Don’t hold your breath for Kenya’s Fiscal Consolidation

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This article first appeared in my weekly column with the Business Daily on July 1, 2018

The budget speech for FY 2018/19 is of interest because desires of government seem to be in opposition. On one hand is the previously articulated intent from government for fiscal consolidation and on the other, the need to finance the Big Four. This article will focus on fiscal consolidation and assess the budget using this lens with a focus on planned expenditure, revenue generation and borrowing. Under fiscal consolidation, expenditure should reduce, revenue generation increase and borrowing reduce.

Budget: Treasury Cabinet Secretary Henry Rotich

(source: https://www.businessdailyafrica.com/analysis/ideas/-Kenya-fiscal-consolidation/4259414-4640846-wga0eu/index.html)

Already we can see that appetite for increased expenditure continues unabated. Planned total expenditure for the FY 2018/19 is Ksh 2.56 trillion (equivalent to 26.3 percent of GDP). Under the current administration, projected spending has gone up from Ksh 1.6 trillion in 2013/14 to Ksh 2.29 trillion in 2017/18 and now to 2.56 for 2018/19. Clearly, expenditure continues to grow indicating an inability to effect fiscal consolidation measures which are exacerbated by weaknesses in the composition of expenditure. Of planned spending, recurrent expenditure will amount to KES 1.55 trillion, development expenditure is projected at KES 625 billion, and transfers to County Governments will amount to KES 376.4 billion. It seems the element of expenditure that has been cut is the most economically productive, namely development expenditure. Indeed, development expenditure will only be 24 percent of total expenditure (below the 30 percent threshold), recurrent about 60 percent and transfers to county 15 percent. So government seems to be cutting development expenditure while allowing the excesses of recurrent spending to continue. Thus, the government is not leveraging the budget to drive public spending in an economically productive manner.

In terms of revenue generation, the government argues that revenues will rise by 17.5 percent to about KES 1.95 trillion (equivalent to 20 percent of GDP) in the FY 2018/19 from the estimated KES 1.66 trillion collected in the FY 2017/18. Part of the ‘revenue enhancement’ steps include higher corporate tax as well as a tax on the informal economy. What may materialise is not more revenue, but less. Kenya already struggles with high costs of production attributed to high power, transport and labour costs, as well as endemic corruption and rent seeking. These are dynamics that affect both big and small private sector players. Increasing tax on the private sector may well push them to a level where the combined effect of high production costs and higher taxes cut into profits substantially reducing the total government can claim as tax revenue.

Finally, government announced that in the fiscal year ending in June 2018, they estimate a fiscal deficit of 7.2 percent of GDP, down from 9.1 percent of GDP in the previous year. Indeed under, their fiscal consolidation plan, government project the fiscal deficit to narrow to 5.7 percent of GDP in the FY 2018/19 and further to around 3 percent of GDP by FY 2021/22. While this is a step in the right direction, government seems to have a problem in keeping on a disciplined path of fiscal deficit reduction. Last year government’s target for the 2018/19 fiscal deficit was 6 percent, yet here we are at 7.2 percent.

Image result for fiscal policy

(source: http://www.theedvantage.org/economics/fiscal-policy)

The fiscal deficit of KES 558.9 billion will be financed by external financing amounting to KES 287.0 billion, while domestic financing will amount to KES 271.9 billion. This clearly indicates that domestic borrowing will be substantial. In the context of an interest rate cap, government knows that continued heavy borrowing in the domestic market squeezes out private sector and places upward pressure on interest rates.

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

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