prices with most countries, low income groups consume and less food shortages (see box 6.1). The EAC maize relatively more of food products, and are more balance sheet was in fact positive in 2006-2008 (see vulnerable to inflation (see figure 6.7). The price- figure 6.5). raising effect of rules and regulations can be seen on Figure 6.4: Significant price-raising effect of SPS on food types in Kenya and Uganda Figure 6.5: Food surplus and deficit countries in the EAC 45 EAC Maize Balance sheet 1,000 40 35 500 % price-raising effect of SPS 30 '000 MT 25 - 2006-07 2007-08 2008-09 2009-10 Kenya 20 Uganda (500) 15 10 (1,000) 5 0 (1,500) Rice Bread Other Sugar Fresh fruit Fresh Kenya Uganda Tanzania Rwanda EAC cereals & flour vegetables Source: Cadot and Gourdon, World Bank 2012. Source: World Bank computations based on data from RATIN. Box 6.1: Openness to regional trade can be a win-win…….East Africa can feed itself 2011 will be remembered for the challenging economic times, when food and fuel prices soared not just in Africa but globally. The drought in the horn of Africa unmasked the region’s vulnerability to recurrent droughts. In Kenya, more than 3.7 million people were affected by the drought. The country also had an influx of refugees from neighboring Somalia, in Dadaab refugee camp, creating an additional burden to the country. The food crisis put the spirit of EAC regional integration to the test. Tanzania is one of the countries in the region, which often produces more than its food requirements (see figure 6.5). In 2011, Tanzania produced 1.1 million tons of maize, more than its domestic requirements, while Kenya faced Figure 6.6: Restricted trade resulted in a recent lose-lose a food crisis. However, in July 2011 Tanzania placed an for Tanzania producers and Kenyan consumers export ban on maize to the EAC region, and beyond. At this time 100,000 tons had been ear-marked for export to Maize Prices the region. 550 500 Maize Export ban The end result was a lose–lose. Prices in Tanzanian fell, 450 in Tanzania so the farmers lost the producer prices they would have 400 US $/MT otherwise enjoyed. Prices peaked in other countries, so the 350 consumers lost. Figure 6.6 shows the unfolding scenario 300 between Kenya and Tanzania; in Kenya prices peaked to 250 US$ 513 per ton, while in Tanzania prices dropped to US$ 200 284 per ton. The prices shown here are retail prices, so 150 presumably producer prices for the Tanzanian farmers Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 were much lower. It is not clear if the ban remains, or if it Nairobi Dar es salaam has been lifted. Source: World Bank computations based on data from RATIN. Source: World Bank. June 2012 | Edition No. 6 30 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) different income groups (figure 6.8). For example, 6.3 Institutional failures T due to SPS measures, the poorest 20 percent of he established reporting mechanisms and households in Kenya will experience on average a 23 monitoring committees for NTBs have so far percent rise in goods they purchase, compared to only been ineffective. Raising awareness and improving a 14 percent rise in goods purchased for the 20 percent transparency are necessary steps but it is becoming richest households. These findings demonstrate that increasingly apparent that they are not sufficient, due the NTB agenda is not only extremely important for to lack of progress in removing identified NTBs. Only Kenya’s trade competitiveness, but also for poverty 50 percent of the NTBs identified by EAC in 2008, and reduction (see box 6.2 on NTBs for maize in the EAC). approximately 30 percent in 2011, were eliminated by partner states within the agreed timeframe (see Certain rules and regulations have become NTBs in annex 6-8 for details). In addition, in 2008 there were Kenya’s food sector. There are legitimate reasons more NTBs in higher categories19 (requiring less than for governments to introduce rules and regulations 6 months for removal), whereas in 2011 there were in order to protect consumers (such as food safety more NTBs in lower categories, especially in category regulations), but where rules and regulations are D, where over one year is required to eliminate each unduly restrictive or poorly designed or implemented, NTB (see figure 6.9); reflecting possibly an increased NTBs result. The EAC NTB report17 identified NTBs for political resistance to consider NTBs for more rapid elimination, and those which relate to the region’s removal. To date, the approach to eliminate NTBs food sector and have not been eliminated,18 are has focused on establishing national monitoring set out in table 6.1. The NTBs range from non- committees and publicizing specific NTBs, but recognition of SPS certificates by Kenya on Ugandan without sufficient attention being paid to the actual tea, administrative delays in maize clearance, reduction efforts. The absence of a clearly defined cumbersome processes for food products, and other monitoring mechanism with time limits for action, charges and bonds (see box 6.3 for a diary standards means that each partner state is responsible for case study). Figure 6.8: Price-raising effect (%) of (SPS) measures hurt Figure 6.7: Lower income groups are hurt more by inflation low-income groups the most 25 25 Nairobi Lower 20 20 Nairobi Middle 15 Percent 15 yoy % change 10 Nairobi Upper 10 5 5 0 0 May May May Mar Mar Mar Nov Nov Aug Aug Dec Dec Apr Apr Apr Feb Sep Oct Feb Sep Oct Feb Jun Jun Jan Jan Jul Jul 20% (poorest) 20% (middle) 20% (richest) 2010 2011 2012 Population income brackets in Kenya Source: World Bank based on CBK and KTB data. Source: Cadot and Gourdon, World Bank 2012. 17 EAC Secretariat, Draft EAC Timebound Programme for Elimination of Identified NTBs. 18 As at the time of publication of the EAC NTB report. 19 The EAC Secretariat has defined 4 categories of NTBs (categorized on the basis of ease of removal, and degree of trade distortion): Category A – To be addressed immediately; (ii) Category B – To be addressed in 1-6 months; (iii) Category C – To be addressed in 6-12 months; and (iv) Category D – To be addressed in >12 months. Annex 5 shows a line item analysis of each identified NTB, its period for elimination and whether or not it was eliminated on time. 31 June 2012 | Edition No. 6 Table 6.1: Existing NTBs in the food sector – Identified in the EAC NTB Report NTB summary description Affected Ministry, Impact to Action required Bottlenecks Latest update from EAC countries Department, businesses preventing action Secretariat Time Bound or Agency Publication responsible Non recognition by Uganda. Ministry of Uganda to identify. Mutual Resistance from Kenya reported that it Kenya for SPS certificates Agriculture recognition of issuing authority. recognizes SPS for transit tea issued by Uganda for tea Kenya. SPS certificates. meant for exports. Still a destined for Mombasa problem on the ground. action. Charges on plant import Uganda and Kenya Plant Adds to cost of Abolish charges. Resistance from SPS certificate required for tea permit (PIP) at Malaba on Burundi. Health Services. doing business. issuing authority. destined for Mombasa auction. Ugandan tea destined for Other issues will be addressed auction at Mombasa. once the EAC draft protocol on SPS is finalized. Timeframe pushed to December 2012. Ugandan ban on beef & Kenya. Uganda Ban on market Political goodwill Pressure from Uganda to report when it will beef products from Kenya. Departments entry and loss of to mutually businesses not lift the ban. of Veterinary potential markets. recognize to recognize Services; inspection products from Ministries procedures, within EAC due of livestock inspection to fear of loss of development reports and markets. and Agriculture. certificates. Uganda’s certification Kenya. Uganda dairy Denial of market Political goodwill Pressure from Uganda to report when it will procedures on exports of board. entry. Loss of to mutually businesses not lift the ban. milk from Kenya. potential market recognize to recognize valued at USD 1 inspection products from million for one procedures, within EAC due Kenyan milk inspection to fear of loss of processor. reports and markets. certificates. Requirement that to Uganda. Tanzania Ban of products. Abolition of the Unknown. Tanzania to report back. export herbal products Herbalists requirement. to Tanzania one must Organization. either be a member of the Tanzania Herbalists Organization or declare the formulas used. Tanzania require cash Rwanda. Tanzania Adds to cost of Abolition of the Unknown. Tanzania to report back. bonds for transportation Revenue doing business. requirement. June 2012 | Edition No. 6 of sugar to Rwanda. Authority . 