66308 December 2011 | Edi�on No. 5 Naviga�ng the storm, Delivering the promise with a special focus on Kenya’s momentous devolu�on THE WORLD BANK Navigating the storm, Delivering the promise with a special focus on Kenya’s momentous devolution TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS i FOREWORD ii ACKNOWLEDGEMENTS iii EXECUTIVE SUMMARY v THE STATE OF KENYA’S ECONOMY 1 1. Kenya’s economic performance in 2011 2 1.1 An economy under pressure 2 1.2 A economy out of balance 6 1.3 Restoring macroeconomic stability 10 1.4 Rebalancing the economy 12 2. Outlook for 2012 13 2.1 Achieving moderate growth: the World Bank’s projections 13 2.2 Risks to economic growth in 2012: Euro crisis and elections 14 SPECIAL FOCUS: KENYA’S MOMENTOUS DEVOLUTION 17 3. The Promise of devolution: power for the people and equity 19 3.1 Kenya’s long journey to constitutional transformation 19 3.2 Devolution and people’s expectations: the hope for a more balanced model of development 21 3.3 A challenging starting point: enduring inequality and a highly ambitious devolution project 21 4. Financing the promise of devolution 26 4.1 How much will counties need? 27 4.2 How much should each county get? 34 4.3 Protect the urban growth engine 39 4.4 Design an integrated financing architecture 42 5. Get accountability right from the start 45 5.1 Build strong public financial management systems 44 5.2 Promote accountability to citizens 47 6. Manage risks 49 6.1 Risks of poor spending 49 6.2 Human resource risks 50 6.3 Structure funding to improve capacity 50 7. Navigate a major public sector transition 51 ANNEXES 55 Annex 1: A new macroeconomic environment in 2011 56 Annex 1.1: Key macroeconomic indicators 56 Annex 1.2: GDP Growth rates, Kenya and Sub Saharan Africa 57 Annex 1.3: Kenya’s GDP per capita 57 Annex 1.4: Sectoral Growth rates 57 Annex 1.5: Quarterly GDP Growth rates 57 Annex 1.6: GDP growth rate of other African countries 58 Annex 1.7: Kenya’s Inflation 58 Annex 1.8: Kenya’s foreign exchange rates 59 Annex 1.9: Capital markets indices 60 Annex 1.10: Interest rates 61 Annex 1.11: Credit distribution to the private sector 62 Annex 1.12: Oil price movements 2010 62 Annex 1.13: Kenya’s Fiscal position 63 Annex 1.14: Balance of Payment (September) 64 Annex 1.15: Maize production 2009 and 2010 65 Annex 1.16: Key Macro-economic indicators low case, baseline and high case scenario 65 Annex 1.17: Shocks: Comparing 2009 with the 2012 outlook 66 Annex 1.18: Break down of overall inflation: October 2011 66 Annex 2.1: Economic Activities 67 Annex 2.2: Methodology and assumptions underpinning estimate of spending on county functions 69 Annex 2.3: Fiscal gap approach to horizontal sharing and options for Kenya 72 Annex 2.4: The impact of various thresholds on corporate management of urban areas 73 LIST OF TABLES Table 2: Macro Economic indicators 2007-2013 13 Table 3: Kenya’s growth is lower in election and post-election years 15 Table 4.1: Current funding for devolved functions likely to be delivered 30 Table 4.2: Impact of different population thresholds on the number of municipal and city boards 40 LIST OF FIGURES Figure 1: Kenya’s current account deficit has hit 10% and top exports can no longer cover oil imports vi Figure 2: A massive challenge of administrative and fiscal re-engineering vii Figure 3: Current funding for functions likely to be devolved is well in excess of 15% viii Figure 1.1: Kenya’s growth is projected at 4.3 percent in 2011, balanced across sectors but below the average for SSA 3 Figure 1.2: The first half of 2011 has seen strong growth in tourist arrivals and ICT penetration 4 Figure 1.3: Overall inflation has been driven by food and transport … hurting the poor most 5 Figure 1.4: Kenyans pay too much for maize and sugar 5 Figure 1.5: Debt has increased to 48.8 percent of GDP and interest rates rose sharply 6 Figure 1.6: How the genie came out of the bottle – Explaining the decline of the Kenya shilling 7 Figure 1.7: The current account deficit is at record levels 8 Figure 1.8: Exchange rate volatility accelerated in 2011 9 Figure 1.9: Kenya’s monetary response: First too little – then a strong catch-up 10 Figure 1.10: Real interest rates turned negative while lending to private sector remained robust 11 Figure 1.11: The Kenya Shilling strengthened against the major currencies since October 2011 11 Figure 1.12: The government is taking a tighter fiscal position 12 Figure 1.13: The depreciation in the Ksh has marginally improved Kenya’s competitiveness 12 Figure 1.14: Kenya’s openness to trade has stagnated while Asian economies have taken off 13 Figure 2.1: Starting 2012, growth should again reach 5 percent – if no shocks occur 14 Figure 2.2: Kenya has experienced slow growth in many election and post-election years 16 Figure 3.1: Economic activity is concentrated in Nairobi, Mombasa and Kenya’s South West 23 Figure 3.2: There are significant differences in access to health care between counties 24 Figure 3.3: Primary education is relatively evenly spread but not secondary education 24 Figure 3.4: Access to water and sanitation, which is highly unequal, affects health, development and livelihoods 24 Figure 3.5: Kenyans think Local Authorities have performed poorly at basic service delivery 25 Figure 4.1: Kenya’s devolution involves a major restructuring of public administration 26 Figure 4.2: Once major functions are all specified, unbundling them is the next step 28 Figure 4.3: Current funding for functions likely to be devolved is well in excess of 15% 31 Figure 4.4: The ‘room to move’ in the national budget is limited 32 Figure 4.5: Existing service levels reflect entrenched spatial inequities 33 Figure 4.6: Cutting the cake: illustrating a population-based formula 34 Figure 4.7: Own-revenue potential will vary widely across counties 35 Figure 4.8: Winners and losers of radical equalization 38 Figure 4.9: County own revenues will be derived mostly from cities… 41 Figure 4.10: …but County Assembly members will be mostly from rural areas 41 Figure 4.11: Flows of revenue from different sources for county governments 42 Figure 4.12: Three basic options for financing counties 43 Figure 5.1: Getting information flows right: top-down and bottom-up accountability 46 Figure 7.1: Projection of health staff positions likely to be devolved 53 LIST OF BOXES Box 3.1: Decentralization in Kenya: overcoming post-independence concentration of power 20 Box 3.2: The promise of devolution as seen by Kenya’s leaders 21 Box 3.3: What Kenyans hope devolved government will do for them 22 Box 4.1: Key elements of Kenya’s devolution arrangements 27 Box 4.2: How will counties be funded? 29 Box 4.3: How functions might be transferred 32 Box 4.4: Equalization as an explicit goal of the Constitution 35 Box 4.5: People versus places ... re-inventing the wheel? 36 Box 4.6: Simulating the complexity of sharing revenue across counties 37 Box 4.7: How Papua New Guinea introduced equalization gradually 39 Box 4.8: Recentralization of urban service delivery? 40 Box 4.9: Existing funding arrangements that would be conditional grants if continued 44 Box 6.1: Performance criteria under the Local Authorities Transfer Fund: A possible model 50 Box 7.1: The risks from trying too much too soon ... lessons from Uganda 54 ABBREVIATIONS AND ACRONYMS CBK Central Bank of Kenya CBR Central Bank Rate CCK Communication Commission of Kenya CDD Community-Driven Development CDF Constituency Development Fund CIC Commission on Implementation of the Constitution CRA Commission on Revenue Allocation CRR Cash Reserve Ratio GDP Gross Domestic Product EAC East African Community ERS Economic Recovery Strategy ICT Information and Communication Technology KANU Kenya African National Union KES Kenya Shillings KEU Kenya Economic Update KNBS Kenya National Bureau of Statistics KRA Kenya Revenue Authority KTB Kenya Trourism Board LASDAP Local Authority Service Delivery Action Plan LATF Local Authority Transfer Fund MIC Middle Income Country NARC National Rainbow Coalition NEER Nominal Effective Exchange Rate ODA Official Development Assistance RCA Revealed Comparative Advantage REER Real Effective Exchange Rate RMLF Road Maintenance Levy Fund SME Small & Medium Enterprise SSA Sub-Saharan Africa TFDG Task Force on Devolved Government UACA Urban Areas and Cities Act VAT Value Added Tax WB World Bank December 2011 | Edition No. 5 i FOREWORD I t is my pleasure to present the fifth Kenya Economic Update, which we launch as Kenya enters a defining year in its history. While 2011 has already been challenging, managing Kenya’s economy will become even more difficult in 2012. Kenya will need to weather the impact of the unfolding Euro crisis, conduct national elections, and continue to implement its new Constitution, including its far-reaching devolution. This is why we called this report “Navigating the storm, Delivering the promise�. In the past, Kenya has managed economic shocks well. If Kenya succeeds in overcoming its ongoing economic challenges, implementing devolution effectively, and conducting national elections peacefully, the government will be in a position to begin delivering the promise of a more prosperous future. This report has three main messages. First, Kenya has been navigating through rough economic waters in 2011. A combination of external shocks and domestic policy challenges raised inflation to around 20 percent, and widened the current account deficit to above 10 percent of GDP. As a result, growth for 2011 is estimated to be slightly below expectations, at 4.3 percent. Second, for 2012, the World Bank projects a growth rate of 5 percent if Kenya is successful in managing risks; if not, growth could drop to 3.1 percent. Third, Kenya’s momentous devolution holds the promise of more equity and prosperity, if government policies strike an appropriate balance between redistribution and growth-enhancing policies, and existing service-delivery arrangements are safeguarded in the short run. For decentralization to be successful, Kenya will need a simple and transparent fiscal transfer architecture, which can be monitored and understood by all citizens, so that they can hold their representatives accountable. The World Bank remains committed to helping Kenya to navigate through the economic storm and deliver on the promise of devolution. The Kenya Economic Updates, which the Bank is publishing every six months, have become our leading vehicle for analyzing development trends in Kenya, and thus contributing to the implementation of the World Bank’s Africa Development Strategy, which puts a special emphasis on knowledge and partnerships. With these reports, we want to support all those who want to improve the economic management of Kenya, and we are proud to have worked with many Kenyan stakeholders during the preparation of this report. In particular, we intend to help inform and stimulate debate on topical policy issues, and to make a contribution to unleashing Kenya’s growth potential. Johannes Zutt World Bank Country Director for Kenya December 2011 | Edition No. 5 ii ACKNOWLEDGEMENTS T his fifth edition of the Kenya Economic Update was prepared by a team led by Jane Kiringai and Aurélien Kruse, together with John Randa and Kathy Whimp, and supervised by Wolfgang Fengler. The core team consisted of Aaron Thegeya, Allen Denis, Betty Maina, Catherine Ngumbau, Christopher Finch, Fred Owegi, Fred Wamalwa, Geoff Handley, Ian Mills, Jonathan Rose, Lucas Ojiambo, Peter Warutere, Roger Sullivan, and Wangari Muikia. The team acknowledges contributions from Alex Mwaniki, Benjamin Muchiri, Edward Al-Hussainy, Gabriel Demombynes, Pamela Audi, Ravi Ruparel, Tabitha Mwangi, and Taye Mengistae. Robert Waiharo, Lucy Wariara Carol Wambugu and Anne Khatimba provided design, editorial and logistical support. The report benefitted from insights of several peer reviewers including Aly Khan Satchu, Jonas Frank and Ragnar Gudmundsson. The team also received guidance from Humberto Lopez and Johannes Zutt. Partnership with key Kenyan policy makers was instrumental in the production of this report. On November 8, 2011, a draft of the report was presented at the Quarterly Economic Roundtable. The meeting was chaired by Professor Njuguna Ndung’u, Governor of the Central Bank of Kenya, and attended by senior officials from the Ministry of Finance, the Central Bank of Kenya, the Kenya National Bureau of Statistics, the Kenya Institute of Public Policy and Research Analysis, the Kenya Revenue Authority, the International Monetary Fund, Ministry of Local Government, the National Executive and Social Council, the Commission on Implementation of the Constitution, and the Australian High Commission. Special appreciation goes to AusAid for supporting the World Bank’s Fiscal Decentralization Knowledge Program. December 2011 | Edition No. 5 iii Main Messages and Key Recommendations Main Messages • 2012 will be a defining year for Kenya. National elections, the establishment of a new system of devolved government, and the possibility of a deterioration in global economic conditions will make the next twelve months extremely challenging. At the same time, if Kenya manages these challenges well–peaceful elections and transition to a new government, successful introduction of a new system of devolved government and continued growth during a global financial crisis–2012 will set the foundation for a more prosperous future. • Kenya is navigating rough economic waters, which will lower growth prospects for 2011 and possibly 2012 as well. High food and fuel prices, the drought in the Horn of Africa, and the Euro crisis have weakened Kenya’s external position, which was already fragile given the large current account deficit. These economic challenges will lower growth to an estimated 4.3 percent in 2011. For 2012, the World Bank projects growth to recover slightly and reach 5.0 percent, if Kenya succeeds in managing the risks. • Kenya’s constitutionally-mandated devolution is one of the most ambitious programs of its type in the world. The bulk of decentralization reforms will be implemented in 2012 and will impact Kenya’s social stability, service delivery, and fiscal health for years to come. In responding to the economic crisis, Kenya’s policy makers will need to find the fiscal space required to deliver on the promise of devolution, while protecting public investment. Key Recommendations to respond to the economic turbulence • Remain steadfast in containing macroeconomic pressures, by reigning in inflation expectations while containing the debt-to-GDP ratio. This will require maintaining tight monetary policies and fiscal prudence to manage the economy over the short term. • Guarantee a level playing field for all market participants and avoid regressive economic policies. Price and currency controls distort economic activity and typically result in worse outcomes, namely higher prices and a weaker currency, while increasing opportunities for corruption. • Enhance export competitiveness. Kenya will succeed economically and be less vulnerable to shocks only if it balances its economy through stronger exports. It now needs to move beyond tea, tourism and horticulture, where it is already performing strongly. Kenya is well positioned to make new products (such as textiles, chemicals and automotive parts) and enter new markets (such as Asia) if it continues to improve its infrastructure and investment climate. Increased domestic energy production, especially geo-thermal, would play a critical role, as it will also reduce dependence on expensive fossil-based thermal energy. Key Recommendations to manage Kenya’s decentralization successfully • Ensure a fair distribution of national resources commensurate with county needs and capacity and balancing national interests. This will involve clarifying the responsibilities of county governments and the process for transfering of functions will be phased over time. • Devise a simple and transparent transfer architecture that promotes spatial redistribution without compromising growth and efficiency objectives. While tackling geographic inequities is a central promise of devolution, this will need to happen over time, so as not to jeopardize future growth and existing service delivery. The objective should be to equalize opportunities for all Kenyans, while recognizing that economic growth will be concentrated in certain areas. • Build capacity in Kenya’s counties, particularly the weaker ones. Paradoxically, those counties that stand to benefit the most from devolution in theory (the more remote, least developed counties) could lose out in practice, if their capacity to manage devolved funds effectively and transparently is not sufficiently developed. • Get accountability right from the start. Accountability should focus on both funds and performance, and systems should emphasize both central monitoring and reporting, but also maximize the involvement of citizens so they can hold their representatives accountable. • Ensure transition does not interrupt service delivery. Effective coordination of the transition at both national and county levels will be crucial. Urban services will be particularly vulnerable since the existing institutions in charge of urban services will be abolished. This will require a clear and inclusive decision on who is in charge of coordination and agreement on a high-level strategy for implementation. EXECUTIVE SUMMARY K enya is entering a decisive year. Three main developments will make 2012 extraordinary. First, Kenya will hold national elections for the first time since the traumatic post-election violence of 2007-08, which ended Kenya’s high growth momentum abruptly. Second, Kenya’s economy will need to navigate through a severe economic storm, which could well become a hurricane, especially if Europe enters into a recession. Third, the country will implement its most ambitious governance reforms ever, namely the devolution of responsibility to forty-seven new counties. Kenya’s policy makers will need to display tremendous skill and steadfast leadership in order to balance the need for fiscal prudence, with ensuring that resource flows to new local governments are sufficient to meet their needs. High expectations of the promise of devolution need to be met by equally high quality planning and execution of its delivery. Flying on one engine through the to the National Cereal and Produce Board’s policy economic storm of maintaining high maize producer prices, and its inefficient marketing systems. As a result, overall K enya will enter 2012 from a weaker-than- expected economic position. Kenya’s economy is navigating rough economic waters, where existing inflation is expected to reach an estimated average of 13 percent for the whole year–with Kenya’s poor bearing the brunt of the cost. The Central Bank’s structural weaknesses have been compounded by recent move to increase the benchmark policy rate short-term shocks. The most visible sign of Kenya’s from 7 to 16.5 percent has calmed the markets, economic challenge is the depreciating Shilling, which reached an all time low against the US improved prospects for 2012, and proven that Dollar in October 2011. The elements behind this decisive action could shape expectations. situation are high international food and fuel prices, the drought compounded by conflict in the Horn of Despite challenges, Kenya is still projected to grow Africa, the Euro crisis, widening fiscal and current at 4.3 percent in 2011. This is lower than in 2010 account deficits, and major inefficiencies in Kenya’s (5.6 percent) but substantially higher than during agriculture sector. The recent developments are also the recent crisis of 2008-09, and also above Kenya’s undermining one of Kenya’s main strengths over the long-term average performance (3.7 percent). The last decade: the credibility and predictability of its services sector remains buoyant and tourism is also macroeconomic policies. expected to have a record year, in spite of the recent security concerns. Agriculture was also performing Kenya has been caught in a vicious inflationary better than expected in the first half of 2011, after a cycle. Higher import prices–initially for food and good year in 2010. The short rains are promising a fuel–have sparked inflation, which in turn weakened strong harvest for end 2011 and early 2012. the Shilling and put further pressure on prices. Because of the sharp depreciation of the Shilling, In the absence of further shocks, inflation will slow import prices continued to rise even after global down in the first half of 2012. Global food and fuel food and fuel prices had started to retreat. Like in prices have already been declining, and there is a many other African countries, inflation increased possibility that global commodity prices will fall substantially as global food and fuel prices rose further, if Europe’s economic situation deteriorates sharply in the first half of 2011. But in Kenya, food further. Kenya’s good harvest prospects should prices have been well above high global prices due lower the demand for food imports. Finally, the December 2011 | Edition No. 5 v Central Bank’s tighter monetary policies will slow Kenya’s economic imbalance is driven by a credit supply and start to reduce core inflation. combination of weak exports and high dependence on oil imports. Its export performance is poor due But exchange rate and inflation woes are just the to a number of factors, including inefficiencies tip of the iceberg: underneath the surface is a deep at the port of Mombasa, and an inadequate and structural problem. Kenya’s economy is increasingly expensive supply of energy. This makes Kenya too imbalanced, with a expensive for international investors, especially growing gap between in manufacturing, despite low labor costs than in exports and imports. emerging Asia. Kenya is globally competitive in This makes the economy a number of sectors–especially tea, tourism and particularly vulnerable to horticulture–but it has not ventured sufficiently into external shocks. In 2011, The current new products, especially light manufacturing, where imports soared (mainly account deficit opportunities could materialize as Asia’s emerging due to higher oil and now stands at economies start to graduate from these sectors. food costs), while exports above 10 percent At the same time, oil currently accounts for over a remained stagnant. The third of the import bill, which reinforces the need of GDP, which is for accelerating non-fossil based domestic energy gap between imports and exports of goods and even higher than generation. The scaling-up of Kenya’s geothermal services, known as the in Greece energy production provides an unmatched current account deficit, opportunity to create reliable clean energy and at now stands at above 10 the same time reduce the import bill. percent of GDP, which is even higher than in Greece. Today, Kenya’s four main exports do not even earn If macroeconomic stability is restored, Kenya can enough to pay for its oil imports, not to mention reach 5 percent growth in 2012. This is a slight other imports beyond oil (see figure 1)! For too downgrade from the World Bank’s last projection long Kenya’s economy has been like an airplane of 5.3 percent, reflecting domestic economic flying on one engine: its strong domestic demand challenges and a weaker global environment. and a vibrant service sector keep it up in the air, but Kenya’s economic vitality will depend crucially to get to its destination, the second engine (exports) on the restoration of macroeconomic stability, will have to pick up. prospects for stabilization in Somalia, and a smooth Figure 1: Kenya’s current account deficit has hit 10% and top exports can no longer cover oil imports 4.0 May Oil 5.0 3.5 Capital & �nancial 4.0 Account 3.0 3.0 Top 4 exports US$ Billions 2.5 2.0 Overall Balance 2.0 US$ Billions 1.0 1.5 0.0 1.0 Apr* Jan Jan Jan Jan Jan Jan Jan Oct Oct Oct Oct Oct Oct Apr Apr Apr Apr Apr Apr Jul Jul Jul Jul Jul Jul Jul -1.0 -2.0 0.5 2005 2006 2007 2008 2009 2010 2011 -3.0 0.0 -4.0 Current Account Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sept -5.0 2009 2010 2011 Source: World Bank computations based on CBK data December 2011 | Edition No. 5 vi run up to the next elections, followed by a peaceful an entirely new level of government. In one go, transition of power from one administration to the Kenya’s eight provinces and over 280 districts will next. Services will continue to drive growth in this be replaced by forty-seven brand new counties. In election year as the country gets into campaign many countries, devolution is a process of giving mode. Investment growth will be moderate, as political autonomy to administrative units that are players will hold off on major decisions until a new already in place. By contrast, in Kenya, devolution government is in place. will entail creating new political and administrative units at once. However, there are substantial risks going forward, Figure 2: A massive challenge of administrative and fiscal especially if the economic crisis in the Euro zone re-engineering deepens and if the national elections usher a period of economic uncertainty. If one or both risks fully 8 Provincial Administra�ons materialize, growth could be as low as 3.1 percent. The ongoing crisis in Europe will have a negative impact on some of Kenya’s main exports which are Massive transferof func�ons still dependent on European markets (horticulture 47 New Coun�es and �nance of the central government and tourism). On the domestic scene, election years in the past have been problematic for Kenya’s growth as investors have held back, waiting to see the outcome and whether there would be a peaceful 280+ Districts transition. Over the last 30 years, election years 175 Local Authori�es Administra�ons have been associated with a one percentage point lower growth rate than the long-term average. If Source: World Bank government does not take pro-active steps to set the For many Kenyans, devolution carries the promise stage for a peaceful run-up to voting and a smooth of a more equitable model of development. The transition thereafter, this unfortunate pattern could prevailing feeling is that investments and services be repeated in 2012. have been spread unequally across the country, often following political and tribal affiliations, thus Delivering the promise of devolution fuelling resentment. To a large extent, this is in fact E conomic turbulence has hit Kenya at the very correct: not only is economic activity concentrated moment when it is preparing for the most spatially (which is not inherently problematic), far-reaching institutional reforms in its history. but access to services (which determines future In the long run, successful implementation of opportunities), also remains highly unequal. The the Constitution is likely to be the single most hope is that devolution will address these historical critical factor in determining Kenya’s development and spatial inequities, by shifting significant prospects. The establishment of a new leadership resources and responsibilities to semi-autonomous team in the justice sectors has created great hopes and locally accountable county governments. But for lasting change. The next wave of reform, of there are important challenges to be managed along even greater scale and importance, is the transfer the way, if the theoretical promise of devolution is of functions and finance to forty-seven entirely new to be made a reality. county governments. In a tight fiscal environment, matching resources Kenya’s devolution program is one of the most to needs will be extremely challenging. In order ambitious in the world, because it is transferring to avoid major resource allocation mismatches, a substantial amount of power and resources to which could leave either the county or the national December 2011 | Edition No. 5 vii governments strapped for cash, a detailed process could well be the biggest losers in practice. of function assignment will have to be worked-out. The capacity of the new county governments to In turn, this process should guide the division of manage funds efficiently and transparently, and revenues between the two levels of government. to retain skilled staff to deliver devolved services Moreover, equitably sharing the county share will vary tremendously. Regions of the country of national revenue across the forty-seven new which have been historically left out are precisely counties will be immensely challenging as the fiscal the ones for which capacity constraints are likely space is simply not there to expand public spending. to be most binding, with the potential for weak Any attempt to drastically rebalance expenditures financial management, major disruptions in service spatially, would undermine existing service delivery delivery, and unmet expectations. Therefore, the and compromise future growth. success of devolution will depend critically on capacity building and preparation at the local level. The Constitution mandates that a minimum of 15 The national government will also have a crucial percent of national revenue is to be transferred supporting role to play, in setting and monitoring unconditionally to counties, but this would not minimum standards of financial management and be enough to finance the full set of devolved service delivery. functions. Therefore, determining how many of these functions will effectively be devolved and Establishing strong systems and institutions when, and designing the transfer architecture for accountability of county governments will around this, will constitute the main challenge and determine whether devolution is successful. potentially determine whether additional fiscal Devolution requires renewed emphasis on stress is created or whether service delivery is likely enhancing accountability of local government to to decline in the short run. Preliminary estimates citizens. In many countries, accountability failures suggest that current spending on functions that have undermined devolution, leading to more could be devolved is well in excess of the minimum corruption and weaker public services. With Kenya’s 15 percent. (See figure 3) pioneering “Open Data� initiative and a world- class ICT sector, the tools are there to be used to A central paradox of Kenya’s devolution is that ensure that there is accountability between county counties which stand to gain the most in theory governments and citizens. Figure 3: Current funding for functions likely to be devolved is well in excess of 15% Source: World Bank December 2011 | Edition No. 5 viii The State of Kenya’s Economy Ksh/US$ 110 105 100 Exchange rate 95 90 85 80 75 January 2010 September 2011 0 -500 -1000 -1500 -2000 -2500 -3000 Current account de�cit -3500 -4000 US$ Millions K enya’s economy has been navigating through an economic storm in 2011. Economic growth is still robust, although below potential and initial expectations. At an estimated 4.3 percent, Kenya’s growth rate will fall short of its 2010 performance, when the economy rebounded strongly at 5.6 percent but will be higher than Kenya’s long-term average rate of 3.7 percent. The ongoing economic crisis underscores Kenya’s structural challenges, especially weak exports, which are the primary cause of Kenya’s recent macroeconomic instability, and contributor to the sharp decline in the Kenyan shilling. For 2012, the Word Bank projects a 5.0 percent growth rate, if the government is able to effectively manage the current crisis, maintain political stability in the run-up to the elections, and address the security challenges arising from the conflict with Somalia. 