Kenya’s budget making flawed

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This article first appeared in my weekly column in the Business Daily on September 25, 2016

Last week I attended an event organised by International Budget Partnership (IBP) Kenya that analysed whether National and County budgets share resources fairly. IBP made the point that one of the key drivers of constitutional reform was to enhance the fair distribution of resources in the pursuit of equity.

IBP defines equity and fairness in the context of budget as constituting six principles: need based on the idea that people who need more should get more; capacity considers the extent to which a person/population can meet their own need; effort is rooted in the idea that people deserve more when they make more of an effort; efficiency that argues that resources should be allocated where they will be used most effectively to increase total welfare; basic minimum principle that everyone deserves at least some minimal share of resources and finally, fair process where resource allocation outcomes are decided in an open and transparent way and justifications are given for decisions.

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(source: http://cdn.publishyourarticles.net/wp-content/uploads/2015/06/equity.jpg)

These principles are by no means exhaustive and do not include elements such as fiscal responsibility, however IBP’s analysis of county budgets with these principles in mind revealed glaring problems. First of all, budgets in Kenya are dominated by the notion of equal share. In the case of  the Constituency Development Fund (CDF) in which KES 35.2 billion were dispersed in 2015/16, 75 percent of the fund is shared equally among the 290 constituencies and only 25 percent is distributed based on the proportion of all poor people in Kenya that reside in a particular constituency. The massive portion in equal share is fundamentally problematic because the current CDF provides each geographical unit with a similar amount regardless of the size of the population in the constituency. So in densely populated areas, much less is received per person (per capita allocation) than in sparsely populated areas. An example, is Kitutu Masaba and Mwatate which both have a poverty rate of 50 percent, yet there are three times as many poor people living in Kitutu Masaba than in Mwatate.

Even in cases where proportions are used, problems emerge. Allocations are made to Level 5 hospitals which have a regional catchment area and serve as referral hospitals for more than one county, yet are managed by individual host counties. So a conditional grant was introduced to finance Level 5 hospitals. According to IBP, in 2015/16 the single criterion for allocating the grant among the 11 hospitals was the bed occupancy rate. The concern is that given the wide variation in the actual number of beds in each facility, using bed occupancy rates introduces a distortion. For example, both Meru and Nakuru had occupancy rates of 77 percent so both were allocated KES 356 million. Yet Meru has 306 beds and Nakuru, almost double this amount with 588 beds. https://i0.wp.com/www.the-star.co.ke/sites/default/files/styles/new_full_content/public/articles/2015/10/02/1215234.jpg

(source: http://www.the-star.co.ke/sites/default/files/styles/new_full_content/public/articles/2015/10/02/1215234.jpg?itok=uKtZ9WXQ)

Finally the issue of process in budget allocation, particularly at county government level, is worrying. Political power and considerations routinely trump the fair distribution of resources at county level. In some cases, county cabinet secretaries skew allocations towards their village areas at sub county level. Thus communities with no representative in county level cabinets are financially marginalised. In some counties, budget allocations are based on lists of projects drawn up by Members of County Assemblies (MCAs). How those projects were chosen, why they were chosen, whether they are in line with County Development Plans is not clear. And allocating funds based on MCA lists facilitates nepotism and fiscal indiscipline. Further, presently at county level, little or no justifications are made as to why resources have been allocated as they have been.

Clearly there are fundamental problems with how public funds are allocated in Kenya. A key step that would make budget making a tool that facilitates equitable development is to reduce the amount allocated in equal share and rather base most allocations on well thought through weighted criteria. Further, given the mismanagement of funds especially at county level, the principle of fiscal discipline should carry considerable weight and reward demonstrated responsible use of resources.

Anzetse Were is a development economist; anzetsew@gmail.com

Infrastructure investment and economic growth

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This article first appeared in my weekly column with the Business Daily on September 18, 2016


There appears to be an on-going assumption that publicly funded infrastructure investment will spur economic and social growth and development in Kenya. In fact, the government is so certain of this that they are getting into substantial debt in order to finance infrastructure projects. Indeed according to the International Budget Partnership, Kenya’s 2016/17 national budget 30.4 percent of total gross expenditure was allocated to energy, infrastructure and ICT. Infrastructure investment in this article refers primarily to investment in energy and transport infrastructure.