32 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 33 NTB summary description Affected Ministry, Impact to Action required Bottlenecks Latest update from EAC June 2012 | Edition No. 6 countries Department, businesses preventing action Secretariat Time Bound or Agency Publication responsible Charge of Kshs 5,000 Rwanda. Kenya Plant Increases cost of Abolishment of Unknown. Kenya to remove charges. by Kenyan Plant Health Health Services. doing business. the charge. Inspectorate Services for every truck entering Kenya carrying Rwandan Tea. Complaints on Uganda. Kenya. Delays in Harmonize EAC SPS Protocol Kenya to comply with regional administrative delays in clearance; policies on SPS to address the laws and policies. maize clearance in Busia increased cost of and GMO. matter. and Malaba borders. doing business. Cumbersome registration, Kenya. Tanzania Food Delays in food Need to Insistence Need to harmonize the Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) testing and certification and Drug trade. harmonize by TFDA to procedures. procedures for food Administration. national export duplicate efforts products. / import of the Bureau of procedures Standards. under one body. Wheat flour value Tanzania. Rwanda and Delays in Verification Unknown. The EAC Secretariat to obtain addition into Rwanda and Kenya. clearance of exercise to information from Tanzania and Kenya. goods. Increases be conducted report back. cost of doing urgently. business. Konyagi has been refused Tanzania. Kenya. Increases cost of Mutual Kenya must be Urge Kenya to comply with entry into Kenya for not doing business. recognition of willing to accept regional standards. meeting international standards to be Konyagi standard. standards of alcohol adhered to. content (37.5%) vs 35%. Source: World Bank analysis of EAC NTB Report. Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Figure 6.9: More and more NTBs identified, but more status-quo benefits a small group, and the costs are and more time given for removal borne by many, are difficult. The challenge to activate EAC Secretariat Identified NTBs a critical mass for consensus and reforms is often 16 huge. Groups in danger of losing their privileges will be 14 determined to prevent restructuring. Nevertheless, 12 the potential gains to the economy and to producers Number of Identified NTBs 10 and consumers of food, are substantial. 8 2008 6 2010 Export taxes impose costs and inhibit the 4 development of regional chains and export 2 diversification. A case in point is the illegal imposition 0 of cess charges by county and local councils, on A B C D EAC 4 Categories of NTBs export products which affect the competitiveness of Kenya’s horticulture sector, by raising the costs of Source: World Bank analysis of the EAC NTB Report. doing business. These authorities are governed by voluntarily removing NTBs, without being subject directives from the Ministry of Local Government, to possible sanctions for non-compliance (R. Kirk, and efforts by the Ministry of Agriculture to prevent Defragmenting Africa, World Bank 2012). the practice, are not successful. In addition, levies, taxation, licenses and permits differ between local With the high prevalence and price raising effects authorities, and can be revised without consultation of rules and regulations, trade in food products in with the business community. A producer who was the EAC remains restricted. Kenya is a maize deficit interviewed, said that government bodies seem to country, yet interventions such as those by the look upon the export horticulture sector, as a cash- National Cereals and Produce Board (NCBP) (see box cow that is easily milked. Cess charges at road blocks 6.2) serve to discourage the development of intra- can add up to KES. 40,000 per month for a single truck, regional trade and do little to support job creation with one grower estimating that his lorries spend a amongst smallholders, who have little interaction total of 45 hours each month at roadblocks, between with the NCBP, and who buy most of their maize from Nairobi and Naivasha (World Bank discussions with large farms in the Rift Valley. Any reforms where the traders, 2012). Such charges increase the cost of Box 6.2: Case Study – NTBs affecting maize, who’s capturing the rents? Maize policy in Kenya is characterized by efforts to support and stabilize prices through the operations of the National Cereals and Produce Board (NCPB). In the 1980s, the NCPB played a major role in the domestic maize market, purchasing 600,000 to 800,000 tons annually. Since then, maize markets have been liberalized and private sector trade plays a much larger role. However, NCPB continues to purchase maize to defend a floor price. Since 2000, NCPB purchases have been 30,000 to 190,000 tons per year. NCPB operations are estimated to have increased domestic maize prices by 20 percent during 1995-2004. Its purchases had a large effect on prices, because they account for 25 to5 percent of all maize sold by the agricultural sector in Kenya. Most of the maize purchased has been directly from large-scale farmers in the Rift Val- ley. To defend high maize prices, the government has limited maize imports. In mid-2001, a temporary ban was imposed on cross-border imports of maize, because of low prices associated with a good harvest. Another temporary ban was introduced in 2004, in response to an outbreak of aflatoxin poisoning argued to be caused by imports from Uganda. And recently Kenya prevented Tanzanian trucks carrying maize, from entering Kenya, forcing them to off-load and reload onto Kenyan trucks. The main beneficiaries from high maize prices within the country have been the farms, while the main los- ers have been the net buyers, i.e. urban consumers and maize purchasing rural households. Source: Based on World Bank Kenya Economic Update analysis (2009). June 2012 | Edition No. 6 34 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Kenyan goods, making farmers less competitive than in order to exploit economies of scale in regulatory they would normally be in the EAC market. Also, expertise, prevent fragmentation of the market by these charges are illegal, and only compound national differences in standards, and to limit the scope for efforts to remove NTBs agreed regionally. regulatory capture. However, it is important to tailor those standards to the specific preferences and needs Standards need to be specific to the market. The of regional actor, in order to avoid non-compliance or development of an appropriate standard may be unnecessary implementation costs (see box 6.3). desirable at a regional, rather than national level, Box 6.3: Case Study – Harmonized EAC dairy standards are a potential NTB Consistent with developed country norms, the newly developed EAC standards focus on pasteurization as the key to ensuring product safety. This technology is widespread in developed countries, but is difficult and expensive to apply in the context of smallholder dairying, which is the dominant form of production in East Africa. While smallholders in Africa can, and do supply perfectly good raw milk for pasteurization, the infrastructure and quality control systems needed for delivery of smallholder supplies to a processing plant, results in consumer prices that are four to five times higher than for raw milk traded through informal channels. Moreover, consumers in East Africa have found an alternative to reducing health hazards not recognized in the EAC standards, which is to consume raw milk after boiling. This practice reduces the otherwise high bacteria levels found in East African milk, to safe levels, a point not recognized during the harmonization process, because the Codex standards were developed for Western countries, which consume pasteurized milk. As a result of setting the regional standards too high, the EAC’s harmonized dairy standards have been difficult to implement, and provide little practical guidance for farmers, dairy traders, and large processors, on how to upgrade their operation. According to the letter of the law, more than 95 percent of the EAC’s milk supply is technically illegal because it does not comply with the new standards requirements, and could be stopped from regional trade at any time. Source: World Bank, Africa Can Feed Africa, 2012. 