Budget faces fiscal hitches, but it’s a recipe for growth

 

PHOTO | BILLY MUTAI From left: Parliamentary Budget and Appropriations Committee chair Mutava Musyimi, National Treasury Cabinet Secretary Henry Rotich and Devolution Cabinet Secretary Anne Waiguru pose for a photo at Parliament buildings in Nairobi on June 12, 2014 before the budget reading.   NATION MEDIA GROUP

In Summary

• We are confronted by a series of internally and externally driven fiscal challenges that are responsible for budget shortfall.
• Government borrowing from the domestic market increases the demand for credit in the short-term, which in turn raises the cost of borrowing by raising the interest rates.

By Prof Joe Kieyah
More by this Author

Kenya’s inability to balance the proposed Sh1.8 trillion budget is a policy concern.

We are confronted by a series of internally and externally driven fiscal challenges that are responsible for budget shortfall.

 

Such challenges include potential increase of rate of inflation, youth unemployment, rising imports bill, insecurity, declining agricultural and manufacturing productivity, public sector wage bill and constitution implementation issues. Moreover, these challenges may further impede the revenue calculus of the budget.

Endowed with the ultimate oversight power, the citizens through their parliamentary representatives must remain vigilant on the budget implementation process.

The public discourse must balance between the expenditure activities that are distributive and efficient in nature. In other words, activities of sharing the national pie must go hand-in-hand with the activities of baking the pie.

The former had been conspicuously missing in the public discourse, which has been dominated by the equity issues of sub-dividing the pie.

The dominance of equity issues is attributable to the implementation of our constitution which has, unfortunately, taken a trajectory of distribution as evidenced by the political wrangling of entitlement. We must strike a reasonable balance between equity and efficiency.

The budget is an economic policy tool that articulates a comprehensive statement of any nation’s priorities. In our case, it sets out priority programmes for economic transformation and builds a shared prosperity to be implemented in two years bottom-up framework.

The overall objective is to accelerate and sustain a 10 per cent annual economic growth rate that will transform the economy into a middle-income status in a decade.

Notably, taxes will be expected to contribute to about 67 per cent of the total revenue with income tax, Value Added Tax and excise duty taking the lion’s share. The budget shortfall will be financed through fiscal deficits that combine domestic and international borrowing in the ratio 2:1.

Evidently, domestic borrowing is a credible policy tool to jump-start a stalled economy. However, application of such policy tool must be exercised with a caution of crowding-out the private sector.

Government borrowing from the domestic market increases the demand for credit in the short-term, which in turn raises the cost of borrowing by raising the interest rates.

Such increase would lock out some private actors out of the domestic credit market. Inferrably, reduced demand for private credit translates to low the demand for private investment, which impede economic growth.

In our case, whether domestic borrowing will have significant crowding-out effects on private sector is an empirical question. But, should it happen, it would be catastrophic because it might undermine the government’s on-going initiative to reduce interest rates to spur economic growth.

Similarly, external borrowing is a powerful policy instrument that we have used successfully in the past. If used prudently, it can enhance investment levels and growth rates of an economy. However, it can be a burden if the cost of servicing the debt outweighs the returns of the investment financed.

A case in point is the mismanagement of external borrowing in Sub-Saharan Africa that led to debt crisis of 1990s. The burden of external borrowing compromised the fiscal responsibilities of several countries in the region to provide public goods and services to their citizens.

Conceptually, the external debt encompasses foreign loan instruments that are negotiated between the borrower and lender on purported agreeable terms. Developed countries on one hand advance loans with an objective of getting a return on investment, but of more import is to further their strategic interests.

On the other hand, developing countries like Kenya ostensibly borrow externally to cater for inadequacy of internal capital formation or consumption. The choice between external and internal borrowing determines the characteristics of domestic capital markets.

The decision to issue the highly anticipated $2 billion Eurobond denominated in Euros that has been pending for 17 years is creating a buzz. Conjecturally, the enormity of this external borrowing is driven by the inadequacy of the capital markets to raise the money locally.

The benefits of the bond include easing pressure on domestic borrowing thus lowering the cost of domestic credit. This might counter the adverse crowding-out associated with domestic borrowing.

Moreover, the bond may ease the pressure on the foreign exchange that will enable the government to sustain the stable exchange rate. Such an outcome would be welcoming given the recent weakening of the shilling.

Successful debut of the bond would amplify investor confidence and raise Kenya’s profile as new frontier for investment.

However, on the other hand, the bond may have some monetary and inflationary impacts. The proceeds of the bond are likely to be deposited with the CBK prior to spending and refinancing of other debts. This could raise Net Foreign Assets and consequently increase the money supply and thus fuel inflation. In the event of a liquidity increase of the banking system, CBK may be forced to mop up excess liquidity with domestic debt instruments and consequently crowd-out private investments.

Since 2007, Kenya has witnessed a 31 per cent decline of international tourist arrivals due to post-election violence and terrorism, among other global challenges.

This crucial sector has deteriorated further following the recent issuance of travel advisories by traditional source markets that include Britain and Australia.

The tourism sector directly or indirectly contributes an estimated 12 per cent of the Gross Domestic Product. Taking cognisance of this fact, the government collaboratively with key stakeholders have taken initiative to attenuate the possible fallout of the travel advisories.

The government offered tax incentives to stimulate the domestic tourism with complementary discounted vacation package for the tourism industry.

Such remedial measures supplemented by the diaspora remittances may assuage the poor performance of the sector in the long run. For instance, last year, diaspora remittances stood at Sh112 billion relative to Sh94 billion from tourism. With the improvement of global economy, the remittance is likely to increase and could as well compete for the number one position as foreign currency earner.

In conclusion, the fiscal challenges notwithstanding, a rigorous scrutiny reveal a budget leaning heavily to investment spending than consumption. This is in line with government’s strategy for economic growth.

Prof Kieyah is Principal Policy Analyst at Kippra. Views expressed in this article do not represent Kippra’s position.