Why is Kenya’s Fiscal Consolidation Agenda Facing Failure?
Category: Fiscal Consolidation
By: Faith Nzomo,
The earliest proposition of fiscal consolidation can be traced back to the Keynesian theory which argues that fiscal austerity measures reduce growth and increases unemployment through aggregate demand effects. According to this theory, government undertaking contractionary fiscal policies of either reducing government spending or increasing tax rates, will eventually suffer a reduction in aggregate demand leading to reduced output through the multiplier mechanism. In simpler terms, this proposition asserts that cuts in government spending and tax hikes have adverse effect to growth and employment and therefore care should be taken when implementing these policies.
Opponents of this theory however argue that contractionary fiscal policy might actually yield to expansionary economic outcomes which might offset the negative Keynesian effect (Giovazzi and Pagano,1990). This is because fiscal adjustments which leads to reduction in budget deficit, improves credibility with reduction in interest rates leading to reduction in the risk premia. Therefore, if governments reduced borrowing requirements, this results in lower interest rates leading to crowding in private investments. Consequently, increase in investors’ confidence and the improved expectations concerning macroeconomic stability would also have similar effects.
An empirical analysis on fiscal adjustments in OECD countries by Alesina and Perotti (1995) added to this literature by showing how fiscal consolidation increases aggregate demand by producing expansionary effects but measures involving tax increases proved to be short lived. The study further showed that if a government aims to successfully reduce deficits with minimal harm to the economy, then fiscal adjustment should mainly focus on cutting spending. Additionally, for the policy to be effective in the long-run, the spending cuts should be in public employment, transfers and government wages.
It is against this back drop that this blog seeks to identify whether the Kenyan government is implementing the correct policy mix in achieving the fiscal consolidation agenda and if the agenda that has been in place for the last couple of years has successfully managed to reduce fiscal deficit. Ideally, increase in government debt imposes unjustifiable burden on future generations and this according to PFM Act, contravenes the fiscal responsibility principles that the government is required to adhere to when managing public resources. In particular, Article 15 (2d) of the PFM Act of 2012 states that:
Public debt and obligations shall be maintained at a sustainable level as approved by parliament for the national government and for the county assembly for county government.
Over the past decade, debt-to-GDP ratio in Kenya as well as in other developing nations has risen to historically high levels. The situation in Kenya worsened in the aftermath of the COVID-19 pandemic after the government resorted to extensive borrowing to finance recovery measures[1][2]. Adding to these challenges, Kenya’s macroeconomic environment has deteriorated in recent years due to ongoing geopolitical conflicts. These conflicts have disrupted global supply chains, leading to higher inflation and interest rates, further pushing debt ratios up.
Figure 1 below highlights growth in gross government debt over the last decade. Debt to GDP levels have been on an upward trend over the past decade rising from 39.8 percent in 2013 to the highest rate recorded in the country’s history of 73.3 percent in 2023. The upward trend and the resultant high debt stock has forced the government, to implement fiscal consolidation measures which are geared towards reducing budget deficits and ultimately putting the country in a long-lasting debt reduction path.
A report from the Office of Controller of Budget (OCOB) on budget implementation for the last 9 months of FY 2023/24 shows that public debt stock has increased in nominal terms for the past one year from Ksh. 9.39 trillion in March 2023 to Ksh. 10.42 trillion in March 2024. Consequently, in FY 2022/23, over 87 percent of the budget allocation to the Consolidated Fund Services (CFS) was to servicing debt and this amount rose to 90 percent in FY 2023/24. The report indicated that total spending on debt servicing for the first 9 months of FY 2023/24 increased to Ksh 1.24 trillion from Ksh. 831 billion in FY 2022/23.
Time and again, the government of Kenya has published in the Budget Policy Statement (BPS) the plan to implement a fiscal consolidation agenda which is “geared towards reducing the annual increment in debt with minimal effect on service delivery”. Specifically, the plan claims to focus on broadening the revenue base by implementing tax administrative and tax policy measures coupled with expenditure rationalization measures geared towards improving efficiency and reducing wastage of public resources.
