The macroeconomic performance of the Kenyan economy improved significantly in 2010 compared with 2009. While the economy grew by 2.6% in 2009, it is estimated that the growth rate of gross domestic product (GDP) nearly doubled to reach 5.0% in 2010. The increase in growth can be attributed to the good rainfall during 2010 and higher prices for Kenyan exports on world markets. The abundance of agricultural output, coupled with increased competition in some key services, helped contain inflation in 2010. However, the Kenyan economy faces two challenges: diversification and the reduction of its dependence on the vagaries of nature.

The outlook for 2011 is promising and a combination of trends could contribute to ensure positive prospects in the short to medium term. The approval of the constitution, continued investment in infrastructure and government policies targeting development in the private sector should all enhance Kenya’s business environment and reinforce a dynamic private sector. Second, deepening regional integration and the launch of the East African Community common market are creating a single trading and investment environment in which Kenyan firms to have access to a larger market. Last, prudent monetary and fiscal policy is expected to reduce inflation and keep interest rates low, creating a credible and stable macroeconomic environment. Given these prospects, the Kenyan economy is forecast to grow by 5.3% in 2011 and 5.5% in 2012.

This positive outlook may however be subject to two main challenges. First, Kenya will need to reduce its high reliance on agricultural outputs to limit its vulnerability to climate hazards by diversifying the economy. Second, Kenya may be vulnerable to another political shock as it faces 2012 elections. Contributing further to the uncertainty weighing on the political environment is the indictment of six high-level Kenyan officials – including the current finance minister and deputy prime minister – by the International Criminal Court for alleged crimes connected to the 2007 post-election violence.

Table 2: GDP by sector (in percentage)

Source:Data from Kenya National Statistics Bureau.

Figures for 2010 are estimates; for 2011 and later are projections.

Table 3: Demand composition

Source: Data from Kenya Central Bureau of Statistics (KNBS) and Ministry of Finance; estimates (e) and projections (p) based on authors’ calculations.

Figures for 2010 are estimates; for 2011 and later are projections.

Fiscal Policy

In 2010, the government continued to implement its economic stimulus programme, funding public projects in agriculture, services, infrastructure, health and education as well as various community-based initiatives through the Constituency Development Fund and Group funds (Youth and Women fund). To mitigate the impact of multiple shocks, the government eased its macroeconomic policies. The deficit of the primary balance increased from 3% of GDP for the fiscal year 2008/09 to 3.2% in 2009/10. It is expected to deteriorate further down to a deficit of 4.1% of GDP for fiscal year 2010/11. The overall deficit also grew from 5.4% of GDP in 2008/09 to 5.8% in 2009/10 and is forecast to increase to 6.8% in 2010/11.

Total revenue collection and grants increased to 24.9% of GDP in the fiscal year 2009/10, from 23.3% of GDP in 2008/09. Government total expenditure and net lending followed the same path, increasing from 28.7% of GDP in 2008/09 to 30.8% of GDP in 2009/10. Total government expenditure for the fiscal year 2009/10 increased by 21.7% amounting to KES 725.2 billion, against a target of KES 791.4 billion. The shortfall was attributed to lower absorption in both recurrent and development expenditures by the ministries. On the one hand, recurrent expenditure amounted to KES 510.5 billion, against a target of KES 536.3 billion, therefore representing a 95% execution rate. The lower-than-targeted recurrent expenditures mainly emanated from the operations and maintenance expenditures. On the other hand, development expenditures were executed at 84% compared with the target.

Cumulative external financing at the end of the 2009/10 fiscal year represented a net borrowing of KES 22.4 billion compared with KES 11.7 billion in 2008/09. Total disbursements including appropriations in aid amounted to KES 39.8 billion against a target of KES 66.5 billion. Public debt increased from KES 1 075.7 billion by the end of September 2009 to KES 1 294.4 billion by the end of September 2010.

From January to September 2010, domestic debt increased by 28% compared with a similar period in 2009. The stock of Treasury bills increased by 5.8% while Treasury bonds increased by 24.5%. External public debt increased from KES 525.5 billion in December 2009 to KES 589.7 billion in September 2010. The Fitch Rating for 2010 remained B+ for long-term foreign debt, B for short-term foreign debt and BB- for domestic long-term foreign debt.

