Kenya’s Public Debt Distress: Issues and Scenarios
Category:
By: Leo Kipkogei Kemboi, Victoria KWAMBOKA,
Kenya’s fiscal policy space has changed significantly in the last 10 years. Kenya went on an expansionary fiscal policy driven by huge spending on infrastructural development. As a result, gross public debt increased from 44.4 percent of GDP at end-2010 to an estimated 79% of GDP at end-2021. The increased debt levels have been driven by high deficit. In 2020, Kenya’s debt problem was exacerbated by the COVID-19 global shock.
Chart 1: Kenya’s Debt Position (Share of GDP-%)
Source: IMF Data Mapper 2021[1], * projections
Since the 2013/14 financial year the annual net borrowing has increased by Ksh 685.72 billion to reach Ksh 7.25 trillion by November 2020. Between 2013 and 2020, the debt stock has increased by 300%. The high level of debt stock has resulted in a surge in debt servicing charges. In 2019/20, Ksh 718 billion amount of debt was repaid compared to Ksh 886 billion that was borrowed, this was equivalent to 7% and 8.7% share of GDP respectively. The debt service to tax revenue ratio has increased from 30% in 2013/14 to 49% in 2020/21.
The continued debt issues have spiralled out of control and lead to the breaching of debt indicators. The present value of public debt to revenue and grants ratio indicator of 300 was breached in 2019 when the public debt to revenue and grants ratio threshold of 300 was surpassed. Another indicator of debt service to revenue and grants ratio was breached in 2017 when debt service to revenues and grants ratio surpassed 38.2 against a threshold of 30. It is projected to reach a high of 74.5 in 2022. The most recent public debt sustainability analysis shows that Kenya’s level of debt distress has worsened from moderate to high.
Chart 2: Kenya has breached the Debt Indicators
Source: IMF Country Report 20/56
This piece aims to give possible scenarios on how Kenya’s debt position/distress might unfold. In this, we identify three possible scenarios which includes structural adjustments, hard landing and limiting expenditures.
Scenario 1: Structural Adjustment
Kenya’s debt problem has graduated to being a structural problem where solutions proffered have to be structural adjustments. Kenya entered into a 38-Month IMF program from April 2021 which recommends a fiscal consolidation accompanied by structural reforms to protect the fiscal space and create a conducive environment for private sector credit and investment to boost economic growth. The planned fiscal consolidation and accompanying structural reforms contained in the Memorandum of Economic and Financial Policies (MEFP) by the Kenya Nationals Treasury would protect fiscal space for the authorities’ development agenda while also supporting private credit and investment, leading to a higher and more inclusive medium-term growth”. Essentially, this would give the National Treasury time to allow economic growth to happen. In the medium term, the National Treasury hopes to change the structure of Kenya’s public debt. The success of this program remains to be seen and can only be evaluated at the end of the program.
Scenario 2: Limiting Expenditure in the Short-run
Scenario 2 is the path which Kenya should follow. Conventionally, huge public debt is organically reduced by allowing economic growth to happen. However, a higher public debt works against increasing economic growth. Public debt crowds out private investment and this worsens the economic growth performance in the long run (Elmendorf and Mankiw, 1999)[2]. The literature also shows that by rising long-term interest rates, higher public debt can crowd out investment which also (Modigliani, 1961[3]; Gale and Orszag, 2003[4]; Baldacci and Kumar, 2010[5])[6]. The Private sector investment is essential for replenishment of capital stock, adoption of frontier technology, boosting firm productivity and ultimately this propels the private sector-led growth. However, the contribution to growth from Kenya’s private sector investment has been falling as per the National Treasury’s comprehensive public expenditure review in 2017[7].
