IMF Africa Regional Economic Outlook 2010 Some Discussion Points by Njuguna Ndung’u Governor, Central Bank of Kenya October 25, 2010

Overall Thrust of the Report General Agreement with the main findings of the report that Sub Saharan African (SSA) countries growth performance likely to bounce back to pre-crisis level of above 5 percent in 2010/11. SSA Economies withstood this crisis better than previous crises because of better macroeconomic management pre-2008 i.e. steady growth, low inflation, good debt management: Kenya’s case… Future SSA growth (in 2011 and 2012) still contingent on recovery in advanced countries The policies implemented by most SSA countries to mitigate the negative shocks of global financial crisis were the correct ones e.g. Running down the foreign reserves Allowing exchange rate to depreciate to offset the impact of external shocks (automatic stabilizer) Fiscal stimulus to stabilize growth Accommodative monetary policy - lowering policy rates and providing liquidity to banks But above all did not cut development spending – so did not sacrifice long-run capacity for growth But, African countries can be classified as: 1) Coastal Resource Rich 2) Coastal Resource Poor 3) Land-locked Resource Poor 4) Land-locked Resource Rich – Each with different growth experience and resilience. We can parade policy outcome/mapping and perhaps tell the policy/resource story more forcefully. 2

Effects of the Crisis Still Being Felt in SSA Demand and prices of Commodity Exports still lower than Pre-crisis level Commodity exports that had been one of the main drivers of growth in many SSA countries dropped Crisis had led to lower demand for African Exports Key commodity prices have fallen to 2007 levels or even lower The crisis has taken a heavy toll on countries that are highly dependent on natural resources (e.g. copper, oil, timber and diamonds) The fall in copper and diamond prices has resulted in a significant drop of export receipts for Zambia and Botswana, respectively

Commodity Prices have not Recovered Downward Slide in Commodity Prices (source AfDB) 4

Kenya’s Experience Through weakening of local currencies, declining reserves and stock exchanges Depreciation as a result of non-resident outflows from equity and bond markets (“Flight to Safety”). The market-determined or flexible exchange rate acted as an automatic stabilizer during this crisis in most African economies Weakening of Stock Exchanges as a result of Outflow of non-resident funds and unfavorable investor sentiments: about global recession and negative impact on domestic economies Drawdown of foreign exchange reserves The law requires 4 months of import cover [EAC convergence criteria requires 6 months import cover] Kenya went to as low as 2.7 months of import cover But this is what forex reserves are for, accumulate in good times and cushion against shocks and drawdown in bad times 5

Economic Performance: Kenyan Economy’s Vulnerability to Shocks Period Quarter on Quarter Growth Remarks 2008Q1 1.3 Political violence shock 2008Q2 2.4 Recovery quarter 2008Q3 2.7 2008 Q4 -0.1 Drought – Agric growth -5.7% 2009Q1 5.6 Agric growth -1.4%, hotel +158% 2009Q2 0.9 Drought - Agric growth -4.4 2009Q3 0.5 Drought - Agric growth -3.5 2009Q4 3.6 Agric growth -1.2 2010Q1 4.8 Agric growth +6.5 2010Q2 5.4 Agric growth +5.8% Source: KNBS Economic performance vulnerable to internal and external shocks in 2008, 2009 Performance of primary sector (agriculture or commodity exports critical to most African economies) 2010 when Agriculture recovers, the economy does well Agriculture, manufacturing , Construction and Electricity driving growth in 2010 6

Monetary Policy Stance The CBK pursued an accommodative monetary policy stance to help cushion the economy from the negative effects of the Global Financial Crisis. Measures taken so far Reduction of Cash Reserve Ratio from 6% to 4.5% thus releasing an equivalent of Ksh.12.5bn for lending to the economy Consecutive reduction of CBR from 8.75% to 6.00% to signal to banks to lower lending rates Allowing a reduction in foreign exchange reserves to less than 3 months import cover to take pressure off the depreciation pressure of the Kenya shilling vis-à-vis the hard currencies [Had the CBK not allowed this, the inflationary effect of the shilling’s depreciation would have been worse - in terms of intermediate imports, oil prices etc]

Results of Monetary Policy Kenya; Policy Rates Coordinating Short Term Rates during the Crisis Period

Fiscal Policy Action Fiscal Stimulus (ESP - KES22b) in budget of 2009/10 mainly to finance wage goods and infrastructural projects to Solve the problem of Unemployment (both Youth and General unemployment in Kenya) Development budgets protected against cuts unlike the 1980s and 1990s when short-run shocks were used as an excuse to cut Development Budgets this sacrificed long-term growth

Fiscal Policy Action - Results The capacity for growth has not been sacrificed: Kenya is moving to towards its growth trajectory – in 2010 it is predicted to be 5% Infrastructure continues to attract a larger proportion of the budget, this year 11%: to continue to expand the production potential of the economy – further capacity for growth The domestic resource mobilisation through the infrastructural bond program has had tremendous success so far Inflation has not been sacrificed, still low and stable: monetary policy has worked, but we now have a structural transformation that will shape future monetary policy The SMEs binding constraint: access to finance will be solved through a revolving fund by the Ministry of Finance and commercial banks

Outlook: Policy Action for the EAC Safeguard hard won macro-stability when the economies begin to recover However, Kenyan economy still operating below full potential and inflation is still very low. Scope to raise the capacity for growth – thru’ public investments that are complimentary to private investment There is scope for use of the fiscal space to finance development projects in infrastructure There is still monetary space to use the CBR and other institutional structural reforms to signal further lending rate cuts to spur investment

Lessons from the Report Policy decisions (both fiscal and monetary) undertaken to mitigate the effects of the internal and external shocks were right and have been vindicated As the recovery gathers more momentum, Kenya should change gear towards medium term financial and debt sustainability. Thus building another fiscal space to cushion future shocks But also the future strong recovery requires a focus on global and regional outlook. Regional infrastructure will create stronger stimulus for growth capacity and resolve binding constraints especially for manufacturing sector supplying the region

Kenya Has a Different Take The New Constitution Legal framework that will support strong institutions that define the rules of the game Strong institutions will support market development Strong incentives will encourage prudent behaviour in the market Debt sustainability ex-post – to be in tandem with increasing capacity for future growth Future Investments in public and private sector can be driven by: Sovereign Bond and Foreign Direct Investments; Public Private Partnership for domestic resource mobilization.