1. Kenya’s economic performance for Kenya’s cash crops, mainly horticulture, coffee in 2011 and tea. 1.1 An Economy under Pressure • Industrial sector growth remains driven by construction while manufacturing is lagging. The D espite a number of economic challenges, Kenya will still experience a satisfactory growth rate of 4.3 percent in 2011. This will be higher than construction sub-sector recorded an impressive 8.1 percent growth in the first half compared to a 2.2 percent growth in the same period Kenya’s long-term growth rate of 3.7 percent but still in 2010. Manufacturing grew at a modest 3.2 a full percentage point below the average projected percent, compared to 5.5 percent in the same for Sub-Sahara Africa. In the first half of 2011, the period last year. The drought impacted hydro Kenyan economy grew by 4.5 percent, driven by power generation and the resulting high cost a strong performance in the financial sector (8.2 of energy has adversely affected the industrial percent), construction (8.1 percent), as well as hotels sector. The share of hydro power in Kenya’s and restaurants (6.4 percent). Moderate growth was energy supply declined from 57 percent in July recorded in the agricultural and industrial sectors. 2010, to 43 percent in July 2011. This in turn Overall growth for 2011 is expected to be balanced increased dependence on back-up thermal power across all key sectors, with the services sector generation, which uses expensive imported fuel as maintaining its position as the growth engine over its feedstock. Industries that depend on imported the last decade (see figure 1.1 and table 1): raw materials, saw their production costs increase • Agriculture has performed average despite the significantly due to high import costs (oil and moderate drought. Agriculture production grew steel), along with the depreciation of the shilling. by 3.5 percent in the second first half of the year The costs of imported machinery and equipment as rains normalized, especially in Kenya’s “bread also increased substantially. The combined effect basket�, the Rift Valley, and production held of these factors has negatively impacted the up again. The drought mostly affected Kenya’s competitiveness of industry, resulting in a sluggish livestock production in Northern and Eastern performance in 2011. regions. It is estimated that the drought shaved off • The services sector is holding up, fueled 0.2 percentage points from GDP growth, mainly as by continued growth in ICT and a strong a result of livestock mortality. Beyond these arid performance in tourism. Services grew by 4.3 regions, low rainfall and high temperatures affected percent in the first half of 2011, mainly driven tea production. In addition, the crises in North by financial intermediation (8.2 percent); hotels Africa and Europe adversely affected the demand and restaurants (6.4 percent), and transport and December 2011 | Edition No. 5 2 The State of Kenya’s Economy Figure 1.1: Kenya’s growth is projected at 4.3 percent in 2011, balanced across sectors but below the average for SSA Sectoral growth rates Half year growth rates 8.0 7.0 6.0 6.0 5.0 4.0 4.0 Percent Percent 2.0 3.0 2.0 0.0 2009 2010 2011 1.0 -2.0 0.0 H1 H2 H1 H2 H1 H2 -4.0 Agriculture Industry Services 2009 2010 2011 GDP Growth of selected countries SSA 2011 10 9 8 7 6 Percent 5 4 3 2 1 0 South Africa Kenya SSA average Rwanda Uganda Tanzania Ethiopia Source: World Bank computations based on KNBS data communication (5.2 percent). Tourist arrivals Since June 2010, subscriptions increased by more increased by 13.6 percent in the first half of than 25 percent. In the same period, internet users 2011, compared to 2010 levels. Despite Europe’s increased by 60 percent, climbing to 12.5 Million. economic slowdown, 46 percent of arrivals were This indicates that the data revolution is now also in still from Europe, 25 percent from the rest of Africa, full swing. A key factor in the growth of internet usage 12 percent from the Americas, and 10 percent from is the new affordable tools, including smart phones Asia. However, the emerging security concerns and social networking applications with both internet stemming from Kenya’s incursion in Somalia will and mobile interface that are proving increasingly dampen tourist arrivals for the remainder of the popular, especially among the urban youth. The year, though the high season is over. sector has also generated additional innovations, including M-banking, linking mobile money with The ICT revolution is reaching new milestones and personal bank accounts, M-credit, and M-insurance, is stimulating growth in other services. The mobile which are expanding the reach of financial services phone revolution has continued, with subscriptions to previously unbanked segments of the population peaking at 25.3 Million at the end of June 2011, (see figure 1.2). which is more than the number of adults in Kenya. December 2011 | Edition No. 5 3 The State of Kenya’s Economy Figure 1.2: The first half of 2011 has seen strong growth in tourist arrivals and ICT penetration ICT Penetra�on 350 Tourist arrivals at JKIA by origin Jan - Jun 30.0 300 25.0 Number of per sons in millions Number of visitors ‘000 250 20.0 200 15.0 150 10.0 5.0 100 0.0 50 1999 2001 2003 2005 2007 2009 2011 0 Africa Asia Europe Others Popula�on >15yrs Mobile subscrip�ons Mobile money customers Internet subscrip�ons 2010 2011 Source: World Bank based on CBK and KTB livestock. The drought only marginally affected However, Kenya’s economy Kenya’s agricultural production, but severely has come under pressure affected communities owning livestock, who live in 2011. Four mutually Food inflation in drought-afflicted areas. Below normal rainfalls reinforcing shocks have remains the driver resulted in higher power costs as hydropower curtailed Kenya’s high of overall inflation production declined, adversely affecting the growth momentum: and the situation competitiveness of the industrial sector. • Higher global fuel prices, is particularly • The Euro crisis, which created uncertainty in the which were triggered severe for maize global markets and increased currency volatility. by the crisis in the Europe is the main market for Kenya’s horticulture, Arab world. In the first and sugar, where and the third destination for Kenya’s tea. The nine months of 2011, Kenya’s policies economic slowdown in Europe, along with the international crude oil have contributed crisis in the Arab world, a significant destination prices increased by 37.4 to rising prices for Kenya’s tea, negatively impacted the growth of percent¹. This resulted in a Kenya’s key exports. 42.2% increase in Kenya’s oil import bill. Oil now represents 26% of Kenya’s imports. Escalating food and fuel prices, in turn, drove up • Higher food prices, notably maize, of which Kenya inflation, which increased by 18.9 percent from the imports substantial quantities. Kenya’s food beginning of 2011, through to the third quarter. This deficit had to be met through highly priced imports is the highest rate of inflation Kenya has seen since of maize, with global prices increasing from a 9 the introduction of a new methodology for measuring -month average of US$ 167 per metric ton in 2010 inflation in 2009. Transport inflation has doubled – to US$ 299 in 2011. Moreover, Kenyans ended up from 13 to 26 percent in the first ten months of the paying up to US$ 530 per metric ton of maize, due year. Likewise food inflation has more than doubled to additional policy distortions that disrupted the from 10 to 26 percent, between January and October domestic food market. 2011 (see figure 1.3). Second round effects are now emerging as core inflation, which excludes food and • Drought in the Horn of Africa, which led to a energy prices, increased from 1.4 to just over 10 massive influx of refugees and significant loss of percent in the same period. Food inflation remains ¹Crude oil price increased from an average of US$ 79.7 per barrel in 2010 to US$ 109.4 in the first 9 months of 2011. December 2011 | Edition No. 5 4 The State of Kenya’s Economy the driver of overall inflation, and the situation is maize, a number of well connected businessmen particularly severe for maize and sugar, where Kenya’s benefit from disproportionately high prices, which policies have actually contributed to rising prices: they manipulate through their control of import licenses, to the detriment of Kenyan public. • Maize. Kenyans paid a record US$ 45 per bag of maize in July 2011 which was more than double High inflation tends to hurt the poor the price at the beginning of the year and about disproportionately. This is especially so when 70 percent above the already high world market inflation is driven by high food and fuel prices, as the prices (see figure 1.4). poor spend a significant proportion of their income precisely on food and transport. A breakdown of • Sugar. Kenya’s record high inflation in the second Kenya’s inflation by urban income groups shows half of 2011, is strongly influenced by rising sugar that low income households have been hit hardest prices. Today, Kenyans pay about twice as much for by inflation in 2011. For instance, in October 2011, sugar as Europeans, even though the drought did the inflation experienced by low income households not affect sugar-producing areas. As in the case of was 19.6 percent, compared to the previous year, by Figure 1.3: Overall inflation has been driven by food and transport … hurting the poor most Food Transport Core Overall 30.0% 30.0% M onthly Infkation yoy % change M onthly Inflation yoy % change 25.0% 25.0% 20.0% 20.0% Nairobi Lower 15.0% Nairobi Upper 15.0% 10.0% 10.0% Nairobi Middle 5.0% 5.0% 0.0% 0.0% Mar Mar Oct Oct Apr Nov Jun May Jun Ap r Aug Jan May Aug Jul Dec Jul Feb Sep Feb Sep Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct 2010 2011 2010 2011 Source: World Bank computations based on KNBS data Figure 1.4: Kenyans pay too much for maize and sugar 0.60 Duty Suspension Duty Suspension Kenya EU US World 0.50 Drought 180 S u ga r P r i c e s U S Ce n t s / K G 160 Poli�cal Crisis 140 0.40 M aize Prices US$ / KG Drought 120 100 0.30 80 60 0.20 40 20 0.10 0 Kenya Global O ct O ct O ct Aug Dec Aug Dec Aug Apr Apr Apr Feb Feb Feb Ju n Ju n Ju n 0.00 May May May May May Jan Mar Jan Mar Mar Jan Jan Mar Jan Mar Jul Jul Jul Nov Nov Jul Nov Jul Sep Nov Sep Sep Sep Sep 2009 2010 2011 2007 2008 2009 2010 2011 Source: World Bank computations based on KNBS data December 2011 | Edition No. 5 5 The State of Kenya’s Economy contrast to 14.5 percent for high income households triggered the depreciation of the Kenyan shilling to (see figure 1.3). an all time low (see figure 1.6). At the same time, Kenya’s current account deficit reached a record These shocks hit the economy at a time when fiscal high: between December 2010 and September 2011, policy buffers had been depleted and monetary it grew by almost 4 percentage points, from 6.7 to policy was still expansionary. The fiscal stimulus of 10.5 percent of GDP. In the first three quarters of 2009 and 2010 was largely financed through domestic 2011, imports expanded by 22.7 percent, compared borrowing, which increased public debt as a share of to 15.0 percent for exports, increasing the current GDP, by three percentage points (up to 48.8 percent account deficit by US$ 1.9 Billion. By May 2011, against a policy target of 45 (see figure 1.5). earnings from Kenya’s top exports (tea, horticulture, and manufactured goods), along with international The Central Bank was still pursuing a broadly travel, were not sufficient to pay for oil imports alone accommodative monetary policy in response to (See figure 1 in the executive summary). the 2009 economic crisis when the 2011 shocks hit. Domestic interest rates both in the short and long end of the market were at historic lows until they The prevailing expansionary policies accentuated started to rise in the second half of 2011 (see figure internal and external macroeconomic imbalances. 1.5). Furthermore, the Central Bank had run down Growth in credit to private sector, reflecting robust foreign exchange reserves during the 2009 crisis, domestic demand, put pressure on domestic prices. so that foreign exchange reserves were below the By September 2011, private sector credit had grown statutory 4 months of import cover at the beginning by 36 percent since the beginning of the year. Rising of 2011. aggregate demand could not be met by domestic production, and spilled into high demand for 1.2. An economy out of balance imports. Export growth proved to be lackluster as Kenya’s main European and Middle Eastern markets K enya’s economy has been out of balance for a long time but in 2011 a number of external shocks exposed Kenya’s unsustainable external experienced their own economic pressures. Finally, increasing international prices for fuel and food created inflationary pressures domestically while also position. The rapid rise of oil prices in the first half increasing the cost of the import bill. The resulting of 2011, and the Euro crisis in the second half of the imbalances were reflected in a widening current year, as well as the drought in the Horn of Africa, account deficit, and a depreciating shilling. Figure 1.5: Debt has increased to 48.8 percent of GDP and interest rates rose sharply 50 Projec�ons in March and October 18.0 Interbank 91-Tbill CBR 49 16.0 48 14.0 Policy target of 45% Public Debt as % of GDP 47 12.0 Fiscal posi�on 46 Mar2011 10.0 Per cent 45 8.0 44 Fiscal posi�on Oct2011 6.0 43 4.0 42 2.0 41 0.0 40 J an J an J an J an J an Sep Sep Sep Sep Sep May May May May May 2008/09 2009/10 2010/11* 2011/12** 2012/13** 2013/14** 2007 2008 2009 2010 2011 Source: World Bank computations based on MOF & CBK data December 2011 | Edition No. 5 6 Figure 1.6: How the genie came out of the bottle – Explaining the decline of the Kenya shilling Source: World Bank December 2011 | Edition No. 5 7 The State of Kenya’s Economy The State of Kenya’s Economy Short term flows help to finance the current account following a strong performance in 2010. The deficit, but constitute a source of volatility. The moderate growth of horticulture exports (2-2.5 deficit in the current account is largely financed via percent for the first three quarters of 2011) broadly short term financial flows, which consist of money reflects Europe’s economic growth, while tea exports invested in the equity and money markets, often were also affected by disruptions in North African referred to as footloose capital. These inflows can markets. Exports of coffee grew by 9.2 percent as at quickly reverse into net outflows (see figure 1.7). Yet September 2011, despite a decline in production as Kenya’s imports consist mainly of oil, capital machinery and intermediate inputs, which are all essential for a result of a 128.7 percent increase in coffee prices growth, and are difficult to scale back. Although since 2010. Tea exports contracted by 1.8 percent Kenya’s balance of payments has previously been in in the same period, despite a 25.3 percent increase surplus (the tip of the iceberg), it remains vulnerable in prices. The political crisis in Egypt and marked to external shocks and outflows of footloose capital. decrease in demand from Pakistan, the major destinations for Kenyan tea, resulted in a slowdown The global downturn, particularly in Kenya’s export in exports, while drought conditions contributed to markets, has curtailed the growth in exports, below normal levels of production (see figure 1.7). Figure 1.7: The current account deficit is at record levels putting pressure on the overall balance of payment 5.0 6.0 Capital & Overall Balance 4.0 Financial Account 4.0 3.0 2.0 2.0 0.0 Oct Oct Oct Ap r Jul Oct Oct Oct Sep Jan Jan Apr Jul Ap r Jul Apr Jul Ap r Jul Apr Jan Jan Jul Jan Ap r Jan Jan Jul 1.0 Overall Balance -2.0 0.0 -4.0 2005 2006 2007 2008 2009 2010 2011 Oct Oct Oct Oct Oct Oct Apr Jul Apr Jul Apr Jul Apr Jul Apr Jul Apr Jul Apr Jul Jan Jan Jan Jan Jan Jan Jan Sep -1.0 -6.0 -2.0 -8.0 Current Account 2005 2006 2007 2008 2009 2010 2011 -3.0 -10.0 Current Account -4.0 -12.0 -5.0 -14.0 4 Financing of Balance of Payments 4.5 4.0 25.0 4 Import growth 3.5 3 20.0 Goods & services yoy % growth M onths of I mpor t cover 3.0 3 15.0 US$ Billions 2.5 2 short 2.0 10.0 term Export 2 flows growth 1.5 5.0 1 1.0 0.0 1 0.5 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep 0 0.0 -5.0 2008 2009 2010 2011 June 2011 Sept 2010 2011 Capital Account Investment Assets and Liabili�es -10.0 Short Term flows Net Errors and Omissions Gross Reserves Source: World Bank computations based on CBK data December 2011 | Edition No. 5 8 The State of Kenya’s Economy Remittances increased significantly in 2011, but the 2011. In the last twelve months, the shilling lost growth in service exports was disappointing. The approximately a quarter of its value against the growth of services exports was flat in 2011, which US dollar, the UK sterling pound and the Euro. The is in contrast to the 23.4 percent increase registered shilling depreciated from KSHS 81 to the US dollar in 2010. This is explained by current transfers which in January 2011, to a high of Kshs 104 in September declined by 3.0 percent from US$ 2.3 billion in 2011, before settling back to under Kshs 100 to 2010, to US$ 2.2 billion in 2011, mainly as a result the US dollar in November 2011. There are two of declining public current transfers (money sent to main underlying reasons for these developments: NGOs and civil society organizations declined from investors’ uncertainty with the Kenyan economy in US$ 0.2 billion in 2010, to US$ 0.06 billion in 2011).² the year ahead, and negative terms of trade shock Remittances grew by 33.2 percent increasing from US$ 0.6 Billion in 2010, to US$ 0.8 Billion in 2011. which resulted in a deterioration of the trade balance. In turn, uncertainty induced depreciation may have The Kenya shilling exchange rate had to yield to the further contributed to a higher trade deficit over the pressure on the external account, and experienced short run, while the trade deficit may have further a significant depreciation in the third quarter of increased investors uncertainty (see figure 1.8). Figure 1.8. Exchange rate volatility accelerated in 2011 180 4.00 160 3.50 STG POUND Election Violence 3.00 Global Domestic Crisis 140 Financial Crisis 2.50 120 EURO 2.00 K SH 100 1.50 US DOLLAR 1.00 80 0.50 60 0.00 40 135 US dollar STG Euro 110.0 130 Nor malised r ates October 1st 2010 = 100 In the last 12 months to September 125 30, 2011. The Kenya shilling has lost 105.0 120 23% againts the US Dollar, 25 % the UK sterlling and the 26% the Euro 100.0 115 110 95.0 105 90.0 100 95 85.0 90 US DOLLAR STG POUND EURO Source: World Bank computations based on CBK data ²Current transfers are those transactions in which an economy provides real and financial resources that are immediately or shortly consumed by other economies without receiving equivalent values in return. Examples are workers’ remittances sent or received by residents to or from non- residents, and donations or gifts given or received by the government to or from other government or non-residents. December 2011 | Edition No. 5 9 The State of Kenya’s Economy The initial adjustments made by the Central Bank Credit to the private sector crowded out lending of Kenya in the policy rate were not sufficient to to government, impacting budget implementation. contain inflation. When inflation started to rise at the Interest rate on government paper (91 day T-Bills) end of 2010, the initial policy stance was appropriate turned negative in January 2011 and the subscription as inflation was still below the Central Bank’s five to government paper (both T bills and bond auctions) percent target. But when that target was exceeded declined. In the first quarter of FY 2011/12 only at the end of the first quarter of 2011, the Central 44 percent of government bonds were subscribed Bank could have considered raising the Central Bank compared to 121 percent in a similar period in FY Rate (CBR). Negative real lending rates in the first 2010/11. Consequently, domestic borrowing was 0.4 three quarters of 2011 and robust growth in credit to percent of GDP against a target of 1.5 percent. This the private sector, indicate that CBR increases did not forced the government to trim down expenditures achieve the intended objective. Real lending rates and net lending to 5.9 percent of GDP, compared turned negative in June 2011, and credit to private to the initial plan of 7.3 percent. Development and sector remained robust, growing at 36 percent in recurrent expenditures were scaled back by 0.7 and the year to September 2011.The market also began 0.6 percentage points of GDP, compared to initial reacting to inflationary concerns in April 2011, as targets. reflected in the steep rise in interbank and 91-day T-Bill rates, but the CBR remained unchanged. CBK 1.3. Restoring macroeconomic stability S finally raised the CBR dramatically in October 2011, ince October 2011, CBK has taken decisive action in an effort to contain spiraling inflation. In figure to restore macroeconomic stability. The CBK’s 1.9, a simulated CBR, adjusted for domestic capacity Monetary Policy Committee raised the CBR by 400 utilization, shows a hypothetical path, if the CBR had basis points in October 2011, and by a further 550 been adjusted periodically as inflation picked up, basis points in November 2011. These recent hikes compared with the actual CBR.� in interest rates along with additional measures Figure 1.9. Kenya’s monetary response: First too little – then a strong catch-up announced by Ministry of Finance, have begun to stabilize the exchange rate and curtail the flight from No�onal CBR which 20.0 reflects Infla�onary the shilling(see figure 1.10).� 18.0 Presure and domes�c capacity 16.0 Actual CBR u�lisa�on Adjustments to the CBR have resulted in substantially movements did not 14.0 reflect upside risk to higher short term interest rates. Domestic interest 12.0 infla�on rates both in the short and long maturity instruments Per cent 10.0 have risen sharply, while capital markets activities 8.0 have diminished. The recent tightening of monetary 6.0 policy through significant increases in the CBR, and 4.0 open market operations to reduce liquidity led to an 2.0 Overall Infla�on increase in short term rates. By October, 2011, the 0.0 repo, interbank and the 91 Day Treasury bills rates Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct had increased by 16, 14 and 12 percent respectively, 2010 2011 as growth in money supply declined.