And Then, Floods...A critical macroeconomic assessment of IMF Conditionality on Kenya, 2021-present

By April 2021, in the context of long-standing deep growth shortfalls, a heavily overvalued exchange rate, an excessively loose fiscal stance, and an elevated public debt stock, Kenya’s prospects were threatened by rising global interest rates, a large bullet payment due, and droughts.

What was needed was an IMF program to deliver an immediate change in the policy mix, with a sharp front-loaded fiscal consolidation to allow a monetary loosening sufficient to correct the exchange rate and inward orientation while keeping inflation on target. But the total fiscal correction should not have been at the expense of medium-term growth, even if that required debt write-offs to reconcile it debt sustainability. And the entire package should also have been resilience to further shocks.

But that was not the program that Kenya got. The program misdiagnosed misalignment, thus back-loaded fiscal adjustment, and required medium-term primary fiscal balances well above global best practice at the expense of growth potential, all reflected in relentless tax increases. And when its conditionality on the Central Bank of Kenya turned out to be mis specified—including that in practice it treated a large non-permanent relative food price shock as a matter only of inflation—that was not corrected. So, the program also delivered a monetary stance which was too tight, impeding the necessary correction in the exchange rate, all at the expense of short-run growth as well.

These basic failures of quality control at the IMF meant that the program achieved neither its stated goals nor the fundamental correction that was required—hence major nationwide social unrest.

A reset of the program for 2024/25 should be led by an immediate big relaxation in monetary policy, an unchanged underlying primary balance outturn of a deficit of 1 percent of GDP remaining there thereafter, leaving revenue ratio targets to the authorities, and activating a targeted program of income support given food price shocks. If that requires debt write offs to secure sustainability, those should be calibrated against a medium-term primary deficit of 1 percent of GDP. Alongside a major retrenchment in the number of conditions and an increase in IMF transparency are necessary.