fiscal policy

TV Interview: The effect of the elections on the economy

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On September 7 2017, I was on a panel on Citizen TV discussing the effect of the elections on the Kenyan economy.

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How Kenya can restructure fiscal policy in the next 5 years

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This article first appeared in my weekly column with the Business Daily on August 27, 2017

Fiscal policy in Kenya over the past 5 years has been characterised by several features the first of which is aggressive growth in expenditure. Cytonn Investment makes the point that over the past 6 years, total expenditure in annual budgets have grown at an average of 14.7 percent yet revenue growth has only increased by 12.7 percent. This has led to more borrowing and expanding fiscal deficits with an increase in debt levels from 40.7 percent debt to GDP in 2011 to the current 54.4 percent. While some argue that Kenya’s debt is not at distress levels, if current patterns of spending continue the distress point will be quickly reached. Thus, it is important to ask how policy should be structured over the next 5 years to put the country on a more sustainable fiscal path.

At national level, fiscal focus should target cutting non-essential expenditure; government needs to be very firm on this and make the hard decisions required to prevent profligate spending, particularly in recurrent expenditure. Cytonn makes the point that recurrent expenditure accounts for 58.8 percent of the 2017/2018 budget. One way to address this issue is through robust support to the Salaries and Remuneration Commission (SRC) to cut salaries and better align compensation packages to reflect the economic reality of a developing African economy. The current association between public office and wealth accrual needs to be severed and stern fiscal policy backed by political commitment can make this happen. Further, a keener eye should be cast over the efficiency of government spending; procurement at national and county must focus on value generated for funds spent. Without doing so, Kenya will find itself on a path where careless and inefficient spending leads to debt accretion that doesn’t stimulate the economic growth required to meet debt obligations.

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(source: http://www.itworks-inc.com/wp-content/uploads/2015/11/delegating-expenditure-approvals.jpg)

Secondly, revenue generation needs to be ramped up; expenditure is growing at 14.7 percent and revenue collection by only 12.7 percent.  Revenue collection has to grow faster than expenditure if the country is to have greater funds available for public investment. One way to do this is by better supporting the KRA to prevent illicit financial flows from the country; a serious problem for African countries. The United Nations Economic Commission for Africa estimates that Africa loses more than USD 50 billion through illicit financial outflows per year. Devex points out that companies evade and avoid tax by shifting profits to low tax locations, claiming large allowable deductions, carrying losses forward indefinitely, and using transfer pricing. Government ought to undertake an audit of tax policy, restructure outdated tax laws and correct faulty tax arrangements with multinational companies; KRA needs to be supported to improve enforcement of these laws.

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At county level, fiscal policy needs to be characterised by, again, cutting down on unnecessary spending. County governments have to take the initiative on this and so far there have been encouraging signs of newly elected governors choosing to fully or partially redirect massive inauguration budgets to more productive areas; this should be encouraged. Further, county government budget processes ought to be more transparent; at the moment there are significant gaps in understanding how county budgets are formulated and implemented. More counties should follow in the footsteps of Elgeyo Marakwet county and develop a transparent, formula-based budget development process that prevents elite capture in budget formulation and deployment.

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

Mega infrastructure development not silver bullet for economy

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This article first appeared in my weekly column with the Business Daily on August 20, 2017

It is not a secret that the current and previous Kenyan governments (Kibaki and Kenyatta administrations) have prioritised investment in and the development of infrastructure. Kenya has prioritised infrastructure spending and development for the past 15 years. As the Brookings Institution points out, there is the view that investment in infrastructure- energy, transport, communication, irrigation, and water supply- propels economic output. The direct effect is raising the productivity of land, labour, and other physical capital. For example, steady supply of electricity reduces disruptions and time wasted at the work place. It complements the contributions of education, health, marketing, and finance. Infrastructure investment is seen as a foundation for and enabler of economic growth.

Government has allocated a significant percentage of annual budgets to infrastructure. Indeed, between FY 2016/17 to FY 2019/20, the government committed about 30 percent of total budget expenditure to infrastructure; compare this to 2.8 percent to agriculture. The concern is that despite this fiscal commitment, we have not seen the attendant economic growth; the economy has never even pretended to reach the 10 percent target of Vision 2030. So this begs the question as to what Kenya is getting wrong. Why isn’t infrastructure investment notably boosting economic growth? There are several reasons that provide insights to answer this conundrum.

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(source: http://www.theeastafrican.co.ke/image/view/-/2332200/medRes/528395/-/ssuyxr/-/infra.jpg)

The first, harsh, reality is that the link between infrastructure and economic growth is more tenuous than previously assumed. The London School of Economics points out, the most recent studies on the magnitude of infrastructure’s contribution to growth tend to find smaller effects of infrastructure investment on growth than those reported in the earlier studies; this is linked to improvements in methodological approaches. Kenya shouldn’t assume that infrastructure investment and development will automatically lead to significant improvements in economic growth. Yes there is a link between the two, but less pronounced than was previously assumed.

The second reason that could explain the muted effect of infrastructure spend is that Kenya has such a massive infrastructure deficit that current investment has barely had any notable effect. According to the Capital Markets Authority, Kenya’s current estimated infrastructure funding gap is USD 2-3 billion per year over the next 10 years. However, the reality is that the infrastructure deficit in Kenya’s neighbours is likely more pronounced, yet the fact that countries such as Ethiopia have emphasised infrastructure investment and routinely hit double digit growth questions the plausibility of this argument.

