• While Kenya's external liquidity position as presently favorable, we note the economy's increased exposure to external shocks.
• Kenya's government is now under pressure to show they can deliver on key macroeconomic policy commitments - especially on the fiscal front.
• Political disagreements on key measures - especially proposed tax increases and the removal of interest rate controls - contributed to Kenya's inability to bring it's IMF-supported economic program back on track.

Treasury Secretary Henry Rotich announced on 13 September that the country's USD989-million Standby arrangement (SBA) with the IMF would be allowed to expire on 14 September. However, the government will stay engaged with the IMF and is considering whether to pursue a new facility with the Fund.

At Kenya's request, the IMF granted a six-month extension of the SBA on 12 March 2018 to give the authorities more time to complete program reviews and finalize corrective policies to address key fiscal, monetary and financial issues which the IMF viewed as challenging to strong economic performance. The highlighted corrective measures were: fiscal consolidation; adjusting interest rate controls (either by outright removal or significant modification) to eliminate adverse impacts on bank lending and the conduct of monetary policy; modernizing the monetary policy framework with the introduction of an interest rate corridor around the central bank's policy rate as part of establishing a full inflation-targeting regime; and other reforms to encourage better public expenditure management, financial sector depth, and improved quality of macroeconomic statistics.

Kenya's relationship with the IMF has been under greater scrutiny over the last 15 months as it did not complete two IMF reviews required to maintain access to financial support for its economic programme. Following the first program review in January 2017, the second and third reviews (in June and December 2017 respectively) were postponed. This was mainly due to unresolved discussions on appropriate policies in the wake of fiscal slippages from both revenue underperformance and spending pressures during 2017. Also, the IMF repeatedly expressed concern about the interest rate cap established in September 2016 and pointed to its effects through dampened credit growth, weaker bank profitability, lower tax revenues and constrained monetary policy effectiveness.

Outlook and implications

Kenya's government opted not to renew its IMF financing; however, it is worth noting that the authorities did not draw down on any part of the package during 2016-2018 - even during 2017 when the economy was adversely by both severe drought conditions and heightened political tensions during an extended election period. The government points to this as evidence of its adept macroeconomic management, and this alongside a pick-up in economic activity helped to revive investor confidence and business sentiment in 2018.

Despite the loss of the SBA as an additional external buffer, IHS Markit notes that Kenya's external liquidity position is presently favorable. Gross international reserves are still fairly solid at USD8.56 billion as of early September, although they've fallen from their April peak at USD9.5 billion. Strong agricultural exports, improved tourism revenues and steady diaspora remittances have bolstered foreign exchange earnings. The external current-account deficit has slightly narrowed, and the central bank expects it to fall to 5.4% of GDP by December from 6.3% of GDP in March.

However, we also note Kenya's vulnerability to prevailing headwinds and how the loss of the IMF SBA exposes it more to economic risks. While the growth environment has improved, higher perceived investment risk in the absence of the IMF-supported economic program could cool optimism. Kenya's government is now under pressure to show the they can trim the fiscal deficit down to their 5.7% of GDP target and also keep public debt from rising closer to 60% of GDP. Meanwhile, a stronger pick-up in inflationary pressures would test how long the central bank can pursue its eased monetary policy stance. Despite a favorable external position, the Kenyan the shilling remains vulnerable to global capital market headwinds which have impacting some emerging and frontier market currencies.

Kenya's inability to bring it's IMF-supported economic program back on track during the six-month extension period is indicative of still-unresolved difficulties surrounding the establishment of corrective policies for macroeconomic issues that remain of concern to the IMF - particularly on the fiscal and monetary policy fronts. Strong political opposition in the National Assembly against key measures put forward by the National Treasury with President Kenyatta's support - from proposed select tax increases intended to help drive fiscal consolidation efforts to the interest rate cap removal - continues to play out and cast uncertainty on how soon the government will arrive at a more unified political stance. We view a broad consensus on these issues as key prior to Keyna's reengagement with the IMF.