Cumulative debt service payments to external agencies, as of the end of September 2010, amounted to KES 8.6 billion: 81.2% in principal and 18.8% in interest. For the first quarter of the fiscal year 2010/11, government expenditure on interest and other charges on domestic debt increased to KES 16.2 billion from KES 14.1 billion in the first quarter of the fiscal year 2009/10. For the current fiscal year 2010/11, budget estimates are that government domestic borrowing will amount to 3.8% of GDP while external borrowing shall account for 3.0% of GDP. Gross domestic debt-to-GDP ratio is projected to increase from 24.2% in June 2010 to 27.1% in June 2011.

For the fiscal year 2010/11, the government plans to contain the increase in expenditures through improved public financial management while maintaining strong revenue collection. In addition, the composition of expenditures will be shifted from recurrent to capital expenditures. For 2010/11, total government revenues and grant should represent 24.5% of GDP. Overall expenditures are projected at 31.3% of GDP. The overall recurrent expenditures are targeted at 21.3% of GDP, an increase from 20.9% of GDP recorded in fiscal year 2009/10. Current expenditures are projected at 21.9% of GDP, compared to 20.3% of GDP in 2009/10. Additional expenditures are targeted at supporting infrastructure by reducing the cost of doing business and encouraging private sector investment.

The overall fiscal deficit (after grants) is expected to worsen from the equivalent of 5.8% of GDP in 2009/10 to 6.8% of GDP in 2010/11. The government plans to cover it by net external financing of 3% of GDP and domestic borrowing of 3.8% of GDP, including domestic infrastructure bonds on 1.1% of GDP. Over the medium term, the government expects to take the fiscal deficit down to about 5% of the GDP and to bring the debt-to-GDP ratio towards 45%. The debt management strategy will aim to diversify sources of financing by emphasising long term maturities and concessional loans.

Table 4: Public finances (percentage of GDP)

Table 5: Current account (percentage of GDP)

Source:Data from CBK data; estimates (e) and projections (p) based on authors’ calculations.

Figures for 2010 are estimates; for 2011 and later are projections.

Figure 2: Stock of total external debt (percentage of GDP) and debt service (percentage of exports of goods and services)

Kenya’s historical trade partners are mainly located in Europe (the UK, Germany and the Netherlands) and East Africa (Uganda and Tanzania).  The US seems to have played a minor role in trade relations prior to 1999. Pakistan and India have persistently increased their share of trade over time. For its exports, Kenya has concentrated on the African markets with Rwanda and Egypt as key targets. For imports, Kenya has of late increased its trade relations with the US, South Africa, Saudi Arabia, the UAE, Iran, Japan, Singapore and China. Regarding investment, the country has had one of the most open regimes for FDI in Africa since its independence. The main historical sources of investment have been the UK, Germany and India as well as other European countries such as Italy, the Netherlands and France.

India’s relations with Kenya started before independence with the voyages of merchants. Indira Gandhi participated in the country’s independence celebrations in 1963. In 1981, the two countries granted each other Most Favoured Nation status under an India-Kenya trade agreement. In 1989, an India-Kenya Double Taxation Avoidance Agreement was signed. Recently, investment and trade partnerships between the two countries have culminated in a wave of new investment. Petrochemicals and chemicals, telecommunications and floriculture are the sectors in which Indian firms have been investing the most. Recent investments by Indian firms include Bharti Airtel (telecom), Essar (telecom and refining), Tata Africa (cars, pharmaceuticals, information technologies, etc.) and Reliance (petroleum products).

In 2010, India is Kenya’s sixth largest trading partner. Kenya mainly exports vegetables, soda ash, tea, metal and leather to India and imports pharmaceuticals, machinery, steel products, automobiles and power transmission devices. Indian official development assistance (ODA) is limited and comes in the form of loans and credit. A loan of INR 50 million (Indian rupees) was granted to the government of Kenya in 1982 in addition to lines of credit offered by EXIM Bank of India to the Industrial Development Bank. In November 2010, during the visit of the Kenyan prime minister to India, an agreement granting a line of credit of USD 61.6 million from EXIM Bank of India to the government of Kenya to be utilised in the power transmission sector was signed. As part of the Indian co-operation, more than 100 scholarships are offered by the government of India each year to Kenyan nationals.

Since the early 2000s, Kenya has been building new economic partnerships with African, Middle Eastern and Far Eastern countries. Since the Narc government took over in January 2003, its policy has targeted the intensification of trade relations with Eastern countries. The government has entered into trade and economic partnerships with five countries in the Middle East and Asia (China, Iran, UAE, Japan and Singapore) but the key economic partner is China.