35 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Box 6.4: What really happens along the northern transit corridor? Things you need to know… This case study is based on the experience of thirteen drivers who made fifteen trips along the Northern Corridor. Thirteen trips transported imports from the port of Mombasa, and two of the trips transported exports back to the port. At the port of Mombasa and its licensed Container Freight Stations drivers can wait for more than 5 hours to load their trucks unless they pay ‘facilitation’ fees. The longest waiting duration along the entire corridor is at the port of Mombasa. If trucking companies are large enough, they may be able to build warehouses in Mombasa, to cut down on the loading duration and inefficiency. However, this response further entrenches the cartel structure of the trucking industry. Queues can take between 1 to 2 hours at each weighbridge. There are 6 weighbridges in Kenya, and 3 in Uganda. It takes approximately 20 minutes to weigh a truck but the greatest challenge is the long queues before reaching the weighbridge. As a result, there is a clear incentive for truck drivers to pay bribes in order to skip the queues. Travel costs are significantly affected by fuel costs. Fuel cost accounts for about 20 percent of the transport cost. In addition to the direct cost of fuel, trucks have to pay for the weight of the fuel on weighbridges. A Mombasa-Kigali journey requires 1,000 litres of fuel, which translates to 1 ton in weight. This takes the space of one ton of the payload and if the truck is overloaded there is a fine of US $ 115 and the truck is detained at the weighbridge. Overloaded trucks damage the Kenyan roads. The Kenyan authorities impose a maximum axle load requirement to protect their roads; however, the limit has become a controversial issue in the EAC region. In practice, many overloaded trucks manage to avoid being caught at weighbridges with drivers paying a small price (e.g. 500skh) in individual bribes, compared to the significant cost to the Kenyan economy of the damaged roads. Competition amongst industry players, and recklessness amongst some truck drivers, contributes to many road accidents. Some truck drivers rush to make deliveries so that they can return quickly for more business. Should an accident occur and the driver not be injured, a lot of time is spent waiting for the police to respond and, since the police lack the necessary equipment for moving damaged trucks, waiting for the truck company to send a towing vehicle. Trucks have been prevented from carrying return cargo – which acts as a NTB – but rules are changing. Protectionist policies have prevented trucks from carrying return goods, even if it is within the EAC – leading to idle capacity, inefficiencies, increased levels of transit traffic and associated higher transport costs. However, late last year, KRA announced that this rule will be reversed, to permit cargo to be carried, but only if trucks are fitted with an electronic tracking system. The Kenyan Transport Association has raised concerns on whether or not the policy will be applied evenly amongst EAC partner states. Source: World Bank. June 2012 | Edition No. 6 36 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 7. Growing and Diversifying Kenya’s Exports – Services Matter A lthough Kenya’s export performance has improved over the last decade, imports have grown much faster. Kenya’s top exports consist of traditional agriculture (tea and coffee) and horticulture products, as well as manufacturing and services. Kenya’s services have experienced dynamic growth and the sector has further potential for expansion. However, regulatory barriers restrict services, particularly in the banking, professional and business sectors. Services trade liberalization and regulatory reform are needed to build compatibility, harmonize standards, recognize qualifications, and strengthen the business environment to enable Kenya to benefit fully from EAC integration 7.1 Kenya’s promising service sector Furthermore, Kenya has additional scope to develop K its services sector, and the compound average growth enya’s exports can be classified into four rate (CGAR) for Kenya’s services exports in 2000-2008 categories. Traditional agricultural exports was almost 15 percent, whereas for services imports (tea, coffee), non-traditional agricultural exports it was 10.5 percent. The EAC region as a whole, has (horticulture), manufacturing and services. While also performed strongly in service exports; Rwanda’s Kenya has historically depended upon tea for export CGAR for services exports over the same period earnings, manufacturing and services have grown was 19.5 percent (albeit from a lower base), and for in recent years. Dependent upon oil imports, services imports was 14.6 percent; while Uganda’s Kenya’s manufacturing sector is vulnerable to trade CGAR for services exports was 17 percent and for shocks, and global competitiveness depends upon services imports was almost 15 percent. infrastructure investments and reducing NTBs, and the ability to modernize and strengthen the port of Figure 7.1: Service exports have increased for Mombasa as a coastal hub. all EAC countries, but particularly Kenya 25 Kenya’s trade in services20 has experienced recent growth. In 2010, Kenya’s services exports 20 as a percentage of GDP were higher than the 15 ratios registered by countries at similar levels of Percent development, implying that the country’s services 10 Service imports exports are above the sample average conditional Service exports 5 on the level of per capita income. This suggests that Kenya has a comparative advantage in the export of 0 services. Services exports in Kenya increased from less 3) ) ) 3) ) 3) ) 03 03 ) 03 03 03 /0 /0 /0 1/ / 1/ 1/ 08 01 8/ 08 08 (0 (0 (0 (0 i( a( than 8 percent in 2001-2003 to 11 percent of GDP in a( ( di nd ia ia da da ny ny n an an ru ru an an Ke Ke nz nz Bu Bu Ug Ug Ta 2008-2010 (see figure 7.1), and registered a positive Ta balance throughout the last decade (see figure 7.2). Source: World Bank analysis based on IMF BOP and WDI 2012 data. 20 Trade in services takes four different forms: (i) cross-border supply– similar to trade in goods – that involves services flows from one country to another such as banking services transmitted via email; (ii) consumption abroad that refers to situations where a consumer – a tourist or a student – moves to another country to obtain the service; (iii) commercial presence that implies that a service supplier of one country establishes a territorial presence, including through ownership or lease of premises, in another country to provide a service (for example, domestic subsidiaries of foreign insurance companies or hotel chains); and (iv) presence of natural persons that consists of persons of one country entering the territory of another country to supply a service (for example, doctors or teachers). 37 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Figure 7.2: Kenya is exporting more services than ever 7.2 Unleashing Kenya’s services before, and the gap between service exports and imports is growing Financial services22 400 350 K enya-based banks are leading regional integration in the EAC banking sector... About eleven multinational and Kenyan owned banks, use 300 Kenya as a hub to expand their operations in the EAC 250 region. There are four indigenous Kenyan banks with Millions 200 Service exports branches within the region. These banks include 150 Service imports Kenya Commercial Bank (KCB), Equity Bank, Fina 100 Bank, and Commercial Bank of Africa. These banks 50 have a total of 63 branches outside Kenya (16 in 0 Tanzania, 31 in Uganda and 16 in Rwanda). A 2009 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 World Bank survey revealed that 56 percent of the Source: World Bank analysis based on IMF BOP 2012 data. banks operating in the East African region are hubbed in Kenya. Most of the banks surveyed have yet to Kenya is in early stages of exporting higher value achieve full integration of their operations in the added services. Kenya’s revealed comparative region, but partial integration has taken place in the advantage21 in services exports is in four sub- areas of ICT, risk management, customer service, and sectors: transportation, communication, financial treasury operations. Two-thirds of the banks state and cultural services (see table 7.1). These figures that regionalization has facilitated the introduction suggest that consistent exports of other higher value of financial products and services, which would not added sectors such as business process outsourcing have been possible in the absence of scale. (BPO), information communication technology (ICT), and insurance services have yet to fully emerge. …but differences in regulations limit their benefits But anecdotal evidence suggests that Kenya has from regional integration. The establishment of already started to take advantage of the growing a single licensing regime, which would remove opportunities, in these areas. barriers to entry posed by separate capitalization requirements for each subsidiary, and enable cross- Table 7.1: Kenya has a revealed comparative border branching, is favored by a majority of the advantage in services shown in bold (2010) banks as a measure which would promote deeper Commercial 0.82 integration. Major impediments to attaining full Transportation 1.30 integration cited by banks are: the lack of a common Travel 0.62 tax regime; resistance from bank supervisors Communication 1.80 (particularly in Tanzania and Uganda, who are averse Insurance 1.02 to banks under their jurisdiction, being managed by Financial 2.09 Kenyan parents); differing regulatory requirements; ICT 0.02 restrictions on the mobility of labor; and, the existence of differing capital movement polices within the EAC. Personal, cultural & recreational 1.68 Source: World Bank analysis based on IMF BOP 2012 data. 21 The index of revealed comparative advantage (RCA) initially introduced by Balassa (1965) can be used to assess the structure of a country’s exports. The RCA for a services sector is the country's share of world exports of a service divided by its share of total world services exports. A value of the index greater than unity implies that a country is relatively specialized in the services sector and thus has a revealed comparative advantage in such exports compared with the world average. 22 The section, including policy recommendations, is based on Wagh, Lovegrove and Kasangaki, World Bank, Defragmenting Africa 2012. June 2012 | Edition No. 6 38 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Distribution services23 to formal retail trade facilities, with monthly sales K reaching the US$ 700 million mark, and selling space enyan supermarkets began establishing foreign reaching close to 40 million square feet, up from 15 operations in the EAC in about 2002 and have million square feet today (Nakumat CBC, 2011). since stepped up their efforts to penetrate the regional market. Currently, the three largest Kenyan Kenya’s presence in the distribution sector of the supermarkets have a combined total of seven branches East African economies has been made possible by in Uganda, and two in Rwanda. The main market extensive trade liberalization measures, adopted entry strategy employed by these supermarkets has by the EAC, but regulatory barriers remain. Major been the acquisition of existing supermarket chains. drivers of investment in East Africa include the In 2011, Tuskys acquired the Ugandan supermarket adoption of the EAC Common Market Protocol, chains, Good Price and Half Price, and has now four and the harmonization of tax regimes, and customs stores in Uganda. The estimated Kenyan FDI in the import regulations. Although all East African countries East African supermarket segment amounts to about have made progress in removing explicit restrictions US$ 22 million (see table 7.2). Total Kenyan FDI to trade, the lack of regulation in critical areas, and outflow in distribution services is estimated to be onerous regulation affecting the entry and operation around US$ 26 to 32 million, over the period 2002– of firms, continue to pose serious problems to 2009. Expected investment in the EAC distribution competition, and affect trade and investment in the services sector over the next five years is projected distribution sector. to be between US$ 30 to 50 million. Table 7.2: Kenyan Supermarkets with EAC Presence24 Business services25 Kenyan Supermarket No. of Branches in EAC Countries Estimated FDI Investment Flows* K enya has several world class firms that already provide and export business services26 to the region, and beyond. A recent survey of over fifty Uganda Rwanda ($ millions) Kenyan business services exporters undertaken by the Nakumatt 2 2 8.25 World Bank reveals that the subsectors with greatest Tuskys 4 11 export turnover totals are insurance, accounting, non- Uchumi 1 2.75 banking financial, and BPO services. The substantive Total 7 2 22 scope for trade in certain professional services, such as Source: World Bank (2011). accounting is further confirmed by the heterogeneity of professional endowments across countries. Kenya With a population of approximately 140 million has a relative abundance of professionals, whereas in people, the East Africa region provides a vast retail Rwanda, there is a relative scarcity of professionals, market for formal retail traders, with important suggesting a good potential for intra-regional trade, benefits for consumers and producers. According based on comparative advantage (see figure 7.3). to Nakumatt Holdings Research, the current regional population has an opportunity to sustain at least 10 Kenyan firms are starting to export higher major retail stores in each town. In the next ten years, value business services. Despite the novelty of Nakumatt Holdings is forecasting that close to 25 exporting business services, and in contrast with million customers across the region will have access most developing countries that tend to export 23 The section, including policy recommendations, is based on Dihel (2012), World Bank, Defragmenting Africa 2012. 24 Average investment required for establishing a supermarket in EAC is US$ 2.75 million. This figure was calculated using past investment spend of Kenyan supermarkets in EAC. Nakumatt invested about US$ 3 million for each of its Uganda branches, US$ 2.5 million of their Rwanda branch. Uchumi invested about US$ 2 million for its branch in Uganda, and are poised to spend US$ 2.5 million for their planned branch in Tanzania. 25 This section, including policy recommendations, is based on World Bank, Exporting Services 2012 and World Bank, Developing Professional Services in Africa, 2011. 26 Business services are generally provided on a private sector basis and require a high level of skills that are usually certified, and include accounting, architectural, engineering, legal, BPO, ICT, information communication technology enabled services (ITeS), and more. 39 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Figure 7.3: Kenya can export professional services to lower rates compared to international or developed Uganda and Rwanda countries’ providers. Kenyan firms have a competitive Number of Accountants per 100,000 inhabitants advantage in understanding target markets in the East Africa region, due to their knowledge of soft or Mauritius South Africa cultural issues, such as the slow pace of conducting Botswana business or the insistence on face to face meetings. Kenya South African and developed countries’ service Zambia Tanzania firms that do not possess such skills, have failed to Malawi penetrate the EAC market. At the international level, Uganda Kenyan firms are value service providers, able to Rwanda provide quality services at lower costs, compared to Mozambique providers from the foreign market. 