Political Economy

Revenue generation targets unrealistic

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This article first appeared in my column with the Business Daily on July 23, 2017

I am of the view that revenue generation targets are unrealistic, informed mainly by finding ways to cater to the government’s ballooning expenditure rather than any realistic economic dynamics. Over the past few years, revenue collection has fallen short of the targets, but it should be noted that the Kenya Revenue Authority (KRA) almost reached targets despite the constraints they face. For example, in the year just completed (FY 2016/17) total revenue collection stood at KES 1.365 trillion representing a performance rate of 95.4 percent. However, the shortfall in shillings was KES 66.64 billion- a significant number.

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 aggressive increases in government expenditure and seem oblivious of the serious constraints that mute tax collection.

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The first issue is that revenue generation targets tend to be revised upwards over the course of the year. KRA’s original revenue target for the financial year 2016/17 was KES 1.415 trillion which was revised to KES 1.431 trillion, an increase of KES 16.24 billion. This is a concern because motivations behind increases in targets are not clear. Is the increase due a realisation in Treasury that it cannot raise as much as anticipated in borrowing and thus they place pressure on KRA in the form of increasing revenue generation targets?

The second constraint is that the macroeconomic environment informs the extent to which targets deviate from forecasts. For example, it is estimated that a 1 percent point reduction in GDP growth reduces revenue by KES 13.4 billion. In terms of inflation, a 1 percent point increase in inflation requires that revenue targets be raised by KES 13.0 billion to cater for the value of money lost due to inflation. Thus macroeconomic dynamics inform the extent to which KRA can hit targets.

Thirdly, government policy decisions particularly those related to tax policy affect the ability to generate revenue. The non- implementation of tax policy in terms of the adjustment of specific excise rates in FY 2016/27 did not occur negatively impacting revenue generation by KES. 4.911 billion. Additionally, the duty free importation of essential foods (maize, milk, sugar) led to a revenue loss of KES 4.363 billion in the 4th quarter of 2016/17. Indeed, it is estimated that government policy decisions cost KES 13.006 billion in revenue generation in FY 2016/17.

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(source: https://www.dur.ac.uk/images/law/research/researchhub/Taxpolicybig4.JPG)

Fourthly, government itself is to blame; delays in remitting income tax from public institutions costs KES 823 million.

Finally, sectoral issues inform the ability of KRA to collect tax. For example, declining profitability among large firms where 16 NSE listed firms issued profit warnings in 2016, had an adverse impact on corporation tax. Additionally, the downsizing and shutting down of firms which resulted in over 7,000 staff lay-offs in various institutions, mainly banks, adversely affected PAYE performance.

It is time that revenue generation targets were informed by the dynamics elucidated above. If this does not happen, government will continue to be seen to be trying to buffer itself from its aggressive expenditure through creating unrealistic targets rather than submitting austerity budgets that limit unnecessary spending.

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

 

 

Is agriculture being neglected under devolution?

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This article first appeared in my weekly column with the Business Daily on June 16, 2017

 It is not a secret that Kenya has been suffering the consequences of a ravaging drought for about a year now. Q1 2017 GDP growth stood at 4.7 percent largely due to a notable contraction in agriculture. The 1.1 percent contraction in agriculture is obviously informed by the drought. For example, the drought has decimated the production of tea one of Kenya’s key exports; production is expected to drop by 12 to 30 percent. Livestock production has also been devastated with estimated losses of 40 to 60 percent of livestock assets particularly in the North East and Coast. Maize farmers in Uasin Gishu continue to generate measly yields from their farms.