Over the last eight years, the expenditure has increased by an average of 250 billion every year while revenue has been going up by an annual average of 111 billion. It showed no matter what happens, revenues can never match expenditures. Kenya sustained deficits elevated the risk of debt distress. Kenya’s parliament which is tasked with approving the tax code has tried to counter this revenue problem caused huge leaps in expenditure annually by expanding the tax regime to cater for the sustained deficits by introducing new taxes or varying the scope of taxation. Kenya’s taxation regime since 2014 has changed significantly and it includes a wider scope of VAT, excise taxes amongst other taxes on bases such as electricity, LPG, minimum tax, digital service tax among others. However, the introduction of new taxes and increasing its scope of taxation doesn’t seem to achieve the desired goal of reducing the fiscal deficit.
The expenditure as a share of GDP has averaged between 26-30% for the last 9 years while revenue as a share of GDP has averaged between 16-20%. If all factors are held constant, the government will never be able to match revenues. As indicated, the appropriate response cannot be to tax more because there is an optimal taxation point in which taxes cannot be able to rise beyond some point as established by economist Arthur Laffer. When the budget deficit is zero or close to zero, there is minimal pressure on taxation as the actual demand coincides with the economy’s potential.
Taking a look at the chart below, we keep the expenditure/GDP constant at the annual average for the forecast period 2021/22- 2025/26 and simulate the revenue as a share of GDP with a mean of 18% and the standard deviation of the historic data. Noticeably, regardless of whether the expenditure is kept constant at the annual average, if we don’t minimize it, revenue will never catch up with expenditure and we will still have huge deficits.
Chart 3: Simulation of Expenditure and Revenue Trends
Source: Authors own calculations
Scenario 3: Hard Landing
If no effective solution is brought forward that limits the budget deficits or restructures tenure of debt to reduce magnitude of debt service , continuous deficits might trigger a hard landing. Ball and Mankiw (1995) lists hard landing as one of the outcomes of continuous deficits and defines it as a situation where demand for domestic assets collapses. Ball and Mankiw argue that the likelihood of such an event and its effects are highly uncertain but it’s one of the most compelling reasons for reducing budget deficits[8]. A hard landing can be trigged by adverse market events which could come from economic growth, a one-time currency, and suppressed exports.
Conclusion
In conclusion, unless we limit the expenditure, Kenya’s fiscal gap will keep widening and will eventually have a hard landing if big . In addition to that, unless we limit government borrowing, increasing the scope of tax will not increase revenue beyond the optimal point. This is because government borrowing mops out what could have been used for private sector investments. Economic growth is achievable without exerting pressure on the existing tax regime.
End Notes
[1] IMF Kenya Data, https://www.imf.org/external/datamapper/GGXCNL_G01_GDP_PT@FM/KEN April 2021
[2] Elmendorf, D. and N. G. Mankiw. 1999. “Government Debt.” In J. B. Taylor and M.Woodford (eds.). Handbook of Macroeconomics. Vol. 1C. Amsterdam, The Netherlands: North-Holland.
[3] Modigliani, F. 1961. “Long-Run Implications of Alternative Fiscal Policies and the Burden of the National Debt.” Economic Journal 71(284): 730–55.
[4] Gale, W. and P. Orszag. 2003. “The Economic Effects of Long-term Fiscal Discipline.” Urban-Brookings Tax Policy Center Discussion Paper No. 8. Washington, DC: The Brookings Institution.
[5] Baldacci, E. and M. Kumar. 2010. “Fiscal Deficits, Public Debt and Sovereign Bond Yields.” IMF Working Paper WP/10/184. Washington, DC: International Monetary Fund.
[6] Calderón, César, and J. Rodrigo Fuentes. “Government Debt and Economic Growth | Publications.” publications.iadb.org, July 2013. https://publications.iadb.org/publications/english/document/Government-Debt-and-Economic-Growth.pdf.
[7] The Ministry of National Treasury and Planning 2018. The Kenya Comprehensive Public Expenditure Review 2017 . From Evidence to Policy.
[8]Ball,Laurence,and N Mankiw. “What Do Budget Deficits Do?”,1995. https://scholar.harvard.edu/files/mankiw/files/whatdobudgetdeficitsdo.pdf.
