Ideas & Debate

Fiscal indiscipline bane of interest rate capping

Increased borrowing by the government from commercial banks continues to push out the private sector largely considered risky by lenders. FILE PHOTO | NMG
Increased borrowing by the government from commercial banks continues to push out the private sector largely considered risky by lenders. FILE PHOTO | NMG 

As the political sprout continues to wither, it’s time to continue looking at the government from a pure fiscal standpoint. 

In the four months period between July and October 2017, total revenues (tax and non-tax) stood at Sh412 billion, which represented a 10 per cent year-on-year growth over a similar period of fiscal year 2016.

On the expenditure side, recurrent and development expenditure issues, consolidated fund appropriations and total issues to county government amounted to Sh497 billion, leaving the government with a running deficit of some Sh85 billion—which was fully financed through borrowings.

However, the most outstanding aspect of those numbers is the fact that the government spent a third of the revenues on public debt service.
Whilst that quantum seems elevated, I will deliberately steer clear of making any debt (un)sustainability call on the same—for the simple reason that making such a call requires broad quantitative and qualitative considerations.

Indeed, the concept of sustainability of debt has evolved from the definition based on meeting a group of indicators and thresholds, to a more general approach where it is conceived as a process (Ryan, Mana, 2014).

The process comprises a series of actions and functions aimed at sustaining first, the debt flows and then the borrowing and consequential debt service.

On the other hand, the International Monetary Fund (IMF), emphasises that debt sustainability should be based on the ability of a sovereign to meet pre-set thresholds, set on certain indicators such as debt service ratio which I cited above.

But that notwithstanding, interest payments on total public debt, as a percentage of ordinary revenues, has continued on an upward path, rising from 10 per cent in the fiscal year 2006/07 to 19 per cent in the fiscal year 2015/16, falling slightly to 17 per cent in fiscal year 2016/17. The surge has been a net result of weakening fiscal trajectory, which is set to continue.

In the current fiscal year 2017/18, as part of fiscal deficit financing, the government has revised its commercial borrowing plans to Sh781 billion from the original estimate of Sh666.7 billion—out of which Sh.531 billion will be sourced domestically and the balance externally.

Simply put, fiscal deficit is the difference between the government’s expenditures and its revenues (excluding the money it has borrowed). That elevation in deficit financing, combined with the accompanying financing aggression, portends two events.

First, subsequent monetary policy considerations will be dominated by the fiscal situation, especially concerns around debt service ratio and the need to keep government’s borrowing costs low, a situation referred to as, in economic terms, fiscal consolidation. We are already in this scenario.

Second, and most important, is the crowding-out of private sector—which has been unfolding for some time now. This crowding out, in my view, has impaired the efficacy of the Banking (Amendment) Act, 2016. Picture this: between September 2016 and November 2017, the government borrowed some Sh414 billion at an average price of 13 per cent with an average tenor of seven years.

Compared to the current risk-pricing cap of 14 per cent, that quantum significantly lowers commercial banks’ opportunity costs of lending to the real economy. 

Why would a commercial bank lend to a risky entity at 14 per cent, while the government, largely considered risk-free, is borrowing at 13 per cent for a slightly stretched tenor? And commercial banks have taken cue.

In the first nine months of the year, they have channelled Sh150 billion into purchase of government securities, while funnelling Sh44 billion to the real economy.

Essentially, for this to work, the government needs to get out of unnecessary debt market aggression and bring down its local currency borrowing costs to not more than eight per cent.

Consequently, with the fiscal trajectory set to soften further, it is imperative that the government prioritises fiscal consolidation, by instituting measures to limit the expenditure and increase revenues.