China was the fourth country to recognise Kenya’s independence in 1963. It considers Kenya as a gateway to Africa. New enhanced economic relations between Kenya and China began in 2005 with President Kibaki’s visit to China. The trip culminated with a five-part agreement covering: ODA for infrastructure and energy, extended aviation services, technical assistance for assessment and industrial products’ classification and standards, and modernisation of equipment at the Kenya Broadcasting Corporation (KBC). As a direct consequence of these agreements, Kenya’s imports from China grew by 224.5%, from KES 23.0 billion in 2005 to KES 74.5 billion in 2009. Imports from China between January and November 2010 amounted to KES 110.1 billion making China the first origin of imports before the UAE (KES 108.4 billion) and India (KES 82.9 billion).

Chinese direct investments in Kenya also escalated. Between 2004 and 2007, China invested a capital of KES 2.5 billion. In 2009, FDI from China culminated to KES 530 million up from KES 53.4 million in 2008. Chinese companies are active in construction, tourism and manufacturing. There are currently 96 investment projects undertaken by the Chinese, mainly road construction projects, employing a workforce of about 9 000 Kenyans. An increasing number of small to medium-sized Chinese firms specialising in auto repair and maintenance, home furnishings, construction equipment and agricultural machinery have also settled in Kenya.

China provides monetary and non-monetary aid to Kenya, exclusively on a project basis. It supports infrastructure, equipment and plants, academic and technical training, human relief and tariff exemption. The share of Chinese aid became significant in 2002 when it exceeded 1% of total development assistance received by Kenya. In 2005, the share of Chinese development assistance rose to 8.25%, placing China second among bilateral donors. China’s development aid policy differs from Kenya’s traditional partners by its greater flexibility in accommodating internal political constraints. No pre-conditions are imposed on the attribution of aid. The assistance is only tied to the formal recognition of Chinese Taipei under the One China Principle and to the use of Chinese companies and procurement of material.

Trade between the UAE and Kenya is growing very fast. Between 2004 and 2009, Kenyan exports to the UAE have increased from KES 2.4 billion to KES 10.7 billion, representing a 347% increase. However, most of the trade favours the UAE since Kenya imports significantly more. Between 2005 and 2009, imports from the UAE increased by 42.8% from KES 62.8 billion to KES 89.7 billion. In addition to being Kenya’s major supplier of oil, the UAE has emerged as a favoured shopping destination. Kenyans travel there regularly to purchase household and office electronic appliances, automobile spare parts and motor vehicles. Even though the UAE largely contributes to imports and exports, it does not contribute at all to foreign direct investments.

Israel is a notable emerging investment partner. While foreign direct investments coming from Israel amounted to KES 800 million between 2004 and 2008, and to only KES 78 million in 2009, these flows increased dramatically in 2010 – approaching KES 4 billion. Overall, Israel contributed to the creation of 701 local jobs between 2004 and 2010. It has continually invested in the agricultural sector over the years, mainly in agricultural machinery and irrigation.

Trade and investment relations between Australia and Kenya have been limited but Australia began to show an interest in Kenyan minerals and petroleum resources industry in 2010. Flow Energy Limited entered the Kenyan coast to explore the possibility of oil and gas in Lamu. This represented a large part of Australia’s investment in Kenya in 2010, which amounted overall to KES 16 billion. With the prospect of oil, Australia is posed to be a major investor in Kenya. An oil agreement between Kenya and Iran, in which Iran offered to sell oil to Kenya at better prices, caused an upward leap in trade in 2007.

The irregularities of the 2007 elections caused a wave of violence throughout the country. In 2008, a power-sharing agreement was signed between President Kibaki and the opposition. In April 2008, a 42-member coalition cabinet was sworn in that included new ministries for co-operative development, Northern Kenya development and Nairobi metropolitan development. A reform agenda was part of the power-sharing agreement. The aim of the constitutional reform is to reinforce the effectiveness of the system of checks and balances. The Constitutional Review Act of December 2008 launched the process of constitution drafting. In August 2010, Kenyans voted on a referendum for the new constitution. The constitution received broad support and was approved by 66.9% of the voters.

The new constitution maintains Kenya’s presidential system but establishes additional checks and balances on executive power and envisions a process of decentralisation. The decentralisation process as well as the implementation of check and balances will take place progressively through the passage of further acts over the five coming years. The International Criminal Court (ICC) is investigating alleged crimes committed during the 2007 post-election violence. On 15 December 2010, the ICC indicted six high-level Kenyan officials, including the current finance minister and deputy prime minister. The outcome of these indictments, as well as the 2012 elections, poses risks for Kenya’s economic outlook.

