Why Treasury faces uphill task in Budget cut plans

Kenya will struggle to deliver considerable budget cuts amid President Uhuru Kenyatta’s push for implementation of his capital-intensive legacy projects as well as elevated expenditure on salaries and debt service, economists have warned.

National Treasury Cabinet Secretary Ukur Yatani has vowed to steadily bring down fiscal deficit – shortfalls in government revenue compared with its spending – which have stayed above six percent of gross domestic product (GDP) since the current administration took power.

He hopes to achieve this through “sustained brutal” expenditure cuts, reverse heavy borrowing trend witnessed in the last six years and “double efforts” in mobilising tax collections.

“Given the President’s commitment to his Big Four projects, the ability to constrain spending is likely to be limited. This is further compounded by the high level of recurrent spending on salaries and debt service,” London-based David Cowan, the chief economist for Africa at Citi Bank, says in an outlook report on Kenya.

National government’s expenditure on wages and salaries is estimated at Sh487.6 billion this financial year, which is Sh70.1 billion more than a year earlier and Sh206.4 billion growth over the Sh281.2 billion spent during the Jubilee administration’s first year in office (2013/14).

The Treasury projects this will rise marginally to Sh490.7 billion in the year starting July, while debt repayments (principal and interest) are seen rising from estimated Sh572.64 billion to Sh630.1 billion.

Mr Yatani is already facing a Sh161 billion hole in this financial year’s Sh1.42 trillion budget ending in June for state ministries, departments and agencies (Executive arm of the government) despite the “brutal spending cuts” he pledged last October.

He disclosed this in the 2020 Budget Policy Statement (BPS), the document which forms the legal basis for public expenditure, adding that options are limited with cash allocated to development projects remaining the realistic candidate for budget cuts.

The Treasury had initially planned to reduce budget gaps from 7.7 percent in the financial year ended June 2019 to a revised 6.3 percent (initially 5.9 percent) of GDP in the current year, 4.9 percent thereafter and further to 3.0 percent in the year starting July 2023.

The fiscal consolidation plan has, however, been partly derailed by Sh78.1 billion increment in the budget for the current fiscal year ending June driven by the need to fund Mr Kenyatta’s “Big Four” projects under manufacturing, food and nutrition security, affordable housing and universal health coverage.

This has further been exacerbated by sharp shortfalls in revenue, which Mr Yatani estimated at Sh138 billion in the half-year period through December 2019, pushing some analysts to raise their projection on fiscal deficits.

Genghis Capital senior macroeconomic analyst Churchill Ogutu, for example, has forecast the fiscal gap to hover around seven percent of GDP in the current fiscal year after domestic borrowing was raised by Sh84.6 billion to Sh391.4 billion last December, while commercial debt target remained intact at Sh200 billion.

“We are worried that fiscal consolidation will remain elusive. For the current fiscal year, we note that the fiscal deficit target has been a moving target, surprising on the downside,” Genghis Capital analysts said last October.

Mr Yatani in October pledged to scale back on expensive short-term, commercial borrowing – largely from commercial banks and international capital markets (Eurobond) – in favour of concessional multilateral and bilateral loans in the next three years.

This is aimed at lessening debt payment load on taxpayers, with the government in recent years spending nearly half of tax receipts to pay creditors.

The window for Kenya to access foreign loans on concessional terms from development lenders such as the World Bank Group is, however, small after the country upgraded its economy to lower middle-income status in September 2014.

“The government needs to take a much more active approach to debt management. The National Treasury positively talks about tapping cheaper loans, notably from bilateral and multilateral lenders, but, at present, policy implementation is still quite limited,” Citi analysts said.

Mr Kenyatta’s administration has ramped up spending since he came to power in April 2013 to build new roads and maintain existing ones, construct a modern railway from the coastal city of Mombasa to Suswa (near Naivasha), as well as bridges, electricity plants and transmission lines.

This has largely driven up borrowing to plug the budget deficit amid widening misses in revenue goals set by the Treasury.

As a result, Kenya’s fiscal deficit shot up from about 2.9 percent of GDP in the 2013-14 financial year, peaking at 9.1 percent during the fiscal year ended June 2017, before gradually slowing to 7.7 percent last financial year.

The increased debt accumulation saw Kenya spend Sh826.20 billion, or 57.37 percent, of the Sh1.44 trillion tax collections (as gazetted by the Treasury) to pay loans in the year ended June 2019.

The elevated expenditure of revenue on servicing debt leaves little cash for development projects such as building and maintenance of the road network, affordable housing, revamping of the ailing health sector and improving quality of education.

This forces the Treasury into fresh round of borrowing, hence keeping fiscal deficit above the three percent of GDP target agreed by the six-nation East African Community trading bloc.

The fiscal consolidation plan – ordinarily characterised by deliberate expenditure cuts and enhanced revenue mobilisation – has been rocked by underperformance in collections by the Kenya Revenue Authority (KRA).

Statistics from the Treasury indicate ordinary revenue – comprised of taxes and non-tax streams such as levies, rent of buildings, fines and forfeitures – missed the Sh1.77 trillion target for the year ended June 2019 by a record Sh272 billion.

The revenue target fell short by Sh195 billion in the year 2017/18, Sh74 billion in 20116/17, Sh90 billion the year before, Sh55 billion in 2014/15 and Sh108 billion in 2013/14, the data captured in the 2020 Budget Policy Statement, show.

Mr Cowan said enhancing revenue growth holds the key to narrowing stubbornly perennial Kenya’s budget gap.

“It seems the easiest way to achieve that (fiscal deficit target), given the constraints in having cuts in spending, is to raise revenue. The market is not expecting these guys to have three percent fiscal deficit in the next few years, but the trend needs to be in the same way,” Mr Cowan said in an interview in Nairobi.

“They (Treasury) have to get on top of fiscal deficit. That’s the bottom line. They need to show that they can keep fiscal deficit under control and slow down the rising debt stock.”

He added: “Raising taxes is a question of political will. It’s unpopular because nobody wants to pay taxes. If you want to raise you have to have political will to raise taxes. It seems there’s a change in the team at the National Treasury that’s more dynamic, and have accepted the current fiscal trajectory cannot continue.”