The question becomes, how did this happen? This is the first major drought to affect the country since the advent of devolution. Are there issues that have emerged in the context of devolution that allowed the drought to grip the country to the extent it has? The answer seems to be yes.Image result for agriculture Kenya

(source: https://ccafs.cgiar.org)

The first issue is budget allocations to agriculture. According to the International Budget Partnership (IBP), national government allocated the sector as follows: 2 percent in 2015/16, 1.3 percent in 2016/2017 and 1.8 percent in 2017/18. As IBP points out, the Maputo Declaration 2003 calls for allocation of at least 10 percent of total national budget towards agriculture. The average expenditure on agriculture in Africa is 4.5 percent; Kenya’s national allocations are sub-par. These paltry allocations may be due to the fact that that agriculture isn’t an attractive sector to finance. Infrastructure remains a priority for national and (it seems) county governments because physical assets can be pointed to as proof of ‘development’. The same cannot be done with agriculture, as a result agriculture seems to wallowing in financial neglect.

The second concern is the lack of coordination between county and national government. It is still not clear who is responsible for what in the agriculture sector. While agriculture has been devolved, the truth is that the national government through the Ministry of Agriculture, is still a key player in the sector. In the work I have done at county level, it has become abundantly clear that neither county nor national government are of the view that they are fully in charge of the sector. As a result, the sector is wallowing in a lack of ownership riddled by a lack of collaboration and coordination between the two levels of government. This is surely a contributing factor that allowed the drought to reach the scale it did.

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(source: https://anzetsewere.files.wordpress.com/2017/07/af82e-kenya-ag-1.jpg)

The third is a breakdown in support services to small holder farmers and poor early warning systems; both of which should sit in the county government. It has been noted that extension services that rural farmers in particular used to enjoy are no longer there. Aside from subsidies in fertiliser for example, small holder farmers on whom most Kenyans rely for food, need continuous support to make their farms more productive, limit post-harvest loss and make sure their products reach markets. County governments also seem to have failed in the early warning systems that should have signalled the crisis as they are present at grassroots levels. County governments seems to be having difficulty in playing their role in the sector and it is not clear why. Perhaps it may be a combination of a lack of technical capacity as well as limited financial allocations to the sector.

What is clear is that the situation detailed above cannot continue to happen. National and County government need to not only prioritise agriculture in terms of budget allocations but also solve the coordination problem that is so clear.

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

Lingering effects of interest rate cap

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This article first appeared in my weekly column with the Business Daily on July 9, 2017

The interest rate cap has led to several consequences, some of which have been elucidated in this column. The most concerning are the effects is has had on monetary policy and access to credit for the private sector. However new medium to long-term effects are beginning to emerge.

The first is that, private sector, particularly SMEs are getting used to functioning without the credit lines on which they used to depend. Data from the CBK indicates that credit to the private sector expanded at 3.3 percent in the year to March 2017, the slowest rate in more than a decade. So while some private sector may be turning to the shadow lending system for credit, many more may be growing accustomed to getting by with no credit lines at all. In effect, the cap may be dampening the private sector’s appetite for credit. Thus the concern is not only that the economic engine of the country is being starved of liquidity, the engine may be getting to used to ticking away at sub-optimal levels due to poor access to credit with dire consequences to GDP growth. GDP grew at just 4.7 percent in the first quarter of the year, and although part of this is due to a contraction in agriculture, the cap has also informed the sub-par growth. Will dampened appetite for credit become a long-term trend or will private sector aggressively take up credit lines if the cap is reversed?

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Secondly, since the cap has made government the preferred client for many banks, the cap has created the very situation government has been stating it has been trying to avoid and that is crowding out the private sector. Thus the irony is that in government assenting to the cap, it has created the very situation it sought to circumvent. Indeed in the 2017/18 financial year government plans to finance 60.7 percent of the fiscal deficit using domestic sources. In the past government would somewhat limit heavy borrowing from domestic markets but in the age of the interest rate cap, government is well aware of its priority status and thus seems to be leveraging this to finance the budget with domestic sources perhaps more aggressively than had previously been the case. Will this become a long-term habit that proves difficult to break?

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Thirdly, however, there is a silver lining in the cloud; banks are going to come out of this period more efficient than ever. The cap has caused banks to ask themselves hard questions such as: how much labour is actually required to effectively meet client needs? How many branches need to remain open to serve clients and hit targets?  The cap may be accelerating the automation drive that had already began to occur in the banking sector and banks should embrace this era of capped rates to become more efficient. Banks will likely emerge from the interest rate cap as leaner and more efficient entities than would have been the case if the cap hadn’t been effected. This is a long term effect on the banking sector and may well have lasting benefits on profit margins.