� Source: World Bank computations based on CBK data �Note (i) The simulated CBR is a hypothetical CBR which is adjusted to take into account domestic Inflationary Pressure and domestic capacity utilization (ii) It can be calculated as simulated where CBR is the Central Bank Rate, π is the inflation rate that excludes food and energy prices, r is the equilibrium interest rate (assumed to be 2 percent), y is the log of quarterly GDP and y* is the log of trend quarterly GDP. We assume that when formulating monetary policy, the CBK put equal weight in fighting inflation deviation from target and GDP growth from target. �The Shilling has reversed its path appreciating from 107 in October to 93 in November. �Money supply growth (M1, M2 and M3) has been declining significantly since February 2011. The growth in M3 has declined from 20.8 percent in February to 16.7 in August while M2 and M1 have declined from 21.4 and 27.6 percent respectively to 15.0 and 20.7 percent in August 2011. December 2011 | Edition No. 5 10 The State of Kenya’s Economy Figure 1.10: Real interest rates turned negative while lending to private sector remained robust 60.0 15.0 Public Real Deposit Real Lending Real 91-Tbill 50.0 credit 10.0 40.0 P e r ce n t gr o w t h 5.0 30.0 Private 0.0 Credit 20.0 Per cent Nov Nov Nov Nov Jul Sep Jul Jul May Sep May Sep Jul Jul Sep Sep Mar Ma r May Ma r Mar May Ma r May Jan Jan Jan Jan Jan -5.0 10.0 2007 2008 2009 2010 2011 -10.0 0.0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 -15.0 -10.0 2007 2008 2009 2010 2011 -20.0 -20.0 Source: World Bank computations based on CBK data Figure 1.11 The Kenya Shilling strengthened against the major currencies since October 2011 US dollar STG Euro 110 Normalised rates October 3rd 2011=100 105 100 95 90 85 Source: World Bank computations based on CBK data Long term interest rates have remained relatively 20-25 percent, while deposit rates have increased to steady but increased steeply in November, in 10 percent. The interest rate spread (lending minus response to the tighter monetary policy stance. deposit rates) remains steady at around 10 percent. However, the transmission mechanism, between short term and long term rates in the market, is The additional credit from the International still weak. Tighter monetary policy has led to sharp Monetary Fund (IMF) will rebuild foreign exchange increases in interbank and 91 day Treasury bill rates, reserves and support the Kenya Shilling. The but long term rates have not responded in a similar government has approached the IMF for additional fashion. However, after the CBR increased to 16.5 financing through the Exogenous Shock Facility. If the percent in November, lending rates have increased to credit is approved it will provide an additional US$ December 2011 | Edition No. 5 11 The State of Kenya’s Economy 250 Million to the existing US$ 500 Million facility. 1.4 Rebalancing the economy T Front loading disbursements in FY 2011/12 will help he current shocks have revealed Kenya’s rebuild foreign exchange reserves and stabilize the declining international competitiveness as a shilling. major structural weakness in the economy. While the recent policy measures will constrain demand Recent shocks have provided fresh impetus to fiscal and restore exchange rate stability in the short consolidation. Fiscal consolidation started in FY term, problems will remain in the long run if supply 2011/12. Initially the Government planned to reduce side weaknesses in Kenya’s exports are not tackled debt to GDP ratio from 48.8 percent in FY 2010/11 to urgently. 46.7 percent by 2013/14. However, the recent shocks and the need to reduce domestic demand have called The weakening of the shilling has translated into only for a more aggressive consolidation, which would marginal benefits for exporters. A look at the trade reduce debt by an additional 2 percentage points, to weighted nominal effective exchange rate (NEER), 44.6 percent by 2013/14. The consolidation is to be which is a measure of how the shilling performs achieved through spending cuts in the medium term, against the currencies of Kenya’s trading partners, to improve the primary deficit from -2.7 percent to indicates that the shilling had lost 20 percent of its -2.2 percent of GDP and by a further 0.1 percentage value against them from January 2011 to September point in FY 2012/13 (see figure 1.12). 2011. However, export competiveness measured by the real effective exchange rate (REER) improved by If the envisaged consolidation takes place, it will about 7 percent (see figure 1.13). There are three rebuild fiscal policy buffers back to pre crisis levels. possible explanations for this: (i) the benefits of a However, fiscal consolidation will be more difficult in weaker exchange rate are being eroded to some light of emerging pressures. The implementation of extent by high domestic inflation (the real exchange the new Constitution and the elections in FY 2012/ rate has depreciated much less than the nominal 13 will build additional spending pressures (see the exchange rate); (ii) Kenya’s export products have outlook for FY 2012-13 and special focus of this a high import content (for instance chemicals and report). fertilizer), and the benefits of a weaker currency are Figure 1.12: The government is taking a tighter fiscal Figure 1.13: The depreciation in the Ksh has marginally position improved Kenya’s competitiveness 0 2011/12 2012/13 2013/14 130 NEER & REER Normalised January -0.5 125 Since January 2011: NEER NEER has depreciated by 19% Primary Deficit as % of GDP 120 REER has depreciated by 8% -1 115 REER 2009 =100 110 -1.5 105 100 -2 95 90 -2.5 May May May Jan Mar Jan Mar Jan Mar Nov Nov Jul Jul Jul Sep Sep Sep -3 Fiscal projection March 2011 Fiscal projection October 2011 2009 2010 2011 Source: World Bank computations based on MOF Source: World Bank computations based on CBK data December 2011 | Edition No. 5 12 The State of Kenya’s Economy significantly offset when the currency depreciates; external vulnerability: (i) Kenya’s openness to trade and, (iii) the depreciation seen since January 2011 is has improved only marginally in the last decade being driven mainly by fundamentals, and reinforced compared to comparator countries (see figure 1.14); by speculative activity. (ii) the gap between potential and actual exports to current markets has widened; and, (iii) export The current shocks have increased Kenya’s diversification has progressed slowly and the export vulnerability and highlighted structural problems basket remains concentrated. In addition, the state of in the economy that require long-term solutions. infrastructure, particularly energy, rail, and the port In the second economic update of June 2010, it of Mombasa undermine export competitiveness. was argued that the ‘Kenyan economy is running on These challenges need to be addressed and resolved one engine’, that economic growth is largely driven for Kenya to increase its export competitiveness. by domestic demand, and export growth is fragile. The extent of Kenya’s economic fragility is reflected 2. Outlook for 2012 in the recent volatility of the shilling. Kenya’s trade performance is below its potential. Three structural 2.1. Achieving moderate growth: the World Bank’s weaknesses in Kenya’s export performance were projections T identified, that have contributed to the current he World Bank projects a growth rate of 5.0 Figure 1.14: Kenya’s openness to trade has stagnated while percent in 2012, increasing to 5.5 percent in 2013. Asian economies have taken off Ongoing public investment in roads and energy will Kenya Cambodia Thailand Vietnam drive growth, while private investment is anticipated 90 to grow moderately for two main reasons: first the 80 tighter monetary policy stance adopted in the last 68.3 Exports as % of GDP 70 quarter of 2011 is expected to continue in 2012; and 60 second, investors are likely to remain cautious until a 50 38.0 new government is elected and peacefully installed. 40 30 25.2 Private consumption will increase from 2011 levels 20 once inflation is contained, and the harvest from the 10 current short rains produces an increase in the food 0 supply. But fiscal consolidation will constrain growth 1993 1995 1997 1999 2001 2003 2005 2007 2009 in public consumption, as discussed in the previous Source: WDI section (see table 2). Table 2: Macro Economic indicators 2007-2013 Variable 2007 2008 2009 2010 2011* 2012** 2013** GDP 7.0 1.6 2.6 5.6 4.3 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 Source: World Bank December 2011 | Edition No. 5 13 The State of Kenya’s Economy The pressure on the external account will ease challenges facing the Government (see section 2.2 as the current account deficit narrows. Tighter below). Figure 2.1 shows the various economic monetary policies and the depreciated currency growth scenarios for 2012 and 2013. will act as a brake on aggregate domestic demand. Figure 2.1: Starting 2012, growth should again reach Also, the drop in international oil prices from an 5 percent – if no shocks occur average of US$ 105 per barrel to a forecast price of US$ 97 per barrel in 2012, will reduce the costs 8.0 Low High Baseline of oil imports. Imports of intermediate goods 7.0 used for production such as capital equipment and 6.0 5.5 6.0 machinery, will decrease as private investment slows 5.0 5.5 4.3 down. Production of tea and coffee should increase 5.0 Percent 4.0 4.5 following good rains in late 2011. With improving 3.0 3.1 conditions in Middle Eastern markets, exports of 2.0 these crops will most likely increase. The flower 1.0 industry is looking at markets in Asia, which could 0.0 become competitive as these economies continue to 2007 2008 2009 2010 2011 2012 2013 grow. A similar situation applies to tourism and the Kenya Tourist Board has in fact begun an aggressive Source: World Bank campaign to attract tourists from Central Europe and Asia. Kenya is already seeing the dividends from this strategy, as tourist from China increased by 50 2.2 Risks to economic growth in 2012: Euro crisis percent between 2010 and 2011. Another bright spot and elections O for Kenya’s exports are the ECA countries, whose n the external front, the most challenging economies are growing rapidly. Finally, strong growth development would be full blown recession in EAC countries should translate into higher regional in the Euro zone�. Europe remains Kenya’s main exports of manufactured goods. This combined with market for horticultural exports and tourism. Any a depreciated shilling should allow Kenya to expand crisis in the euro area would affect the demand for its exports of manufactures within the region. these products, and further weaken Kenya’s foreign exchange position. The current slow-down in Europe Growth could even approach 5.5 percent in 2012, if has led to anemic growth in Kenya’s horticultural a number of favorable factors materialize. Kenya’s exports, and this sector would be hit hard by a Euro economic and political situation would need to crisis, unless the industry is able to diversify its stabilize, and world markets would need to grow markets. more rapidly, than what is currently forecasted. With moderate inflation, an improved current Internal challenges in 2012 constitute another set account, and a small decline in interest rates, private of risks to economic growth. There are two major investment would pick up. However, a smooth run up challenges which the government will need to to the elections will be essential for this scenario to address with great skill, in order to avoid economic materialize. disruption: But growth could fall to around 3.1 percent if the • Successfully managing the economic transition from environment worsened instead of improving. a high inflation environment with a deteriorating This scenario could develop if a number of adverse fiscal position, to a moderately growing economy developments materialize, either from external with restored macroeconomic fundamentals; shocks or from any of the numerous domestic and, �Annex Table A1.17 (Economic Shocks: Comparing 2009 vs. 2012 Outlook) compares the situation Kenya faced in 2009 at the time of the last global downturn with the situation it is likely to face in 2012. December 2011 | Edition No. 5 14 The State of Kenya’s Economy • Successfully managing the fiscal pressure associated management of post-election dynamics is equally with the run-up to the 2012 elections, and the challenging. Over the last six elections, three were current military incursion in Somalia. followed by low-growth, especially in 2008, when the post-election violence put an abrupt end to the Growth will suffer if Kenya is not be able to reduce achievements of previous years (see figure 2.2). inflation or restore its fiscal balance. Inflation should moderate in coming months as higher interest rates Elections have impacted activity via a number of curb consumption and investment. Furthermore, channels. Most election years have had several expected reductions in the international price for oil, common factors. They were characterized by negative and increased domestic production of food should growth in investment and household consumption, reduce the pressure on prices. Finally, the government which typically decline in periods of uncertainty. is committed to restoring the fiscal balance, and has Elections in Kenya are prone to uncertainty because already demonstrated this by reducing borrowing they have often resulted in violence and new policy and spending in 2011. It remains to be seen if the regimes. government can hold the line on spending in 2012. In particular, it may need to intervene to keep growth Looking forward into 2012, the economic on track if the private sector holds back significantly circumstances are more challenging than in 2007. because of the political uncertainty. The government will need to control public spending in light of inflation pressures and public debt burden. The second major risk is the uncertainty associated Although the government has committed to reducing with the run-up to the 2012 elections� and the expenditures, it will face spending pressures related political transition to a new government. In the to the devolution process, and to organizing and past, Kenya’s growth performance has suffered financing the 2012 elections. during election years (both before and after the election). Over the past three decades, Kenya has The 2012 elections will not only usher in a new had its lowest growth periods - on average about one national government, but also a new system of percentage point below the long-term average - in or devolved government. Businesses and investors will just following election years (see table 3). need to adjust to new institutional arrangements at Table 3: Kenya’s growth is lower in election and the local level, that are yet to be fully developed, and post-election years to the possibility that a new government may come Average Growth rate in with new policies. The result is likely to be a wait- All years 1980-2010 3.4 and-see attitude from the private sector. But there Election years 2.4 is also an upside dividend if the election is handled Post election years 2.7 well. The election period presents an opportunity for Non election years 3.9 Source: World Bank based on KNBS the government to restore public confidence in the legitimacy and power of institutions, and its ability to Kenya has experienced low growth in two thirds of ensure justice, equity, and an enabling environment the election years over the last thirty years. In these for development. The new government will need cases, pre-election violence and political uncertainty to manage these expectations, and the outgoing deterred domestic and international investors. The government will have to ensure a peaceful, flawless year 2007 was an exception, when Kenya benefited transition. Presently, there is every indication that the from stable macroeconomic policies and the current government is aware of these challenges, and Economic Recovery Strategy (ERS), and achieved its is proceeding with a program to keep the economy highest growth rate (7 percent) in recent history. The and the country on an even keel. �One of the uncertainties surrounding the 2012 elections is the ongoing investigations by the International Criminal Court (ICC) on the violence that followed the 2007 elections. The ICC is investigating six politically influential Kenyans (including several potential candidates for the Presidency in 2012) and will decide in January 2012 whether to confirm charges against these individuals for a full trial. It is unclear what impact the ICC decision will have on the run-up to the 2012 elections, but a decision to go for full trial could result in some domestic political turmoil. December 2011 | Edition No. 5 15 Figure 2.2: Kenya has experienced slow growth in many election and post-election years December 2011 | Edition No. 5 16 The State of Kenya’s Economy Source: World Bank Special Focus: Kenya’s The State of Kenya’s Economy Momentous Devolution T he turbulence in Kenya’s economy coincides with implementing the constitutional blueprint for a new political and administrative architecture; arguably the most momentous and far-reaching reforms in Kenya’s post independence history. At the heart of this transformation is the devolution of power to county governments and the design of arrangements that will turn the constitutional vision into a reality. Kenyans bring to this process a tremendous enthusiasm and energy, but the devil lies in the detail. The design of fiscal, accountability, public service and transition arrangements will determine whether Kenya can weather the economic storm in a way that enhances social equity, service delivery, citizen engagement, and so deliver on Kenyans’ expectations of constitutional transformation. Devolution is a central promise of Kenya’s new profoundly shaped by how effectively the transition Constitution. But the ambition and magnitude of process is managed, covered in section seven. the administrative and political changes, and the formidable expectations about what it will deliver, If too much is expected of devolution, outcomes mean that making it work will pose substantial will inevitably disappoint some. In order to manage challenges. The hope is that Kenya will become a expectations, it is useful to focus on what devolution more equal and economically balanced country, can and cannot realistically achieve. In particular, but making that hope a reality will take time, four popular myths that strongly influence common particularly given the current economic uncertainty. understandings of how devolution works need to be The downside risks—of service delivery failure and dispelled: political backlash—are very realif devolution is not Myth #1: With devolution, central coordination skilfully managed and seen to deliver tangible results. is no longer needed. Some Kenyans express the Successful implementation will require careful sentiment that the central government should largely coordination and planning, clear communication, as stay out of devolution and leave it to the counties to well as visionary and committed leadership. manage their own affairs. The paradox is that, in fact, devolution requires sustained central coordination to This Special Focus reviews the promise of devolution be effective. and the steps needed to deliver on it. Section three briefly covers the history of devolution in Kenya, Myth #2: Devolution will result in additional because history and context are key to understanding resources and services at the local level. There is a the passion that Kenyans have invested in the perception that the new counties will receive major devolution process. Then, by analysing gaps in new funding, and enjoy wide latitude to spend funds access to services and growth variations across differently. Indeed, devolution involves shifting Kenya’s counties, the importance of equity is stressed responsibilities and resources to the sub-national level, but the starting point is the existing levels of as a central promise of devolution. In section four, public spending. Counties will receive significant consideration of the main steps and challenges in public funding but also the responsibility for funding designing fiscal arrangements that can deliver on the existing services: if they decide to shift resources promise are discussed. Fiscal arrangements are core to new uses, they will need to make cuts in other to the design, but so are mechanisms for ensuring services that are currently provided. good accountability by county governments to their citizens, covered in section five. Section six looks at Myth #3: Devolution will immediately address ways of managing the risks when funds are not well entrenched inequity across and within counties. spent. Finally, the outcomes of devolution will be Some counties will start at a relative disadvantage December 2011 | Edition No. 5 18 Special Focus – Kenya’s Momentous Devolution and it will take time to build up their capacity history (see box 3.1), which will also fundamentally and ability to use resources well. The paradox is shape the way it is implemented. that counties that stand to benefit the most from devolution in theory, because they were neglected The new Constitution marks the end of a highly under the old constitution, will be the least equipped centralized state and attempts to resolve the critical in practice to make efficient and transparent use of issues of state power versus citizens’ rights and their resources, and retain the skilled staff that are control over the development process. Previous essential to making services work. This means that endeavors had failed. A powerful centralized state dramatic redistribution will not occur overnight: it was ushered into place at independence, influencing will need to be phased in gradually. key decisions including the formation of the judiciary and the parliament. The Kenya African National Myth #4: Devolution will automatically result Union (KANU) finally lost power in the December in increased accountability. Countries around 2002 general election, to a united National Rainbow the world implementing decentralization reforms Coalition (NARC), which promised a new constitution have repeatedly found themselves struggling with soon after it was installed in power. In 2003, NARC increased corruption, elite capture, and deterioration established the Constitution of Kenya Review in service delivery. Kenya’s own experience with Commission, which embarked on an all-inclusive decentralized service delivery has repeatedly process to overhaul the Constitution. The first draft highlighted the challenges when transparency and was tested, but defeated, during a 2005 referendum, accountability systems are weak. Building a culture leading to a political crisis that continued to the of accountability into the fabric of the new devolved December 2007 general election in which the results county governments, will require early and sustained of the presidential vote were disputed. effort. The new Constitution establishes a powerful 3. The promise of devolution: power framework for democratic reforms, devolution for the people and equity of state power, land reforms, gender equality and human rights. Progress to date on implementing 3.1 Kenya’s long journey to constitutional constitutional reforms has seen the appointment transformation of independent office holders, including the Chief K enya’s new Constitution marks a critical turning point for the nation. On August 27th 2010, Kenyans witnessed President Mwai Kibaki sign the Justice, Attorney General, Auditor-General and Budget Controller, and three important constitutional bodies, the Commission on Implementation of the new Constitution into law. This historic event was Constitution (CIC), the Commission on Revenue one of Kenya’s greatest moments. In response to the Allocation (CRA), and the Independent Electrol and people’s expectations of greater democracy, human Boundaries Commision. rights and accountability of the government to its citizens, the Constitution ushered in a new republic Devolution of political and economic power to the with expanded, transparent political and economic new counties will take effect after the next elections. structures, including devolution to forty-seven The new county governments feature full separation counties. The new system builds on over sixty years’ of powers between the Governor and County experience with local government, a brief flirtation Assembly members, and a non-elected executive with federalism at independence, and a decade of appointed by the Governor with the approval of failed attempts at constitutional reform. The design the Assembly. They will enjoy a guaranteed share of the system of devolved government must be of national revenues, comprehensive law-making understood against the backdrop of this complicated powers, a limited range of exclusive taxing powers, December 2011 | Edition No. 5 19 Special Focus – Kenya’s Momentous Devolution Box 3.1: Decentralization in Kenya: overcoming post-independence concentration of power Embryonic decentralization under the colonial state (1950s). Like in many other African countries, Kenya’s system of local government was established during colonial rule. The colonial government had two separate systems; one for settlers and another for indigenous Kenyans. The system was restructured in the 1950s with the creation of African District Councils and a system of County Councils in white settler areas. These authorities had a majority of elected councilors, power to employ staff, formal legal status, and a system for collecting their own revenues (mainly the graduated personal tax). They also benefited from limited intergovernmental transfers. This two-tiered system was combined under the 1963 Local Government Act, which gave the new councils significant responsibilities and revenue-raising powers. Aborted devolution post-Independence (1960s). The 1963 Constitution provided for a system of devolution now popularly referred to in Kenya as ‘majimbo’. It established regions with elected assemblies and executive authority over roughly a third of government functions including health, education, agriculture, part of the police forces and local government. However, the newly independent government sought to weaken devolution in three ways: by exercising much closer control over regional civil servants than the Constitution envisaged, by delaying implementation of provisions allowing regions to assume full responsibility for their own finances, and by delaying the transfer of functions to the regions. The system was abolished in 1964 and replaced by provincial and district administrations. While local authorities continued to exist, their powers were assigned administratively rather than under constitutional authority. Centralization of political and economic power (1960s - 1980s). Over the following two decades, the powers of local governments were gradually eroded. Although Sessional Paper 12 of 1967 included proposals to strengthen local government, the government reversed course with the Transfer of Functions Act in 1969, transferring many of local governments’ functions back to the center along with their main sources of local revenue, leaving local governments considerably weaker than before. Following constitutional amendments in 1982 that concentrated power in the central government and president still further, the District Focus for Rural Development Program was introduced, as a means of involving local people in development and sharing resources more equitably. Ultimately, the program became a vehicle for presidential political patronage, undermined the role of local governments, and resulted in little meaningful redistribution of economic development. Piecemeal decentralization (1999-2010). This decade saw the introduction of devolved (geographically earmarked) funds in an attempt to address spatial inequality. The most notable were the Local Authority Transfer Fund, (LATF)-created through the LATF Act No 8 of 1998, the Road Maintenance Levy Fund, (RMLF)created through the Kenya Roads Act, 2007, the Rural Electrification Fund, created through the Energy Act of 2006 and the Constituency Development Fund, created through the CDF Act of 2003. Despite these piecemeal efforts to address inequality in resource distribution, political tensions remained high spilling over into the 2007 election crises and subsequent unrest, which proved to be the tipping point leading to demands for a new Constitution. Source: World Bank, adapted from Cherry Gertzel, ‘The Politics of Independent Kenya’, 1970 and Paul Smoke, ‘Local Government Finance in Developing Countries, the Case of Kenya.’ 