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Kenya’s Public Debt Distress: Issues and Scenarios
| Post date: Thu, Nov 25, 2021 |
| Category: |
| By: Leo Kipkogei Kemboi, Victoria KWAMBOKA, |
Kenya’s fiscal policy space has changed significantly in the last 10 years. Kenya went on an expansionary fiscal policy driven by huge spending on infrastructural development. As a result, gross public debt increased from 44.4 percent of GDP at end-2010 to an estimated 79% of GDP at end-2021. The increased debt levels have been driven by high deficit. In 2020, Kenya’s debt problem was exacerbated by the COVID-19 global shock.
Chart 1: Kenya’s Debt Position (Share of GDP-%)
Source: IMF Data Mapper 2021[1], * projections
Since the 2013/14 financial year the annual net borrowing has increased by Ksh 685.72 billion to reach Ksh 7.25 trillion by November 2020. Between 2013 and 2020, the debt stock has increased by 300%. The high level of debt stock has resulted in a surge in debt servicing charges. In 2019/20, Ksh 718 billion amount of debt was repaid compared to Ksh 886 billion that was borrowed, this was equivalent to 7% and 8.7% share of GDP respectively. The debt service to tax revenue ratio has increased from 30% in 2013/14 to 49% in 2020/21.
The continued debt issues have spiralled out of control and lead to the breaching of debt indicators. The present value of public debt to revenue and grants ratio indicator of 300 was breached in 2019 when the public debt to revenue and grants ratio threshold of 300 was surpassed. Another indicator of debt service to revenue and grants ratio was breached in 2017 when debt service to revenues and grants ratio surpassed 38.2 against a threshold of 30. It is projected to reach a high of 74.5 in 2022. The most recent public debt sustainability analysis shows that Kenya’s level of debt distress has worsened from moderate to high.
Chart 2: Kenya has breached the Debt Indicators
Source: IMF Country Report 20/56
This piece aims to give possible scenarios on how Kenya’s debt position/distress might unfold. In this, we identify three possible scenarios which includes structural adjustments, hard landing and limiting expenditures.
Scenario 1: Structural Adjustment
Kenya’s debt problem has graduated to being a structural problem where solutions proffered have to be structural adjustments. Kenya entered into a 38-Month IMF program from April 2021 which recommends a fiscal consolidation accompanied by structural reforms to protect the fiscal space and create a conducive environment for private sector credit and investment to boost economic growth. The planned fiscal consolidation and accompanying structural reforms contained in the Memorandum of Economic and Financial Policies (MEFP) by the Kenya Nationals Treasury would protect fiscal space for the authorities’ development agenda while also supporting private credit and investment, leading to a higher and more inclusive medium-term growth”. Essentially, this would give the National Treasury time to allow economic growth to happen. In the medium term, the National Treasury hopes to change the structure of Kenya’s public debt. The success of this program remains to be seen and can only be evaluated at the end of the program.
Scenario 2: Limiting Expenditure in the Short-run
Scenario 2 is the path which Kenya should follow. Conventionally, huge public debt is organically reduced by allowing economic growth to happen. However, a higher public debt works against increasing economic growth. Public debt crowds out private investment and this worsens the economic growth performance in the long run (Elmendorf and Mankiw, 1999)[2]. The literature also shows that by rising long-term interest rates, higher public debt can crowd out investment which also (Modigliani, 1961[3]; Gale and Orszag, 2003[4]; Baldacci and Kumar, 2010[5])[6]. The Private sector investment is essential for replenishment of capital stock, adoption of frontier technology, boosting firm productivity and ultimately this propels the private sector-led growth. However, the contribution to growth from Kenya’s private sector investment has been falling as per the National Treasury’s comprehensive public expenditure review in 2017[7].