On the governance side, the country ranked 26th on the 2010 Ibrahim Index of African Governance published by the Mo Ibrahim Foundation. It scored poorly on personal safety, accountability and corruption, and infrastructure. There have been numerous calls for improved transparency in the public sphere. The finance ministry has acknowledged that corruption diverts a large share – about one third – of the national budget, leaving fewer resources for the targeted communities. The country scored 2.1 out 10 on a scale from 10 (highly clean) to 0 (highly corrupt) on the 2010 Corruption Perception Index calculated by Transparency International. Kenya ranks 154th out of 178 countries.

Modest progress has been made towards achieving most of the Millennium Development Goals (MDGs). The country is considered off-track when it comes to eradicating extreme poverty (MDG 1) by 2015 though the percentage of population below the poverty line did drop from 56.0% in 2000 to 46.9% in 2008/09. High inflation rates between 2003 and 2009 have eroded the purchasing power of the population, dramatically affecting the poor and most vulnerable. Persistent poverty and unemployment, particularly among youth, remain major challenges.

Kenya’s Human Development Index (HDI), where 0 is the lowest score and 1 the highest, has increased from 0.464 in 2009 to 0.470 in 2010, compared with 0.389 in sub-Saharan Africa and 0.624 in the world. The country belongs to the group of those where human development is low ranking, 128th out of 169 countries. The Youth Development Index (YDI) evaluates the degree of inclusion and social integration of youth in education, health and income. Kenya’s YDI is slightly above its HDI at 0.5817 in 2009. Looking at the composition of this index, income appears to be the major challenge with Kenya’s Youth Income Index at 0.44. To address the issue of youth being unemployed and lacking skills, the government has formulated the National Youth Policy and established the National Youth Council.

Kenya is very likely to achieve universal primary education (MDG 2) by 2015 with an adult literacy rate of 73.6% in 2010 and a combined gross enrolment ratio in education of 59.6%. The number of mean years of schooling for adults is 7 years and expected years of schooling of children is 9.6 years. To improve access to quality education, the government invested in free primary education and free tuition in secondary schools in 2009/10 and plans to allocate an additional KES 2 billion to these programmes in 2010/11. Kenya could possibly achieve MDG 3 – to promote gender equality and empower women – if some changes are made. The new constitution affirms the right for men and women to be treated equally and benefit from equal opportunities. As part of the new constitution, each one of the 47 counties will elect a woman MP. As a result, at least 16% of all members of parliament will be women. This represents an improvement from the 2007 elections where only 15 women were elected as members of parliament.

Kenya made progress towards reducing child mortality (MDG 4) even though it probably will not be sufficient to achieve this goal fully by 2015. Infant mortality has been significantly reduced – from 77 per 1 000 live births in 2003 to 52 per 1 000 in 2009 – and immunisation coverage increased to 77% in 2008/09 from 57% in 2003. When it comes to improving maternal health (MDG 5), Kenya’s maternal mortality rates actually worsened between 2003 and 2008/09, reaching 488 per 100 000 in 2008/09. Major progress is needed to get Kenya back on track.

Despite the progress achieved towards combating HIV/AIDS and malaria (MDG 6), these diseases remain major issues for Kenya. The overall prevalence of HIV in Kenya was estimated to stand at 7.4% among persons aged 15-64 in 2008. Prevalence among women in this group was 8.7% while among men the rate was 5.6%. It was estimated that Kenya has 1.33 million Kenyan adults infected with HIV. Since 2007, malaria has remained the most common and severe ailment in terms of morbidity and mortality. It currently accounts for 20% of all admissions to health facilities in Kenya. Malaria was estimated to cause 20% of all deaths in children under the age of 5 in 2010. Out of a population of 39 million Kenyans, 25 million are currently at risk of getting malaria.

Health care provision in Kenya is a central theme in the government’s social sector expenditure. Public expenditure on health has increased significantly since the fiscal year 2007/08. It increased from KES 23.8 billion in 2007/08 to KES 30.5 billion in 2009/10. However, the provision of health services in Kenya remains generally suboptimal. It is currently estimated that 50% of health facilities lack electrical power, water and sanitation services. The doctor-patient ratio is 17 per 1 000 while the nurse-patient ratio is 120 per 1 000. Preliminary results for the Kenya health and demographic survey (KHDS), released in 2009, indicated that the total fertility rate for Kenyan women aged between 15 and 49 declined from 8.1 in 1975 to 4.6 in 2008. In its 2010/11 budget, the government planned to allocate KES 1 billion for the recruitment of 15 additional nurses and 5 public health technicians in each constituency.