Cash deficit: Treasury walks tightrope on debt as Kenya’s public spending soars

When a country’s economy is growing by more than 5 per cent a year and then discovers that it has at least 600 million barrels of oil, it is hard to avoid triumphalism.

It puts politicians in the enviable position of being able to promise Kenyans great things today and great things tomorrow.

The consensus is that, having grown by a fraction under 5 per cent over the last three years, the country’s economy will grow by around 6 per cent in 2015.

That, at least, is the view of the World Bank and the International Monetary Fund (IMF), as well as the Jubilee Government.

In its Global Economic Prospects report published in January, the World Bank forecasts that Kenya’s growth rate would be boosted by higher public investments and the recovery of the agriculture and tourism sectors.

But is there a bit too much optimism about the economy?

Not enough

The reality is that not all the charts are pretty to look at. Kenya’s current account and overall deficit levels have been well into the red for a number of years.

A briefing paper by US banking giant Citigroup, titled Kenya on the Cusp, focuses on the “nagging doubts” about the country’s twin deficits — its current account and fiscal deficits — which it cites as the main challenges to the country’s economic performance over the next decade.

The trouble for Citigroup and other analysts is that the relatively high growth rates are still not nearly enough for the Government to be able to balance its books.

As Citigroup’s report puts it, the Jubilee Administration is “still struggling to achieve fiscal consolidation, with a widening current account deficit”.

Kenya’s economic growth, it notes, is “robust, but not high enough”.

The country’s current account — the gap between spending on its imports and earnings from its exports — has been consistently high.

Think of the world as a marketplace, where each country has a stand to sell its produce and the opportunity to buy goods from other countries.

Simply put, Kenya has been living “beyond its means” by buying more from other countries in the global marketplace compared to what it sells — which includes its tourist destinations, tea, coffee and other horticultural items.

The current account deficit averaged 8.8 per cent of the value of what the country produces (its gross domestic product, or GDP) between 2011 and 2013, but is expected to have hit 12 per cent in 2014.

However, many argue that running a current account deficit is not a bad thing at all.

This is because, for instance, importing machinery, which Kenya does not manufacture will help the country’s industries one way or another, and the final effect translates into more jobs created locally.

But the flip side of running a current account deficit is that the country’s currency is left extremely vulnerable to shocks in the global economy.

The Consensus Economics Forecast for the shilling in January projected that the exchange rate would rise to Sh93.81 to the dollar in 12 months’ time, and Sh95.95:$1 in 24 months’ time.

This will make imports, which the country relies on, more expensive, though it will favour its exports.

But what remains worrying is that Kenya’s overall fiscal deficit remains stubbornly high at 6 per cent of GDP.

The fiscal deficit occurs when the Government spends more than it generates in revenues, which it gets mostly from taxing individuals and corporate Kenya.

Expensive projects

The fiscal deficit has remained stubbornly high because the Government has ambitious, expensive projects — like building roads and other infrastructure, and improving healthcare — yet it has not been growing its revenue at a faster or equal rate to match its spending.

The need to grow revenues partly explains why in the last two years, the Government has been keen on re-introducing more taxes on the Kenyan citizen.

Think of the capital gains tax, which players in the stock market are bitterly fighting, and the interesting news earlier this month that there are plans to abolish value added tax (VAT) exemptions on oil products by August 2016.

An initial plan agreed to by the Government and IMF in 2011 was to have reduced the fiscal deficit to below 4 per cent of GDP by 2013.

This target was not attained, and the Jubilee Government appears to have kicked plans to rein in spending into the long grass.

The deficit is likely to stay at around 6 per cent for the next two years, and the IMF does not expect it to fall below 5 per cent of GDP until the 2017-18 fiscal year.

The debt burden also continues to edge further upwards.

Kenya’s debt burden is not yet a major source of worry, but it has risen steadily towards the psychologically important 50 per cent of GDP level since 2010, when it stood at 40 per cent.

Economists largely attribute this to the Government’s prioritising of infrastructure investment over German-style budgetary discipline.

Capital spending — which is spending on assets with a useful life beyond one year — is set to almost double to around Sh600 billion in 2015 and 2016, under current Budget plans.

There is nothing faulty in the judgement that investments of such magnitude are sorely needed.

The Economic Prospects report noted that alongside an “urgent need across the region for structural reforms to increase potential output growth, an acute infrastructure deficit is evident, especially in energy and roads.”