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

 

How Kenya can reach Vision 2030 GDP goals

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This article first appeared in my weekly column with the Business Daily on July 2, 2017

Kenya’s annual GDP growth rate has been ticking along steadily at between 4 to 7 percent over the past five years. At no point has it hit the Vision 2030 target of 10 percent. Why not? Was Vision 2030 a pipe dream littered with deliberately illusory goals and targets? Why has the 10 percent target not been reached, and how can this be changed? There are three factors that can unlock the country’s economic growth at a fundamental level in both the long and short term.

The first is the long term issue of agriculture. The agriculture sector is a conundrum; on one hand Kenya’s agricultural sector is very efficient and profitable. Kenya is one of the leading exporters of black tea in the world, and the country’s floriculture and horticulture sector are important economic players in the sector. On the other hand, the country continues to struggle with food security as the maize price dynamic has illustrated. The ILO makes the point that the agricultural sector employs 61 percent of Kenya’s workforce, yet only contributes 30 percent to GDP.Related image

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This conundrum can be rectified through a multi-pronged approach that links productive sectors to less productive ones, more effective deployment of agricultural subsidies to farmers (particularly small holder farmers), and the revival of technical skills transfers to farmers at county and ward levels. Doing so will allow the labour locked in the sector to enter profitable activity either in agriculture or other sectors.

The second factor is the interest rate cap which is an overarching, hopefully short-term, constraint to meeting the 10 percent target. Earlier this year the World Bank made the point that Kenya faces a marked slowdown in credit growth to the private sector. At 4.3 percent, this remains well below the ten-year average of 19 percent and is weighing on private investment and household consumption.

Part of this massive slowdown can be attributed to the interest rate cap which has compromised two fundamental levers that support economic growth: access to credit and monetary policy. The interest rate cap has engendered a contraction in liquidity to SMEs in particular, essentially slowing down the country’s economic engine. Due to the cap, SMEs are unable to get the liquidity they need in order to expand and generate more jobs as well as income. The second lever compromised by the interest rate cap is monetary policy, reducing its ability to buffer Kenyans from economic volatility. With inflation standing at 11.7 percent in May, the cap has made it almost impossible for the CBK to step in with remedial measures such as raising interest rates as the consequences of doing so are unclear. Thus, in the short term, the interest rate should be reversed so that monetary policy can play the role it ought to, and robust credit access is restored to Kenyans.

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The third factor is the informal economy which is not only important for economic growth but also engendering equitable growth. 90 percent of employed Kenyans earn a living in the informal sector, yet it continues to be neglected. Too much of the country’s labour is locked in micro-businesses with low levels of productivity, too inadequately skilled and resourced to drive the country’s equitable growth. Thus financial, skills and technological resources ought to be directed to the sector to catalyse the ability of informal businesses to graduate into authentic profitability, sustainable job creation and robust income growth.

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

 

 

Systemic fiscal weaknesses need to be urgently addressed

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This article first appeared in my weekly column with the Business Daily on June 25, 2017

Last week the International Budget Partnership (IBP) presented information on what is driving fiscal performance at national and county level, with a focus on revenue inflows. This is a behemoth task in itself due to significant data gaps that impede comprehensive analysis. For example, gazettes released by the National Treasury tend to be incomplete and it is not clear when the disbursements actually happen. Additionally, figures frequently change (particularly revenue inflows) mid-year with no explanations and the same information can be presented in numerous formats making analysis on consistent data sets difficult.

That said, there is enough data from FY 2011/12 to 2016/17 to make some important observations. The first challenge that has emerged has to do with the sequencing of revenue inflows into National Treasury that affects county budget disbursements. National Treasury does not receive all of the revenue required to be dispensed over the fiscal year in equal tranches; that is 4 sets of 25 percent of revenue each quarter over the fiscal year.

