Balancing Prudence and Government Borrowing in Financing Development in Kenya

Balancing Prudence and Government Borrowing in Financing Development in Kenya

Government borrowing is necessitated by a commitment to deliver on development agenda. While tax revenue is a major source of government finance, the amounts mobilized are not always adequate to fully finance the desired delivery of public services and development agenda.

Generally, in fiscal budget preparations, priority spending takes into account the size of resource envelope, and then required borrowing is determined. As a practice, the government borrows externally to finance development spending, while domestic borrowing provides adequate cash flows to meet recurrent spending. In recent period, the government has diversified to the international capital market to take advantage of the favourable global financial conditions. In addition, public private partnerships have been fronted as an alternative to financing development projects.

The need to speed up infrastructure development in delivering the Kenya Vision 2030 has witnessed an upward trajectory in public debt. According to the Global Infrastructure Outlook 2017 on Kenya, approximately Ksh4 trillion additional public investments are required to address the existing infrastructure gaps. Infrastructure development is a necessary ingredient in achieving sustainable strong inclusive economic growth. It serves to expand the capacity for more economic activity by improving the business environment, which promotes private investments, and provides opportunities for job creation. Nevertheless, it is important that increased infrastructure spending is appropriately balanced to ensure debt sustainability.

The government prioritizes debt sustainability in maintaining macroeconomic stability. In this regard, the Joint World Bank and IMF Debt Sustainability Framework for Low Income Countries (LICs) are used in assessing the risk of debt distress. The framework categorizes countries by the quality of their policies and institutions using the Country Policy and Institutional Assessment Index (CPIA) in defining the indicative thresholds for net present value (NPV) debt levels[1].

Kenya, for example, with a CPIA index of 3.82 in 2016 is categorized as a strong policy country. As such, her relevant indicative thresholds in monitoring risk of debt distress include: 50 per cent for the NPV of external debt-to-GDP ratio, 200 per cent for the NPV of external debt-to-exports ratio, and 300 per cent for the NPV of external debt-to-revenue ratio. In addition, the indicative threshold for total public debt to GDP is 74 per cent in PV terms[2]. The same criteria guides the East Africa Community (EAC) Monetary Union Protocol in setting the macroeconomic convergence criteria as partner states, Kenya included are expected to maintain a total NPV public debt to GDP ratio of 50 per cent.

Currently, Kenya’s debt in NPV terms is below all the above thresholds, which means that debt sustainability has been maintained. From the 2017 Medium Term Debt Management Strategy for 2017/18 – 2019/20, the NPV of public and publicly guaranteed (PPG) external debt to GDP ratio stood at 24.8 per cent in June 2017, which is well below the threshold of 50 per cent. The NPV of external debt to exports and revenue ratio was 138.8 per cent and 118.6 per cent, respectively, which is within the indicative thresholds. During the same period, the PV of total public debt as a share of GDP stood at 48.5 per cent, also well below the thresholds of 74 per cent but edging close to the EAC protocol convergence threshold. That said, ensuring fiscal stability is a priority in maintaining debt sustainability.

When debt servicing compromises allocations to development spending, this impacts adversely on economic growth. For example, when several low income countries experienced debt distress in 1996, the Heavily Indebted Poor Countries (HIPC) initiative was launched by IMF and World Bank to grant debt relief to support these countries in sustaining strong economic growth; Kenya was not among these countries. When “debt overhang” effects hit or debt-servicing crowds out public investment expenditure, long term growth can be compromised as private investors reduce or postpone investment as anticipated returns are lower to enable pay back to creditors. This implies that a threshold exists beyond which debt compromises economic growth. For example, the World Bank in its 2010 report finds that below an average long-run PV public debt to GDP ratio of 64 per cent, debt has a positive relationship with economic growth in developing countries. Thus, monitoring debt dynamics remains critical in ensuring government borrowing to support growth.

The Government of Kenya has continued to strengthen debt management to ensure that debt sustainability is maintained. For example, Kenya CPIA rating for debt management increased from 4.0 to 4.5 in 2010 and 2011, respectively, and has since remained constant throughout to 2016. The 2010 Constitution of Kenya and Public Finance Management Act (PFMA) 2012 provide strict procedures, accountability and reporting requirements for strengthening debt management at both National and County Government. A key deliverable under the PFMA is the Medium Term Debt Management Strategy (MTDS) prepared by the National Treasury. Further, National Treasury has established a fully-fledged directorate for public debt management and efforts are underway to capture all public debt payments in the IFMIS.

Further, to reign in the recurrent spending, the government through the Salaries and Remuneration Commission (SRC) is taking initiatives to rationalize the public wage bill. The SRC has reviewed remuneration of all state and public officers and set remuneration levels for graded jobs. This is expected to keep the public sector wage bill within the threshold provided for by the Public Finance Management Act.

Steps are also being taken to strengthen revenue collection by improving tax policy and administration. The Kenya Revenue Authority (KRA) has adopted integrated customs management systems (ICMS), to improve customs processes and procedures by reducing paperwork and fastening clearance. The authority has equally launched the Regional Electronic Cargo Tracking System (RECTS) to monitor movement of cargo along the northern corridor as well as the Integrated Scanner Management Solution to interconnect all cargo scanners to a Central Command and Control Centre. KRA is also in the process of integrating the tax system with IFMIS, NTSA and NHIF in the process of strengthening tax administration.

There are also ongoing efforts to strengthen project management to guarantee higher and timely returns. The government intends to adopt a strict approach on how public investments are selected and included in public investment’s plan. The process will ensure public investments are properly appraised and risk analyzed to ensure their rate of return or payback period is higher than the cost of debt used to fund them.

Good governance in public service is now ingrained in Chapter Six of the 2010 Constitution, which sets out the standards for anybody who intends to take up a public office. This has seen several independent offices created to instill discipline and ensure prudence in the use of public finance including the Controller of Budget, Audit General, Ethic and Anti-Corruption Commission, and Office of Public Prosecutor.

All these measures aim to ensure the government can borrow responsibly to finance the development agenda anchored in Kenya Vision 2030.

 

[1] NPV is discounted value of difference between the outstanding nominal debt and future debt-service obligation that is, sum of interest and principal.

[2] PV is discounted value for all future debt-service obligations on existing debt.

 

Authors: Joseph Ndung’u and Vincent Okara, Young Professional, Macroeconomics Division, KIPPRA

Photo: Courtesy of MyGov.com

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