There are several arguments that support massive infrastructure investment. The first, no brainer argument is that Kenya’s and indeed Africa’s infrastructure needs are so dire that any investment in the sector is bound to have positive effects. According to the Africa Infrastructure Country Diagnostic, the continent’s infrastructure spending needs stand at about $93 billion per year. Clearly, there is a need for this investment.

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(source: http://kbctv.co.ke/wp-content/uploads/2016/06/construction.jpg)

Additionally, the lack of infrastructure can be argued to be eating into economic growth. Some estimate that the negative effect of poor power supply alone reduces per capita growth by 0.11-0.2 percentage points in Africa. Further, other studies show that infrastructure investment increases the growth potential of an economy by increasing the economy’s productive capacity by lowering production costs or providing opportunities for human capital development for example.

Infrastructure is also tied into social development. According to a report by European Commission, good quality infrastructure is a key ingredient of sustainable development because countries need efficient transport, energy and communications systems. So some argue that not only does infrastructure boost economic growth, it can lead to a better quality of life for citizens as well.

This all sounds very impressive but massive and aggressive infrastructure investment carries sizeable risks. According to the London School of Economics emerging research seems to suggest that the magnitude of infrastructure’s contribution (to growth) display considerable variation across studies. So the notion that infrastructure is directly linked to or even engenders economic growth is not cast in stone.  Indeed recent literature tends to find smaller effects on links between infrastructure investment and economic growth than those reported in the earlier studies. So perhaps estimates that have previously linked infrastructure investment to economic growth and development may be overstating the causal effects.

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(source: http://www.startyourbusinessmag.com/wp-content/uploads/2016/06/economic-growth.jpg)

Further, it is assumed that government is making the right infrastructure investment decisions for Kenya and that the contracts are being given to the right people. The Economist makes the point that even in countries like the USA public investment is wasted on inflated contracts with politically connected suppliers. The same magazine also makes the point that even in countries like the USA whose public financial management is considered to be more transparent with lots of bureaucrats to conduct cost-benefit analyses, identifying the most beneficial investments is hard. These problems are magnified in countries like Kenya where there is limited information on how infrastructure projects were chosen, how the cost benefit analysis was done and how contractors were or will be selected.

Finally, the manner in which the infrastructure plans are implemented will inform if Kenya will truly gain from this investment drive. A study by FONDAD argues that in order for infrastructure investment to truly stand a chance to create economic and social development shifts, they have to be done with great economic scrutiny at the selection stage, integrity in procurement, efficiency in implementation, effective post-completion management to ensure maintenance and efficient operation and, continuing accountability to users.  Does Kenya tick all these boxes?

It is clear that infrastructure investment is a priority for government and the continued emphasis in government spending in this docket will continue. Bear in mind that, as KPMG states, a significant portion of these infrastructure projects are debt financed. It is therefore crucial that Kenyans are cognisant of the need for infrastructure investment but risks associated with aggressive infrastructure investment, and direct the warranted scrutiny at related projects.

Anzetse Were is a development economist; anzetsew@gmail.com

 

 

 

The link between the mobile economy and the informal economy

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This article first appeared in my weekly column with the Business Daily on September 11, 2016


The growth in the use of mobile phones in Kenya and indeed Africa has created a mobile economy that is estimated to have generated 6.7 percent of GDP in Africa in 2015. According to GSMA, an association that represents the interests of mobile operators globally, mobile technologies and services contributed about USD 150 million of economic value on the continent. Closer to home, mobile subscriber penetration in East Africa hit 46 percent in 2015 and smartphone adoption is due to hit 54 percent in 2020. Kenya is well aware of how access to mobile phones has deepened financial inclusion through the provision of access to financial transactions. Indeed a study by CGAP, an organisation that seeks to promote financial inclusion, indicated that in Kenya, mobile money transfer has overtaken even informal financial groups as the most used financial service. CGAP found that even in more rural areas, 61 percent of people were registered mobile money transfer users while only 51 percent and 36 percent were using informal financial groups and banks respectively. Indeed by 2014, 58.4 percent of all Kenyan adults had a mobile account and approximately 90 percent of all senders and recipients of domestic remittances used a mobile phone.

