Report from the Field: Incorporating Microfinance into Kenya's Economic Recovery Strategy

By Beatrice Sabana, Chair, Kenya National Committee, International Year of Microcredit

With a population of 30 million people and a per capita income of US$260, Kenya is categorized the 20th poorest country in the world.[1] Estimates indicate that about 47% of the rural population and 29% of the urban population live under conditions of absolute poverty, where malnutrition and seasonal famine are not just a consistent fear, but also a frequent reality in their lives. On the other hand, the unemployment rate, currently estimated at between 25% and 35%, threatens to get out of hand as roughly 0.5 million school dropouts continue to join the ranks of the unemployed every year. High levels of poverty combined with slow economic growth in the formal sector have thus forced many Kenyans into self-employment and informal activities, yet access to financial services remains a major challenge.

As of June 2003, there were an estimated 3,460 legally constituted microfinance service providers in Kenya, including 3,397 savings and credit co-operatives and co-operative-like community-based intermediaries, 56 microfinance institutions (MFIs), four commercial banks, two building societies, and the Kenya Post Office Savings Bank. Excluded from this list were 17,305 rotating savings and credit associations (ROSCAs), 115,884 registered women groups', and 1,342 primary agricultural producer and marketing cooperative societies, also involved in providing credit countrywide. There are approximately 3.8 million Kenyans depending entirely on financial NGOs, cooperatives, and the Kenya Post Office Savings Bank for financial service services.

In June 2003, the total deposits held by financial cooperatives, NGOs, the Kenya Post Office Savings Bank, and community-based financial intermediaries was estimated at Kshs 82.3 billion (US$1.1 billion)[2] while total loans outstanding was Kshs 71.4 billion (US$940 million). (The financial cooperatives alone were holding more than Kshs 70 billion (US$920 million) as of December 2003.) Altogether, the microfinance sector comprises a very large and diverse group of institutions providing a range of loans and savings products to their clients. It is estimated that there are 3.8 million Kenyans depending entirely on financial NGOs for financial services, while another estimated 1.1 million depend on informal associations and groups for similar services countrywide.

The Poverty Reduction Strategy In the year 2002, the Kenyan government prepared a poverty reduction strategy paper (PRSP) that outlined key policies and strategies for poverty reduction. The main objectives of the PRSP were to:

Identify national development objectives.

Link policy planning and budgeting.

Ensure rational public expenditure.

Harmonize the financing system.

Establish an effective monitoring and evaluation system.

The PRSP was based on five key principles: giving a voice to the poor, participation and ownership, transparency, openness and accountability and equitable distribution of national resources and development initiatives. The PRSP developed strategies for revitalization of the following sectors:

- Agriculture and rural development.

- Human resource development.

- Physical infrastructure.

- Trade, including tourism.

- Public safety, law and order.

- Information and communications technologies.

The PRSP was developed through a participatory process that started at the district level and was scaled up to the national level. At the district level, initial stakeholder discussions were organized with political, administrative, religious, private sector, and social and civil society leaders. The leaders identified the key causes of poverty in their respective districts and prioritized their development needs, as well as appropriate poverty reduction strategies. At the end of the district consultations, a national stakeholder conference was convened during which the results from each district were verified and combined to form the national poverty reduction strategy. According to the World Bank, the PRSP provided a sound basis for IMF concessional assistance. However, this PRSP was not implemented owing to the 2002 elections, which ushered in a new government.

In 2003, the new government, elected on a platform of reform, developed its own Economic Recovery Strategy for Wealth and Employment Creation (ERS) drawing heavily on the PRSP developed by the previous administration, but also reflecting its own priorities. Unlike the PRSP, the ERS is based on a strong reform agenda in all the key sectors as well as articulating strategies aimed at tackling corruption and strengthening political and economic governance. In his first address to Parliament, President Mwai Kibaki said: "microenterprises are expected to play a crucial role in the creation of jobs in Kenya. However, we recognize that the sector's growth potential is inhibited by several constraints. These include: poor access to markets, lack of credit and a poor policy environment. My government will soon be presenting to the House, a sessional paper on the development of micro and small enterprises for poverty reduction and employment creation".

Microfinance and the Economic Recovery Strategy (ERS)

The ERS was developed through a participatory process similar to that of the PRSP process, with the Association of Microfinance Institutions playing a particularly active lobbying role in both the consultations, and in submitting petitions to the Minister of Finance and the Minister of Finance. The resulting document outlines a recovery strategy centered on reanimated private sector activity and investment, and specifically micro, small and medium sized enterprise development. The Government's objectives, policies and strategy for MSMSE development are also articulated in an investment programme. Minister of Finance Hon. David Mwiraria said: "Microfinance institutions and the savings and credit co-operative societies play an important role in our economy. There is need to encourage and promote them by creating a conducive and enabling environment as well as setting up a regulatory framework".

The ERS strategy is based on three interlinked pillars:

1. Economic growth, supported by reforms in the financial sector, including microfinance. The strategy to achieve these reforms is to strengthen the intermediation role of the financial sector, specifically by:

Accelerating the enactment of the Microfinance Institutions Act, as a step towards enhancing competition in the financial sector.

Cleaning up the balance sheet of government-owned banks in preparation for their privatization, and establishing a non-performing assets resolution fund to warehouse bad debts.

Enhancing tax incentives to encourage more savings through the pension schemes.

Reviewing the tax incentive structure in order to encourage contributors to withdraw from schemes after retirement age by making withdrawals tax-free.

2. Expansion and rehabilitation of infrastructure through increased investment in the sector.

Equity and poverty reduction will be aided by actions to improve access to basic services, such as education, health, management of HIV/AIDS and the revival of agriculture. The strategy focuses on universal primary education, improved access to basic health, expanded productive capacity in agriculture, development of the hitherto overlooked and semi arid areas, upgrading the living conditions for urban dwellers that have suffered from poor urban infrastructure and social services due to the urbanization process.

3. Governance, including strengthening public safety, law and order.

The ERS paper identifies microfinance as one of the sectors that will facilitate economic recovery, and it outlines various measures that will be undertaken to facilitate the development of the sector. Key among them is the passage of the microfinance bill, which will provide a legal and regulatory framework for the industry. The bill is expected to be enacted into law by the end of 2005. The law will allow MFIs to mobilize and intermediate savings from the public, thus providing them with access to low cost commercial capital. The law provides a regulatory framework under the Central Bank of Kenya, which ensures that all deposit-taking MFIs adhere to prudential standards. It also seeks to protect depositors by requiring deposit-taking MFIs to contribute to the deposit protection fund. The IMF/World Bank- supported financial sector reform programme also features a component on reforms in the microfinance industry.

As a result of the ERS, a Rural Finance Department has been created at the Central Bank of Kenya, while a microfinance unit has been established at the Ministry of Finance. The government has also accepted stakeholder proposals on formulating a microfinance policy. Finally, a microfinance mapping process, funded by the UK's Department for International Development as part of its contribution to the International Year of Microcredit, is in progress. The results of the mapping process will provide useful supply and demand side data on the microfinance industry, including outreach, industry players, market share, products on offer, and financial performance. This data will be useful to investors, development partners, MFIs, government and clients.

Thus, in Kenya, microfinance has been recognized as an important contributor to the ERS financial reform agenda.

To learn more about this author, visit United Nations Capital Development Fund's Website.

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