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Growth Recovery in Kenya: What Caused it and How Can it be Sustained Praveen Kumar AFTP1 September 29th, 2008 Presentation Outline I. II. III. IV. Kenya’s Growth experience Analysis of drivers of recent trends Constraints to accelerating and sustaining growth Outline of a growth strategy 2 Overall message Macro framework reasonably sound, fiscal well-managed Micro-reforms are working. Key growth challenges are: Keeping political risk low Using fiscal space wisely to scale-up infrastructure services Reducing micro-risks such as corruption, security 3 Growth bypassed Kenya even as it accelerated in neighboring countries… Trends in annual GDP growth (Real LCU) 10% 9% 8% 7% Mozambique Uganda Tanzania 6% 5% Kenya 4% Mauritius 3% 2% 1% 0% 1991 1993 1995 1997 1999 2001 2003 2005 4 % …but recovered strongly after 2003 8 7 6 5 4 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 (est) Year 5 0 Financial Intermediation Transport and Communication Hotels and restaurant Wholesale and Trade Construction Manufacturing Agriculture and Forestry GDP growth (percent) 20 15 1.4 1.2 10 1 0.8 0.6 5 0.4 0.2 Contribution (percent) Recovery was broad-based 1.8 1.6 % Change (annualized) 0 Contribution to Change in total GDP (annualized) 6 Investment grew in an impressive manner… Annual Percentage Change in Expenditure on GDP (constant 2001 prices) 2003 2004 2005 2006 2007* Government Consumption 6.0 0.6 -0.6 1.5 7.2 Private Consumption 2.2 2.4 6.4 7.6 7.3 Gross fixed Capital Formation -8.0 7.3 27.8 18.5 13.3 Exports of Goods and Services 7.2 12.8 9.7 3.4 6.0 Imports of Goods and Services -0.1 12.3 15.0 18.2 12.7 Source: Economic Survey 2008, KNBS. (*) Provisional 7 for example, Imports of Machinery and Transport Equipment Increased (% of Gross Domestic Expenditure) % of gross domestic expenditure 16.0 12.0 machinery and industrial transport machinery 8.0 industrial transport equipment 4.0 0.0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 year 8 TFP also improved Contribution to GDP per unit of labor change (%) Period Average Annual Change in GDP per unit of labor (%) Physical capital Human Capital TFP 1960-1980 3.0 0.4 0.8 1.8 1981-1990 0.7 -2.0 0.1 2.6 1991-2000 -1.2 -1.1 1.0 -1.1 2001-2007 1.6 0.9 0.1 0.5 2003-2007 2.4 1.0 0.1 1.3 1960-2007 1.4 -0.4 0.6 1.2 Source : Staff calculations. GDP, investment, and Labor Force data are from World Development Indicators database, World Bank. Capital stock data are from Nehru and Dhareswar (1995). Factor shares in GDP are based on Economic Surveys. KNBS. 9 Three drivers of positive trends after 2003: Lagged benefits of liberalization of price, trade, exchange rate & interest rate forced by reduced aid after the Goldenberg scandal uncovered in 1992; Solid foundation for solvency based on significant revenue collection as a payoff to the reform of tax policy & administration which started in the mid1990s; & critically; Declining political risk after the successful 2002 elections fueling an improvement in sovereign creditworthiness & the private investment climate; 10 Driver 1: Economic liberalization in the mid 1990s Era of price controls ended; Import licenses abolished, tariff structure simplified – average tariff reduced; Unified, market-based exchange rate adopted and exchange controls lifted; KRA established, tax reforms introduced; Agricultural marketing liberalized; Major spur for reform was: the need to establish macro credibility in the wake of the Goldenberg scandal, and the reduction of aid. 11 Driver 2: Sustainable trajectory of public debt 80 70 Debt to GDP ratio Domestic debt External debt 60 50 40 30 20 10 0 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 12 What lowered the debt ratio? Debt decomposition Factors Explaining Falling Indebtedness 1996/97-2006/07 (% points of GDP, annual average) 1996/97 - 2002/3 2003/04 - 2006/7 1996/97 - 2006/7 -1.8 -5.8 -3.2 1. Primary Deficit (- surplus) -1.7 -0.1 -1.1 2. Real GDP growth -1.4 -2.8 -1.9 3. Real interest rate 2.1 0.3 1.5 4. Real exchange rate (- appreciation) 0.6 -2.5 -0.5 5. Other Factors -1.4 -0.7 -1.1 Change in public sector debt Contribution from 13 Solid foundation for solvency – Revenue mobilization Significant reforms in tax policy Improved tax administration 30.5 25.5 20.5 15.5 10.5 Revenue, excluding grants Import Duty Income Tax Excise Duty VAT 2006/07 2005/06 2004/05 2003/04 2002/03 2001/02 2000/01 1999/00 1998/99 1997/98 1996/97 0.5 1995/96 5.5 14 Driver 3: Decline in country risk Cost of domestic borrowing declined Sovereign risk ratings improved Reduced perception of risk by firms 15 Driver 3: Decline in country risk: Cost of domestic borrowing Interest Rate Decomposition (In percent) 1999 2000 2001 2002 2003 2004 2005 2006 2007 13.3 12.1 12.7 8.9 3.7 3.0 8.4 6.8 6.8 U.S. Treasury Bill 4.7 5.8 3.5 1.6 1.0 1.4 3.2 4.7 4.4 Difference 8.6 6.2 9.3 7.3 2.7 1.6 5.3 2.1 2.4 Actual KSh./US$ depreciation 17.8 7.0 0.7 -1.9 -1.2 1.6 -6.4 -4.1 -9.7 EMBI Africa (In Basis Points) .. .. .. 