0 20 40 60 80 100 120 But Kenyan exporters of business services are Source World Bank, Developing Professional Services, 2011. facing a variety of challenges. At the regional level, basic business services (such as back office tasks, numerous barriers limit the mobility of professionals, or low value offshoring), Kenyan firms are starting and differences in regulation, further segment the to export higher value offshoring services, such markets for business services in East Africa. Skills as product development, R&D, business ventures, mismatches and skills shortages, pose as a significant and transformational sourcing (see box 7.1). There challenge to many Kenyan exporters. Another factor could be substantial gains for Kenya’s economy from that constrains service providers from exporting, expanding the number of these firms. is a widespread lack of knowledge about exporting opportunities, markets, and processes, and a lack The recent success of Kenyan services exporters of awareness, on how to acquire such knowledge. has occurred at both the regional and international Very often, Kenyan service providers - especially levels. At the regional level, Kenyan firms are smaller ones - lack international networks, and find premium quality service providers, especially in it very difficult to obtain market intelligence on countries which lack skilled professionals. Kenyan foreign markets (see box 7.1). Finally, difficulties in firms are perceived as superior, and offer better penetrating foreign markets, also come from Kenya’s services compared to local counterparts, and at low international brand equity, as a business service provider. Box 7.1: Knowledge sharing for service sectors To assist with the implementation of MRAs, the World Bank Professional Services Knowledge Platform for Eastern and Southern Africa is being developed to provide: • Information and analysis of the current situation regarding the performance of the particular sector, and its impact on other sectors, and the wider economy. This may require surveys of both users and providers of the service. • An assessment of barriers to trade and foreign investment, and current regulatory policies in the form of a trade, and regulatory audit together with an assessment of their impact on entry and conduct in the market. • A review of the necessary steps to remove explicit barriers to trade, and the regulatory options for an integrated services market, including measures that can be pursued at the national level, and those that are likely to be more effective in collaboration with partner countries, at the regional level. • An assessment of capacity building that will be necessary for effective implementation, and monitoring of outcomes in the sector, and the impact of current regulation. In pursuing these outputs, the platform aims to support a process that ensures regular consultation between private and public stakeholders; effective communication between the regulator, sector specialists, and government ministries; and extensive dissemination of information at national and regional levels, for increased awareness of policy issues. Source: World Bank. June 2012 | Edition No. 6 40 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) 8. Policy Recommendations Non-Tariff Barriers at the National Level which need to be identified and prioritized. For E example, are there sufficient officers at the border to stablish a trade regulatory committee to review apply SPS requirements? – A lack of staff can lead to existing rules and regulations – removing those long delays and spoilage. that cannot be justified – and inform the design and implementation of new rules. More specifically Non-Tariff Barriers at the Regional Level the trade regulatory committee should oversee the implementation of new rules and regulations which affect regional trade, and facilitate the inter-ministry coordination that is essential to address a wide range D isseminate the price-raising effect of rules and regulations. A significant number of SPS or TBT measures that are unnecessarily burdensome to of non-tariff barriers. trade are still in place in many EAC countries, including Kenya. It is important for the Government of Kenya Inform firms and individuals. An inclusive to put in place procedures to ensure that SPS and and transparent process for the design and TBT measures are designed and implemented, in the implementation of rules and regulations is crucial least trade-restrictive way, without compromising for deeper regional integration. The political legitimate public policy objectives, and set an economy constraints and vested interests can make example for EAC partner states to follow. the removal of NTBs a challenging task, particularly when consumers lack sufficient information, and fail Develop an effective monitoring mechanism with to organize themselves. The case studies show that possible sanctions for non-compliance. The EAC it is important to consult with the private sector and Secretariat has already identified NTBs for removal, other stakeholders, and develop a framework for but implementation is not adequately taking place. providing information to them. The COMESA-EAC-SADC Tripartite online reporting and resolution system is showing signs of encouraging Introduce an appeal mechanism to allow affected progress and good practice. The binding dispute stakeholders – both domestic and foreign – to contest settlement process of the WTO, and the experience decisions made by civil servants. There should be of the EU in establishing a legally binding mechanism a channel to allow firms and individuals to dispute with sanctions for non-compliance, provide additional the decisions made by officials, in implementing relevant models for the EAC to consider. regulations, especially for small producers, who do not have access to the mechanisms that are available Consider the development of appropriate standards to large firms, to influence decisions (World Bank, at a regional, rather than national, level. This would Defragmenting Africa, 2012). exploit economies of scale in regulatory expertise, prevent fragmentation of the market, by differences Review capacity of government ministries and in standards, and limit the scope for regulatory agencies to address the regulatory reforms. capture. However, it would be important to tailor Assessing capacity gaps that undermine the effective those standards to the specific preferences and needs and efficient implementation of new rules and of regional actors, in order to avoid non-compliance, regulations. There are clearly critical gaps in the or unnecessary implementation costs. standards and conformity assessment infrastructure, 41 June 2012 | Edition No. 6 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Service Exports at the National Level and play an important role in helping to reduce the E barriers that Kenyan service firms face in their export liminate regulatory barriers that limit the development efforts. development of service markets. Domestic regulations on the entry, and on the operations of Service Exports at the Regional Level services firms often undermine competition, and constrain the growth of strong services sectors in the EAC. Reforms should focus on eliminating such disproportionate entry requirements, or regulatory R emove remaining trade in services barriers. Examples of these barriers include restrictions on the free movement of labor, including visa and measures that limit competition. For example, in immigration laws and regulations, and labor policies distribution services, lengthy registration procedures, preventing the mobility of professionals. The EAC multiple licenses, or inadequate zoning regulations, Common Market Protocol has initiated the integration need to be addressed. Price controls imposed across process in services in East Africa. All five EAC partner the region, and the cartels in place in several East states have scheduled commitments in seven services African countries, represent a serious impediment to sectors, and have adopted the annexes on removing competition and should be removed. Furthermore, restrictions, on the free movement of workers and rules and regulations which strengthen the business on the right of establishment. But barriers affecting environment, have to be put in place. Inadequate trade, investment and labor mobility remain in place. codes on investment, commerce, labor, and taxation, as well as the lack of bankruptcy procedures, create Encourage regional education-related reforms to significant uncertainty and burden for firms which are address skills-shortages and skills-mismatches. This trying to conduct business operations, in the formal could take the form of establishing regional education distribution sectors of East African countries. hubs, in order to address the fragmented market. Reduce costs of access to, and improve quality Align regulatory and supervisory frameworks and of, education. Encourage collaboration between reporting requirements in financial services. Banks universities, professional associations, and the surveyed cite single licensing as an important aid private sector. Education-related reforms that to further integration. Adopting single-licensing address skills-shortages and skills-mismatches need will have to be accompanied by mutual recognition to be encouraged. Solutions that equip students with among regulators, and this will require