Over the last eight years, the expenditure has increased by an average of 250 billion every year while revenue has been going up by an annual average of 111 billion. It showed no matter what happens, revenues can never match expenditures. Kenya sustained deficits elevated the risk of debt distress. Kenya’s parliament which is tasked with approving the tax code has tried to counter this revenue problem caused huge leaps in expenditure annually by expanding the tax regime to cater for the sustained deficits by introducing new taxes or varying the scope of taxation. Kenya’s taxation regime since 2014 has changed significantly and it includes a wider scope of VAT, excise taxes amongst other taxes on bases such as electricity, LPG, minimum tax, digital service tax among others. However, the introduction of new taxes and increasing its scope of taxation doesn’t seem to achieve the desired goal of reducing the fiscal deficit.
The expenditure as a share of GDP has averaged between 26-30% for the last 9 years while revenue as a share of GDP has averaged between 16-20%. If all factors are held constant, the government will never be able to match revenues. As indicated, the appropriate response cannot be to tax more because there is an optimal taxation point in which taxes cannot be able to rise beyond some point as established by economist Arthur Laffer. When the budget deficit is zero or close to zero, there is minimal pressure on taxation as the actual demand coincides with the economy’s potential.
Taking a look at the chart below, we keep the expenditure/GDP constant at the annual average for the forecast period 2021/22- 2025/26 and simulate the revenue as a share of GDP with a mean of 18% and the standard deviation of the historic data. Noticeably, regardless of whether the expenditure is kept constant at the annual average, if we don’t minimize it, revenue will never catch up with expenditure and we will still have huge deficits.
Chart 3: Simulation of Expenditure and Revenue Trends
Source: Authors own calculations
Scenario 3: Hard Landing
If no effective solution is brought forward that limits the budget deficits or restructures tenure of debt to reduce magnitude of debt service , continuous deficits might trigger a hard landing. Ball and Mankiw (1995) lists hard landing as one of the outcomes of continuous deficits and defines it as a situation where demand for domestic assets collapses. Ball and Mankiw argue that the likelihood of such an event and its effects are highly uncertain but it’s one of the most compelling reasons for reducing budget deficits[8]. A hard landing can be trigged by adverse market events which could come from economic growth, a one-time currency, and suppressed exports.
Conclusion
In conclusion, unless we limit the expenditure, Kenya’s fiscal gap will keep widening and will eventually have a hard landing if big . In addition to that, unless we limit government borrowing, increasing the scope of tax will not increase revenue beyond the optimal point. This is because government borrowing mops out what could have been used for private sector investments. Economic growth is achievable without exerting pressure on the existing tax regime.
End Notes
[1] IMF Kenya Data, https://www.imf.org/external/datamapper/GGXCNL_G01_GDP_PT@FM/KEN April 2021
[2] Elmendorf, D. and N. G. Mankiw. 1999. “Government Debt.” In J. B. Taylor and M.Woodford (eds.). Handbook of Macroeconomics. Vol. 1C. Amsterdam, The Netherlands: North-Holland.
[3] Modigliani, F. 1961. “Long-Run Implications of Alternative Fiscal Policies and the Burden of the National Debt.” Economic Journal 71(284): 730–55.
[4] Gale, W. and P. Orszag. 2003. “The Economic Effects of Long-term Fiscal Discipline.” Urban-Brookings Tax Policy Center Discussion Paper No. 8. Washington, DC: The Brookings Institution.
[5] Baldacci, E. and M. Kumar. 2010. “Fiscal Deficits, Public Debt and Sovereign Bond Yields.” IMF Working Paper WP/10/184. Washington, DC: International Monetary Fund.
[6] Calderón, César, and J. Rodrigo Fuentes. “Government Debt and Economic Growth | Publications.” publications.iadb.org, July 2013. https://publications.iadb.org/publications/english/document/Government-Debt-and-Economic-Growth.pdf.
[7] The Ministry of National Treasury and Planning 2018. The Kenya Comprehensive Public Expenditure Review 2017 . From Evidence to Policy.
[8]Ball,Laurence,and N Mankiw. “What Do Budget Deficits Do?”,1995. https://scholar.harvard.edu/files/mankiw/files/whatdobudgetdeficitsdo.pdf.
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