529 232 177 145 74 166 1,338 2,037 1,426 2,276 732 667 523 481 .. .. .. .. 238 141 95 85 85 164 824 756 731 765 418 356 245 169 239 91-day Treasury Bill -Nigeria -South Africa EMBI + Spread (In basis points) Source : Central Bank of Kenya; International Financial Statistics; JP Morgan; and, Staff Estimates 16 Decline in country risk Sovereign risk ratings ICRG* Institutional Investor** 80 II rating 30 60 25 20 15 Month-year 10 Se p97 Se p98 Se p99 Se p00 Se p01 Se p02 Se p03 Se p04 Se p05 Se p06 Se p07 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 40 Jan-95 ICRG Rating 35 Kenya Uganda month-year Mozambique Tanzania Zambia *Scale 0 to 100, with 100 as lowest risk. **Scale of zero to 100, with 100 representing the least chance of default 17 Reduced perception of risk by firms Percent of Manufacturing Firms Perceiving Issue as Being a Major or Severe Constraint to Business Issue 2003 2007 Crime, Theft and Disorder 69 59 Tax Rates Electricity Corruption Transportation 69 47 73 36 56 55 54 53 Practices of Competitors in Informal Sector Tax Administration Customs and Trade Regulations 64 52 40 50 50 42 Telecommunications Business licensing and Permits 45 13 28 28 Macroeconomic Instability Access to Finance Political Instability Access to Land Labor Regulations Inadequately Educated Labor Force Source : Kenya ICA, 2003 and 2007. 50 71 47 23 22 31 28 26 18 16 16 11 18 What can be done to accelerate and sustain growth: Multi-pronged analysis Growth diagnostics Cross – country benchmarking A stylized (real) macro-model (MAMS) Use of ICA Sectoral analysis: Tourism, ICT, agriculture 19 Key results from Growth Diagnostics Cost of finance is not a binding constraint in Kenya currently Scarcity of human capital is not a binding constraint currently High cost of infrastructure services - energy, ports etc hurting returns Macro risk receded, but micro-risks (corruption, security situation) deterring investment 20 Evidence of high business costs from ICA 2007 Cost of crime, security, bribes, and lost production are several times higher in kenya than in other countries Cost as % of sales Kenya (2007) China (2002) India (2006) S. Africa (2003) Senegal (2003) Tanzania (2006) Uganda (2006) Production lost due to crime 3.9 0.3 0.2 0.6 1 1.1 1 Payment for security 2.9 0.8 1.3 0.9 1.5 2.3 1.4 Bribes 3.6 1.9 2.1 0.3 0.4 3.4 3.7 Production lost in transit 2.6 1.2 0.8 0.8 n.a. 1.6 1.2 Production lost due to power outages 7.1 2 7.8 0.9 5.1 10.7 10.2 Total costs 20.1 6.2 12.2 3.5 n.a. 19.1 17.5 Source : ICA, 2007 21 Cross-country benchmarking on deeper determinants of growth Indicators used by Johnson, Ostry and Subramanian (2007) Institutions – broad political and economic Extent of integration into global economy Two sets of countries Fast-growing SSA countries that are not resourcerich, not post-conflict 12 Sustained Growth economies 22 Benchmarking Institutions: Kenya does OK on indicators of broad political and economic institutions Indicator (range) A higher value indicates… Fast growing SSA countries – average (year) Sustained growth countries– average (year) Constraint on the executive (1–7)a More constraint 3.9 (2004) Economic risk (1–50)b Lower risk 31 (2002) 31.7 (1984) 33 (2002) Investment risk (1–12) Lower risk 8.1 (2006) 7.1 (1996) 9.5 (2006) Control of corruption (1–6)c Higher control 2.4 (2005) 3.4 (1996) 1 (2005) Income inequality–Ginid Higher inequality Source: Johnson, Ostry, and Subramanian (2007). a. Polity IV database. b. ICRG database. c Normalized Kaufmann-Kraay index. d. WDI database. 49 2.2 (T)e Kenya (year) 39.5 (T) 6 (2004) 43 23 Benchmarking Institutions: Kenya has high social fractionalization Indicators of Social Fractionalization, Fast-Growing SSA Countries, Sustained Growth Countries, and Kenya Indicator Fast-growing SSA countries average Sustained growth countries average Kenya 0.72 0.3 0.83 0.75 0.33 0.85 0.53 0.68 0.76 0.3 0.32 0.29 0.7 0.86 0.89 0.54 0.42 0.78 Ethnica Ethnic b b Religion Ethnicc Linguisticc Religion c Source : Johnson, Ostry, and Subramanian (2007). Note : A higher value represents higher fractionalization. a. Easterly and Levine (1997). b. Fearon (2003). c. Alesina and others (2003). 