On revenue mobilization measures, the government claims to be focussed on increasing tax revenue through the implementation of the revised Finance Bills together with the Medium-Term Revenue Strategy (MTRS). This, according to MTRS (2024/25 – 2026/27) would increase ordinary revenue to GDP ratio from a rate of 14.1 percent in FY 2022/23 to 20 percent by end of FY 2025/26 and to 25 percent by 2030.
The result of these measures remains to be seen. Perennial increment in tax rates through the annual revision of the Finance Bills have resulted to minimal increases in ordinary revenue (see figure 2). The last decade has seen decline in ordinary revenue as a share of GDP from 18.1 percent in FY 2013/14 to as low as 13.9 percent in FY 2020/21. Although the reduced revenue streams in FY 2020/21 can be attributed to the negative effects of COVID 19, the situation did not improve even after the pandemic subsided. We can thus conclude that high tax rates are generally harmful to the economy.
As witnessed recently, the proposed increase in tax rates sparked widespread public backlash leading to countywide demonstrations which resulted to the rejection of the 2024 Finance Bill. Rejection of this bill which was projected to raise additional revenue amounting to Ksh. 346 billion resulted to a revenue shortfall of the same amount which require financing either through borrowing or government undertaking expenditure cuts[1] . The national government tried to revise their expenditure estimates[2] downwards but this has not offered the much-needed reprieve since the cuts only covered less than half of the resource gap. This will most likely increase fiscal deficit which has remained above 5 percent as a share of GDP against a target rate of 3.3 percent by end of FY 2024/25.
In conclusion, the country in deed needs a successful fiscal consolidation agenda. Continued implementation of the current fiscal consolidation agenda which mainly focuses on increasing tax revenue will not yield the expected results as deficit and debt ratios continue to soar. In addition to this, the country is still witnessing rising expenditures coupled with unrealized revenue targets despite the efforts to reform tax structure. Should the country take a radical approach and implement a fiscal consolidation agenda which focusses on cutting spending and specifically, cutting down on the government wage bill? Yes. Reason being, studies by Alesina et. al. (1995) shows that fiscal consolidation which aggressively tackle expenditure side particularly the untouchable components such as social security, government wages and employment were more successful.
The Cabinet Secretary for National Treasury and Economic planning in the recent budget speech, mentioned the plan to suspend new recruitment over the next fiscal year. He further laid out a proposal to implement other expenditure rationalization measures including, auditing of payrolls, pensions and transfers to eliminate ghost workers and ghost recipients of these benefits. The actual operationalization of these plans however remains to be seen. Government therefore, needs to prioritize and come up with realistic plans on the implementation of the proposed expenditure cuts and minimization of wastage of public resources by putting up actual plans instead of the mere mentioned promises in public forums and those documented in government publications. This will deliver the much-anticipated fiscal consolidation results of reduced deficits and further position the country on a sustainable path of debt reduction hence solving the debt problem once and for all.
References
Alesina, A., & Perotti, R. (1995). Fiscal expansions and adjustments in OECD countries. Economic policy, 10(21), 205-248.
Giavazzi, F., & Pagano, M. (1990). Can severe fiscal contractions be expansionary? Tales of two small European countries. NBER macroeconomics annual, 5, 75-111.
Medium-Term revenue Strategy
https://www.treasury.go.ke/wp-content/uploads/2023/09/Draft-MTRS-Final.pdf
[1] https://ieakenya.or.ke/?wpdmdl=3448
[2] https://www.treasury.go.ke/wp-content/uploads/2024/08/PBB-FY2024-25-Approved-Supplementary-I.pdf
[1] https://www.imf.org/en/News/Articles/2021/03/17/na031721-imf-loan-to-support-economic-recovery-in-kenya
[2] https://www.worldbank.org/en/news/press-release/2021/06/10/kenya-receives-750-million-boost-for-covid-19-recovery-efforts
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Why is Kenya’s Fiscal Consolidation Agenda Facing Failure?
| Post date: Fri, Aug 23, 2024 |
| Category: Fiscal Consolidation |
| By: Faith Nzomo, |
The earliest proposition of fiscal consolidation can be traced back to the Keynesian theory which argues that fiscal austerity measures reduce growth and increases unemployment through aggregate demand effects. According to this theory, government undertaking contractionary fiscal policies of either reducing government spending or increasing tax rates, will eventually suffer a reduction in aggregate demand leading to reduced output through the multiplier mechanism. In simpler terms, this proposition asserts that cuts in government spending and tax hikes have adverse effect to growth and employment and therefore care should be taken when implementing these policies.