that national market-relevant skills, and address the absence of regulators converge around some broadly defined institutions which offer specialized courses, need to international principles27. It is also important to build- be addressed. up regionally compatible financial infrastructure. Kenya, Tanzania and Uganda have already made Involve the Export Promotion Council. The EPC substantial progress in integrating their real time gross can collect and disseminate to Kenyan service settlement systems. Rwanda and Burundi also need firms market information, and highlight available to align their payments systems with the regional opportunities. Most Kenyan service exporters feel that system. Deepening links between financial institutions direct incentives to exports, such as tax incentives, are warrants a similar deepening of cooperation between unnecessary. Rather, what they consider to be crucial supervisors. Home-host supervisory communication, is for the government to facilitate access to foreign and consolidated supervisions are important, to markets. The Government of Kenya could, through ensure that weaknesses in one financial institution/ its trade supporting institutions, and in collaboration market, do not put the regional financial system at with business and professional associations and the risk. private sector, develop a services export strategy 27 For example, the Basel core principles for bank supervision developed by the Basel Committee on Banking Supervision, which is an international committee of banking supervisory authorities established in 1974, the International Organization of Securities Commissions (IOSCO) and others. June 2012 | Edition No. 6 42 Special Focus: Deepening Kenya’s Integration in the East African Community (EAC) Recognize professional qualifications in professional Kenyan service firms (as well as firms in neighboring services. The free movement of EAC professionals countries), in their exports of services to the region. across the borders needs to be complemented The five EAC partner states have taken the first steps by the recognition of their qualifications. The towards mutual recognition in professional service, in implementation of full-fledged mutual recognition the context of the EAC Common Market negotiations agreements that cover areas such as education, – they have already signed MRAs in accounting and examinations, experience, conduct and ethics, architectural services, and additional MRAs are professional development and re-certification, scope expected to follow in engineering and other sectors. of practice, and local knowledge, would likely benefit 43 June 2012 | Edition No. 6 ANNEXES 45 Annexes Annex 1: Map of EAC June 2012 | Edition No. 6 Source: NYSTROM Horff Jones Education Division. Annexes Annex 1.1: GDP Growth rates, Kenya and Sub Saharan Africa Percent 2007 2008 2009 2010 2011 2012f GDP growth rate Kenya 7.0 1.6 2.6 5.6 4.4 5.0 GDP growth rate SSA 6.5 5.2 2.0 4.8 4.9 5.3 GDP growth rate World 3.7 1.5 -2.2 4.1 2.7 2.5 GDP Per capita growth rate Kenya 4.4 -1.0 -0.1 3.0 1.9 2.4 GDP per Capita growth rate SSA 4.1 3.1 -0.3 2.7 3.3 3.5 Source: Global Economic Prospectus January 2011, KNBS. **f –forecast. Annex 1.2: Key Macro-economic indicators low case, baseline and high case scenario Percent 2007 2008 2009 2010 2011 2012** 2013** Baseline GDP 7.0 1.6 2.6 5.6 4.4 5.0 5.5 Private Consumption 7.3 -1.3 3.8 2.8 3.0 3.9 4.1 Government Consumption 4.4 2.3 5.5 4.8 4.5 4.3 4.6 Gross Fixed Investment 13.6 9.5 0.6 7.4 10.2 9.5 11.0 Exports, GNFS 7.3 7.5 -7.0 6.1 8.9 6.7 6.7 Imports, GNFS 11.1 6.6 -0.2 3.0 8.6 6.7 6.7 Low case scenario GDP 7.0 1.6 2.6 5.6 4.4 3.1 4.5 Private Consumption 7.3 -1.3 3.8 2.8 3.0 3.9 4.1 Government Consumption 4.4 2.3 5.5 4.8 4.5 4.3 4.6 Gross Fixed Investment 13.6 9.5 0.6 7.4 10.2 6.8 7.9 Exports, GNFS 7.3 7.5 -7.0 6.1 8.9 2.0 6.0 Imports, GNFS 11.1 6.6 -0.2 3.0 8.6 6.7 6.7 High case scenario GDP 7.0 1.6 2.6 5.6 4.4 5.5 6.0 Private Consumption 7.3 -1.3 3.8 2.8 3.0 3.9 4.1 Government Consumption 4.4 2.3 5.5 4.8 4.5 4.4 4.6 Gross Fixed Investment 13.6 9.5 0.6 7.4 13.9 11.0 12.1 Exports, GNFS 7.3 7.5 -7.0 6.1 9.0 7.0 7.2 Imports, GNFS 11.1 6.6 -0.2 3.0 8.6 6.7 6.7 Source: CBK; KNBS; World Bank estimates. June 2012 | Edition No. 6 46 Annexes Annex 1.3: Kenya’s GDP per capita 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 GDP/Capita (US$) 402 397 438 461 523 611 719 774 738 760 774 GDP growth rate 4.5 0.5 2.9 5.1 5.9 6.3 7.0 1.6 2.6 5.6 4.4 Source: WDI & KNBS. Annex 1.4: Sectoral Growth rates Percent Sector/ Year Share of GDP 2007 2008 2009 2010 2011 Agriculture (25.0) 2.1 -5.0 -1.4 6.3 1.6 Industry (18.4) 7.1 4.8 3.4 5.3 2.8 Service (56.6) 8.1 2.6 4.3 5.4 5.1 GDP 7.0 1.6 2.6 5.6 4.4 Source: KNBS. Annex 1.5: GDP growth rate of other African countries Percent 2009 2010 2011 2012f Ethiopia 8.8 8.1 7.7 7.2 Tanzania 6.0 7.0 6.5 6.9 Ghana 4.7 7.7 13.4 10.0 Rwanda 4.1 7.5 7.0 6.8 Uganda 7.1 6.3 6.5 6.6 Kenya 2.6 5.6 4.4 5.0 SSA average 1.7 4.8 4.9 5.3 South Africa -1.8 2.8 3.5 4.1 Source: Global Economic Prospectus 2011. 47 June 2012 | Edition No. 6 Annexes Annex 1.6: Kenya’s Inflation Percent Overall Inflation Food Inflation Transport Inflation 2011 January 5.4 8.6 8.4 February 6.5 9.8 13.1 March 9.2 15.1 15.9 April 12.1 19.1 20.4 May 12.9 20.1 22.2 June 14.5 22.5 22.7 July 15.5 24.0 23.6 August 16.7 23.9 24.3 September 17.3 24.4 24.8 October 18.9 26.2 26.2 November 19.7 26.2 28.0 December 18.9 25.0 25.6 2012 January 18.3 24.6 22.4 February 16.7 22.1 16.2 March 15.6 20.3 13.0 April 13.1 16.2 10.1 May 12.2 14.6 8.4 Source: KNBS. Annex 1.7: Kenya’s foreign exchange rates KSH/US$ KSH/Euro 2011 January 81.0 108.2 February 81.5 111.3 March 84.3 117.9 April 83.9 121.1 May 85.4 122.4 June 89.1 128.1 July 89.9 128.5 August 92.8 133.0 September 96.4 132.7 October 101.4 138.7 November 93.7 127.1 December 86.7 114.2 2012 January 86.3 111.4 February 83.2 110.1 March 82.9 109.6 April 83.2 109.6 May 84.4 108.0 Source: CBK. June 2012 | Edition No. 6 48 Annexes Annex 1.8: Capital markets indices Dow Jones Industrial Nairobi Stock Exchange Average Index Index 2011 January 11,823 4,527 February 12,130 4,265 March 12,221 3,873 April 12,811 4,006 May 12,442 4,078 June 11,935 3,968 July 12,143 3,733 August 11,285 3,444 September 10,913 3,292 October 11,955 3,382 November 12,046 3,401 December 12,218 3,128 2012 January 12,633 3,203 February 12,952 3,184 March 13,212 3,337 April 13,214 Source: CBK & Dow Jones Industrial Average. Annex 1.9: Interest rates Percent Lending rates Central Bank Rate 2011 January 14.03 6.00 February 13.92 5.75 March 13.92 6.00 April 13.92 6.00 May 13.92 6.25 June 13.92 6.25 July 14.14 6.25 August 14.32 7.00 September 14.8 7.00 October 15.21 11.00 November 18.51 16.50 December 20.04 18.00 2012 January 19.54 18.00 February 20.28 18.00 March 20.34 18.00 April 18.00 Source: CBK & Dow Jones Industrial Average. 49 June 2012 | Edition No. 6 Annex 1.10: Credit distribution to the private sector Ksh Billions Trade Real estate Private house- services Other activities Percent Credit Total Private Agriculture Manufacturing construction Building & communication Transport & insurance Finance & quarrying durables Consumer Business Mining & holds Growth yoy Mar-09 15.4 3.0 -0.8 -0.7 -0.9 -1.0 -0.6 5.2 3.0 -4.8 2.3 -3.5 14.1 28.6 Jun-09 20.2 -1.4 -3.1 2.2 3.4 -1.5 2.8 4.3 8.1 -1.4 4.2 12.2 -9.5 22.5 Sep-09 1.8 5.6 1.8 8.9 -2.1 4.2 -1.3 3.1 -15.9 18.4 2.2 -7.1 -16.1 10.6 Dec-09 52.4 0.4 -0.3 26.6 7.9 5.1 5.3 6.5 2.7 -12.1 6.5 -9.0 13.0 13.9 Mar-10 21.1 -1.1 4.7 -12.2 -9.9 1.9 4.3 0.9 5.8 24.6 3.2 4.2 -5.5 14.4 Jun-10 39.9 2.4 6.2 7.5 -4.8 0.6 -4.4 27.9 2.3 2.8 -4.2 8.8 -5.2 16.8 Sep-10 43.7 1.9 10.9 9.5 0.6 -6.4 -2.4 11.3 -0.2 -0.9 2.1 8.6 8.7 22.9 Dec-10 45.5 1.2 2.6 13.7 0.9 0.1 1.5 5.9 -1.5 6.5 5.4 4.2 5.2 20.3 Mar -11 66.0 2.0 4.9 4.7 3.6 3.7 -1.1 6.1 7.8 15.3 5.9 -4.8 17.8 25.7 Jun -11 90.2 5.6 11.8 12.0 3.3 11.6 2.6 13.0 3.1 13.7 1.7 2.2 9.5 30.7 Sep -11 114.9 5.6 15.2 19.6 4.9 7.7 2.6 10.5 2.4 16.4 7.3 11.1 11.6 36.3 Dec -11 116.3 5.3 14.5 19.1 5.1 8.7 3.0 13.7 2.5 16.4 7.3 8.3 12.2 30.9 Source: CBK. June 2012 | Edition No. 6 50 Annexes Annexes Annex 1.11: Oil price movements 2011 Pump Prices - Petrol (Ksh/Lt) Murban oil price ($/barrel) 2011 January 95.67 94.8 February 98.08 101.27 March 102.44 111.63 April 111.17 116.62 May 115.35 113.60 June 114.93 112.15 July 115.39 113.95 August 117.22 109.05 September 117.75 110.09 October 120.50 108.95 November 124.10 114.35 December 119.10 111.80 2012 January 112.00 114.20 February 111.30 120.45 March 111.70 127.00 Source: KNBS, World Bank. Annex 1.12: Kenya’s Fiscal position Percent of GDP 2008/09 2009/10 2010/11 2011/12 2012/13* 2013/14** Revenue and Grants 22.6 22.4 24.8 25.4 25.4 25.5 Revenues 21.8 22.3 24.1 24.0 24.2 24.4 Tax Revenues 20.4 20.6 22.0 21.6 22.0 22.3 Income tax 8.2 8.5 9.3 9.4 9.5 9.6 Value-added tax 5.7 5.8 6.2 6.8 6.0 6.1 Import duty (net) 1.7 1.7 1.7 1.7 1.7 1.6 Excise duty 3.1 3.0 2.9 2.5 2.5 2.5 Nontax Revenue 3.2 2.9 3.6 4.7 4.6 3.5 Grants 0.8 0.8 0.7 1.4 1.2 1.1 Expenditure and Net Lending 26.6 29.5 29.3 30.3 29.8 29.3 Recurrent expenditure 19.5 20.5 21.1 20.5 19.7 19.2 Interest Payments (4+5) 2.3 2.6 2.7 2.6 2.5 2.4 Wages and Benefits (civil service 6.9 7.0 7.2 7.0 6.8 6.7 Development and Net Lending 7.2 8.7 7.9 9.6 9.6 9.7 Budget Deficit (commitment basis) -4.0 -6.4 -4.5 -4.9 -4.3 -3.8 Public Debt to GDP (Net) 42.1 44.8 48.8 43.1 44.1 41.9 Source: Ministry of Finance. 