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According to data over the time period analysed, in Q1 only about 20 (not 25) percent of total revenue in-flows have been received, this goes up to 47 percent by mid-year. What this means is that the bulk of financing for the fiscal year is received in the second half; as a result national government disbursement to counties follow a similar pattern where the bulk of county finances are sent in the later half of the year. This may explain complaints by governors that they do not get their disbursements on time and they blame Treasury for this.  But to be fair, National Treasury is not in full control of when revenue inflows come in. Nonetheless, since it is clear that this is a systemic issue that recurs, national government ought to start taking remedial action so that county governments are not affected by their revenue inflow constraints.

However, county governments are not innocent bystanders when it comes to fiscal weaknesses; counties almost consistently fail to approve their budgets on time and thus do not submit the attendant requisitions that lead to allocations. It seems that in most cases, county budgets have not been approved by the June 30 deadline; this leads to delays in disbursements. The factors behind these delays at county level are not clear but seem to be an amalgam of county capacity constraints as well as disagreements between County Executives and County Assemblies on what should feature in county budgets.Image result for fiscal policy

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A third factor at play that is informing fiscal performance is to do with sources of revenue. We know that county governments are still very poor at generating their own revenue and thus are almost entirely reliant on national government allocations. This makes them less autonomous in controlling their fiscal performance. At national level, the issue is that government is being increasingly affected by delays in revenue inflows partly because taxes are making a decreasing share of national government revenue inflows. National government is becoming more reliant on other sources of revenue beyond taxes, which means more borrowing and government often does not control when those disbursements are received. So at both county and national level, government is not in full control of revenue inflows which leaves the country exposed to cash crunches on which quick remedial action cannot be taken.

It is important that national and county government develop revenue inflow strategies that mitigate current challenges so that expenditure and development plans can be more efficiently effected.

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

 

How Kenya can industrialise in 5 years

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This article first appeared in my weekly column with the Business Daily on June 18, 2017

Manufacturing can play a crucial role in Kenya’s inclusive growth by absorbing large numbers of workers, creating jobs indirectly through forward and backward linkages to agriculture, raising exports and transforming the economy through technological innovation.

It is with this in mind that the Overseas Development Institute and the Kenya Association of Manufacturers coordinated a multi-stakeholder process to determine how the manufacturing sector can create 300,000 jobs and increase the share of manufacturing in GDP to 15 percent in 5 years.

A plan titled ‘10 policy priorities for transforming manufacturing and creating jobs’, has been developed focused on key actions that can be taken to build the manufacturing sector and achieve the aforementioned goals. The plan is rooted in the Kenya Industrial Transformation Programme and the Vision 2030 Manufacturing Agenda targeted at priority sectors of both formal and informal manufacturers (jua kali) as both sectors need support if Kenya is to industrialise equitably.

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(source: http://www.industrialization.go.ke/images/kenya_manufacturing.jpg)

The first issue to address is the business environment in Kenya. While Kenya has moved up 21 places, in its position World Bank’s Ease of Doing Business Rank, considerable constraints exist particularly in dealing with construction permits, paying taxes and registering property. Thus further action is needed to improve the business environment. Additionally, for manufacturing to flourish the country needs a fiscal regime that is more articulated to support the sector. Fiscal policy at both national and county level needs to be more deliberately leveraged to support industrialisation through, for example, developing fiscal incentives that drive investment into manufacturing.

The third action point concerns making land more accessible and affordable. Research by Hass Consult reveals that the price of land in and around Nairobi has increased by a factor of 6.11 to 8.05 since 2007. Aggressive increases in land price dampen investor appetite for investment in manufacturing which tends to be land intense. Thus there is a need to prevent inflationary speculation on land prices, and develop government land banks earmarked for industry.