Budgetary discipline

Economist Paul Otung added that “concern over the persistent current account and fiscal deficits, though warranted, should not dampen the ‘investment spirit’. The deficit is still sustainable. And anyway, borrowing to fund infrastructure spending is usually good.”

So if increased Government spending is too important to be sacrificed at the altar of budgetary discipline, there are two options the country has left, and neither is mutually exclusive: making Kenya a more competitive and dynamic economy to invest in, and increasing the tax take.

The first option is largely being taken care of by the ongoing reforms process and increased spending on infrastructure.

However, Fred Wafula, a macroeconomist, while agreeing that spending to increase the country’s “productive capacity” is wise, the infrastructure projects need to benefit sectors that will generate foreign exchange earning and support increased exports.

“The capital spent on building roads and railways has to be paid back, so it needs to boost sectors of the economy that will generate hard currency to settle a hard currency debt.”

Mr Wafula added that while better roads will boost tourism, for instance, which will increase hotels’ income, raising VAT and income tax collections for the Government, these benefits may be felt long after debt matures.

“In the meantime, how do you balance the short-term risks? The Government needs to do something in other sectors that will bring early returns from infrastructure,” he said.

“Enabling the generation of cheaper energy to lower electricity costs is a step in the right direction. But we cannot then have some agencies in this sector agitating for an increase in tariffs. This will lower the benefits of cheaper electricity to manufacturers, undoing efforts to increase State revenue by attracting more investors.”

Spillover effects

As regards tax take, under the new GDP data used since last year, the Treasury collected taxes worth 19.2 per cent of GDP in 2014. While this is still above the regional average, it is not enough to balance the books.

And this has had spillover effects on Kenya’s debt profile.

The consensus among analysts is that recent growth rates and foreign investments into Kenya are despite, rather than because, of the Government — Kenya is ranked a lowly 136th in the World Bank’s Doing Business survey, largely as a result of corruption which “continues to act as a brake” on the economy, in the words of Citigroup.

One development that is almost unequivocally good news is the oil price slump that has seen the price of Brent crude oil fall from more than $100 per barrel (Sh9,155) to below $50 (Sh4,600) in the six months since last July. However, the price has begun to rally in the last two weeks.

Although the World Bank has warned that a prolonged slump in prices would make exploration firms less inclined to invest in getting Kenya’s oil out of the ground, Tullow Oil, the British company that has led exploration in Kenya, has indicated it will maintain its projects in the country.

Good news

The drop in price should reduce the current account shortfall.

In 2013, oil accounted for $4.1 billion (Sh375 billion) of Kenya’s $17.1 billion (Sh1.6 trillion) total imports, equivalent to 6.5 per cent of GDP. This bill would be halved if consumption remains unchanged.

But two years out of a general election, structural reforms and changes to the tax regime — for example, new taxes on property and capital — are hardly the way to win popularity.

Some also doubt the need for serious surgery, pointing to Citigroup’s remark that “while the fiscal deficit has not really been brought under control, it has not ballooned out of control either.”

On his part, Mr Otung argues that the situation should not worry people too much, provided that the deficit does not persist for more than five years, and that extra Government borrowing is used to finance one-off infrastructure projects rather than recurrent spending.

However, as the recent pressure on the shilling caused by the strengthening dollar — which has seen the Central Bank of Kenya spend some of its jealously guarded dollars to prop up the currency — has shown, the world economy is constantly encountering headwinds that could easily knock Kenya off its path.

In its last report on Kenya, the IMF concluded that “a redoubling of efforts to improve the tax take” was needed from the Government, and it is difficult for local analysts to avoid arriving at this conclusion.

Tax revenues

If infrastructure spending is to reach the Sh600 billion that the Government has targeted, then larger tax revenues will also be required to balance the books.

In addition, reforms are need to improve the overall competitiveness of the Kenyan economy and attract foreign investment.

“There also needs to be active co-ordination, not competition, of Government policies to boost the country’s attractiveness as an investment destination,” said Wafula.

“Promoting foreign direct inflows will also ensure the current account deficit does not weaken the shilling.”

One of the lessons governments should have learned from the 2008-9 financial crisis is that it pays to fix your roof while the sun is shining. Running consistently high fiscal and current account deficits alongside a steadily rising debt burden in times of plenty is almost tempting fate.

But perhaps the real ‘nagging doubt’ is whether, two years away from an election and with favourable economic conditions, the Government is doing as much as it can to tackle its twin deficits.

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