Opponents of this theory however argue that contractionary fiscal policy might actually yield to expansionary economic outcomes which might offset the negative Keynesian effect (Giovazzi and Pagano,1990). This is because fiscal adjustments which leads to reduction in budget deficit, improves credibility with reduction in interest rates leading to reduction in the risk premia. Therefore, if governments reduced borrowing requirements, this results in lower interest rates leading to crowding in private investments. Consequently, increase in investors’ confidence and the improved expectations concerning macroeconomic stability would also have similar effects.
An empirical analysis on fiscal adjustments in OECD countries by Alesina and Perotti (1995) added to this literature by showing how fiscal consolidation increases aggregate demand by producing expansionary effects but measures involving tax increases proved to be short lived. The study further showed that if a government aims to successfully reduce deficits with minimal harm to the economy, then fiscal adjustment should mainly focus on cutting spending. Additionally, for the policy to be effective in the long-run, the spending cuts should be in public employment, transfers and government wages.
It is against this back drop that this blog seeks to identify whether the Kenyan government is implementing the correct policy mix in achieving the fiscal consolidation agenda and if the agenda that has been in place for the last couple of years has successfully managed to reduce fiscal deficit. Ideally, increase in government debt imposes unjustifiable burden on future generations and this according to PFM Act, contravenes the fiscal responsibility principles that the government is required to adhere to when managing public resources. In particular, Article 15 (2d) of the PFM Act of 2012 states that:
Public debt and obligations shall be maintained at a sustainable level as approved by parliament for the national government and for the county assembly for county government.
Over the past decade, debt-to-GDP ratio in Kenya as well as in other developing nations has risen to historically high levels. The situation in Kenya worsened in the aftermath of the COVID-19 pandemic after the government resorted to extensive borrowing to finance recovery measures[1][2]. Adding to these challenges, Kenya’s macroeconomic environment has deteriorated in recent years due to ongoing geopolitical conflicts. These conflicts have disrupted global supply chains, leading to higher inflation and interest rates, further pushing debt ratios up.
Figure 1 below highlights growth in gross government debt over the last decade. Debt to GDP levels have been on an upward trend over the past decade rising from 39.8 percent in 2013 to the highest rate recorded in the country’s history of 73.3 percent in 2023. The upward trend and the resultant high debt stock has forced the government, to implement fiscal consolidation measures which are geared towards reducing budget deficits and ultimately putting the country in a long-lasting debt reduction path.
A report from the Office of Controller of Budget (OCOB) on budget implementation for the last 9 months of FY 2023/24 shows that public debt stock has increased in nominal terms for the past one year from Ksh. 9.39 trillion in March 2023 to Ksh. 10.42 trillion in March 2024. Consequently, in FY 2022/23, over 87 percent of the budget allocation to the Consolidated Fund Services (CFS) was to servicing debt and this amount rose to 90 percent in FY 2023/24. The report indicated that total spending on debt servicing for the first 9 months of FY 2023/24 increased to Ksh 1.24 trillion from Ksh. 831 billion in FY 2022/23.
Time and again, the government of Kenya has published in the Budget Policy Statement (BPS) the plan to implement a fiscal consolidation agenda which is “geared towards reducing the annual increment in debt with minimal effect on service delivery”. Specifically, the plan claims to focus on broadening the revenue base by implementing tax administrative and tax policy measures coupled with expenditure rationalization measures geared towards improving efficiency and reducing wastage of public resources.