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(source: http://mobileworldcapital.com/wp-content/uploads/2015/09/M-PESA.jpg)

In my view the emergence of the mobile economy and specifically mobile money, mobile banking and mobile lending intersects with the informal economy and indeed enables this section of the Kenyan economy. About 82 percent of Kenyans in employment are employed by informal businesses and organisations across the country which indicates that most Kenyans seem to derive their livelihood from the informal economy. And although the informal economy is not without its challenges, such as serious productivity problems, it is an important part of the story of Kenya’s economy.

There are three ways through which the mobile economy intersects with and enables the informal economy. The first is through facilitating financial transactions that enable informal businesses to receive payments for goods and services from clients and customers. Many informal businesses have a mobile money facility through which they can receive payments in a more secure and convenient manner than cash transactions.

Secondly, mobile money allows informal businesses to communicate with and make payments to suppliers and distributors. This allows informal businesses to manage and coordinate activity and transactions with numerous parties in their value chain across the country. It would be useful for more research to be done on this issue in order to better understand the extent to which the mobile economy has informed improvements in efficiency and productivity in informal firms and how this can be leveraged further.

Image result for mobile money kenya (source: http://ithubkenya.com/wp-content/uploads/2016/09/mobile-money-800×445.png)

Finally, the mobile economy has created an avenue through which informal business people can apply and qualify for loans through their mobile phone. Indeed, it is not unheard of in Kenya for informal businesses in large informal markets to borrow money at the beginning of the business day to purchase stock, and pay the loan off at the end of the day after the sales of the day are complete. Mobile lending offers a convenient alternative to travelling and applying for normal bank loans, particularly for businesses operating in more remote areas far away from brick and mortar banking halls. Further mobile lending may allow informal business people who may not qualify for loans from mainstream banks, to get access to mobile micro-loans thereby boosting informal business activity.

Perhaps the mobile economy, and specifically mobile money and mobile lending, intersect and enable the informal economy effectively because it accommodates informal financial behaviour. However, there is clearly a need to better understand the relationship between the mobile economy and informal economy. Of particular interest would be on how mobile tools and applications can be used to improve the productivity and profitability of informal businesses.

Anzetse Were is a development economist; anzetsew@gmail.com

Dynamics in Manufacturing in East Africa

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This article first appeared in my weekly column with the Business Daily on September 4, 2016

Last week I attended and presented at a roundtable on Manufacturing in Kenya hosted by the Overseas Development Institute (ODI). The roundtable was under ODI’s Supporting Economic Transformation Programme (SET) which is supported by DFID. As part of the roundtable I developed a paper on manufacturing in Kenya and thought it would be useful to share some insights I unearthed during my research on manufacturing in the East Africa region.

At the moment, the manufacturing sector in Kenya is the largest in the East Africa region. However in terms of growth, other countries in East Africa are growing at a faster rate. Data from ODI indicate that the growth of the manufacturing sector in Kenya is growing far slower than Ethiopia, Rwanda, Tanzania and Uganda. If this trend continues, other East African countries will begin to dominate manufacturing in the region. Further, governments in East Africa seem to be putting in more pronounced effort to build manufacturing through the creation of industrial parks in countries such as Ethiopia and making land available for manufacturing particularly for labour intensive manufacturing. Uganda and Tanzania are also determinedly positioning themselves as investment destinations for manufacturing in Africa. This impetus needs to be more strongly echoed in Kenya from the highest levels of county and national government.  Further, while Kenya remains an attractive investment destination for manufacturing, other countries in the region are aggressively courting such investment. And frankly there is a growing sense that the bureaucracy and corruption in Kenya as well as difficulty in getting the right information on requirements linked to building manufacturing plants in the country are hampering investment into the sector.

