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Post Budget Analysis: Dr. Mudida on The Shilling's Growth

  Jun 19, 2015

The continued depreciating value of the shilling has caused a turbulent upset to the Central Bank of Kenya’s monetary policy; shock absorption price controllers’ aim at penning down through the increase of the monetary rate from 8.5% to 10%. Although the decisive measure is sought to stabilize the shilling’s crisis, the overlay foundation of the nation’s proposed budget may be a complete house of cards to support its growth.


Budget Deficit


This year for the first time, the projected budget has surpassed the 2 trillion Kenyan Shilling budget mark. The outlook generally is quite impressive, because if you look at the budget allocations, they are actually meant to spur growth. We have continued to invest largely on infrastructure, in the standard gauge rail way, roads, improvement of port facilities, energy, upgrading geothermal energy facilities and security- aimed at restoring confidence to our tourism sector. In general we can expect growth to be contained in the medium term.



Fiscal expansion has grown quite progressively. 2003- 2007, was a stage of fiscal consolidation; where the government was trying to reduce the budget deficit and control debt, then 2008-2010, was a period of fiscal stimulus, aimed at stimulating the economy after the post-election violence, and since 2011, it has been a period of fiscal expansion where every year government’s expenditure has gone up.



This could mirror progressive development, but are we cutting the cloth according to our size? The revenue is projected to about 1,358.0 billion, equivalent to 20.8 % of GDP whereas the expenditure is projected to be 2.1 trillion. Reflecting the overall fiscal balance including grants, expenditures related to SGR, the overall deficit would be 426.3 billion, equivalent to 6.5% GDP.



With such a deficit, the government’s move is to borrow. This as per budget speculation, this will be financed by net external financing of KSH 340.5 billion, 5.2% of GDP and KSH 229.7 billion, 3.5 % of GDP of domestic financing. Fully aware that these are speculations projected on a medium term, closing the deficit gap will be quite a walk on a tight rope.


Let me explain: Domestic sources pose the challenge of exerting more pressure on domestic markets. This tends to crowd out the private sector through higher interests rates, leading to spending more and at the same time, causing a reduction on investment spending.


On the other side, external /foreign borrowing, subjects us to exchange rate fluctuations because we have to repay in foreign currency. Looking at the strength of our Shilling, we are more likely to pay more, to match the deficit in Dollar currency.


Revenue Expenditure


The biggest concern is that our borrowing levels may seem sustainable at the moment but they are coming quite close to the targets and with accumulated interest’s payments from borrowing.


Increasing revenue may seem as a valid option, but unfortunately, we don’t have too much room for maneuvering because our tax base is quite narrow. 40% of our tax comes from income tax, 25% vat and from a relatively narrow tax base where we are concentrating on large corporations fundamentally; there is always the looming danger of over taxing.


Reducing borrowing by finding other ways to fund expenditure through public-private partnerships, (which has been one of the biggest proposals for a few years) and creating an enabling environment to facilitate that, will be a good boost to our debt target limit adherence, as well as fertile soils which could attract and grow investments.


Another big challenge is on controlling re-current expenditure, especially on salaries. Recurrent expenditure has always been more than twice of development expenditure, an equivalent of about 16% of GDP, which is still quite high, as compared to the development expenditure which is at about 7% of the GDP.


An ideal state would be to have the development expenditure exceed the recurrent. Although there has been quite a substantial increase in development expenditure over the last few years, this has not been fulfilling. If recurrent expenditure keeps going up, there is pressure to keep on borrowing more and more.


Some of this pressure comes from the county governments, with about 300 billion KES being allocated to the counties, an equivalent of 4% of the GDP, of which, a lot of this is on recurrent expenditure, used in running the devolved system of government. We don’t expect that to change significantly, unless the counties get internal means of generating revenue, which they are on track to do, but may take some time before it fully materializes on self sufficiency.


Debt Sustainability


Interest payments have been increasing quite substantially and in fact, they are becoming quite a burden to the economy. Fortunately, we are still within boundaries. The debt levels in Kenya are still sustainable because our target has not yet exceeded the GDP by 45% which is the public debt limit. We are currently at 43% of the GDP, which still keeps us within target.


The rebasing last year increased the size of the economy to 25% with the debt dropping from 53% to 43% of the GDP. It is safe to say that the debt is still sustainable, however, increased accumulation of interest payments are certainly going to be a concern.


We need to be very careful about that trend. This could undermine some of the achievements of the monetary policy. In fact, it is very important to achieve coordination between monetary and fiscal policy. If you are have a fiscal policy that intends to borrow more and more, then that will tend to basically exacerbate the impact on higher interest rate, which could slow down growth.

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