On revenue mobilization measures, the government claims to be focussed on increasing tax revenue through the implementation of the revised Finance Bills together with the Medium-Term Revenue Strategy (MTRS). This, according to MTRS (2024/25 – 2026/27) would increase ordinary revenue to GDP ratio from a rate of 14.1 percent in FY 2022/23 to 20 percent by end of FY 2025/26 and to 25 percent by 2030.
The result of these measures remains to be seen. Perennial increment in tax rates through the annual revision of the Finance Bills have resulted to minimal increases in ordinary revenue (see figure 2). The last decade has seen decline in ordinary revenue as a share of GDP from 18.1 percent in FY 2013/14 to as low as 13.9 percent in FY 2020/21. Although the reduced revenue streams in FY 2020/21 can be attributed to the negative effects of COVID 19, the situation did not improve even after the pandemic subsided. We can thus conclude that high tax rates are generally harmful to the economy.
As witnessed recently, the proposed increase in tax rates sparked widespread public backlash leading to countywide demonstrations which resulted to the rejection of the 2024 Finance Bill. Rejection of this bill which was projected to raise additional revenue amounting to Ksh. 346 billion resulted to a revenue shortfall of the same amount which require financing either through borrowing or government undertaking expenditure cuts[1] . The national government tried to revise their expenditure estimates[2] downwards but this has not offered the much-needed reprieve since the cuts only covered less than half of the resource gap. This will most likely increase fiscal deficit which has remained above 5 percent as a share of GDP against a target rate of 3.3 percent by end of FY 2024/25.
In conclusion, the country in deed needs a successful fiscal consolidation agenda. Continued implementation of the current fiscal consolidation agenda which mainly focuses on increasing tax revenue will not yield the expected results as deficit and debt ratios continue to soar. In addition to this, the country is still witnessing rising expenditures coupled with unrealized revenue targets despite the efforts to reform tax structure. Should the country take a radical approach and implement a fiscal consolidation agenda which focusses on cutting spending and specifically, cutting down on the government wage bill? Yes. Reason being, studies by Alesina et. al. (1995) shows that fiscal consolidation which aggressively tackle expenditure side particularly the untouchable components such as social security, government wages and employment were more successful.
The Cabinet Secretary for National Treasury and Economic planning in the recent budget speech, mentioned the plan to suspend new recruitment over the next fiscal year. He further laid out a proposal to implement other expenditure rationalization measures including, auditing of payrolls, pensions and transfers to eliminate ghost workers and ghost recipients of these benefits. The actual operationalization of these plans however remains to be seen. Government therefore, needs to prioritize and come up with realistic plans on the implementation of the proposed expenditure cuts and minimization of wastage of public resources by putting up actual plans instead of the mere mentioned promises in public forums and those documented in government publications. This will deliver the much-anticipated fiscal consolidation results of reduced deficits and further position the country on a sustainable path of debt reduction hence solving the debt problem once and for all.
References
Alesina, A., & Perotti, R. (1995). Fiscal expansions and adjustments in OECD countries. Economic policy, 10(21), 205-248.
Giavazzi, F., & Pagano, M. (1990). Can severe fiscal contractions be expansionary? Tales of two small European countries. NBER macroeconomics annual, 5, 75-111.
Medium-Term revenue Strategy
https://www.treasury.go.ke/wp-content/uploads/2023/09/Draft-MTRS-Final.pdf
[1] https://ieakenya.or.ke/?wpdmdl=3448
[2] https://www.treasury.go.ke/wp-content/uploads/2024/08/PBB-FY2024-25-Approved-Supplementary-I.pdf
[1] https://www.imf.org/en/News/Articles/2021/03/17/na031721-imf-loan-to-support-economic-recovery-in-kenya
[2] https://www.worldbank.org/en/news/press-release/2021/06/10/kenya-receives-750-million-boost-for-covid-19-recovery-efforts
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Is Monetary Policy Too Tight?
We recommended (“And then, Floods”) that the Central Bank of Kenya policy rate should be lowered by 300 basis points, from 13 to 10 percent, from August 6. Instead, a reduction of just 25 basis points, from 13 to 12¾, was made on that date. Someone is wrong. Who? In explaining the 25bp decision, it […]
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