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That said, the good news from a regional perspective is that the East African Community (EAC) is seeking to position itself as the next global manufacturing destination. This is positive and long overdue because clearly there is room for growth in the sector in the region. According to the African Development Bank the combined manufacturing sector of seven countries in Eastern Africa as a whole is only about one-third the size of the manufacturing sector in Vietnam, which has a population one-third the size of the seven countries. If the East Africa region is to become the ‘go-to’ location for investment in manufacturing in Africa, more coordination of manufacturing policy and activity across the EAC as well as with Eastern African countries outside the EAC is needed.

However, from a Kenyan perspective there are issues within the East Africa region that negatively inform the growth of manufacturing in the country. An on-going issue that adversely affects the uptake of manufactured products from Kenya in the region is pricing. Cost of production in Kenya remains high which makes the end price point of Kenyan manufactured goods high. This cost of production issue essentially promotes the purchase of cheap manufactured imports from India and China that have aggressively entered the regional market and routinely undercut Kenyan manufactured equivalents on price point.

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Another dynamic affecting the growth of Kenyan manufacturing in the region is related to the competition emerging between manufacturing sectors in East Africa. Due to development of manufacturing in neighbouring countries a scenario is emerging where neighbouring countries seem to want to reserve domestic markets for domestically manufactured products. Thus there is a sense that neighbouring countries in the EAC seek to prevent Kenyan manufactured goods from entering their countries because they want to keep domestic markets to themselves. Thus, perhaps EAC markets are not as open as one would hope.

What is clear is that it that challenges exist for the Kenyan manufacturing sector from a regional perspective. At the same time, there is ample opportunity for the region to sell itself as the manufacturing hub of Africa. The question is how to balance national ambitions with regional development goals; perhaps it is time for a candid conversation on this issue.

Anzetse Were is a development economist; anzetsew@gmail.com

Interest rates are capped, what next?

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This article first appeared in my weekly column with the Business Daily on August 28, 2016

Last week on Wednesday President Kenyatta assented to the Bill to cap interest rates at 4 percent above the Central Bank Rate (CBR). Given the CBR is currently at 10.5 percent, the new law stipulates banks cannot charge more than 14.5 percent on loans. The immediate effect of this decision is already being felt. As of when this article was written, prices of shares of banks listed on the Nairobi Securities Exchange (NSE) had plummeted by up to 10 percent. Given that a great deal of activity in the NSE is from foreign sources, the dip in prices signals that the world was watching Kenya on this issue and do not seem to like the direction of the decision made.

However, the overall concern with the rate cap decision is the associated uncertainty. Banks themselves are trying to figure out how the new law will affect them and their operations. There are basic questions that are yet to be answered: will existing debt portfolios be affected by the law? Will regulated microfinance rates be capped? How will the new law affect lending? This cap creates an aura of uncertainty going forward which is of particular concern given that Kenya is going into an election year which comes with uncertainty of its own.

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(source: http://letscrowdsmarter.com/wp-content/uploads/2016/03/Interest-Rates.jpg)

Beyond the uncertainty, an issue that will be front and centre is whether the lower interest rates will actually expand access to credit. In the mind of the Kenyan public, lower interest rates will translate to cheaper loans. What the public seems to be forgetting is that capping interest rates may make it harder to qualify for the loan in the first place. There is a real possibility that the law will lead to a contraction of credit; banks will not lend to parties whom they feel are riskier than the stipulated 14.5 percent. Indeed, because rates have been capped, there is no margin of error for banks in lending decisions. Thus there is there a real possibility that qualification requirements for credit will become even more stringent and onerous than before as banks seek to ensure that each lending decision is a sure bet.

So while there may be jubilation for the next few months, it may be short lived. Kenyans may find that getting that ‘cheap loan’ is not as easy as they had anticipated. In short, it is conceivable that the credit market will be drier than was the case before the capping. Leading from this scenario is the possibility of a broadening of the gap between credit demand and supply. There has been concern expressed on how such a credit gap may strengthen unregulated shadow lending mechanisms; this is a real and present danger.