51 June 2012 | Edition No. 6 Annexes Annex 1.13: Simulating the effects of crude oil price increase on the Current Account US$ Billions 2009 2010 2011 2012base 2012SC1 2012SC2 2012SC3 1. CURRENT ACCOUNT -1,671 -2,512 -4,489 (6,108) (6,108) (6,771) (7,245) 2. MERCHANDISE ACCOUNT -5,768 -7,169 -9,056 (11,004) (11,004) (11,667) (12,141) 2.1 Exports (fob) 4,528 5,225 5,726 6,348 6,348 6,348 6,348 2.2 Imports (cif) 10,296 12,395 14,782 17,352 17,352 18,016 18,490 Oil 2,192 2,673 4,081 5,023 5,023 5,686 6,160 Chemicals 1,324 1,603 1,947 2,237 2,237 2,237 2,237 Manufactured Goods 1,411 1,774 2,250 2,641 2,641 2,641 2,641 Machinery 3,065 3,808 3,686 4,090 4,090 4,090 4,090 Other 2,205 2,380 2,605 3,123 3,123 3,123 3,123 3. SERVICES 4,097 4,657 4,567 4,896 4,896 4,896 4,896 4. CAPITAL & FINANCIAL ACCOUNT 2,451 2,675 4,439 6,188 6,188 6,188 6,188 4.1 Capital Account 290 154 204 225 225 225 225 4.2 Financial Account 2,161 2,522 4,235 5,962 5,962 5,962 5,962 5. OVERALL BALANCE 781 163 -51 80 80 (584) (1,058) GDP 29,400 33,029 34,163 43,252 43,252 43,252 43,252 Oil price 79.5 106 106 106 120 130 As percent of GDP 1. CURRENT ACCOUNT -6 -7.6 -13.1 -14.1 -14.1 -15.7 -16.8 2. MERCHANDISE ACCOUNT -20 -21.7 -26.5 -25.4 -25.4 -27.0 -28.1 2.1 Exports (fob) 15 15.8 16.8 14.7 14.7 14.7 14.7 2.2 Imports (cif) 35 37.5 43.3 40.1 40.1 41.7 42.7 Oil 7 8.1 11.9 11.6 11.6 13.1 14.2 Chemicals 5 4.9 5.7 5.2 5.2 5.2 5.2 Manufactured Goods 5 5.4 6.6 6.1 6.1 6.1 6.1 Machinery 10 11.5 10.8 9.5 9.5 9.5 9.5 Other 7 7.2 7.6 7.2 7.2 7.2 7.2 3. SERVICES 14 14.1 13.4 11.3 11.3 11.3 11.3 4. CAPITAL & FINANCIAL ACCOUNT 8 8.1 13.0 14.3 14.3 14.3 14.3 4.1 Capital Account 1 0.5 0.6 0.5 0.5 0.5 0.5 4.2 Financial Account 7 7.6 12.4 13.8 13.8 13.8 13.8 5. OVERALL BALANCE 3 0.5 -0.1 0.2 0 -1 -2 Source: CBK and World Bank staff calculations. June 2012 | Edition No. 6 52 Annexes Annex 1.14: Balance of Payment (2009-2011) US$ Millions Percent change yoy 2009 2010 2011 2009 2010 2011 1. CURRENT ACCOUNT -1671 -2512 -4461 -15.3 50.3 77.6 2.1 Exports (fob) 4528 5225 5756 -10.3 15.4 10.1 Tea 892 1159 1153 -3.5 29.9 -0.5 Horticulture 692 725 678 -9.3 4.8 -6.6 Manufactured Goods 526 608 729 -15.8 15.5 20.0 Chemicals 407 434 557 -15.9 6.6 28.3 Other 811 1032 1077 -8.2 27.3 4.3 2.2 Imports (cif) 10,296 12,395 14,782 -10.4 20.4 19.3 Oil 2192 2673 4081 -28.2 21.9 52.7 Chemicals 1324 1603 1947 -8.4 21.1 21.5 Manufactured Goods 1411 1774 2250 -11.2 25.7 26.9 Machinery & Transport Equipment 3065 3808 3686 0.1 24.3 -3.2 Other 2205 2380 2621 -1.7 8.0 10.1 3. SERVICES 4097 4657 4566 -8.3 13.7 -2.0 3.1 Non-factor services 1876 2527 2344 -14.1 34.7 -7.2 3.2 Income account -38 -158 84 -16.3 316.8 -153.6 3.3 Current Transfers account of 2259 2288 2137 -3.1 1.3 -6.6 which remittances 4. CAPITAL & FINANCIAL ACCOUNT 609 642 891 -0.3 5.4 38.8 5. OVERALL BALANCE 2451 2675 4418 62.9 9.1 65.2 781 163 -43 266.5 -79.1 -126.3 As percent of GDP Overall Balance 2.5 0.5 -0.1 Current Account -5.3 -7.9 -14.1 Capital & Financial Account 7.8 8.4 14.0 Exports 14.4 16.5 18.2 Imports 32.8 39.1 46.7 Source: CBK. 53 June 2012 | Edition No. 6 Annexes Annex 1.15: Maize production 2009 and 2011 2009 2010 Percent Province Bags Bags Increase HA ‘000 (90 Kg) Yield HA ‘000 (90 Kg) Yield in Maize Millions Millions Central 123 1.2 9.4 176 1.4 8.0 21 Coast 118 1.4 12.0 137 1.96 15.5 38 Eastern 465 6.0 13.0 455 3.8 8.3 -38 NEP 2 0.001 0.5 4 0.009 2.1 812 Nairobi 0.3 0.003 12.0 0.7 0.014 19.0 349 Rift Valley 618 14.2 23.1 675 21.1 36.5 48 Western 227 4.5 20.0 233 5.1 22.0 14 Nyanza 296 5.05 17.0 327 5.1 17.3 0 Total 1,850 32.4 17.5 2,008 38.5 19.2 19 Source: Ministry of Agriculture. Annex 1.16: Price Comparison Selected Commodities Units of Average Price : Average Price : Commodity Percent Change Measure March 2011 March 2012 Potatoes (Irish) 1 Kg 57.03 59.32 5.8 Cooking Fat 1 Kg 210.76 220.50 13.8 Cooking Oil 1 litre 202.58 210.45 14.6 Kerosene 1 litre 84.92 84.99 0.1 Diesel 1 litre 95.27 105.97 11.2 Petrol 1 litre 103.32 112.44 8.8 Source: KNBS. Annex 1.17: Inflation April 2012 Breakdown of Inflation April 2012 20.0 18.0 16.0 14.0 12.0 Percent 10.0 8.0 6.0 4.0 2.0 0.0 Source: KNBS. June 2012 | Edition No. 6 54 Annexes Annex 2: Number of products covered by at least one non-tariff measure Non-tariff measure Kenya Uganda Mauritius Senegal Madagascar Sanitary and phytosanitary measures 1,277 1,487 1677 139 702 Technical barriers to trade 4,245 4,838 144 163 516 Pre and shipment formalities 2,370 4,348 22 38 4 Price control measures 126 57 138 Quantity control measures 1,272 41 699 156 564 Para tariff measures 1,845 4,874 123 333 Finance measures Anti-competitive measures 23 31 3 Trade-related investment measures Distribution restrictions 23 Restriction on post sales services Subsidies Government procurement restrictions 21 Intellectual property Rules of origin 169 Export-related measures 944 426 40 58 280 Total 12,315 16,014 2,582 765 2,540 Source: Cadot and Gourdon, World Bank 2012. Annex 3: Sectoral distribution of non-tariff measures in Kenya Kenya 100 80 60 40 20 Quantity Control 0 Price Control Inspec tion TBT SPS SPS TBT Inspec tion Price Control Quantity Control Rubber, Textile & Machine & Foods Chemical plastice Base metal footware equipment Woodpaper A: SPS 75 66 7 0 0 0 B: TBT 61 87 90 91 77 77 C: Inspection 73 42 7 1 78 74 D: Price control 4 7 0 0 0 0 E: Quantity control 0 5 0 0 78 75 Source: Cadot and Gourdon, World Bank 2012. 55 June 2012 | Edition No. 6 Annexes Annex 4: Estimated price raising effect of non-tariff measures by product, country comparison (%) Kenya Uganda Nambia South Africa (SPS) (SPS) (QR) (QR) Rice 42.10 29.90 41.16 Bread 42.10 29.90 41.16 Poultry 42.10 41.16 Fresh milk 42.10 41.16 Cheese 42.10 41.16 Spirits 42.10 29.90 41.16 Beer 42.10 29.90 41.16 Other cereals and flour 38.73 29.90 41.16 Lamb 37.46 41.16 Coffee 36.62 11.96 41.16 Sugar 36.20 29.90 41.16 Other meats and preparations 35.78 16.44 41.16 Fresh fruit 34.94 29.30 40.33 Beef and veal 34.10 41.16 Pasta products 33.68 29.90 41.16 Fresh vegetables 33.26 29.00 41.16 Frozen or preserved vegetables 33.26 28.10 41.16 Tobacco 32.83 29.90 41.16 Preserved fish and seafood 32.83 16.74 39.51 Preserved milk and milk products 32.83 36.63 Other edible oils and fats 29.47 29.30 41.16 2.57 Fresh or frozen fish and seafood 28.20 41.16 Butter and margarine 28.20 41.16 Eggs and egg-based products 25.26 41.16 Potatoes 21.05 41.16 64.35 Pork 18.10 41.16 Household textiles 20.58 Footwear 18.93 Major tools and equipment 15.64 Garments 13.17 Small electric household appliances 5.76 Small tools and miscellaneous 5.76 accessories Only significant effects (at the 5 percent level) are reported. Source: Econometric estimation using ICP price data and World Bank/UNCTAD non-tariff measure data. June 2012 | Edition No. 6 56 57 Annex 5: EAC Time-Bound Programme for Elimination of NTBs – 2008 Annexes Status in December Status in August 2011 Timeframe for 2010 (green is (green is ontrack, NTB summary elimination set in ontrack, red is Category set in No. Category in 2008 red is delayed) and, description 2008 (yellow for delayed) and, if December 2010 if applicable, new starting position) applicable, new timeframe set timeframe set June 2012 | Edition No. 6 1. Corruption along Immediate A Immediate A Immediate the Northern and Central Corridors (police roadblocks, weighbridge and border gates. 2. Non recognition Immediate A Still a problem. B Still a problem. To be by Kenya for SPS recognition SPS To be resolved within resolved certificates issued certificate issued by 3 months by Uganda for Uganda tea destined for Mombasa action. 