1994 and control over their own public servants. These of county government, intergovernmental relations, dimensions of devolution offer the potential for real public financial management, and the transition and meaningful control by local citizens over service process. These bills are, or soon will be, before the delivery and local economic development. CIC. As of December 2011, Kenya is halfway through the This report covers important policy issues that are preparatory phase of the devolution process. The rapidly evolving. Within the next six months, Kenya first constitutional deadlines were met in August will enact the remaining bills into law and make some 2011, with the enactment of the Urban Areas and crucial decisions about how the transition process Cities Act, and a law on national guarantees for should proceed. By early 2013, the first county county borrowing. A further seven bills are currently governments will have been elected. By that time, pending, covering the framework for administration many of the questions raised in the following pages December 2011 | Edition No. 5 20 Special Focus – Kenya’s Momentous Devolution will have been decided, one way or another, and 3.3 A challenging starting point: enduring new issues will be emerging. Indeed, devolution is a inequality and a highly ambitious devolution constantly evolving process with no fixed end point. project T Although the constitutional referendum in many wo factors suggest the need for realism about senses marked the end of a journey, in another sense, how soon devolution can deliver on people’s Kenya is at the beginning of a new and hopeful road, high expectations. First, Kenya is starting from a which offers the opportunity to turn the constitutional base of enduring inequalities in service delivery promise of devolution into a reality. – inequalities that may even be exacerbated in the initial transition phase of devolution. Second, 3.2 Devolution and people’s expectations: the hope Kenya’s devolution is among the most ambitious in for a more balanced model of development the world, in terms of its scope and proposed speed. T he 2010 Constitution ushered in a sense of national renewal. After four decades in which power was perceived to have been removed from the Resolving these inequalities will take time, and a learning by doing approach to devolution, especially given that county administrations will be new and people and concentrated in the hands of a small elite, inexperienced when they start out. Paradoxically, a the new Constitution provided renewed optimism more gradual transition is more likely to result in the that power and resources would be shared more full delivery of the promise of devolution embedded equitably. The Constitution is predicated on five basic in the Constitution. principles; (i) equity and inclusiveness; (ii) equity of A history of spatial inequalities opportunities; (iii) delinking politics and policy; (iv) better access to national resources; and, (v) bringing Spatial inequalities help to explain the passion government closer to the people.¹ These aspirations Kenyans display for constitutional issues and resonate with the views of the top leadership of the the hopes that they have pinned to devolution. country, as well as of ordinary Kenyans (see boxes 3.2 Economic development has been concentrated along and 3.3). a narrow corridor between Mombasa and Kisumu, Box 3.2: The promise of devolution as seen by Kenya’s leaders “The new institutions that will come with the national and county governments need the support of all Kenyans. More importantly, let us use the opportunities being offered by the county governments to develop all corners of the country. The devolved governments must be adequately anchored in readiness to make their contribution to the attainment of Vision Twenty-Thirty.� President Mwai Kibaki (Speech on August 27, 2010 - Presidential Press Service) “By devolving power and resources to the 47 new counties, we shall be investing in local solutions for local problems, and facilitating local ownership of improvements to infrastructure, such as roads, irrigation, schools and hospitals.� Prime Minister Raila Odinga (Speech to Strathmore University August 24, 2010 - Prime Minister Press Service) ¹Final Report of the Task Force on Devolved Government (2011) December 2011 | Edition No. 5 21 Special Focus – Kenya’s Momentous Devolution Box 3.3: What Kenyans hope devolved government will do for them Alice Vutage – Housekeeper in Nairobi. Born in Western Kenya 32 years ago, Alice Vutage migrated to Nairobi in 2000 in search of employment. With little education and determination to support her family back home, she found a job as house-help. Alice is not conversant with the new Constitution. All she knows is that it will improve the livelihood of Kenyans, a fact gathered from her daily interaction with friends and relatives. “People say that the new Constitution will bring a lot of development in the country, and this makes me happy, because I would like to see people in my village leading a better life,� she said. Alice who is a single mother of a two year old daughter, hopes that the new Constitution will help to create job opportunities in her rural area, so that people can engage in economic activities, and become less dependent on financial support from relatives who work in big cities. “I am really eager to see how life will improve for my daughter and I when the new Constitution is implemented,� she said, with a hint of apprehension in her voice. Yvonne Chigiri – 21 year old student from Kilifi. Yvonne is currently pursuing a diploma in human resource management. “What I like most about the new Constitution is the way it addresses women’s issues, compared to the old Constitution,� she said. Yvonne believes that the new Constitution will eliminate inequality in the job market, which in turn will improve welfare outcomes of many households. In addition, she believes that the shift of public service delivery through counties will be a more Kenyans hope the new devolved government effective way of addressing people’s problems. system will… This is because the selected governors will have 1. Improve livelihoods for all; 2. Bring development, infrastructure and jobs direct contact with the people they represent to remote parts of the country; and hence, be in a better position to address 3. Create new opportunities for future their problems more effectively. Although Yvonne prefers to work in generations; Nairobi once she completes her studies, she is hopeful for the youth in 4. Promote more gender equality; rural parts of the country, because urban areas will soon develop in the 5. Ensure more effective service delivery at the new counties and create job opportunities there. “Even though people local level. will still be living in the rural hinterlands of the counties, the new urban areas will soon have the necessary infrastructure for job creation for many youth who are currently jobless,� she said. Source: World Bank leaving wide swathes of the country behind in terms Annex 2.1 contains a detailed methodology for of economic activity and employment. Moreover, the estimating counties levels of economic activity. wealth created by Kenyans has not been adequately redeployed through public service delivery, to Kenya’s experience with spatially unbalanced promote equal opportunities for all. growth is by no means unique. Heavy spatial concentration of economic activity is the norm in most Economic activity has been and remains developed and developing countries. Initial natural concentrated in specific geographic areas. Nairobi endowments (like fertile soils) and location factors and Mombasa, the leading urban centers, account (like proximity to ports) are reinforced by migration for the bulk of Kenya’s total production (see figure of people to areas where they can make a living more 3.1). Eighty percent of Kenya’s economic activity is easily―a process known as agglomeration. Firms generated by only one half of Kenya’s counties (23 tend to cluster where there are other businesses out of 47). Outside of the two biggest urban centres, that supply inputs or buy their products or services. activity is highly concentrated in a few leading areas. These agglomeration and clustering effects explain December 2011 | Edition No. 5 22 Special Focus – Kenya’s Momentous Devolution Figure 3.1: Economic activity is concentrated in Nairobi, Mombasa and Kenya’s South West Source: World Bank to a large extent why some regions have developed services neatly captures opportunities because it faster than others and remain more dynamic; why plays a large role in determining individuals’ welfare cities, as opposed to rural areas will increasingly be over the course of their lives. In this section, coverage driving growth, and why only a few among them have rates for these services are presented. In the graphs the potential to become major industrial and service below, counties have been ranked from left to right in hubs. In China, three coastal provinces accounted for terms of access (from lowest to highest) and colour- over 50 percent of the country’s GDP in 2005.² coded to tag Kenya’s nine most sparsely populated counties, so as to check for correlation between Make growth more inclusive access to services and population density (used as a proxy for remoteness). Although economic activity will be spatially concentrated, development can be inclusive if Inequality of opportunity is pervasive in Kenya, the state redistributes national income through investments and services. In other words, while all indicating partial failure of the Kenyan state over areas may not have the potential to become centers the years to redistribute the national income of economic development, all Kenyans should be through services. The index of access to health entitled to the same level of basic services and services (measuring the share of newborns delivered to equal opportunities, in order to lead a healthy at a health facility) displays the highest levels of productive life. How well has Kenya delivered on this inequality between counties. For example, while front until now? over 8 in 10 children are delivered at a health facility in Kirinyaga, just 1 in 20 have that chance in Wajir, One measure of this is the extent to which Kenyans which is located in the arid northern part of Kenya. have equal access to education, health care, and This is closely mirrored by the index for access to adequate water and sanitation. Access to these safe water. While over the years, primary education ² Source: World Bank World Development Report 2009 December 2011 | Edition No. 5 23 10 20 30 40 50 60 70 80 90 100 0 0 10 20 30 40 50 60 70 80 90 10 20 30 40 50 60 70 80 90 0 100 Kitui Nandi Wajir Mandera Mandera Narok Turkana Turkana Lamu Kajiado Kili� Tharaka Nithi Garissa Marsabit West Pokot Tana River West Pokot Bomet Marsabit Makueni Garissa Wajir Laikipia Mandera Mombasa Narok Baringo Laikipia Bungoma Samburu Isiolo Kwale Turkana Kwale Isiolo Laikipia Samburu Tana River Homa Bay Nairobi Vihiga Kenya’s nine most sparsely populated counties Kenya’s nine most sparsely populated counties Kenya’s nine most sparsely populated counties Isiolo Lamu Samburu Tana River Nyandarua Uasin Gishu West Pokot Garissa Wajir Kirinyaga Trans Nzoia Embu Meru Lamu Migori Taita Taveta Nandi Elgeyo/Marakwet Narok Kitui Kericho Kiambu Machakos Muranga Nyeri Baringo Makueni Embu Kakamega Nyeri Machakos Migori Taita Taveta Vihiga Busia Nyandarua Nakuru Taita Taveta Nyamira Busia Tharaka Nithi Kili� Siaya Kajiado Meru Muranga Elgeyo/Marakwet Kakamega Kakamega Bomet Marsabit Kisumu Kisumu Vihiga Kericho Homa Bay Kili� Kericho Siaya Migori Siaya Machakos Makueni Nakuru Households with an adequate source of water Children below 5 years delivered in a health centre Kirinyaga Kitui Muranga Bungoma Nyamira Embu Trans Nzoia Homa Bay Kisii Children between 15 - 18 years currently attending school Nakuru Uasin Gishu Nyamira Kajiado Kisii Mombasa Kiambu Tharaka Nithi Nyandarua Kisumu Elgeyo/Marakwet Kiambu Uasin Gishu Baringo Meru Source: World Bank computations based on Kenya Integrated Household Budget Survey, 2005/06 Source: World Bank computations based on Kenya Integrated Household Budget Survey, 2005/06 Source: World Bank computations based on Kenya Integrated Household Budget Survey, 2005/06 Kisii Bungoma Nairobi Busia Nandi Nyeri Mombasa Bomet Kirinyaga Kwale Trans Nzoia Nairobi Figure 3.2: There are significant differences in access to health care between counties Figure 3.3: Primary education is relatively evenly spread but not secondary education December 2011 | Edition No. 5 Figure 3.4: Access to water and sanitation, which is highly unequal, affects health, development and livelihoods 24 Special Focus – Kenya’s Momentous Devolution Special Focus – Kenya’s Momentous Devolution outcome gaps have narrowed (thanks to the free Figure 3.5: Kenyans think Local Authorities have primary education policy) there are still significant performed poorly at basic service delivery differences at the secondary level. Ci�zen's views of service delivery by local authori�es (%). 80 Variations in access to services mirror, to a large 70 extent, historical patterns of marginalization. Kenya’s 60 North-Eastern areas—which are the least developed 50 economically—have failed to receive the level of 40 central government attention and support required 30 to equalize access to services (arguably the cost of delivering services there, and the needs will also 20 have been significantly higher). For instance, while 10 malnutrition is relatively low in Mombasa, where 84 0 percent of children are of adequate height for their Very/ Fairly Badly Very/ Fairly Well Local Roads Market Places Refuse Removal age, in Wajir county only 21 percent of children are Source: Afrobarometer Kenya Survey, 2008. (difference from 100% total on of adequate height for their age, implying very high account of ‘don’t know’ answers) levels of chronic malnutrition. Overall, there is close will depend critically on the design of devolved correspondence between low population density government—much of which remains to be and low social outcomes and as figure 3.1 shows, determined—as well as on the management of economic activity as well. Therefore, the only way the massive transition from the current to the new that these inequities can be addressed is through government structure. Flawed design, poor planning, redistribution and the design of adequate fiscal weak coordination and fragmented leadership, could arrangements. compromise the ability of county governments to operate effectively and affect the incentives of Is devolution the solution? leaders to respond to their citizens’ demands for key Some counties will require particular assistance to services. A rushed transition might set counties up to catch-up, but devolution alone is no guarantee that fail, by giving them responsibilities before they have this will happen. While devolution is explicitly seen the capacity to carry them out. If the practical and by many as a direct response to historical patterns of detailed steps involved in Kenya’s radical reforms neglect, it is by no means certain that it can radically are not thought through, the immediate risk is a alter these imbalances by itself. In fact, it could breakdown in service delivery. The greater long-term even result in entrenching disparities, if the right risk is of a political backlash if the Kenyan people feel policies are not implemented. Except for education, that their hopes and aspirations for devolution have most public services will be delivered by county been deceived. governments. A recent survey of the performance of Kenya’s local authorities recorded very high rates of What needs to happen if devolution is to help redress dissatisfaction with the services that local authorities Kenya’s entrenched inequalities of opportunity? are delivering (see figure 3.5). There are many Whether the devolution process can deliver on the explanations about why local governments have promise of the Constitution will depend on design failed, but results to date demonstrate that it will be and implementation: (i) giving counties adequate quite challenging to get devolution right, and there resources to carry out their assigned functions; (ii) will be many opportunities to get it wrong. ensuring that accountability systems give them the right incentives to use resources effectively; (iii) Is devolution the “magic bullet� that will allow Kenya adequately addressing risks that resources—both to turn the page on marginalization and inequitable financial and human—will be badly managed; and, distribution of wealth and opportunities? This (iv) making sure there is orderly coordination and December 2011 | Edition No. 5 25 Special Focus – Kenya’s Momentous Devolution management of the transition from the current autonomy over resources—or else the potential centralised system to the newly devolved one. In the benefits of decentralization will be lost. It will not following chapters, challenges of successful design be possible to strike an appropriate balance between and implementation across these four dimensions these competing considerations overnight; it will take will be considered. time, and devolution should be seen as a constantly evolving process, rather than a short-term journey 4. Financing the promise of devolution towards a fixed end point. M ore equitable distribution of resources lies at the heart of the constitutional objectives of devolution. Achieving this goal is more complicated Kenya’s devolution is also particularly ambitious by global standards. Not only does it involve the creation than it might seem at first. It involves both dividing of forty-seven new elected governments, but the resources vertically (between national and county administrations that support them will be forged out governments), and sharing them horizontally of around 280 existing de-concentrated and district between the counties. Equity needs to be balanced administrations, and 175 local authorities. Managing with efficiency to make sure that existing services change on this scale would be a major undertaking are not compromised, especially in urban areas, that for even the most capable and cohesive government. are critical for future economic growth. Conditional grants may be an important instrument for realising Reaching the goal of improved equity will take key national goals, but they should not crowd out time. County administrations will need to develop the space for county governments to exercise real the capacity to use resources in ways that reduce Figure 4.1: Kenya’s devolution involves a major restructuring of public administration 8 Provincial Administra�ons 47 Coun�es 175 Local Authori�es Solid waste management, public health parking and street ligh�ng, markets, slaughterhouses, water sewerage, storm water drainage, billboards, noise control, �re �gh�ng, libraries, game parrks. 280 + De-concentrated 280 + District Administra�ons Administra�ons Health, agriculture, livestock, �sheries, planning, Liquor licensing, disaster housing, lands, transport, rural electricity, sports and management, control of culture, plant and animal quaran�ne, environment drugs and pornography. and conserva�on. Source: World Bank December 2011 | Edition No. 5 26 Special Focus – Kenya’s Momentous Devolution Box 4.1: Key elements of Kenya’s devolution arrangements Political structures. Kenya’s new Constitution establishes forty seven new county governments, each with an elected Assembly, a Governor and an Executive Committee. Both the Executive Committee and the Governor are from outside the Assembly, meaning that there will be full separation between the legislature and executive at county level, just as there is at national level. Counties (although not county governments) will also have a voice in the national Parliament through the new upper house, the Senate, which mainly comprises forty seven directly elected county representatives. Functions and powers. County governments are responsible for a range of service delivery functions, including health, agriculture, transport and water. In many of these areas, the national government also has responsibilities. In general, the national government is responsible for policy and oversight, while counties are responsible for implementation, but the national government retains some important service delivery functions, including the provision of education and social welfare services. The Constitution also provides for counties to take over urban functions that were previously the responsibility of local authorities established under the Local Government Act. Local government. The Constitution envisages changes to the way urban areas are governed, but does not specify them. The recently enacted Urban Areas and Cities Act provides for urban areas with over 250,000 inhabitants to have corporate bodies to manage urban services. Today, five urban areas in Kenya meet this threshold. In other urban areas with a population under 250,000, the executive responsibilities of local authorities will pass to county governments, although a town committee will advise the county government. In both cases county governments will be responsible for financing urban service delivery. Financing. County governments’ resources will come from four main sources: a) own source revenues, b) equitable share transfers, c) equalisation fund transfers and d) other conditional or unconditional grants from the national government. Staffing. Each county government will have its own public service and will be able to appoint its own public servants, within a “framework of uniform national standards� prescribed by an act of Parliament (Article 235 of the Constitution). Significant numbers of staff that are currently performing devolved functions, in sectors like health, agriculture and urban service delivery, are expected to move across from national to county governments. Changes to local governance and service delivery. The forty seven county governments will take over both functions and revenue raising powers from the one hundred and seventy five local authorities that are currently responsible for urban service delivery and a limited range of other functions. It is expected that the staff of local authorities will be absorbed into the county governments. County Governments will also take over the service delivery responsibilities currently performed by the staff of many deconcentrated line ministries in the counties (including health, agriculture, livestock and others) and also some of the functions of provincial and district administrations (including liquor licensing and control of drugs). Source: World Bank inequality. While systems of strong accountability 4.1 How much will counties need? can be put in place at the start, it will take time for citizens to learn how they can influence their M uch attention has been paid to how much county governments should receive, because this is seen as a measure of whether government elected representatives to make decisions that benefit the majority. Implementing devolution is like is serious about devolution. While this focus is understandable, the real question, to start with, flying a plane: too much speed heightens the risk of is how much county governments will need. The mechanical failure, but too little speed runs the risk fundamental principle of financing devolution is of stalling, both with the same ultimate outcome. that funding should follow functions. Counties need Thus balancing is required across two dimensions; sufficient funding to carry out the functions that firstly between the competing policy considerations, are devolved to them, and to begin to address the and secondly in terms of the time within which it is most noticeable service gaps. In practice, costing planned to achieve them. the counties’ needs presupposes: (i) clarity over December 2011 | Edition No. 5 27 Special Focus – Kenya’s Momentous Devolution the assignment of functions between national and national government, or are considered part of the county levels; as well as, (ii) a roadmap for phasing county functions that have been listed in the Fourth in these functions (and the funding associated with Schedule. Other sectors face similar assignment them) over time. issues. Specify functions While the Constitution provides a broad framework for assignment of functions between national and Even when major functions are all specified, it will be county levels of government, some major decisions essential to ‘unbundle’ the many specific functions still need to be made. The Fourth Schedule of the within each sector. The Fourth Schedule refers to Constitution sets out the respective functions of very high-level aggregated functions and additional county and national governments, and Article 186 decisions are required at a much more detailed intra- provides for the national government to retain sectoral level. These decisions cannot be made on the functions that are not explicitly assigned in the Fourth basis of the Constitution alone, and require careful Schedule (i.e. ‘unspecified’ functions). Crucially, the consideration. They will often have significant cost unspecified functions will have to be defined before implications. For example, in agriculture the 2011/ what is defined as a county function becomes clearer. 12 budget disaggregates agricultural extension into For example, in areas of shared responsibility, like three: Headquarters, Provincial and District extension health, some important activities like training, HIV and services. Should these all pass to county level, or only provincial hospitals are not mentioned in the Fourth some? Figure 4.2 shows a graphic representation of Schedule. A clear decision is needed as to whether different components of the health services, some or these are unspecified functions that belong to the all of which might be devolved. Figure 4.2: Once major functions are all specified, unbundling them is the next step Ot Ot he he rR Fis rd ec Pu he ev u Fo bli .6 rre res cW rie .7 s4 nt try ork & W s 3 .1 .66 Fina ild .2 nce life Urba 1.2 2.4 1b) n Ser 4 ol (0.0 vices Contr 12.3 Food b) Livesto on (0.2 ck & D Nutri� b) ev. 5.3 Care (5.8 Agricult Pr i. Health ure 5.2 ing (0.03b) Family Plann CDF Projects 14 Health Info System (0.1b) .4 Energy 3.4 Health Educa�on (0.01b) Family Planning & Construc�on 30.4 Child Health (0.7b) .3 Road Maint. 11 Nutri�on (0.24b) Enviro n. Hea .8 lth (1.1 Health 17 Healt 6b) .8 Servich & Clin rig. 7 es (0 ical r & Ir e several .03b Wate sin 4 .8 c�ons hav e devolved Dist rict ) ke Ba Most fun Hos & La 9 ts that could b pita l (9.5 iver . 