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(source: http://www.businessdailyafrica.com/image/view/-/832162/highRes/113511/-/maxw/600/-/auqffp/-/money.jpg)

However, there is a silver lining. SACCOs stand to be the biggest winners from this interest rate cap. If the new law leads to lower access to credit from banks, many Kenyans may move to SACCOs to get the credit they need for their personal and business needs. Other parties that can benefit from the unfolding scenario and potential credit squeeze are alternative financing institutions such as impact investors and equity funds. Impact investors may find that fairly credible SMEs that were previously absorbed in mainstream credit markets are finding it harder to get the financing they need and can now be more readily financed through impact investment products.  Equity funds may find that this is the tipping point needed for Kenyans to truly open up to equity financing.

In short, we’ll see what happens. What Kenya can be sure of is that the world is watching this development, and key lessons will be learnt from this, for better or worse.

Anzetse Were is a development economist; anzetsew@gmail.com

Land issues hampering Kenya’s development

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This article first appeared in my weekly column in the Business Daily on August 21, 2016

Kenyans are well aware of the tensions and dynamics around land ownership in the country. The contentious issues around land are often linked to tribal and ethnic tensions; indeed land issues informed the ferocity of post-election violence in 2007/8. But beyond being a tension between different communities, land ownership issues are hampering the country’s economic development.

Firstly, land directly affects agricultural productivity, or the lack thereof. At the moment, statistics indicate that small-scale farming accounts for at least 75 percent of the country’s total agricultural output and 70 percent of marketed agricultural produce. In short, most of the meals eaten by Kenyans come from a smallholder farmer working away on his or her small patch of land. However, one of the reasons why agricultural productivity is so low in the country is precisely because the vast majority of farmers are farming over-worked, nutrient-depleted, small pieces of land that have been subdivided for generations. The situation is made more complex by the fact that many small holder farmers do not have the title deed to the land.

So while there may be a general acknowledgement by their community that the land they farm is indeed theirs, the costs related to registering land and acquiring titles are too high for most smallholder farmers. As a result the farmers do not legally own the land and thus cannot use the land as collateral to access credit that could allow them to make improvements to their farms and farming practices. More importantly, smallholder farms cannot be conglomerated in one large piece that can be more efficiently farmed with higher levels of mechanisation, productivity and profitability. As a result, Kenyans agriculture sector is stuck in a rut with no foreseeable way out because of the land issue. If anything, the situation will worsen as the average size of land holdings continues to reduce due to the cultural practice of subdivisions of the land for each son in the family for inheritance purposes.

(source: http://i.telegraph.co.uk/multimedia/archive/01537/farm_1537840c.jpg)

Manufacturing is also affected by Kenyan’s land problem because even if a company wants to expand operations to another part of the country, the process of procuring land on which the factory or plant will be built is daunting. The lack of legal title depresses demand for land because potential buyers do not want to negotiate the complexities of proving ownership. No one wants the nightmare of procuring a piece of land that is then mired in contention that prevents business activity from moving forward. Thus it must be asked: to what extent are land issues hampering the expansion of industry and manufacturing in the country? Further, the lack of legal ownership also makes it difficult for land holders to come together and combine smaller pieces of land into a mass that can more effectively attract capital investment. In short, both supply and demand are affected by the land question.

Finally, infrastructure development is more costly, mired in delays and incredibly complex because of land issues. In some cases communities do not agree with the valuation of land engendering renegotiations, in other cases absentee landlords make the process of land acquisition long and arduous. However, the most complex is where communities live on what they consider their ancestral land but the land is legally owned by another person or entity. Who is to be compensated in such cases not only from a legal, but also moral point of view? How is compensation to be negotiated without engendering protest? Land is a core factor behind the accrual of delays and expenses in some of the infrastructure projects in the country.

(source: http://www.theeastafrican.co.ke/image/view/-/2918134/medRes/528395/-/maxw/600/-/t4i5alz/-/infra.jpg)

In short, a great deal of Kenya’s economic potential is locked in the land. Sadly, due to the way politics is linked to tribal identity and thus land in Kenya, it may be decades before the country sees a crop of leaders prepared to address the land issue and unlock a great deal of the country’s economic potential.

Anzetse Were is a development economist; anzetsew@gmail.com

TV Interview: Kenyan banks present voluntary rate reduction plan

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Kenyan banks present a voluntary plan to gradually reduce lending rates. Johnson Nderi of ABC Capital and I analyse the proposals.