Unrealistic domestic revenue numbers in annual budgets dangerous for Kenya

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This article first appeared in my weekly column with the Business Daily on July 3, 2016

Last week it emerged that Treasury had overshot its domestic borrowing target. Net domestic debt hit KES 446.6 billion in May, one month before the end of the fiscal year, against the annual target of KES 397 billion. That is an overshoot of KES 49.6 billion. To make matters worse, the accelerated domestic borrowing has been mostly used to fund the recurrent budget. The root of this problem is multi-layered but a key element of this overshoot is that when developing the budget, Treasury uses overly generous domestic revenue numbers. In the analysis of the FY 2016/17 budget the Parliamentary Budget Office (PBO) made an important point; to avoid a big financing gap during the budget approval process, domestic revenues are nudged to their limits so as to accommodate excess spending plans and curb debt financing.

We have seen that revenue collection repeatedly falls short of the target year after year. FY 2015/16 was no different; the KRA had in the 11 months to May collected KES 987 billion, more than KES 200 billion below the annual target of KES 1.2 trillion. Although the inclination is to blame the KRA for under-performing, I am of the view that KRA is given unrealistic targets each FY. These targets seem more informed by ballooning government expenditure and seem oblivious of the serious structural constraints that mute tax collection such as a sizeable informal economy largely out of the tax net. The bottom line however is that there should be far more concern that government seems to have the habit of using overly generous domestic revenue numbers when formulating the budget hiding the eventuality of having to increase borrowing during the course of the FY. There are several implications of this problematic habit.

(source: http://aa.com.tr/uploads/Contents/2015/12/08/thumbs_b_c_e8fd349e2614822b5d973b294371b9cc.jpg)

Firstly, when the annual budget is announced, fiscal deficit figures are artificially low. Because government uses such generous domestic revenue numbers, it artificially narrows the gap between revenue and expenditure. This creates an inaccurate perception of just what the real budget financing shortfall is. As a result, Kenyans and those interested in the country are given the impression that the fiscal deficit is not as large as actually would be the case if the more realistic revenue numbers were used. From where I sit, the use of these inaccurate numbers comes across as a PR strategy by government to make it look as though the budget is more sustainable than is actually the case.

Secondly, due to artificially narrow fiscal deficit numbers, the budget then sets out lower numbers for debt financing needs than what emerges in reality. As a result Kenya’s debt seems more sustainable than is the actual case hiding the fact that Kenya is more leveraged than formal figures used in the budget suggest. As is the case this year, because those domestic revenue numbers were too generous, government has had to finance the deficit created by this shortfall through further borrowing; pushing up the GDP to Debt ratio. Although it must be said that Kenya’s GDP to Debt is still manageable, a continued trend of increasing borrowing in supplementary budgets is worrying as government then has to put even more of future budgets aside to service this ‘unforeseen’ borrowing, increasing the debt burden on a relatively poor economy.

(source: https://saylordotorg.github.io/text_world-regional-geography-people-places-and-globalization/section_10/8f8aef9223c1ff538aed3242447d29b8.jpg)

Finally, the government invariably goes to domestic sources to finance this funding gap which is problematic for several reasons. Not only does government crowd out private sector in the domestic borrowing space, substantial increases in domestic borrowing by government invariably places upward pressure on domestic interest rates making credit even more unaffordable for millions in Kenya. And although domestic borrowing conditions are more expensive than foreign borrowing and often have no grace period, government does this ‘emergency borrowing’ in local markets because they are guaranteed that they will get access to the funds and within a reasonable time period. As a result all government proclamations, strategy and intent to ensure foreign borrowing preponderates so as not crowd out the domestic space do not truly materialise and this has a negative knock on effect on economic growth.

It is time that Treasury used more realistic domestic revenue figures when developing the budget. The continued use of overly generous figures is not only imprudent, it’s dangerous.

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


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