Energy costs continue to be punitive in the country and make Kenya’s manufacturing sector less competitive than even its East African neighbours. Government efforts need to not only target increasing energy generation but also lower energy prices and increase the quality and consistency of energy to the industrial sector. This should be coupled with a key gap constraining the sector- access to finance. Manufacturing companies, particularly SMEs and informal industry, are undercapitalised and face multiple obstacles to obtaining access to finance. Bespoke financing mechanisms aimed at the sector, such as through an Industrial Development Fund, need to be fast-tracked.

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Kenya cannot leverage manufacturing for economic development without creating a more aggressive export push into regional and international markets. Kenya’s exports to the EAC are declining and opportunities such as AGOA can be tapped into more effectively. Additionally, Kenya needs to reorient education policy and skills development towards STEM subjects so that the skills in the labour pool drive the growth of manufacturing.

Finally, overall coordination in the sector is crucial. An agency in government should be created that coordinates all government entities relevant to industrialisation such as agriculture, education and the National Treasury. The private sector also needs to better coordinate particularly along value chains to drive sub-sector growth in a more robust and targeted manner. Finally, there is a need for better coordination between public and private sector through fostering trust and reciprocity to drive industrialisation forward.

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

How to develop light manufacturing in Kenya

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This article first appeared in my weekly column with the Business Daily on June 11, 2017

Last week I attended a meeting organised by the Overseas Development Institute (ODI), the Africa Centre for Economic Transformation (ACET) and the Government of Ethiopia aimed at analysing and sharing lessons on the development of light manufacturing in Africa.

The development of light manufacturing is an important part of Kenya’s plan for industrialisation as articulated in the Kenya Industrial Transformation Programme (KITP) developed by the Ministry of Industry. The Special Advisor to the Prime Minister of Ethiopia, Arkebe Oqubay, made some interesting points about key features of light manufacturing of which countries should be cognisant as they implement industrialisation plans.

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The first is no secret; light manufacturing is labour intensive. This feature makes light manufacturing attractive for African countries as an entry point into industrialisation as it has the ability to absorb large pools of labour. While this is attractive, it seems to me that it can create considerable pressure to rapidly skill up a relatively low skilled labour pool. Human and technical resources have to directed to a young and inexperienced labour pool in order to develop a sector with high labour productivity and high profit-making potential. Clearly it can be done, but has to be well thought out with clear links to education policy.

The second point made was that countries cannot implement a light manufacturing strategy without addressing issues in agriculture. Whether it is textiles and apparel, leather and leather products, or food and beverages (F&B) manufacturing, agricultural inputs are crucial. In this sense Kenya faces a conundrum because certain segments of the agricultural sector such as tea, horticulture and floriculture are highly productive, but the rest of the sector wallows in poor productivity and considerable inefficiencies. It is no secret that textile and apparel firms in the EPZs in Kenya import their fabric from abroad, a factor that dampens the ability of this value chain to be an even bigger employer and income earner for Kenyans. The leather value chain in the country is also sub-par and the production capacity for domestic agricultural input into F&B manufacturing is lacklustre. What is clear is that Kenya cannot make serious forays into light manufacturing until the issues in the agricultural sector and value chains are fundamentally addressed.

The final point Oqubay made was that the sector should be export-oriented if scale is to be achieved in a manner that restructures the economy. Insights from ODI on this issue point to the importance of conducive trade rules and trade facilitation measures that lower trade costs both in terms of accessing inputs and export markets. If manufacturers cannot get the inputs they require and reach target export markets, the sector cannot effectively scale.

Other factors important in industrial policy, as pointed out by ODI, is collaboration and coordination between public and private sector in a manner that creates consensus on the strategic direction of the sector and country at large. When coupled with effective investment facilitation, SEZ creation/industry cluster development, and infrastructure development, it creates an environment where light industry can take off.

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Kenya can build on the successes being registered in infrastructure development and expedite the creation of SEZs, learning from countries like Ethiopia. However, the country needs a sharper focus on improving agricultural productivity, a more coherent skills development strategy, vastly improve investment facilitation and more effectively encourage public-private dialogue on the development of light manufacturing in the country.

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