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(source: http://www.kachwanya.com/wp-content/uploads/2015/05/infrastructure-development-in-kenya.jpg)

The final question to ask is: Is Kenya investing in the right infrastructure? The Brookings Institution makes the point that a push for more infrastructure only raises economic growth and people’s well-being if the focus is on quality and impact and not on the quantity and volume of investment. Has Kenya has fallen short here? Has the government conducted an audit of the impact of investment infrastructure investment and development thus far? Has there been an audit on the quality of the infrastructure developed thus far? Is Kenya investing in the right infrastructure? How efficient is our investment into infrastructure? Without an answer to these questions, the country will not learn from past mistakes and thus infrastructure development will not be recalibrated to be more effective.

It is therefore crucial that the government undertakes a thorough analysis on the nature, scale, efficiency and impact of infrastructure investment and developments made thus far so that the required improvements can be effected.

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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(source: http://www.goldmansachs.com/citizenship/10000women/meet-the-women-profiles/kenya-women/mary-kenya/slide-show/mary-slide1.jpg)

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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(source: http://www.businessdailyafrica.com/image/view/-/3947270/medRes/1621958/-/62ktdm/-/NT.jpg)

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

 

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 fiscal policy can attract the right type of investment for Africa

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This article first appeared in my column with the Business Daily on March 30, 2017

Someone once told me that there are three types of foreign investors in Africa. The first are those who invest in the country in order exploit raw natural resources and direct them to their projects outside the country. The second are those who invest in countries in order to flood the country’s markets with their products. The third are investors who invest in the country for the long-term in a manner that creates employment, builds incomes, contributes to GDP growth and of course, generates profits. Africa seems to have little problem in attracting the first two investor type, but often struggles to secure the third type. The question for Kenya is, which type of investor is the country attracting? And what can be done to attract the third type of investor?

These questions are important in the context of fiscal policy, of which a key event will take place today when the National Budget 2017/18 will be read. Fiscal policy ought to and can play an important role in attracting the right type of investor to Kenya.

Over the past ten years, the government has been on an investment drive to build the country’s infrastructure. In principle, efficient public investment in infrastructure can raise the economy’s productive capacity by connecting goods and people to markets. The national budgets over the past few years have thus has allocated significant amounts to energy and transport infrastructure such as LAPSSET, the Standard Gauge Railway (SGR), Rural Electrification and the Last Mile Project. With the SGR due to be completed this year, it will become clear what dividends the country will reap from such heavy fiscal commitment to infrastructure. That said, infrastructure investment is a prerequisite to attract the third investor type as the ease and cost of transporting goods are an important business cost and variable.

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The second fiscal strategy that can bring long term investors as well as bolster food security and manufacturing is tax incentives to create productive agricultural value chains. Fiscal policy can more effectively engender a shift from subsistence to commercially productive farming by identifying commercially viable agriculture value chains and linking small holder farmers to manufacturers. Through incentives such as tax remissions along key food and beverage manufacturing value chains, fiscal policy can incentivise higher productivity in farming and contribute to making manufacturing more dynamic than is currently the case. The key however, is consistency in fiscal policy with no abrupt changes in tax remissions or other incentives so as to engender long term investment in food value chains.

Thirdly, the right investor type can be attracted to the country through investment in Kenya’s human capital. As the IMF points out, more equitable access to education and health care contributes to human capital accumulation, a key factor for growth and an improvement in the quality of life. Fiscal policy has two roles here; the first is creating incentive structures for private sector investment into the country’s private and public education and health networks and the second being the country’s own fiscal commitment to health and education sectors. National budget allocations to education stand at about 23 percent, while commitments to health are at about 6 percent of the national budget. Health allocations are paltry and while the education allocations look impressive, a great deal of the funds are directed to free primary education. In order to develop a healthy, highly skilled and productive labour pool, government ought to consider reorienting the almost obsessive fiscal commitment to infrastructure towards more robust allocations to health and post-secondary education. This should be complemented by the creation of incentive strategies that attract investment into national priority nodes for the sectors.Image result for health kenya

(source: https://investinkenya.co.ke/components/uploads/0942a7f713ab6801a17e2cfb325fc99c.jpg)

The fourth means through which fiscal policy can attract the right investors is by managing tax rates at national and county levels.  At the moment, private sector is facing numerous tax burdens due to the lack of harmonisation of tax rates between national and county governments. Fees and charges at county level are unpredictable, non-standardised and onerous; business face multiple payments for advertising and transporting goods across county borders. While these are not technically taxes, they are a form of tax exerted on private sector with no clear link to the service that should be expected for such payments. At national level, the main concern for private sector beyond VAT refunds, is that a small segment of business and individuals are onerously taxed due to the narrow tax base in the country. Thus national government ought to develop a long-term strategy for broadening the tax base.

A key component of broadening the tax base is addressing informality in the economy where millions of informal businesses do not pay taxes. The aim here is not to tax informal businesses, as most are micro-enterprises barely making profits, but rather creating an ecosystem that encourages the development of informal business. Again, fiscal action can be taken by government to direct financing focused at developing micro, small and medium enterprise through more the strategic deployment of the Youth, Uwezo and Women’s Funds. The financing architecture of these three funds has to be fundamentally rethought to focus on building technical skills and business management capacity, and improving productivity and profitability in the informal sector.

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Additionally, the government ought to develop a strategy for Kenya’s cottage industry which is the Jua Kali (informal industry) sector linked to solid fiscal commitments. Through fiscal action, the government should create an investment environment that attracts traditional investors as well as non-mainstream financing such as angel investors, impact investors and venture capitalists to invest in Jua Kali. In this manner, action will not only invest in the informal sector, it will create incentives for investment into a sector in which over 80 percent of employed Kenyans earn a living, in a manner that complements fiscal policy.

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