3. Charges on plant Immediate action A 12 months C December 2012. import permit (PIP) at Malaba on Ugandan tea destined for auction at Mombasa. 4. Inadequate Police Immediate A Partner States to D Partner States to Escort mechanism. report the status report the status during the EAC during the next EAC meeting of Regional meeting of Regional Forum in August Forum 2011. 5. Ugandan ban on beef Immediate A To be considered D Uganda to report & beef products from by the next Sectoral when she will lift Kenya Council on Finance. the ban during the Trade, Industry and meeting of 5th Investment. Regional Forum slated for 1st to 3rd September 2011. 6. Uganda’s certification Immediate A Uganda to report D Uganda to report procedures on exports during the EAC during the 5th of milk from Kenya meeting of Regional meeting of Regional Forum on NTBs in Forum slated for 1st August 2011. to 3rd September 2011. Status in December Status in August 2011 Timeframe for 2010 (green is (green is ontrack, NTB summary elimination set in ontrack, red is Category set in No. Category in 2008 red is delayed) and, description 2008 (yellow for delayed) and, if December 2010 if applicable, new starting position) applicable, new timeframe set timeframe set 7. Several Police Immediate A Kenya and Tanzania D Kenya and Tanzania roadblocks along to report during to report whether Northern and Central the EAC meeting of they have reduced Corridors, estimated Regional Forum on the roadblocks during at 36 between NTBs in August 2011. the 5th meeting Mombasa-Kigali and of Regional Forum 30 between Dar Es slated for 1st to 3rd Salaam to Rusumo September 2011. border point (Ref: RPSF study 2010)) 8.. Lack of interface 1 – 6 months B Within 6 months B The interface of the within the customs’ Revenue is ongoing. systems in the Revenue Authorities in Partner States. 9.. Lack of harmonized 1-6 months B Nov-11 C April 2012. import/export documentation and procedures 10. Delays in transit 1-6 months B Aug-11 C Immediate bonds cancellation 11. Port Charges are not 1-6 month B Claimed done A September 2011. harmonized. (the in 2010, but still Port charges should outstanding in 2011 be benchmarked with international port charges) 12. Customs working On-going D On-going D On-going hours are not harmonized. 13. Inadequate quality Long-term D Long-term D Long-term of infrastructural services. June 2012 | Edition No. 6 58 Annexes 59 Annexes Status in December Status in August 2011 Timeframe for 2010 (green is (green is ontrack, NTB summary elimination set in ontrack, red is Category set in No. Category in 2008 red is delayed) and, description 2008 (yellow for delayed) and, if December 2010 if applicable, new starting position) applicable, new timeframe set timeframe set June 2012 | Edition No. 6 14. Charges by Container n/a n/a By January 2011 B Kenya to report the freight stations status during the 5th meeting of Regional Forum slated for 1st to 3rd September 2011. 15. Existence of several n/a n/a January – March 2011 B Kenya and Tanzania weighbridge stations to report September in the Central and 2011 whether they Northern Corridors have reduced weigh bridges during the meeting of 5th EAC slated for early September 2011. 16. Simplified certificates n/a n/a immediate A Not addressed in 2011 of origin are not update available at all border posts 17. Charge of Kshs 5,000 n/a n/a immediate A Not addressed in 2011 by Kenyan Plant update Health Inspectorate Services (KEPHIS) for every truck entering Kenya carrying Rwandan Tea 18. Lack of adequate n/a n/a March, 2011 B Not addressed in 2011 time by TBS to update allow companies to comply with labeling requirements even when there is no consumer risk 19. Ugandan businessmen n/a n/a Jan, 2011 B Not addressed in 2011 charged US$ 100 visa update fee at Mutukula and Bukoba Status in December Status in August 2011 Timeframe for 2010 (green is (green is ontrack, NTB summary elimination set in ontrack, red is Category set in No. Category in 2008 red is delayed) and, description 2008 (yellow for delayed) and, if December 2010 if applicable, new starting position) applicable, new timeframe set timeframe set 20. Complaints on n/a n/a March, 2011 B Not addressed in 2011 administrative delays update in maize clearance in Busia and Malaba borders 21. Requirements of all n/a n/a March, 2011 B Not addressed in 2011 export cargo to be in update container 22. Privately driven n/a n/a Jan, 2011 B Not addressed in 2011 cars of 8 and above update seating capacity are categorised as commercial vehicles irrespective of purpose of use 23. Charging of Import n/a n/a March, 2011 B Not addressed in 2011 Declaration Form (IDF) update fees of 2.5 percent by KRA for imports from Uganda Source: World Bank analysis of EAC NTB Report. June 2012 | Edition No. 6 60 Annexes Annexes Annex 6: Elimination of NTBs – 2008-2010 Category Ontrack Delayed Total A 7 8 15 B 3 5 8 C 4 4 8 D 2 0 2 Total 16 17 33 Category A NTBs (2008-2010) Category B NTBs (2008-2010) Ontrack Ontrack Delayed Delayed Category C NTBs (2008-2010) Category D NTBs (2008-2010) Ontrack Ontrack Delayed Delayed Source: World Bank analysis of EAC NTB Report. 61 June 2012 | Edition No. 6 Annexes Annex 7: Elimination of NTBs – 2010-2011 Category Ontrack Delayed Unknown Total A 5 2 2 9 B 1 4 6 11 C 0 12 0 12 D 7 0 8 15 Total 13 18 16 47 Category A NTBs (2010-2011) Category B NTBs (2010-2011) Ontrack Ontrack Delayed Delayed Unknown Unknown Category C NTBs (2010-2011) Category D NTBs (2010-2011) Ontrack Ontrack Delayed Delayed Unknown Unknown Source: World Bank analysis of EAC NTB Report. June 2012 | Edition No. 6 62 Annexes Annex 8: Case Study - Truck Drivers journey along the Northern Corridor Transport costs increase the cost of goods significantly. Transport costs are high along the Northern Corridor particularly for the land locked countries. In Kenya transport costs increase the landed cost of goods by about 12 percent, and in Uganda the cost triples to about 36 percent. The transport cost to Uganda would significantly reduce to 25 percent if the rail was used as an alternative. Transport costs increase the landed costs of imports by 12 percent in Kenya and 36 percent in Uganda Rail transport is cheaper but still high for food Rail Transport would be cheaper 40 40 36% 36% 35 35 30% Share of value of goods 30 30 % of value of goods 25% 25 25 20 20 15 15 12% 12% 10 9% 10 6% 5 5 0 0 fertilzer wheat Kenya Uganda road rail Road Rail Source: World Bank staff. Bribes are a small proportion of transport costs. Breaking down the transport costs into different components to isolate the cost of NTBs along the corridor, fuel accounts for 16 percent of the transport charges, bribes at the border posts and weighbridges are persistent but comprise a negligible component of total cost. Drivers pay the bribes from their transport allowance which might explain why they are not significant. All the same bribes are more prevalent at the borders than at the weighbridges. Bribes are a small share of the transport costs and are more prevalent at the border Operations Bribes 6% 0.3% Other, 6% Waiting time 1% Weigh Fuel bridge, 17% 17% User fees Firm 2% Border, 74% 74% Source: World Bank staff. 63 June 2012 | Edition No. 6 Walking on a Tightrope Rebalancing Kenya’s economy with a special focus on regional integration In 2012, Kenya’s economy has been on a tightrope. Policy makers have had to walk a fine line between stabilizing the economy and maintaining the growth momentum. While inflation has declined, the exchange rate stabilized, and the fiscal position improved, fundamental economic imbalances continue to make Kenya vulnerable to shocks. In the absence of economic and social turbulence, Kenya should grow at 5 percent in 2012 and 2013, which would still be substantially below its neighbors. Kenya has been benefitting from the integration and growth momentum in the East African Community (EAC), which has become one of the most vibrant economic regions in the world. However, despite impressive increases in trade between the five EAC partners in recent years, there is still a large untapped potential. EAC trade could increase by several-fold, if unnecessary restrictions in the trade of goods and services–particularly non-tariff barriers- were removed. Produced by Poverty Reduction and Economic Management Unit Africa Region Photo credits: page 1: © World Bank and page 19 courtesy of the East Africa Community. Design by Robert Waiharo