2. componen R in b) dm al A inci rov P H FU EALT NC H E TIO IBL NS SS VED PO OL NS V DE CTIO F UN Note: R = recurrent, D = development Simula�on for year 2010/11 Source: World Bank based on Estimates of Recurrent and Development Expenditures 2010/11 December 2011 | Edition No. 5 28 Special Focus – Kenya’s Momentous Devolution Most counties are unlikely to be ready to take over of delivering the assigned functions from all sources many of these functions right away. Some will be of revenue, and that the resources continue to be ready earlier than others. The Constitution provides sufficient, as county needs change over time. for a transition period during which functions should not be transferred to a county government unless Work out the cost it is ready. A roadmap will be required to guide How much counties need will vary depending on how the phased transfer happens. Phasing could how the transfer of functions is sequenced. Clearly be approached in two ways. One approach is to defining, unbundling and assigning functions is the transfer functions sector-by-sector, for example, by first step; the second step is ensuring that counties first focusing on health functions, then agriculture receive enough collectively to fund those functions. and so on. Another way is to transfer across several This is sometimes referred to as ‘vertical sharing’. sectors at once, but to transfer only some activities, It is an intensely political process in all countries, in each sector initially. Clear communication will also and this is no less true in Kenya. Because there is be required to ensure that the counties realise that never enough to meet all competing demands for a gradual approach to the transfer of functions is expenditure, the process of vertical sharing should be absolutely necessary for the success of devolution, focused on reaching a fair split, taking into account rather than simply an excuse to delay or halt it both national and county needs.³ altogether. Vertical sharing starts with an understanding Funding should then follow function, with resources of the aggregate needs of county governments. available to counties to be matched with estimated Existing spending by the national government on county costs. There are four main sources of future county functions provides a good starting county revenues (see box 4.2) which will need to point. In the 2010/11 fiscal year, the national be considered jointly. The objective of the revenue government budgeted KES 140 billion for a range sharing arrangements should be to ensure that of functions that could conceivably be transferred counties have sufficient resources to meet the costs to county governments over time in line with the Box 4.2: How will counties be funded? Counties will receive revenue to fund their functions from four different sources: • Own source revenues. The Constitution grants counties the exclusive right to collect property taxes and entertainment taxes, as well as fees associated with licensing businesses and charges from other services. Since revenues from these taxes and fees are relatively modest, most counties will be heavily dependent on transfers. There are three kinds of transfers provided for in the Constitution: • Equitable share. First, national revenues are divided equitably between the two levels of government, with counties guaranteed to receive a share of not less than 15 percent of national revenue. This is a lower limit: the National Assembly will decide the percentage annually as part of the budget process, after considering advice from the Commission on Revenue Allocation (CRA). The horizontal allocation of the county equitable share across each of the fourty seven counties will be decided according to a resolution of the Senate made every five years, after receiving advice of the CRA. • Equalisation Fund. An additional amount of 0.5 percent of national revenue is channelled into an Equalisation Fund, to be used to provide basic services to marginalized areas. The allocation of the fund will be decided through the budget process. • Unconditional or conditional grants from the national government. The national government may pay additional conditional or unconditional grants to counties from its share of national revenue. The allocation of these grants will be determined through the budget process. Source: World Bank ³The Constitution of Kenya has provided guidance, both through the criteria listed in Article 203, and in the form of independent advice from the Commission on Revenue Allocation. In this respect, Kenya is already ahead of many countries with much more developed systems of decentralization. December 2011 | Edition No. 5 29 Special Focus – Kenya’s Momentous Devolution Fourth Schedule of the Constitution. This analysis is and what assumptions about the percentage split shown in table 4.1, and uses the 2010/11 fiscal year between county and national governments underpin to simulate the process of determining the vertical the costing. These assumptions are further detailed division of resources. It shows the key functions that in annex 2.2. The amounts attached to each function might be transferred to counties (including the CDF), are converted into a percentage of the total pool of Table 4.1: Current funding for devolved functions likely to be delivered % of vote Type Budget As % of sharable Budget 2012/13 as budget R= Recurrent 2010/11 (KES revenues in extrapolated from 2010/11 Vote devolved D=Development billions) 2010/11 shares (KES billions) Provincial Administration 6.6% R 2.7 0.6% 3.7 D 0.2 0.0% 0.3 River and Lake Basin Authorities 77.9% R 0.8 0.2% 1.1 D 4 0.9% 5.4 Water and Irrigation 32.8% R 2.1 0.5% 2.8 D 5.7 1.3% 7.7 Health 42.7% R 14.2 3.1% 19.2 D 3.6 0.8% 4.9 Road Maintenance (recurrent only) 25.2% R 11.3 2.5% 15.3 D n/a n/a n/a Construction of Roads (development) 67.7% R n/a n/a n/a D 30.4 6.7% 41.1 Energy 17.1% R 0.7 0.2% 0.9 D 2.7 0.6% 3.7 Constituency Development Projects 3.6% R n/a n/a n/a funded through CDF D 14.4 3.2% 19.5 Agriculture 31.7% R 3.3 0.7% 4.5 D 1.9 0.4% 2.6 Livestock and Development 81.4% R 3 0.7% 4.1 D 2.3 0.5% 3.1 Urban Services 66.0% R 12.3 2.7% 16.6 D n/a n/a n/a Finance 2.3% R 1.2 0.3% 1.6 D 0.04 0.0% 0.1 Forestry and Wildlife 40.7% R 1.7 0.4% 2.3 D 0.7 0.2% 0.9 Public Works 49.8% R 0.7 0.2% 0.9 D 2.5 0.6% 3.4 Fisheries 99.9% R 0.9 0.2% 1.2 D 3.2 0.7% 4.3 Other functions 3.9% R 6.7 1.5% 9.1 D 6.6 1.5% 8.9 Total 139.8 31% 189.2 Source: World Bank Staff based on Estimates of Recurrent and Development Expenditures 2010/11 Functions which cost more to deliver compared to others. December 2011 | Edition No. 5 30 Special Focus – Kenya’s Momentous Devolution national revenue available for sharing. This allows government raises most of the revenue, and the the results to be applied to fiscal year 2012/13. national parliament decides on the respective shares For that year, the extrapolated cost of devolved of revenue, it will be up to the national government functions would total KES 190 billion. Depending on to ensure that counties have enough funding to what functions are actually transferred on “day one,� do what they are responsible for. If this does not the amount that counties need in the early years happen, and their resources fall short (as shown in of devolution might be much less, with a gradual figure 4.3), the inevitable result will be that services progression towards this. deteriorate. Because defining functions will remain a central ongoing dynamic in the system of devolution, In thinking about function assignment, it makes it is crucial that these decisions are managed through sense to concentrate on defining the more costly an orderly and transparent process, in which fiscal functions first. Some functions cost a lot more to implications are at the forefront. deliver than others (see highlighted rows in table Coordinate function assignment 4.1). This is why it is so important to make function assignment decisions soon, so that the assessment The process for defining county functions, and the of total county needs is based on an accurate timing of their transfer, should be coordinated understanding of which costs counties will be centrally. Line ministries know the most about how expected to bear. functions are best delivered, but they often seek to retain as many functions as possible. Because the As more functions are transferred to county Constitution requires that a minimum percentage of governments, the counties’ share of national national revenues is shared with counties, devolving revenues will need to increase. International too few functions could leave the government with experience suggests that a good deal of discipline too little funding to finance its own responsibilities. is needed to ensure that changes in the functional This would potentially create pressure for more assignments always result in corresponding reviews borrowing, and threaten the macro-economic of the funding arrangements, so that funding stability Kenya has successfully maintained for a continues to follow function. Since the national number of years. Figure 4.3: Current funding for functions likely to be devolved is well in excess of 15% Source: World Bank December 2011 | Edition No. 5 31 Special Focus – Kenya’s Momentous Devolution Box 4.3: How functions might be transferred The Task Force on Devolved Government has included a proposed mechanism for the transfer of functions to counties in the draft Transition to Devolved Government Bill. The mechanism has four elements: (a) criteria for assessing whether a county is ready to receive a function (b) applications by individual counties for specific functions to be transferred to them (c) a determination on the application by the Transition Authority, also to be established under the same Bill (d) publication of the determination in the gazette. This approach has several advantages. It establishes a natural filtering mechanism: to be able to apply, counties must have some capacity first. It provides a transparent process that is relatively free from discretion (as far as this is possible), and it puts an independent and neutral body in charge. However, there are also some disadvantages. It is likely to generate a large volume of applications, with perhaps between 500 and 2,500 individual applications being generated. The Transition Authority will have to rely on line ministries to help it evaluate applications, because it is unlikely to have the technical expertise to assess whether a county is ready to carry out a function. Finally, the resulting ‘patchwork quilt’ of different counties with different functions (each presumably receiving funding on a different basis), would make the intergovernmental financing and performance management arrangements very complicated. Source: World Bank adapted from the August draft of the Transition to Devolved Government Bill, downloaded from www.cickenya.org Clarity of functions is not just important for financing, financed by borrowing. The amount of ‘room to it is also key for accountability. Unless citizens know move’ within the national priorities is relatively which level of government is responsible for what, small, in comparison to the large spending items. they cannot hold them accountable. Even within a Many of the big items in the national budget are constitutional framework of function assignment, the sticky. Spending on debt servicing, and on paying the distribution of functions is usually dynamic. Changes salaries of teachers, soldiers, police and provincial are likely as both levels of government determine administration, cannot be reduced overnight, or what works best for service delivery. To ensure easily. there is always clarity there should be: a framework for negotiating reallocation of functions between Figure 4.4: The ‘room to move’ in the national budget levels of government (preferably on a whole-of- is limited government basis rather than ministry by ministry); and, a mechanism through which ordinary Kenyans Debt-�nanced spending Debt & pensions can easily find out which level of government is 18% responsible for a particular service. Parliament & oversight Other Police Balance national interests 54% 5% 1% National needs also have to be considered. The Justice sector Defense 3% national government retains important and costly 6% functions, like education and police. The Constitution directs that national interests are also relevant in Education 13% deciding the respective shares of national revenue. Figure 4.4 shows what the national government is currently spending on different functions, including Source: World Bank based on 2011/12 budget debt servicing, and how much of that spending is December 2011 | Edition No. 5 32 Special Focus – Kenya’s Momentous Devolution At a time of fiscal hardship, Kenya simply cannot institutions created under the devolved government afford to give revenues to counties unless the arrangements. Moreover, there are a number of corresponding costs are also shifted there. reasons why the cost of delivering services at central Moreover, transferring functions is never neat and versus local level cannot be assumed to be identical tidy: some residual costs are inevitably left behind, (these reasons include scale diseconomies, efficiency at the national level, and costs of delivery at the differentials etc.). local level cannot be assumed to remain the same. In particular, the proposal for national staff to be Current spending from the national budget also seconded to counties during the transition period� reflects the inequitable treatment of some parts of creates a risk of blowing out the wage bill, if large the country. In the more remote and marginalized numbers of the seconded public servants are not counties, the national government currently does not absorbed into county administrations and return to allocate sufficient resources to assure a basic level of the national level, once the transition phase is over. service delivery to their citizens. These counties will All these issues need to be considered as part of the need additional resources if service and infrastructure function assignment process. gaps are to be closed. Figure 4.5 shows the number of people for each publicly funded hospital bed in Refine the costing over time each county. The county with the poorest access, Current spending by the national government is a Mandera, has more than ten times as many people good starting place, but it does not tell the full story per bed, than do the counties that are best served— of county needs. These will also include: (i) the total Isiolo, Nyeri, and Elgeyo Marakwet. cost of urban service delivery (which is partly funded out of own revenues); (ii) some service delivery costs If access to services must increase in underserved that are currently being financed by donors; and, counties while maintaining existing levels elsewhere, (iii) the costs involved in running the new county the overall cost of service delivery will rise. Over Figure 4.5 : Existing service levels reflect entrenched spatial inequities Number of persons served by each government-funded hospital or health centre bed 4,500 4,000 Persons per hospital or health centre bed Under-served 3,500 In Mandera, each hospital or health 3,000 centre bed serves more than 4,000 persons 2,500 Be�er-served 2,000 1,500 In Isiolo, Nyeri and Elgeyo Marakwet, there are less than 500 persons served by each bed 1,000 500 0 Laikipia Uasin Gishu Isiolo Kajiado Ki l i f i West Pokot Siaya Trans Nzoia Elgeyo Marakwet Meru Kiambu Taita Taveta Busia Vihiga Tana River Kisumu Bungoma Kisii Machakos Narok Turkana Mombasa Kirinyaga Kitui Tharaka Nithi Nyeri Embu Lamu Nyamira Nairobi Nandi Murang'a Wajir Migori Marsabit Nyandarua Baringo Kakamega Garissa Kericho Mandera Bomet Homa Bay Samburu Makueni Nakuru Kwale Source: World Bank based on Health management information systems (www.hiskenya.org) �Section 28 Transition to Devolved Government Bill and Section 157 Devolved Government Bill, ver- sions available on the Commission on Implementation of the Constitution website. December 2011 | Edition No. 5 33 Special Focus – Kenya’s Momentous Devolution time, the annual calculation of the vertical share that people have various understandings of what is should take into account this expansion, reflecting equitable, and because broad principles eventually increases in the population and more equitable need to be translated into a workable transfer access to services. formula. While formulas can capture many different variables, there is always a trade-off involved. The 4.2 How much should each county get? more finely tuned a formula is, the more complicated W it becomes. This is particularly important for Kenya, orking out total needs for all the counties because the Senate will decide the formula for is only a first step; the next challenge is to horizontal sharing. Members of the Senate are likely distribute this total across the forty-seven counties. to want a simple formula they and their voters can This process of horizontal sharing will be particularly readily understand. complex because the goal of equalization will need to be pursued without disrupting services or Equity does not mean each county should get an undermining growth and efficiency. This has two equal share. At the very minimum, a formula should major implications: (i) existing imbalances may only seek to balance the costs different counties will face be tackled over time; and, (ii) equalization policies in delivering their mandated functions. The crudest should target people who will benefit from improved measure of cost differences is population: all other services, rather than trying to achieve equality factors being equal, population is the most significant between different geographic locations. driver of cost differences between counties (figure 4.6 illustrates the outcome of a purely population based Equalize access to services formula). But in addition, counties also experience Equity is a central value in Kenya’s Constitution, but other cost disabilities. For example, delivering services how to achieve it in practice through redistribution to people in remote areas that are sparsely populated is very complex. The difficulty derives from the fact costs more per person. Some populations also have Figure 4.6: Cutting the cake: illustrating a population-based formula Baringo Bomet Bungoma Busia Elgeyo Marakwet Embu Garissa Homa Bay Isiolo Kajiado Kakamega Kericho Kiambu Kili� Kirinyaga Kisii Kisumu Kitui Kwale Laikipia Lamu Machakos Makueni Mandera Marsabit Meru Migori Mombasa Murang'a Nairobi Nakuru Nandi Narok Nyamira Nyandarua Nyeri Samburu Siaya Taita Taveta Tana River Tharaka Nithi Trans Nzoia Turkana Uasin Gishu Vihiga Wajir West Pokot Source: World Bank based on 2009 census, KNBS December 2011 | Edition No. 5 34 Special Focus – Kenya’s Momentous Devolution Box 4.4: Equalization as an explicit goal of the Constitution Article 203 of the Constitution (Equitable share and other financial flows) explicitly underscores the redistribution objective of the proposed transfers architecture. Among the criteria to be taken into account in “determining the equitable share�: - developmental and other needs of counties - economic disparities within and among counties and the need to remedy them - the need for affirmative action in respect of disadvantaged areas and groups Source: World Bank staff based on the Constitution of Kenya higher service needs (for example if the population the per capita revenues raised by local authorities in suffers more illness and disease). A simple formula each of the 47 counties in 2008/09. Local authorities can add measures such as land area (to account for currently have similar revenue raising powers to the much higher unit costs of delivering services those the counties will have, so these figures provide to sparsely distributed populations), or poverty some indication of the revenues counties will be able prevalence (to capture higher needs associated with to mobilise from their own sources. On this basis, the poor communities). Both of these measures are per capita local revenue of Nairobi county would be readily available for Kenya. more than ten times that of Garissa county. This raises an important question about whether the transfers Transfers may need to account for own revenue will take into account both the highly diverse set of potential. Counties are not only unequal in terms of needs as well as available resources. Formulas that needs, they will also have widely different abilities take into account both needs, and resources are often to raise revenues to meet them. Figure 4.7 shows described as fiscal gap formulas (see annex 2.3). Figure 4.7: Own-revenue potential will vary widely across counties Per-head own-revenues of Local Authori�es in Kenya's Coun�es 1,000 900 800 700 600 500 400 300 200 100 - Elgeyo-Marakwet Laikipia Kirinyaga Bungoma Marsabit Nyamira Embu Ki l i fi Machakos Kericho Nyandarua Isiolo Migori Busia Kakamega Nakuru Kajiado Kwale Kiambu V i hi g a Baringo Narok Lamu Murang'a Meru Mandera Bomet Samburu Mombasa Kisumu Nandi Tana River Garissa Trans Nzoia Nairobi Nyeri Kitui Siaya Turkana Kisii Makueni Tharaka Nithi West Pokot Homa Bay Wajir Uasin Gishu Taita Taveta Source: World Bank staff calculations based on LATF annual report 2008/09 December 2011 | Edition No. 5 35 Special Focus – Kenya’s Momentous Devolution Transfers should address equality of opportunity Policies seeking to reduce internal disparities in by equalising access to services—not gaps in production and living standards are likely to be levels of economic development. Article 203 of inefficient and costly. Not all counties, even with the Constitution requires that the formula should adequate infrastructure and public services, have the take into account “economic disparities within and same potential to develop. In these cases, it is much among counties, and the need to remedy them.� � less costly to move factors of production (workers But does this mean that each county can expect to and capital) from lagging to leading regions—where eventually have a capital city the size of Nairobi, or an their full productive potential can be realized—than international airport? to develop remote areas. While large transfers to lagging regions would possibly generate equity and It is not realistic to expect all counties to reach the efficiency benefits for that region, the country as a same level of economic development. As nations whole would be losing. develop, population and production concentrate around urban areas. In Kenya, few probably think that The goal should be that all Kenyans have the Turkana or Garissa will ever catch up with Machakos same opportunities through universal access to or Narok; likewise it is unlikely that Kitale can be services and deeper integration of the economies tomorrow’s Nairobi. The process of development of different regions. While not all regions of Kenya almost universally implies an initial increase in inter- will grow at the same rate, redistributive policies— area disparities in living standards, before the gap including intergovernmental transfers—should seek begins to narrow when countries reach a high level to ensure that all Kenyans, regardless of where they of income. The reason why these gaps in living live, have access to a basic bundle of quality services standards narrow as a country’s income grows is such as basic education and health, drinking water because the benefits of economic development are and sanitation, and security. This means adequately increasingly shared with the whole population as a resourcing counties, to the extent that they are able country becomes more wealthy. The main avenue to use these resources efficiently and transparently. for sharing wealth—achieving inclusive growth—is to Moreover, the distance between lagging and leading improve social services that benefit all citizens. areas should be narrowed through integrated Box 4.5: People versus places ... re-inventing the wheel? The World Bank’s 2009 World Development Report must have seemed extremely familiar to Kenya’s policy-makers. Its flagship recommendation, to target equalization policies at “people versus places� is strikingly similar to the directions of Sessional paper 10/1965. In paragraph 134 of the section entitled Provincial Balance and Social Inertia the paper states: The purpose of development is not to develop an area, but to develop and make better off the people of the area. If an area is deficient in resources, this can be best done by- (i) Investing in education and training of the people whether in the area or elsewhere; (ii) Investing in the health of the people; and (iii) Encouraging some of the people to move to areas richer in resources; and of course (iv) Developing those limited resources that are economic. Good intentions don’t always result in good outcomes. Enduring inequalities in Kenya reflect the failure of the central government over the years to roll out the policies outlined in the 1965 Sessional paper. The transfer system under devolution should empower and resource county authorities to do precisely that. However it does not and should not force them to do so. The challenge on going forward will be to design the proper democratic and financial incentives to realise these outcomes. Source: World Bank �Constitution of Kenya, Article 203(1)(g). December 2011 | Edition No. 5 36 Special Focus – Kenya’s Momentous Devolution Box 4.6: Simulating the complexity of sharing revenue across counties For the purpose of illustration, 15 percent of Kenya’s revenue raised nationally in respect of FY 2010/11 is divided among the fourty seven counties on the basis of three different hypothetical allocation formulas: • Formula # 1: Purely per capita allocation • Formula # 2: Current CDF formula [equal shares (75 percent) and poverty rate (25 percent)] • Formula # 3: Simulated inherited needs [county share of hospital beds] The resulting allocations to six selected counties are as follows: # 1: Total Pop # 2: CDF Formula # 3: Hospital Beds 5,000 4,000 Transfers per capita ( Kshs) 3,000 2,000 1,000 - Kakamega Meru Mombasa Murang'a Nairobi Narok Main take-aways: • The choice of formula will generate widely different outcomes for each individual county and therefore creating and winners losers. • Formulas with equal share components will disproportionately benefit small counties. • Accounting for inequalities will need to be traded-off against the risks of: o Leaving richer counties with significant unfunded liabilities; and o Exposing poorer’ counties to absorptive bottlenecks. Source: World Bank infrastructure development, which will connect • Central government may retain the responsibility marginalized areas to the country’s growth poles. for developing integrative infrastructural policies that facilitate the movement of goods, services What are the implications for the transfers system? and people. • Unconditional intergovernmental transfers should Safeguard economic efficiency and growth first and foremost seek to equalize the capacity of counties to deliver a basic package of essential Large-scale redistribution across counties may not services; be possible or desirable immediately, given budget • Additional policy goals could be financed through constraints and efficiency considerations. All other conditional instruments; things being equal, any formula that would channel December 2011 | Edition No. 5 37 Special Focus – Kenya’s Momentous Devolution significant additional resources to marginalized or delivery. For instance, figure 4.8 presents a very lagging counties would result in reduced funding for crude simulation of “winners and losers� if existing all other counties. There are two major risks: firstly, resources for district health� were reallocated purely even wealthy counties may not have the flexibility on a population basis. Counties like Kisii or Mandera to rapidly reduce outlays, particularly if they are would benefit, but Uasin Gishu or Nyeri would see currently allocated to sticky uses (such as personnel a dramatic decline in the resources available to fund or multi-year projects). Secondly, these counties are existing services. That is because these areas currently also among Kenya’s most dynamic regions, which are have