24 Benchmarking macro and trade policy and outcomes: Kenya looks not bad Macroeconomic and Trade - Policies and Outcomes, Fast-Growing SSA Countries, Sustained Growth Countries, and Kenyaa Measure Fast-growing SSA countries average Sustained growth countries– average Kenya Total exports to GDP 25.1 19.1c 24.7 Manufacturing exports to GDP 4.8 2.2 3.2 Apparel, footwear, textiles exports to GDP 3.9 1.1 0.5 Fuel and ore exports to GDP 3.1 4.2 3.1 Agriculture and food exports to GDP 7.3 7.8 7.7 Trade restrictiveness (0– 1)b 0.9 0.4 1 Balassa-Samuelson average currency overvaluation 10.8 -17.7 9.4 Largest consecutive spell of overvaluation in years since 1970 15.4 6.4 21 Average overvaluation during largest spell 43.8 11.4 16.9 Inflation 7.3 14.6 10.3 Aid to GDP 13.3 4.7 (T -4 to T +5) 4 Source : Johnson, Ostry, and Subramanian (2007). a. Average for years after 2000 unless otherwise indicated. b. Sachs-Warner measure updated by Wacziarg and Welch (2003). It is a dummy variable, with 1 indicating fully open trade. c. All export outcomes for sustained growth countries are averages for T to T+4. 25 Benchmarking extent of integration into global economy: Kenya’s low integration Trends in Shares of Exports in Total GDP, Sustained Growth Countries and Kenya, 1960-2005 100 Vietnam 90 Ireland Thailand Mauritius Taiwan Korea 70 60 50 China Kenya 40 Chile 30 20 10 2005 2002 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 1969 1966 1963 0 1960 % of country's real GDP 80 26 Benchmarking extent of integration into global economy: Kenya’s declining competitiveness Shares in World Exports of Goods and Services, High Performing Economies (HPEs) and Kenya, 1975–2005 0.18 20 HPE goods (right axis) 16 14 0.12 0.10 HPE services (right axis) 0.08 12 10 8 0.06 Kenya services (left axis) 0.04 4 2 2005 2003 0 2001 1999 year 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 0.00 1997 Kenya goods (left axis) 0.02 6 percent of World exports 18 0.14 1995 percent of World exports 0.16 Source: Staff calculations, based on COMTRADE data. Averaged using SITC2 3-digit classification. 27 Benchmarking sophistication of exports: Low sophistication EXPY (Proxy for Degree Sophistication), Sustained Growth Economies and Kenya, 1992-2003 18000 Ireland 16000 Japan Singapore Korea, Rep. 12000 China Thailand 10000 8000 Botswana Chile 6000 Mauritius 4000 Kenya 2003 2002 2001 2000 year 1999 1998 1997 1996 1995 1994 1993 2000 1992 $ per capita 14000 28 A stylized (real) macro-model (MAMS) Real Macro Indicators by Simulation (% annual growth from 2006-2030) base base+g ns base +fdi base +aid v30gradual v30fast Absorption 5.0 6.5 5.4 5.7 8.8 9.2 Consumption-private 4.8 6.0 5.0 5.5 8.1 8.5 2.5 3.6 2.6 3.1 5.6 6.0 Consumption-government 5.4 6.4 5.9 5.8 7.6 7.8 Fixed investment-private 4.6 8.3 5.9 5.9 11.8 12.3 Fixed investment-government 6.5 8.0 7.2 7.2 10.5 10.8 Exports 5.0 7.5 6.5 5.5 10.6 11.1 Imports 5.0 7.0 5.6 5.8 9.7 10.2 GDP at market prices 5.0 6.6 5.6 5.6 9.0 9.4 GDP at factor cost 5.0 6.6 5.6 5.6 8.9 9.4 Total factor employment 3.9 5.3 4.5 4.4 6.4 6.6 Total factor productivity (TFP) 1.1 1.3 1.2 1.1 2.6 2.7 ICORa 3.8 4.0 3.8 3.8 3.3 3.3 Real exchange rate -0.1 0.0 0.2 -0.2 -0.4 -0.4 Consumption-private per capita 29 Outline of growth strategy Keep political risk low – address issues of social and political cohesion Sustain macro-stability Preserve favorable government debt dynamics and use available fiscal space to finance only high-return projects Strengthen institutional framework for project selection and subject capital projects to systematic economic analysis Reduce high costs of backbone services: Logistics costs, particularly of trading across borders Transportation costs Telecommunications and energy costs 30 Outline of growth strategy Improve global integration of Kenyan economy. Towards that: Deepen regional integration, BUT Focus on global competitiveness beyond the region: Use membership of trade groups – EAC and COMESA – to further improve openness Liberalize unilaterally where possible Use multilateral route for securing access to protected Asian markets Maintain a competitive real exchange rate Proactively provide solutions to government/market failures in key export sectors Example ICT Example Tourism 31