Don’t hold your breath for Kenya's fiscal consolidation

The budget speech for FY 2018/19 is of much interest because desires of government seem to be in opposition. On one hand is the previously articulated intent for fiscal consolidation and on the other, the need to finance the ‘Big Four’.

This article will examine fiscal consolidation and assess the budget using this lens with a focus on planned expenditure, revenue generation and borrowing. Under fiscal consolidation, expenditure should reduce, revenue generation increase and borrowing reduce.

Already we can see that appetite for increased expenditure continues unabated. Planned total expenditure for the FY 2018/19 is Sh2.56 trillion (equivalent to 26.3 per cent of our gross domestic product (GDP). Under the current administration, projected spending has gone up from Sh1.6 trillion in 2013/14 to Sh2.29 trillion in 2017/18 and now to Sh2.56 for 2018/19.

Clearly, expenditure continues to grow indicating an inability to effect fiscal consolidation measures, which are exacerbated by weaknesses in the composition of expenditure. Of the planned spending, recurrent expenditure will amount to Sh1.55 trillion, development expenditure is projected at Sh625 billion, and transfers to County Governments will amount to Sh376.4 billion.

It seems the element of expenditure that has been cut is the most economically productive, namely development expenditure. Indeed, development expenditure will only be 24 per cent of total spending (below the 30 per cent threshold), recurrent about 60 per cent and transfers to counties wll account for only 15 per cent.

So the government seems to be cutting development expenditure while allowing the excesses of recurrent spending to continue, thus it is not leveraging the budget to drive public spending in an economically productive manner.

In terms of revenue generation, the government argues that revenues will rise by 17.5 per cent to about Sh1.95 trillion (equivalent to 20 per cent of GDP) in the FY 2018/19 from the estimated Sh1.66 trillion collected in the FY 2017/18. Part of the ‘revenue enhancement’ steps include higher corporate tax as well as a tax on the informal economy. What may materialise is, however, not more revenue, but less.

Kenya already struggles with high costs of production attributed to expensive power, transport and labour costs, as well as endemic corruption and rent seeking. These are dynamics that affect both big and small private sector investors.

Increasing tax on the private sector may well push them to a level where the combined effect of high production costs and higher taxes cut into profits substantially reducing the total government can claim as tax revenue.

READ: Kenya's public debt crosses Sh4.5trn mark

Finally, the government announced that in the fiscal year ending June, they estimate a fiscal deficit of 7.2 per cent of GDP, down from 9.1 per cent of GDP in the previous year.

Indeed, under, their fiscal consolidation plan, the government projects the fiscal deficit to narrow to 5.7 per cent of GDP in the FY 2018/19 and further to around three per cent of GDP by FY 2021/22.

While this is a step in the right direction, the government seems to have a problem in keeping on a disciplined path of fiscal deficit reduction. Last year its target for the 2018/19 fiscal deficit was six per cent, yet here we are at 7.2 per cent.

The fiscal deficit of Sh558.9 billion will be financed by external financing amounting to Sh287.0 billion, while domestic financing will amount to Sh271.9 billion.

This clearly indicates that domestic borrowing will be substantial. In the context of an interest rate cap, the government surely knows that continued heavy borrowing in the domestic market squeezes out private sector and places upward pressure on interest rates.