good access to health services compared to the driving economic growth and generating the bulk rest of the country, and redistribution of resources of the national income out of which redistribution will mean they will get substantially less. In some efforts will eventually be financed. cases, they may get so much less that they cannot afford to maintain services at existing levels. The immediate priority is to preserve existing service delivery. Kenya’s counties start from very Equalize over time. While the short run priority is different positions. This also means that they will to maintain existing service delivery, this does not inherit vastly different obligations in terms of existing mean business as usual forever. Equalization should sticky expenditure liabilities. Any drastic move to be pursued over time. Box 4.7 provides an illustration redistribute resources away from affluent towards of how redistribution can be phased in gradually, and destitute counties could result at best in severe fiscal this should be clearly communicated to the public, so stress, and at worse in the collapse of essential service that it is widely understood. Figure 4.8: Winners and losers of radical equalization 300 WINNERS: Counties likely to get more 200 than they do currently, if the same resources are redistributed using a population formula 100 - (100) (200) (300) LOSERS: Counties likely to get less than they do currently, if the same resources (400) are redistributed using a population formula (500) (600) Source: World Bank calculations based on 2010/11 budget estimates and health facility data - Health Management Information Systems, Min. of Health �To estimate current allocation we have used distribution of nurses as a proxy. December 2011 | Edition No. 5 38 Special Focus – Kenya’s Momentous Devolution Box 4.7: How Papua New Guinea introduced equalization gradually Papua New Guinea introduced a new intergovernmental financing system in 2008. The political negotiations involved in getting sufficient number of MPs to pass the required constitutional amendments meant striking a deal to ensure no province would lose out as a result of the changes. Mechanisms of this kind are often called ‘hold harmless’ provisions. The new arrangements provide for provinces to share a percentage of national revenue called the Equalisation Amount. Over a five-year transition period, the provincial percentage share has gradually increased each year, starting from a base which gave provinces a slight increase over the previous year. The distribution of the Equalisation Share is based on a two- step process. First, an amount equal to the nominal value of the amount each province had received in the year before the new system began was distributed. Second, the remaining balance is distributed on an equalisation basis. As the amount of the Equalisation Share increases each year, there is more available to equalise. At the end of the transition period, these ‘hold harmless’ arrangements stop, and the whole pool is distributed on an equalisation basis. Initially, it was feared that this would result in some provinces’ funding suddenly reducing, but it was decided to deal with this closer to the event. As it happens, these fears have not been realised. Because of strong national revenue growth, the equalisation pool has grown, and the amount available for all provinces is sufficient to ensure any decrease is very small compared with overall levels of funding. Source: World Bank There is a second compelling reason for avoiding As cities grow in size, delivering these functions radical redistribution. Areas that currently receive becomes more complex and expensive. This is why the lion’s share of national revenues not only provide international practice is for cities to be managed by services that reach beyond county boundaries (such democratically elected, fiscally autonomous urban as referral hospitals and international airports), but local governments that can collect taxes from urban also generate the bulk of these revenues to start residents and use them to provide urban services. with. Maintaining services in these areas is essential City governments are amongst the most complex to continued wealth creation for the whole country. public sector organizations, with large programs of Specifically, there is an acute risk that the ability of capital investment, extensive asset management, Kenya’s cities to remain the country’s main engines of and sophisticated accrual accounting systems. growth will be significantly undermined. Mitigate recentralization of urban service delivery 4.3 Protect the urban growth engine The recently enacted Urban Areas and Cities Act 2011 U rban areas are increasingly important for economic growth in Kenya. Currently the bulk of Kenya’s economic output comes from its urban centers recentralizes urban service delivery for most urban areas from local authorities to county governments (see box 4.8). It remains to be seen what impact and as the economy becomes more service oriented, this bold and globally unprecedented experiment in and less dominated by agricultural production, urban management will have over time, but there economic growth will be more dependent on good is a clear risk that urban service delivery may be urban management. Urban areas provide proximity interrupted in the short to medium term. There are benefits to businesses. But firms need more than just two aspects of the new arrangements that give rise proximity: they need an enabling environment that to this risk: (i) the abolition of corporately managed provides well-managed transport networks, good bodies for most urban areas in Kenya; and, (ii) the security, consistent power supply, and management recentralization of management responsibility under of solid waste. In other words, stable and reliable county governments, most of which will likely have a delivery of basic urban services. strong rural bias. December 2011 | Edition No. 5 39 Special Focus – Kenya’s Momentous Devolution Box 4.8: Recentralization of urban service delivery? Under the Urban Areas and Cities Act: • County governments can establish corporate municipal boards for urban areas over 250,000. All other areas have town committees that are unincorporated and operate through the county administration • Cities can be established for urban areas over 500,000. A special purpose city can be created if there is good reason, but this is unlikely to apply to urban areas that are too small to be municipalities • Members of the municipal and city boards will be appointed (in part by the county government, and in part by local associations representing professional, business, informal sector and residents) • Municipal and city council functions include planning, control of land use, regulating public transport, and service provision functions delegated by county governments • Funding for municipal and city county functions will come from grants from the county government, or revenue raising powers delegated by the county government • Citizen fora will provide an opportunity for citizens to air their views • Nairobi is the capital city awill be governed as a county. Kisumu and Mombasa are deemed to be cities Source: World Bank Only three of the existing local authorities qualify to on Devolved Government, which recommended the become city or municipal boards under the Urban minimum threshold for municipal boards should Areas and Cities Act. The Act provides for cities and be 75,000 inhabitants. The threshold was lifted municipal areas to have corporate bodies to manage when the Bill was debated in Parliament. Table 4.1 them, but it sets a minimum population threshold of shows the impact of this different threshold on the 250,000. Urban areas between 10,000 and 250,000 number of corporate entities. The table in Annex are classified as towns and entitled only to an 2.4 shows which urban areas would have corporate unincorporated town committee to advise the county management under different population thresholds. government on management issues. Assuming Nairobi and Mombasa are governed as counties, only Maintain urban services to generate county three urban areas will qualify for municipal boards— revenues and nurture private sector growth Eldoret, Nakuru and Kisumu. Kisumu is deemed a city. Urban residents will contribute a disproportionately large share of county revenues, but they could be the Even if they do not have direct electoral biggest losers under Kenya’s devolution. Only five representation, having corporate entities to manage counties (Nairobi, Mombasa, Kiambu, Kisumu and urban services would provide greater continuity Machakos) have a majority of urban residents (see with existing local authority arrangements. A larger figure 4.10). In these counties, there is less reason to number of urban areas would have had corporate fear the deterioration of urban services because the management under the proposals of the Task Force majority of residents will be very concerned to ensure Table 4.2: Impact of different population thresholds on the number of municipal and city boards Cities under Urban Areas and Cities Act (UACA) (threshold 500,000 + Kisumu) 3 Municipalities under UACA (threshold 250,000) 2 Number of urban areas over 75,000 (TFDG recommendation for municipal threshold) 33 Number of counties that would have at least one municipal board, if threshold is lowered to 75,000 22 Number of counties with no urban area having a municipal board, if threshold lowered to 75,000 25 Source: World Bank December 2011 | Edition No. 5 40 Special Focus – Kenya’s Momentous Devolution Figure 4.9: County own revenues will be derived The risks of under-funding urban services could be mostly from cities… managed by having earmarked funding for urban services, and by setting standards and benchmarks 3,000 for urban service delivery and monitoring them. Nairobi Earmarked funding would involve financing urban LA Revenues per Capita in 2008/ 09 (KES) 2,500 Mombasa service delivery (outside Nairobi and Mombasa) 2,000 through conditional grants. Counties could be 1,500 required to contribute to funding of urban services Narok Isiolo as well, since they benefit from the revenues 1,000 Samburu Laikipia Nakuru Kiambu generated by urban residents. As a complement to 500 this, the national government could set standards Tharaka W. Pokot for urban service delivery, including benchmarks for 0 0 10 20 30 40 50 60 70 80 90 100 the resourcing required to finance effective service delivery. Benchmarking would provide citizens with Urban population in 2009 (%) Source: World Bank calculations based on LATF annual report 2008/09 and 2009 Population Census a basis to assess whether their county governments their county governments look after these services. are giving sufficient priority to urban services. In the other forty-two counties, rural residents will Standards and benchmarks are likely to be important be in the majority. There is a real risk that they will for other sectors too, as there are broad risks of poor use their majority in the Assembly to direct resources prioritization in resource allocation by the counties away from urban services. that need to be managed. Figure 4.10: …but County Assembly members will be mostly from rural areas 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Kericho Baringo Laikipia Kajiado Kirinyaga Kakamega V i hi g a Nairobi Kiambu Kisumu Marsabit Ki l i fi Mandera Lamu Bomet Samburu Murang'a Meru Mombasa Garissa Bungoma Nyamira Embu Turkana Kitui Pokot Nyeri Busia Makueni Siaya Machakos Kisii Nyandarua Wajir Homa Bay Isiolo Narok Nakuru Migori Kwale Elgeyo Marakwet Taita Taveta U. Gishu Nandi Tana River Trans Nzoia Tharaka Nithi Rural Urban Source: World Bank calculations based on 2009 Population Census December 2011 | Edition No. 5 41 Special Focus – Kenya’s Momentous Devolution 4.4 Desing an integrated financing architecture government may also finance them through other C conditional and unconditional grants and via the onditional grants could play a fundamental equalization fund. However, the scope for the role in the new intergovernmental transfers government to target and leverage expenditure at architecture for three reasons: (i) to safeguard priority the county level via conditional instruments will expenditures at the local level such as primary health depend on the fiscal space left after the government care; (ii) to elicit and reward county performance; has accounted for the (unconditional) equitable share and, (iii) to ensure that the equitable share formula and other priority expenditures. (governing the distribution of unconditional grants) can remain as transparent and simple as possible. The higher the proportion of county need that is met through the equitable share, the lesser the But making space for conditional grants implies scope for targeted conditional transfers (and vice adjusting the unconditional equitable share. To versa). Figure 4.12 shows three different financing maintain fiscal flexibility and sustainability, all the models for how those needs could be met. In option different kinds of transfers need to be considered as 1, the equitable share is paid at the minimum level a whole in terms of how adequately they meet the of 15 percent, and the remaining need is met from total needs of counties. conditional grants. In option 2, all county needs are addressed through the equitable share. There is a Consider all the transfers together large range of options in between. Option 3 shows The (minimum 15 percent) equitable share is not one of those, under which the equitable share is the only source of revenue to meet county needs. increased, but not to the full extent of needs, thereby Counties have their own source revenues and the requiring some conditional funding. Figure 4.11: Flows of revenue from different sources for county governments Na�onal Revenue Source: World Bank December 2011 | Edition No. 5 42 Figure 4.12: Three basic options for financing counties Total Conditional Conditional grants grants 15% Equitable share 15% Equitable Equitable share share Option 1: Maximum conditionality Option 2: Maximum flexibility Option 3: Mix of conditionality and flexibility Equitable share is paid at the minimum level All county needs are addressed through Equitable share is increased to more than 15 percent required by the Constitution, 15 percent unconditional equitable share of national revenues, with remaining county needs national revenues addressed through conditional grants Source: World Bank December 2011 | Edition No. 5 43 Special Focus – Kenya’s Momentous Devolution Special Focus – Kenya’s Momentous Devolution Keep in mind the cost of conditional grants relative to the functions they will have to pay for. The to the center county equitable share will be determined through There are strong arguments in favour of some the Division of Revenue Bill, enacted by Parliament. conditional funding to counties if only to continue Treasury, Parliament, the CRA and counties will be existing programs. But conditional funding will need involved in consultations through which the vertical to be considered and prioritized carefully as it will be shares are decided. What the foregoing discussion additional to the minimum 15 percent allocation. highlights is that these discussions must also involve consideration of conditional grants, which will be Government may already be considering the use the other main source of revenue for counties. This of conditional grants to fund counties. A number consultation will need to start early in the budget of existing programs tie funding to spending on process in order to be effective. particular purposes (see box 4.9). If continued, these mechanisms would effectively constitute Fiscal space must be preserved for conditional conditional grants to counties. Additional conditional transfers. For devolution to have any meaning as the grants may also be appropriate for financing cross- Ugandan example suggests (see box 7.1) counties border services—where one county is responsible must be able to freely determine their own spending for delivering a service that several other counties priorities. The Kenyan Constitution does justice to depend on (for example, provincial hospitals). this by imposing a minimum untied transfer. But to the extent that the sharing formula will need to A key implication of this analysis is that decisions be simple and transparent (and therefore relatively about the vertical share and decisions about crude), conditional transfers may also be needed to conditional grants need to be made together. If cater for: (i) counties with special needs; (ii) programs these decisions are made separately, there is a risk of strategic significance; and, (iii) projects that are that counties will be given too much, or too little, asymmetric in space or time. Box 4.9: Existing funding arrangements that would be conditional grants if continued To the extent that they remained earmarked to specific uses, these programs would have to be financed through conditional grants and their costs would not be included in the calculation of the county equitable share: Road maintenance—county share KES 11.3 billion. Road maintenance is currently funded through the Road Maintenance Levy Fund, financed by a fuel excise. If this funding is to continue to be tied to road maintenance, it would need to be an earmarked grant. Constituencies Development Fund (CDF)—KES 14.4 billion. Some commentators have suggested that CDF will be maintained as a dedicated fund, but devolved to counties to manage. If CDF continues to be an earmarked program for spending only on specific projects, and allocations calculated using a specific formula, then it will effectively constitute an earmarked grant. Local Authorities Transfer Fund (LATF)—KES 12.3 billion. Urban services are partly funded from the national government’s LATF. If the national government wishes to earmark funding for urban service delivery, this would not be factored into the calculation of the county equitable share. Staff costs—Not known. The draft Transition to Devolved Government Bill recommends that during the transition period, staff performing devolved functions should be seconded to county governments, and their salaries should continue to be paid by the national government. Around KES 10 billion is currently being spent on the costs of district-level staff in health and agriculture sectors alone. If these remain national costs, they would not be factored into the calculation of the county equitable share. Source: World Bank December 2011 | Edition No. 5 44 Special Focus – Kenya’s Momentous Devolution 5. Get accountability right from the start the risk that county governments will use their T resources poorly: by favoring only some parts of the he Constitution seeks to reshape the way county, by spending on low-priority unproductive citizens relate with government, and places expenditures, or by spending too much on salaries. a strong emphasis on principles of participation, Traditionally, accountability has been about having transparency, and accountability. The spirit of strong systems of reporting to a central authority devolution is to bring government closer to the that can take action if resources are managed poorly people, so that they can better communicate their (i.e. ‘top-down’ accountability). This approach is less needs to the government, and ensure that the effective in decentralized settings. When resource government responds to their needs. In particular, management is decentralized, it is difficult to exercise the Constitution seeks to “enhance the participation top-down oversight, because decision-making is more of people in the exercise of the powers of the State diffused (so it is hard to track who is responsible) and and in making decisions affecting them.�� because these decisions are made a long way from the capital, and are far from centres of oversight. Nonetheless, devolution by itself will not necessarily This means it is even more important for effective produce such responsiveness or accountability. devolution to strengthen the ‘bottom-up’ systems Global experience and empirical research provide of accountability that empower citizens to hold their many examples of accountability failures in elected local representatives accountable. But these decentralization reforms, leading to substandard mechanisms also rely on strong central systems. service delivery and corruption. Factors that prevent The two approaches—top-down and bottom-up— traditional top-down accountability systems from complement each other. functioning well in a decentralized setting include: (i) geographic distance from central government; 5.1 Build strong public financial management (ii) diffused reporting lines; (iii) the multiplicity of systems programs; (iv) projects and funds that are dispersed at the local level; (v) low capacity levels. Kenya’s own experience with decentralized T he new Constitution raises big challenges for public financial management institutions at both national and local level. At local level, the significant funds—such as CDF, LATF and community-driven increase of funding flows to local government, development (CDD) projects—highlight some combined with the massive administrative of these challenges. Kenya’s audits, expenditure reorganization involved in building a new tier of reviews, and civil society monitoring initiatives county governments, will make managing public regularly document white elephant projects and money in the newly decentralized system a key significant levels of waste and leakage in government challenge. Although many civil servants are in place, programs. According to these reviews, factors that most of them will have had little experience at making often limit accountability to local communities major resource management decisions. The skills and citizens include: (i) overlapping roles and of staff across a range of devolved sectors (health, responsibilities across decentralized programs; (ii) agriculture and so on) in planning, budgeting, budget limited systems to reliably account for funds or track implementation and managing human resources, are performance; (iii) limited availability of information likely to be weak or non-existent. on project activities; (iv) finances and performance; and, (v) limited systems to enable communities and A large, rapid, well-planned and carefully citizens to obtain recourse. implemented program of capacity building is required to prepare civil servants and politicians for A mixture of both top-down and bottom-up this new challenge. Staff in many local governments accountability systems are crucial for managing lack sufficient experience in planning, budgeting, �Article 174 (c), Constitution of Kenya December 2011 | Edition No. 5 45 Special Focus – Kenya’s Momentous Devolution Figure 5.1: Getting information flows right: top-down and bottom-up accountability Source: World Bank spending, reporting and accounting for such large • a single channel for flow of funds to county funding flows. New structures, reporting relationships governments that eliminates the fragmentation of and accountabilities will be established at county the current system level to manage these funding flows, with county • a sound framework for managing disbursement of governments responsible for meeting legal public grants to community projects, facility-level service financial management standards set in national delivery, and small projects legislation, and horizontally accountable to County There is also scope to avoid disconnection between assemblies. county governments will be required planning and budgeting systems by integrating to submit their annual financial statements to the both functions under a single department at the Auditor General. If counties make serious or repeated county level. This would require integration of what material breaches of the public financial management are currently separate provisions proposed in the legal framework, they are liable to have their transfers curtailed by the Cabinet Secretary for Finance. draft Public Finance Management Bill, and the draft Devolved Government Bill. However, before capacity can be built, systems need to be put in place. Regardless of how many County assemblies will play an active role in financial laws provide for public financial management, it is management and will also need considerable essential that there should be a single, country-wide support to develop their capacity. County assemblies public financial management system, covering both will be empowered to safeguard the fiscal health of national and county governments. Elements of this the County governments through setting and tracking system would include: levels of borrowing, scrutinising deviations from fiscal responsibility principles, reviewing fiscal strategy • a budgeting format that highlights expenditure on papers, considering budget review and outlook services (particularly transfer of funds to facilities) papers, and County government debt management and projects, with planned outputs specified strategies, considering and approving budget • a common classification system for budgeting and estimates, and enactment of associated County accounting appropriation Acts. This will in turn involve building, December 2011 | Edition No. 5 46 Special Focus – Kenya’s Momentous Devolution more or less from scratch, specialised committee and Community Driven Development projects, structures with additional analytical support in best ensures that this information is relevant for the forty-seven new County assemblies. Learning citizens. Transparency can be safeguarded through from early good performers and sharing experience legal provisions that mandate the publication of what works and what of information on programs, finances, and does not among County performance. assemblies will be important in ensuring all assemblies • Participation mechanisms that enable citizens are able to guarantee a basic Effective to express their views on development priorities level of financial oversight. participation and to monitor the performance of government However, the capacity requires feedback programs. To be effective and fair, these of county assemblies to mechanisms must be open to the public, and hold the county executive systems, such especially to marginalized groups, well designed accountable will only be truly as complaint to allow substantive input, and relevant to citizens effective if the accountability mechanisms so that their participation is meaningful. Effective ‘loop’ is complete, and and customer participation also requires feedback systems, such county citizens are satisfaction as complaint mechanisms, customer satisfaction empowered to hold their surveys, etc., that enable citizens to directly elected representatives surveys provide feedback on service delivery performance accountable as well. and funds. 5.2 Promote accountability to citizens Effective citizen participation requires both P information sharing and participatory feedback reventing accountability failures in devolution mechanisms—a piecemeal approach is unlikely to be requires a sustained effort to enable citizens to successful. Uninformed citizens cannot participate participate in and hold local government to account. effectively, meaning that key fiscal and performance Bottom-up participation and accountability systems reports, especially the budget, must be made can complement traditional top-down accounting, public in a timely and accessible manner. Citizens auditing, and performance management systems. who participate substantially in the identification Effective citizen participation and bottom-up and design of a project are much more likely to accountability requires several key mechanisms to be provide feedback on it, such that participation put in place: promotes accountability. These elements of social accountability can reinforce one another. • Transparency of government programs, rules, finances, and performance. To participate Transparency of national government disbursements effectively, citizens need to access financial to county governments is also important. It is common management and performance information on in devolved systems for lower-level governments to public service delivery in formats that are readily blame service delivery stagnation on the national available, clearly presented, timely and relevant. government’s failure or delay in release of funds. Online access to information is the easiest The Controller of Budget is already constitutionally means of making this information accessible to a mandated to oversee the implementation of the national audience, but paper documents should budgets of the national and county governments. also be available in public offices upon request. In addition to this oversight role, he/she could be Transparency of fiscal information at the facility and required in legislation to publish a simple monthly project level, including for schools, health centers report on intergovernmental transfers, to show the December 2011 | Edition No. 5 47 Special Focus – Kenya’s Momentous Devolution public the volume and frequency of transfers. This which office or official is responsible for compliance. approach was utilized in Nigeria’s decentralized Legislation can also provide strong legal mandates, system, and helped to diffuse public mistrust of as well as sufficient space (time) in the budget central government, focusing public scrutiny and cycle to ensure meaningful participation in budget pressure on the use of funds. Of course, information prioritization and monitoring. alone is not a sufficient condition to improve service delivery, but it is an important ingredient in a broader Drawing on the LATF system, production of financial set of institutional reforms. and performance reports could be tied to transfers, and these documents should be publicized, especially Kenya can draw on its experience using performance- on the internet. The production of these documents based funding, to reinforce both upward and could be among the performance conditions downward accountability by local authorities. The attached to performance grants discussed earlier. A Local Authority Transfer Fund system seeks to reinforce more robust system of performance funding would both citizen participation and timely submission of build on the LATF by also requiring publication of the plans and financial reports, by linking a proportion of reports on the internet, and providing a system of funding to compliance with these requirements. A independent verification, to confirm their accuracy. Local Authority Service Delivery Action Plan (LASDAP) Transparency of this information will better inform must be prepared annually with input from citizens. citizens, and will also aid in creating pressure to improve the quality of the reports. However, while the LATF system was largely successful in ensuring reporting by local authorities, Building on the LASDAP system, devolution laws the information they produced is not usually made could require county governments to involve public. The LATF Regulations specify in detail the citizens in the budget and planning process, give the penalties for late submission of required information, county administration responsibility for facilitating but there is no requirement in the Act for the reports this, and integrate planning and budgeting more to be made public, so the information has typically closely. Responsibility for designing opportunities not been made available to citizens. The Public for participation is better vested in the county Expenditure Review of 2010 also observed that the administration so that it remains political. The quality of reports was quite substandard, reinforcing Governor and assembly members should be invited the need for enhanced capacity and transparency. to participate but should not control who attends. The LASDAP process is intended to include citizens in the local authority planning process through public The county administration should also be responsible meetings, but several reports suggest that attendance for upholding certain good practices of participation, is often limited, and budgets are not well aligned with such as openness, inclusion of minorities and the priorities identified in the LASDAP plans. marginalized groups, and clear communication of events to the general public. Planning and budgeting Several actions can strengthen participation, units should be under a single county department transparency and accountability in public to help make sure that planning actually feeds into financial management and performance of budget development (and vice versa). county governments. A first key action would be to establish a clear legal framework that supports Kenya has the opportunity to be a leader in Africa participation, transparency and accountability. The with respect to transparency and local government public financial management legal framework, and accountability, but getting accountability the devolution bills, are the most appropriate place relationships right will require sustained effort to require transparency of financial and performance to build the capacity of both county governments information, and to detail the mechanism, timing and and citizens to use them effectively. A strong legal December 2011 | Edition No. 5 48 Special Focus – Kenya’s Momentous Devolution framework is important, but building effective provoke a backlash against devolution that leads participation and accountability mechanisms will ultimately to recentralisation. also require substantial capacity at both levels of government. Capacity will be needed at the national 6.1 Risks of poor spending T level to develop systems (including for soliciting he impact of transfers to counties on overall citizen feedback and registering complaints), and inequality critically hinges on the way they are at the local level to implement them (including managed at the county level. Empowering and transforming complex financial information into resourcing county governments is not a guarantee formats that are accessible by citizens). This is an for equity within counties. Devolution will transfer important component of a long-term project of discretion over the use of significant public resources capacity building to support the effectiveness of from the national to the county level. To the extent that devolved government. It is important that these specific regions may have been penalized by central long-term goals should not be overlooked in the neglect or discretion in the past, this is a preoccupation with immediate and major protection. But global experience urgent concerns that will inevitably indicates that local governments will accompany the early transition period. not necessarily be more virtuous. They If not well may face perverse incentives and pursue 6. Manage risks prepared and misguided policies. If unchecked, county K enyans have embraced devolution with the hope that it would solve three enduring governance implemented, devolution leaders could use their offices to benefit powerful subgroups or interests. From a political economy point of view, county bottlenecks: a monopolistic use of state could result in governments may be more prone to power to the benefit of certain groups exacerbated elite capture and less willing to trade-off and regions, widespread corruption, inequalities, narrow local interests for national greater and inefficient administration, and a good. Kenya’s own experience with desire by the majority of the population decentralized decentralized funds has highlighted some for a more equitable distribution of corruption and of these challenges. resources. disrupted services Increased control over resources by Economic theory would say devolution is precisely county governments will not automatically translate the right answer to these problems; but the into expenditure that prioritizes service delivery. experience of many other countries suggests a Many countries’ sub-national governments have less clear-cut picture. If it is not well prepared and trouble spending money well. Common problems implemented, devolution could result in exacerbated include over-spending on salaries and administrative inequalities, decentralized corruption and disrupted overheads, at the expense of service delivery and services. In particular, even if the transfers are fair, infrastructure investment. If county governments and adequately balance competing considerations of spend poorly, service delivery standards could actually equity and efficiency, this alone will not be sufficient worsen, instead of improving. The role of central to ensure that the promise of more equitable service government in setting and monitoring standards delivery is fulfilled. will be critical in managing this risk. The elements of a strong system of performance management While resources are important, counties’ abilities for county governments will include standards for to use them well will be equally key and equally expected service delivery, indicators for measuring challenging. Ironically, counties that need additional them, a system of regular reporting, and incentives resources are least likely to be equipped to use them for county governments to report accurately. well. There is a risk that implementation failure may Funding that is linked to meeting performance December 2011 | Edition No. 5 49 Special Focus – Kenya’s Momentous Devolution Box 6.1: Performance criteria under the Local Authorities Transfer Fund: A possible model Local authorities can receive a full payment from the performance account if they submit seven documents: financial statements (revenues, expenditures, cash and bank balances), statement of debtors and creditors and debt management proposals, abstract of accounts, revenue enhancement plan, and a Service Delivery Action Plan. Criteria for accessing the higher performance account are: • executing the local authority budget as planned • keeping expenditure on personnel emoluments within 5 percent of the budgeted amount • increasing revenue collection by more than 10 percent • implementation of the strategic plan • having an unqualified audit report for the previous financial year Source: World Bank based on LATF Regulation indicators related to the establishment and operation may have another unintended consequence, in that of these systems—rather than to the service delivery it may lead to a widening capacity gap between rich outcomes themselves—can play an important role in and poor counties. reinforcing performance management systems. Kenya already experiences an inequitable 6.2 Human resource risks distribution of staff and skills across counties. An T unintended consequence of having forty seven he importance of human resources in individual county public services may be to further decentralization is often under-estimated. entrench or exacerbate this inequity, particularly if Capable personnel are crucial to achieve the wealthier counties have the power to attract the most promises of devolution, but human resources also skilled public servants. There are a number of ways present substantial risks to the effectiveness of this risk can be addressed, but all of them require a decentralization. Governments with lower capacity national framework—for remuneration, entitlements find that employing more staff is the easiest way of to staff development, and other benefits—that give all to spend money. This tendency is compounded by skilled staff an incentive to work for the county public local pressures to employ staff as a way of shoring up services that need their skills the most, but are least political support. Managing human resources well likely to be able to attract them. relies on three key elements: (i) containing the risk of overspending on salaries; (ii) getting incentives right 6.3 Structure funding to improve capacity to encourage counties to acquire and retain skilled staff; and, (iii) increasing the focus on, and incentives for, good performance. In seeking ways to improve county government performance, carrots may work better than sticks. Linking some proportion of funding to nationally-set Overspending on salaries is a particular risk in the performance benchmarks provides an incentive for Kenyan context, because the Constitution gives county governments to meet those benchmarks. In county governments full control over engagement developed countries (and some developing ones), of staff. Article 235 of the Constitution empowers the performance benchmarks are related to service county governments to hire and fire staff, within a delivery outcomes, or outcome improvements. In framework of uniform norms and standards. In order weaker capacity environments local governments to manage the risk of overspending on unproductive may lack the basic systems of public administration consumption expenditure, this framework should that allows them sufficient control over resources to include benchmarks for expenditure on personnel set and meet performance targets. In these contexts, costs, and a standard remuneration framework. improvement of systems is an essential precursor to Absence of a standard remuneration framework improvement of services. December 2011 | Edition No. 5 50 Special Focus – Kenya’s Momentous Devolution Performance-based grants can reinforce the 7. Navigate a major public sector transition I development of essential public financial mplementing devolution will involve a radical management and performance monitoring systems. transformation of Kenya’s public sector. Such a Funding is calculated on the basis of compliance with transformation presents enormous opportunities a set of indicators relating to both functioning and for improvement, but also carries correspondingly improvement of basic elements of these systems. high risks that—at least for a period—outcomes This is similar to two components of the current Local worsen while the new systems are rolled out. Public Authorities Transfer Fund (see box 6.1). Performance sector transition is also the area of greatest risk for grants systems supported with donor financing have increased fiscal instability. If transition is managed in operated in over twenty countries, some of them a way that increases total public sector employment for more than a decade. Kenya can draw on this in an uncontrolled way, this will be to the detriment experience to improve the approach to performance- of both fiscal discipline and devolution outcomes. based financing for counties. A key lesson is that the design of a robust monitoring system, involving Kenya’s devolution is one of the most ambitious self-reporting, desk auditing, and field review teams to be implemented globally. In many countries, with independent personnel is crucial. Given the decentralization is a process of giving political political context of devolved government, it may be autonomy to administrative units that are already appropriate for the highest level intergovernmental in place. In Kenya, devolution will entail not only coordinating body to play a role in overseeing the creating new political units, but also creating entirely monitoring of county government performance. This new systems of administration that will absorb some approach can be useful in establishing transparency or all of three existing systems of administration. about county governments’ performance among their peers, giving an even greater incentive for The golden rule of implementing decentralization improvement. is ‘do not disrupt service delivery’. Deterioration of services can rapidly erode popular support for Conditional grants, in which some funding is tied to decentralization. The dissipation of support in turn specific kinds of spending, may also play a limited provides ammunition for recentralization. Therefore, role. In general, experience shows that conditional ensuring that county governments do not over-reach grants with complex conditions are relatively themselves too early is important to protect the ineffective because they are very difficult to monitor. widespread support they enjoy at the moment. The However, a simpler form of earmarking referred to risk of service deterioration in the Kenyan situation as function block grants, or sector block grants, can is greater because the changes to systems of public serve to signal the county government about the administration are on such a large scale. amount that should be allocated to a particular sector or program. Conditional grants can also be a useful Three specific aspects of the transition process way to tailor the allocation formula to a particular warrant close attention. The first question is purpose, rather than complicating the general how such a complex transition will be managed equalization formula with several different elements. and coordinated. Second, the single biggest Urban services may be a good candidate for this transition issue will be managing the movement of kind of conditional grant in the Kenyan context for public servants from national ministries and local both these reasons. Ultimately, the effectiveness of authorities to county administrations, in line with any kind of tied funding—whether tied to capacity the staff-intensive service delivery functions that benchmarks or to spending purposes—will depend are being transferred. A third overlapping issue is on strong systems of public financial management. the sudden transition from local authorities to new December 2011 | Edition No. 5 51 Special Focus – Kenya’s Momentous Devolution county governments, which raises serious risks of for increased controls over funding and staff that interrupting important urban services. effectively led to a recentralisation of control over key resource decisions. Uganda’s district Someone needs to be in charge. Decentralization is governments now seems more like de-concentrated one of the most substantial reforms any government administration than a genuinely autonomous system can undertake. Because Kenya’s devolution is so of local government. ambitious, coordinating its implementation is a major undertaking. The Task Force on Devolved Government A clear policy on what will happen to public servants has proposed the establishment of a Transition is needed soon. Around 32,000 local authority Authority. International experience suggests employees and as many as 50,000 national public decentralization is likely to be more successful if it servants are likely to move to county governments. is independently coordinated, but time is a major More than 70 percent of the staff of the two health factor. Further empowering the Commission on ministries alone will move (see figure 7.1). The Task Implementation of the Force on Devolved Government has recommended Constitution may be a more that these staff should initially be seconded, while realistic option given the county governments undertake their own recruitment short time left to get the of staff, including from the ranks of seconded staff. The Around 32,000 new arrangements in place. bills the Task Force has prepared included provision local authority for this approach. However, it is not clear what There should be a plan. employees and entitlements public servants will have—will they be The main function of upto 50,000 entitled to refuse secondment, and if not recruited to the independent body national public a county government, will they be entitled to return supporting implementation to their original job (even though it may not longer should be to steer, not servants are likely exist)? This decision has major fiscal implications if row. It can do this most to move to county the national government is left to continue paying effectively by developing governments staff whose jobs have been devolved even though and getting agreement on occupants have not. a high level strategy for implementing devolution that will guide line ministries. The detailed leg- A basic rule for managing the risks of service delivery work of implementation needs to be done by line disruption is to leave people doing the jobs they do ministries, because they understand the detail and now. As far as possible public employees based in technical dimensions of their functions. Above all, counties—working both for local authorities and de- decentralization is a change management process concentrated administrations—should keep on doing for national ministries whose roles will change from the same jobs, even though they may report to a set actual service delivery, to setting standards and of elected representatives. overseeing them. But oversight will be needed to make sure they stay on track. This should be the job Transition may be particularly dramatic in the case of an independent body. of urban services. The draft legislation to implement devolution provides for the Local Government Act to The plan should aim to devolve incrementally. be repealed at the completion of county elections. Rapid decentralization comes with high risks. In If this proposal is adopted then, regardless of what other countries like Uganda, the impact of rapid other functions they assume, counties will be decentralization was disruption and deterioration responsible for urban service delivery from day of important services (see box 7.1). This provided one. If county governments are unlikely to have any ammunition for line ministries to argue successfully meaningful capacity immediately, it may be better to December 2011 | Edition No. 5 52 Special Focus – Kenya’s Momentous Devolution Figure 7.1: Projection of health staff positions likely to be devolved Health staff current After devolution Ministry of Ministry of National Public Medical Health Services HEALTH MINISTRY/IES 14,568 + 23,433 38,001 23% 8,817 staff Total Health Staff 77% 29,103 staff 47 Coun es Source: World Bank staff based on 2010/11 budget data leave the local authorities in place for a period after to propose that the establishment of administrative the election, to minimize the disruption to urban machinery should not begin until the county services. assembly and county government are elected. While the sentiments that underpin this approach are A framework of uniform national standards understandable, this is a high-risk strategy. for county public services is mandated by the Constitution. Important choices are being made Kenya’s devolution has the potential to transform about how extensive that framework should be. Key government, by giving citizens more equitable access considerations are: (i) whether there should be a to resources, a greater say in how they are spent, and national remuneration framework that applies to all an increased sense of control over their own lives. counties; (ii) which ministry should regulate public But these objectives do not flow automatically from service matters (Local Government or Public Service); devolution, and enthusiasm alone will not guarantee and, (iii) how extensive the national framework should their achievement. Careful design of fiscal, public be—over what matters will county governments have service and accountability components is required, discretion. focusing on devolution as a system, to ensure the All these policy considerations are informed by different elements function together. In public policy, one key choice: how much of the administrative however, today’s solutions are inevitably tomorrow’s architecture of county governments should be put in problems. Implementation will almost certainly not place before they are elected? Most countries put in proceed as planned, and problems will emerge that place transition arrangements to establish the basic were never foreseen. Whether these problems are machinery of administration before first elections are merely bumps along the road, or fatal impediments to held. In Kenya the level of suspicion with which some the success of devolution, is likely to depend on how policy actors regard central government leads them carefully implementation is planned and managed. December 2011 | Edition No. 5 53 Special Focus – Kenya’s Momentous Devolution Box 7.1: The risks from trying too much too soon ... lessons from Uganda Uganda undertook a radical decentralization following the introduction of a new Constitution in the mid-1990s. The reforms were homegrown and there was an unusual degree of commitment to them by the government of the time. By the late 1990s Ugandan local governments were among the most empowered and best financed in Africa. Local governments were given block grants and had substantial autonomy over budgeting and staff. However, over time it became apparent that many local governments were performing poorly in delivering services. A public expenditure tracking study revealed that very little funding was reaching schools. Central agencies that had initially supported decentralization began to realize the impact on their power and resources and argued for stronger central controls in the form of conditionalities on grants. These demands were supported by donors who were financing a substantial proportion of the delivery of basic services. The multiplication of conditional grants coupled with increased fragmentation of local governments removed much of the fiscal autonomy of local governments, and rendered them increasingly impotent in terms of making genuine decisions about local priorities. There has been little impetus to reverse these trends, with the result that Ugandan local governments are now relatively weak. Despite much initial enthusiasm, the pace and trajectory of Uganda’s reform proved too ambitious, and in addition there was too much emphasis on formal development of the system and too little on developing local accountability. This experience illustrates why ‘hastening slowly’ might be the fastest way for devolved governments to achieve real and lasting autonomy. Source: Adapted from USAID, Comparative Assessment of Decentralization in Africa, Uganda Desk Study December 2011 | Edition No. 5 54 ANNEXES Annexes Annex 1: A new macroeconomic environment in 2011 2007 2008 2009 2010 2011** GDP Growth rates (%) 7 1.6 2.6 5.6 4.3 Agriculture 2.3 -4.3 -2.5 6.3 3.5 Industry 7.1 4.7 2.7 5.3 3.6 Services 8.1 2.7 4.6 5.8 4.4 Fiscal Framework (FY) % of GDP Total Revenue 22 21.8 22.3 24.0 24.5 Total expenditure 27.3 26.6 29.5 29.2 30.6 Grants 1.3 0.8 0.8 0.7 1.3 Budget Deficit (incl grants) 4.0 4.0 6.4 4.5 4.8 Total debt 34.6 41.7 45.0 48.8 46.1 External Account % of GDP Current account Balance -3.8 -6.4 -5.6 -7.5 -10 Memo items Inflation (average) 4.3 16.2 10.5 4.1 13.0 Exchage rate (Ksh/$) * 67.3 69.2 77.4 79.2 88.5 Source: World Bank / Ministry of Finance Annex 1.1: Key macroeconomic indicators Change 11-Sept External Account 10-Sep 10-Dec 11-Sep - 10-Dec Current Account (US$ Billions) -2.1 -2.5 -4.0 -1.5 Oil (US$ Billions) 2.6 2.7 3.7 1.1 Capital account (US$ Billions) 0.15 0.15 0.24 0.09 Financial Account (US$ Billions) 2.3 2.5 3.5 1.0 Overall balance (US$ Billions) 0.4 0.2 -0.2 -0.4 Import Cover (months of cover) 4.0 3.9 3.6 0 Interest Rates (%) Real CBR 2.8 1.5 -10.3 -11.8 Real Interbank -2.0 -3.3 -9.9 -6.5 Real 91 day Treasury bills -1.2 -2.2 -5.4 -3.2 Growth in Monetary Aggregates (%) M3 26.0 21.6 19.3 -2.3 M2 23.9 30.5 16.9 -13.6 Private Sector Credit 22.9 20.3 36.3 16.0 Inflation (%) 10 Sep 10 Dec 11 Oct Change 11-Oct - 10-Dec (Overall) 3.2 4.5 18.9 14.4 Food Inflation 5.7 2.8 26.2 23.4 Transport Inflation 4.9 7.6 26.2 18.6 Core Inflation 0.6 0.9 10.4 9.5 Source: World Bank / Central Bank December 2011 | Edition No. 5 56 Annexes Annex 1.2: GDP Growth rates, Kenya and Sub Saharan Africa Percent 2007 2008 2009 2010 2011f* 2012f* GDP growth rate Kenya 7.0 1.6 2.6 5.6 4.3 5.0 GDP growth rate SSA 6.5 5.2 2.0 4.8 5.1 5.7 GDP growth rate World 3.7 1.5 -2.2 3.8 3.2 3.6 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 1.3: Kenya’s GDP per capita 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011f* GDP/Capita (US$) 402 397 438 461 523 611 719 774 738 760 772 GDP growth rate 4.5 0.5 2.9 5.1 5.9 6.3 7.0 1.6 2.6 5.6 4.3 Source: WDI & KNBS Annex 1.4: Sectoral Growth rates Percent Contribution to Sector/ Year GDP Growth 2007 2008 2009 2010 2011f* Agriculture (24.7) 2.3 -4.3 -2.5 6.3 3.5 Industry (15.3) 7.1 4.7 2.7 5.3 3.6 Service (60.0) 8.1 2.7 4.6 5.8 4.4 GDP 7.0 1.6 2.6 5.6 4.3 Source: KNBS Annex 1.5: Quarterly GDP Growth rates Percent Year Quarter GDP growth rate 2009 H1 2.0 H2 3.4 2010 H1 4.5 H2 6.6 2011 H1 4.5 H2f* 4.1 Source: KNBS f* - forecast December 2011 | Edition No. 5 57 Annexes Annex 1.6: GDP growth rate of other African countries Percent 2009 2010 2011f* Ethiopia 8.7 9.0 9.0 Tanzania 6.0 7.0 7.2 Ghana 4.7 6.6 13.4 Rwanda 4.1 6.5 6.5 Uganda 7.1 6.3 6.5 Kenya 2.6 5.6 4.3 SSA average 1.7 4.7 5.3 South Africa -1.8 2.7 3.5 Source: Global Economic Prospectus 2011 Annex 1.7: Kenya’s Inflation Percent Overall Food Transport Year Month Inflation Inflation Inflation 2010 January 4.7 4.1 5.2 February 5.2 7.2 5.9 March 4.5 4.5 4.3 April 3.7 3.8 4.4 May 3.9 4.4 6 June 3.5 4.6 3.9 July 3.6 4.6 3.9 August 3.2 5.5 4.8 September 3.2 5.7 4.9 October 3.1 5.6 5.0 November 3.8 6.7 5.5 December 4.5 7.8 7.6 2011 January 5.4 8.6 8.4 February 6.5 9.8 13.1 March 9.2 15.1 15.9 April 12.1 19.1 20.4 May 12.9 20.1 22.2 June 14.5 22.5 22.7 July 15.5 24.0 23.6 August 16.7 23.9 24.3 September 17.3 24.4 24.8 October 18.9 26.2 26.2 Source: KNBS December 2011 | Edition No. 5 58 Annexes Annex 1.8: Kenya’s foreign exchange rates Year Month KSH/US$ KSH/Euro 2010 January 75.8 108.3 February 76.7 105.1 March 77.0 104.5 April 77.3 103.7 May 78.5 98.8 June 81.0 99.0 July 81.4 103.9 August 80.4 103.8 September 80.9 105.6 October 80.7 112.2 November 80.5 110.1 December 80.6 106.5 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 (1st - 15th) 96.2 131.9 Source: CBK December 2011 | Edition No. 5 59 Annexes Annex 1.9: Capital markets indices Dow Jones Industrial Nairobi Stock Year Month Average Index Exchange Index 2010 January 10,067 3,565 February 10,325 3,629 March 10,850 4,073 April 11,009 4,233 May 10,137 4,242 June 10,144 4,339 July 10,466 4,439 August 10,151 4,455 September 10,860 4,630 October 11,118 4,640 November 11,092 4,528 December 11,578 4,396 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 12,231 3,382 Source: CBK & Dow Jones Industrial Average December 2011 | Edition No. 5 60 Annexes Annex 1.10: Interest rates Year Month Lending Rates Central Bank Rate 2010 January 14.98 7.00 February 14.98 7.00 March 14.96 7.00 April 14.58 6.75 May 14.44 6.75 June 14.39 6.75 July 14.29 6.75 August 14.18 6.00 September 13.98 6.00 October 13.85 6.00 November 13.95 6.00 December 13.87 6.00 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 11.00 November 16.50 Source: CBK December 2011 | Edition No. 5 61 Annexes Annex 1.11: Credit distribution to the private sector Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep 2009 2009 2009 2009 2010 2010 2010 2010 2011 2011 2011 Total Private Credit 15.4 20.2 1.8 52.4 21.1 39.9 43.7 45.5 66 90.2 114.9 Agriculture 3 -1.4 5.6 0.4 -1.1 2.4 1.9 1.2 2 5.6 5.6 Manufacturing -0.8 -3.1 1.8 -0.3 4.7 6.2 10.9 2.6 4.9 11.8 15.2 Trade -0.7 2.2 8.9 26.6 -12.2 7.5 9.5 13.7 4.7 12 19.6 Building & construction -0.9 3.4 -2.1 7.9 -9.9 -4.8 0.6 0.9 3.6 3.3 4.9 Transport & communication -1 -1.5 4.2 5.1 1.9 0.6 -6.4 0.1 3.7 11.6 7.7 Finance and insurance -0.6 2.8 -1.3 5.3 4.3 -4.4 -2.4 1.5 -1.1 2.6 2.6 Real estate 5.2 4.3 3.1 6.5 0.9 27.9 11.3 5.9 6.1 13 10.5 Mining & quarrying 3 8.1 -15.9 2.7 5.8 2.3 -0.2 -1.5 7.8 3.1 2.4 Private households -4.8 -1.4 18.4 -12.1 24.6 2.8 -0.9 6.5 15.3 13.7 16.4 Consumer durables 2.3 4.2 2.2 6.5 3.2 -4.2 2.1 5.4 5.9 1.7 7.3 Business services -3.5 12.2 -7.1 -9 4.2 8.8 8.6 4.2 -4.8 2.2 11.1 Other activities 14.1 -9.5 -16.1 13 -5.5 -5.2 8.7 5.2 17.8 9.5 11.6 Percentage Growth yoy 28.6 22.5 10.6 13.9 14.4 16.8 22.9 20.3 25.7 30.7 36.3 Source: CBK Annex 1.12: Oil price movements 2010 Pump Prices Murban oil price Year Month Petrol (Ksh/Lt) ($/barrel) 2010 January 86.24 77.50 February 86.78 74.20 March 88.52 78.30 April 90.64 84.80 May 92.40 77.90 June 92.17 74.80 July 92.23 73.0 0 August 92.86 74.60 September 96.16 75.90 October 96.73 81.50 November 98.79 85.65 December 94.05 91.85 2011 January 95.67 94.8 February 98.08 101.27 March 102.44 111.63 April 111.17 116.62 May 115.35 113.60 June 114.93 112.15 July 115.39 113.95 August 117.22 109.05 September 117.75 110.09 October 120.50 Source: KNBS, World Bank December 2011 | Edition No. 5 62 Annexes Annex 1.13: Kenya’s Fiscal position % of GDP 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Revenue and Grants 23.3 22.6 23.4 24.7 25.8 26.0 26.3 Revenues 22.0 21.8 22.3 24.0 24.5 24.7 24.9 Tax Revenues 20.2 20.4 20.6 21.9 22.2 22.5 22.7 Income tax 8.0 8.2 8.5 9.3 9.3 9.4 9.4 Value-added tax 5.7 5.7 5.8 6.2 6.2 6.4 6.5 Import duty (net) 1.7 1.7 1.7 1.7 1.8 1.8 1.8 Excise duty 3.2 3.1 3.0 2.9 2.8 2.9 2.9 Nontax Revenue 3.5 3.2 2.9 3.6 4.0 3.9 3.9 Grants 1.3 0.8 0.8 0.7 1.3 1.3 1.4 Expenditure and Net Lending 27.3 26.6 29.5 29.2 30.6 31.0 30.3 Recurrent expenditure 20.6 19.5 20.5 21.1 20.3 20.5 19.8 Interest Payments (4+5) 2.4 2.3 2.6 2.7 2.6 3.2 2.6 Wages and Benefits (civil service) 7.4 6.9 7.0 7.1 6.8 6.6 6.6 Development and Net Lending 6.7 7.2 8.7 8.0 10.1 10.2 10.2 Budget Deficit (commitment basis) -3.9 -4.0 -6.4 -4.5 -4.8 -5.0 -4.0 Public Debt to GDP (Net) 39.3 42.1 44.8 48.8 46.1 45.5 44.6 Source: Ministry of Finance December 2011 | Edition No. 5 63 Annexes Annex 1.14: Balance of Payment (September) US$ Millions Percentage growth 2009 2010 2011 2009 2010 2011 Exports (fob) 4522 5010 5760 -8.2 10.8 15.0 Coffee 199 199 218 23.6 0.3 9.2 Tea 858 1152 1131 1.5 34.3 -1.8 Horticulture 674 713 719 -11.3 5.7 0.9 Manufactured Goods 513 598 718 -17.6 16.6 20.0 Raw Materials 219 216 311 -33.0 -1.5 44.2 Chemicals and Related Products 421 408 547 -7.6 -3.0 33.9 Other 796 927 1145 -12.4 16.4 23.5 Imports (cif) 10202 11803 14483 -7.4 15.7 22.7 Oil 2040 2631 3742 -33.6 29.0 42.2 Chemicals 1314 1528 1893 -6.8 16.2 23.9 Manufactured Goods 1420 1719 2177 -7.2 21.0 26.7 Machinery & Transport Equipment 3061 3430 3958 5.0 12.1 15.4 Other 2245 2376 2525 11.3 5.8 6.2 SERVICES 3824 4720 4706 -12.0 23.4 -0.3 Non-factor services 1750 2512 2479 -17.2 43.5 -1.3 Income account -66 -82 4 -6.0 -25.1 104.8 Current Transfers account 2139 2291 2222 -6.9 7.1 -3.0 Remittances 597 619 824 -2.1 3.7 33.2 CURRENT ACCOUNT -1856 -2073 -4017 -6.4 -11.7 -93.7 CAPITAL & FINANCIAL ACCOUNT 2217 2439 3796 9.1 10.0 55.7 OVERALL BALANCE 360 365 -220 25.4 1.4 -160.4 % of GDP Exports (fob) 14.8 15.6 17.1 Imports (cif) 33.4 36.7 43.1 SERVICES 5.7 14.7 14.0 CURRENT ACCOUNT -6.1 -6.4 -12.0 OVERALL BALANCE 1.2 1.1 -0.7 Source: CBK December 2011 | Edition No. 5 64 Annexes Annex 1.15: Maize production 2009 and 2010 2009 2010 Bags (90 Kg) Bags (90 Kg) % Increase Province HA ‘000 Millions Yield HA ‘000 Millions Yield in Maize 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: Key Macro-economic indicators low case, baseline and high case scenario Variable 2007 2008 2009 2010 2011* 2012** 2013** Baseline GDP 7.0 1.6 2.6 5.6 4.3 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 4.3 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 5.2 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 *Projection **forecast December 2011 | Edition No. 5 65 Annexes Annex 1.17: Shocks: Comparing 2009 with the 2012 outlook Transmission mechanism Impact 2009 Outlook 2012 External Sector Current account deficit at 6.7 percent of Current account already high at 10 GDP. percent of GDP in 2011 from 7.8percent in 2010 could increase due to weak export performance. Monetary and Financial Sector No contagion. NPLs stand at 9 percent No contagion. Local banks are not (September 2009). dependent to significant funding from foreign banks abroad. Capital Adequacy: 19.8 percent against a statutory requirement of 12 percent. Capital Adequacy: 20 percent against a statutory requirement of 12 percent. CBK stimulated credit growth through injecting liquidity in the system and Higher interest rate may increase NPLs lowing CRR, CBR. CBK reducing liquidity through increase in CRR, repos, and signaling liquidity Banks lowered lending rates. through CBR. Foreign exchange The nominal exchange rate – as the Banks increasing lending rates. automatic stabilizer depreciated by 26percent in between June 2008 and The exchange rate has depreciated by 23 march 2009. Trade weighted NEER percent between December 2010 and depreciated by 16percent while REER September 2011. Trade weighted NEER depreciated by 7percent, has depreciated by 18.6 percent between December 2010 and August 2011 while REER depreciated by 6.8 percent. Financial flows (remittances, Remittances projected to grow by 3 Short term interest rates have risen from FDI, other flows) percent (higher than expected but below 2percent in Jan 2011 to over 14percent pre-crisis growth rates). September, short term inflows have risen by US$ 940 million in the first 7 months Net FDI expected to drop by US$500 of 2011. million (but “other financial flows� have increased). FDI which are generally low in Kenya have almost dried up since January 2011. Remittances down 9 percent. Remittances are up by 24 Percent year to July 2011. Official Flows Nairobi Stock exchange index mirrors Nairobi Stock exchange index lost 968 Dow Jones and remains more than 50 points (27 percent) since January 2011. percent below mid 2008 levels. No significant reduction in bilateral flows. No significant reduction in bilateral flows. Source: KEU team Annex A1.18: Break down of overall inflation: October 2011 30 25 20 Per cent 15 10 5 0 Source: KNBS December 2011 | Edition No. 5 66 Annexes Annex 2.1: A frame work for estimating County Levels of Economic Activity Methodology (i) We use the production approach and identify 18 economic activities as detailed in the table below (Economic activities) (ii) At the county level we use gross output as a proxy for economic activity, since it is much harder to get data on value added. For instance, in the case of agriculture, we were able to obtain data on total volume of production for most crops by geographical region. But is much harder to obtain data on wage employment and profits (value added) by agricultural activity. (iii) We develop a simple framework to estimate levels of economic activity (Y) for each county (k) : Where; is economic activity for county k activity i contribution to GDP is gross output of activity i is county k’s share in output of activity i Using this framework we develop a 47 (county) X 18 (economic activity) matrix where the row total aggregates a county’s level of economic activity ( ) and the column total gives gross output of each economic activity as follows ( ): Matrix of economic activity by county Sector / Activity County Crops Livestock … … … Manufacturing … … … … … .18 1 Total County 2 economic activity . . . . 47 National output Total sector activity This simple framework assumes that the technology of production for each activity is the same across geographic regions. However, we differentiate the technology of production for livestock which differs significantly between pastoralist and other forms of livestock farming. December 2011 | Edition No. 5 67 Annexes Economic Activities Sector Subsector Activity Agriculture Growing of crops Cereals Keeping of animals Tea Fishing Coffee Forestry Horticulture other crops Industry Manufacturing Mining & Quarrying Electricity & Water Construction Services Wholesale & Retail trade Repair of Motor Vehicles Hotels and Restaurants Transport – Land, Water, Air, Pipeline Transport & Communication Posts & telecoms Financial Intermediation Renting & business services Real Estate private Public Administration public Education private Heath and Social Work public Other social & personal services Private Households with employed persons Source: World Bank December 2011 | Edition No. 5 68 Annexes Annex 2.2: Methodology and assumptions underpinning estimate of spending on county functions The functions assigned to the national and county governments in the Constitution of Kenya 2010 are generally broad and non-specific. Using 2010/11 as simulation year, the following methodology was used for the purposes of identifying and beginning to cost county functions (using current allocations as a proxy). Step 1: Unbundle the sector functions, consistent with the Constitution of Kenya, down to specific activities and assign these to the two levels of government. Main assumptions are listed in the table below. Basic criteria underlying these assumption decisions were (1) whether the function had spillovers or services that benefited more than one county, (2) the technical complexity of the function, and (3) whether there were economies of scale in the provision of the function. Step 2: Map the expenditure items listed by Vote or Head to the functions and competencies identified in Step 1. Vote Assumptions on functions to be transferred to counties Corresponding share of the budgeted amounts Provincial Administration District Administration devolved by half of the budget to cater (01) for restructuring, taking into account the national officers who 6.6% will be coordinating functions in counties such as education or security functions. Public Service (03) Counties assumed to have their own public services, Matunga District Development which already exists can be devolved 6.8% directly OVP and Home Affairs (05) Field Services of Betting and Control though headquarter services of Betting and Control retained at the national level as a policy 0.4% setting function. Planning and V2030 (06) Rural planning, district development services and smallholders and community services devolved as part of county planning 3.6% activities. Constituency Development Constituency Development Projects assuming CDF is devolved. Projects as part of 3.6% Planning, National Development and Vision 2030 (06) Finance (07) District Treasuries and District Internal Audit to cater for the county financial management activities and infrastructure. 2.3% Regional Development River and lake basin authorities - Kerio, Tanathi, Lake Basin, Ewaso Authorities (09) Nyiro South/North, and Coast Development Authorities devolved 77.9% under county water services – though water service boards are retained at the national level. Agriculture (10) Provincial and District Agricultural and Livestock Extension Services as well as Farmers Training Stations devolved. Horticultural Crop 31.7% Development Services part of devolved functions in county crop and animal husbandry. December 2011 | Edition No. 5 69 Annexes ODPM and Local Provincial Local Government Offices and infrastructure to be Government (12) converted into facilities and services for the management of 12.5% urban services as a county function according to the Urban Areas and Cities Act of 2011. Urban Services based For the provision of urban services that LATF typically funds at the on LATF directed to county level – the financing of urban service provision has been 66% the Ministry of Local transferred to the county governments by the Urban Areas and Government (12) Cities Act of 2011. Labour (15) Micro and small scale enterprise development devolved as a function of county trade development. 13% Livestock and Provincial and district livestock services and veterinary services Development (19) devolved as county animal husbandry functions 81.4% Forestry and Wildlife (55) The portion of forestry and conservation going to the county-level implementation of national government forestry and wildlife 40.7% policies. Fisheries Development All functions except for Deep Sea Fisheries Development because (56) deep sea areas are managed nationally and do not belong to a 99.9% specific county. Medical Services (11) District and sub-district hospitals, primary facilities and primary health care programs devolved as county health services. 39.7% Public Health and Primary health care including family planning and health Sanitation (49) education, rural health and training centers devolved as county 46.9% health services. Roads (13) The portion that goes to the Kenya Rural Roads Authority and the Kenyan Urban Roads Authority is devolved as part of county 70% Road Maintenance based roads functions. on RMLF directed to 25.2% Roads (13) Transport (14) Kenya Ferry Services fully devolved as a county transport function. 7.7% Trade (16) Provincial and field trade development services devolved as county trade development functions. 12% Water and Irrigation (20) Rural, Urban and Special Water Programmes, as well as Irrigation and Land Reclamation, Flood Control Management devolved to 32.8% counties. Water Conservation and Dam Construction devolved at half the budget to cater for its concurrent delivery with the national government Cooperative Development Co-operative Management and training programs devolved as and Marketing (22) county cooperative management, trade functions. 90% December 2011 | Edition No. 5 70 Annexes Energy (30) Rural Electrification Programme devolved to support county electricity and gas reticulation, and energy regulation function. 17.1% Education (31) Early Childhood Development Education (ECDE) devolved under pre-primary education county function. 0.3% Information and Provincial and district information management and rural press Communications (32) devolved to cater for county information and communications. 2.3% Lands (36) District survey and physical planning offices and district lands offices devolved as part of county planning and development 9.2% functions in land survey and mapping. National Heritage and Managing museums and cultural activities at the county level Culture (41) including records management, languages and oral tradition, 55.7% development of performing arts and library services fully devolved. Records kept at provincial level that are considered county are devolved while the rest retained at the national level as a concurrent function. Youth Affairs and Sports Youth development and training field services especially those (42) dealing with sports as a county function, devolved. 27.9% Housing (44) County planning functions in housing including district government estates and provincial Housing management fully devolved. Slum 49.4% Upgrading and Housing Development mostly devolved apart from a portion left to manage policy for slum areas as a national concern. Tourism (46) Local (domestic) tourism devolved as a function of county trade development 2.7% Nairobi Metropolitan Half of the budget going to serve Nairobi’s status as a county Development (57) is devolved while the other half is retained national for 50% Nairobi’s function as the capital city and the house of national government. Development of Northern Northern Kenya and Other Arid Lands functions as county specific Kenya and Other Arid devolved at half the budget while the functions that deal with 50% Lands (58) aspects of national agricultural, veterinary and environmental protection retained national. Public Works (59) Provincial and district public works at half the budget to cater for concurrent functions with national public works. 49.8% Industrialization (60) Small Scale Industries Field Services fully devolved as county trade and development functions. 1.8% December 2011 | Edition No. 5 71 Annexes Annex 2.3: Fiscal gap approach to horizontal sharing and options for Kenya The textbook objective of an equitable sharing formula is to fill the ‘fiscal gap’ between expenditure needs and revenues for each sub-national government. Below is a simple depiction of how a fiscal gap formula works. 1) The first step is to define sub-national expenditure needs (this is the first element in the first equation) given the service delivery functions assigned to them and the cost of delivering these functions 2) The second step is to asses extent to which sub-national governments could meet (part of) these needs out of their own revenues (this is the second component of the first equation) 3) The job of a formula is to share the available resources fairly between individual counties, based on their relative needs: rresources available to sub-national government units (the county equitable share) are allocated among them according to the relative size of each county’s fiscal gap. (this is the second equation) How a Fiscal Gap formula works Equation 1: the fiscal gap EXPENDITURE NEEDS minus FISCAL CAPACITY equals FISCAL GAP Amount a county Revenue a county can raise Shortfall (gap) needs to deliver their using its own taxing powers, mandated functions to meet those costs Equation 2: the county share Fiscal gap of County X X County equitable share = Allocation to County X Fiscal gap of all Counties in Kenya A complex ‘fiscal gap’ formula may not be possible or the number of elderly) as well as factors influencing the cost desirable for Kenya in the near future. Firstly there are of provision (such as geography). An equal share component inherent methodological and practical obstacles to adequately could be added, whose purpose would be to reflect the fixed captured revenue capacity. Secondly, complex formulae can costs associated with running county administrations. undermine the transparency of the allocation and therefore the extent to which all citizens can understand the public Tackling the revenue side would be more difficult and finance architecture and have faith in its objectivity. This perhaps less urgent. Given (i) data limitations and (ii) the is particularly important when geographic distributional moderate extent to which counties’ own revenues are likely decisions overlap with political divisions. to contribute to overall financing of decentralized functions, seeking to equalize fiscal capacity would be needlessly complex A workable formula for Kenya and compromise the objective of transparency. Over time, estimates of fiscal capacity could be built into the formula, In the short term the CRA should concentrate its efforts on possibly relying on a single macro measure of capacity (such getting the expenditure side right first. In practice, the formula as county level GDP). If the CRA wishes to design a formula could focus on equalizing the ability of counties to provide a that accounts for own-revenues the best option in the short standard basket of services in a few critical devolved service term would perhaps be to include actual revenue collection areas. This would include factors that proxy demand for data in the formula but with a discount to minimize perverse services (from the crudest –population, poverty prevalence- incentives on revenue collection effort. to sector specific indicators –such as kilometers of roads or December 2011 | Edition No. 5 72 Annexes Annex 2.4: The impact of various thresholds on corporate management of urban areas Previously, urban centers were arbitrarily assigned corporate management status. The new Cities and Urban areas Act, sets a minimum population threshold of 250,000 residents for cities and municipal areas to have corporate bodies to manage them. In the table below. - Blue highlights show those cities that would have a corporate body under the current Act (with threshold at 250,000 - Yellow highlights show those cities that would have a corporate body if the threshold were lowered to 150,000 - All other cities would have a corporate body if the threshold were lowered to 75,000 County Urban Centre Population (2009) 1 Bomet Bomet 83,729 2 Garissa Garissa 116,317 3 Kajiado Ngong 107,188 4 Kakamega Mumias 99,987 5 Kakamega 91,768 6 Kericho Kericho 101,808 7 Kiambu Ruiru 238,858 8 Kikuyu 233,231 9 Thika 136,917 10 Karuri 107,716 11 Kiambu 84,155 12 Limuru 79,531 13 Kilifi Malindi 118,265 14 Kisii Kisii 81,801 15 Kisumu Kisumu 388,311 16 Awasi 93,369 17 Kitui Kitui 109,568 18 Machakos Kangundo-Tala 218,557 19 Machakos 150,041 20 Mavoko 137,211 21 Mandera Mandera 87,692 22 Migori Rongo 82,066 23 Mombasa Mombasa 938,131 24 Nairobi Nairobi 3,133,518 25 Nakuru Nakuru 307,990 26 Naivasha 169,142 27 Nandi Kapsabet 86,803 28 Nyeri Nyeri 119,353 29 Trans Nzoia Kitale 106,187 30 Uasin Gishu Eldoret 289,380 31 Vihiga Vihiga 118,696 32 Wajir Wajir 82,800 Source: KNBS; 2009 Population Census December 2011 | Edition No. 5 73 Naviga�ng the storm, Delivering the promise with a special focus on Kenya’s momentous devolu�on Kenya is entering a de�ning year in its history. While 2011 has already been challenging, managing Kenya’s economy will become even more difficult in 2012. Na�onal elec�ons, the establishment of a new system of devolved government and a looming global economic crisis will make the next twelve months extremely challenging. At the same �me, if Kenya manages these challenges well – peaceful elec�ons and transi�on to a new government, successful introduc�on of a new system of devolved government and con�nued growth during a global economic crisis – 2012 will be remembered as the year in which Kenya was Naviga�ng the Storm and Delivering the Promise of a more prosperous future. Kenya’s economy has already been weathering rough economic condi�ons in 2011. High food and fuel prices, the drought in the Horn of Africa, and the Euro crisis have weakened Kenya’s external posi�on, which was already fragile given the large current account de�cit. These economic challenges will lower growth to an es�mated 4.3 percent in 2011. For 2012, the World Bank projects growth to recover slightly and reach 5.0 percent, if Kenya succeeds in managing the risks. The ongoing economic crisis underscores Kenya’s structural challenges, especially its weak export performance, which has been a primary cause of Kenya’s recent macroeconomic instability and a contributor to the sharp decline in the Shilling in 2011. The turbulence in Kenya's economy coincides with implemen�ng the Cons�tu�onal blueprint for a new poli�cal and administra�ve architecture; arguably the most momentous and far-reaching reforms in Kenya's almost ��y year history. At the heart of this transforma�on is the devolu�on of power to county governments, and the design of arrangements that will turn the cons�tu�onal vision into a reality. Kenyans bring to this process tremendous enthusiasm and energy, but the devil lies in the detail. The speci�c design of �scal architecture, accountability systems and the management of this massive transi�on will determine whether Kenya can weather the economic storm in a way that enhances social equity, service delivery, ci�zen engagement, and so deliver the promise of ins�tu�onal transforma�on. The World Bank Hill Park Building Upper Hill Road P. O. Box 30577-00100 Nairobi, Kenya Telephone: +254-020-322 6000 Fax: +254-020-3226382 Website: www.worldbank.org/kenya/keu THE WORLD BANK Photo credits: Cover page © World Bank/Phillip Jespersen and page 17 © World Bank/Kenya Country office Design by Robert Waiharo