Pension funds tax: Panic or hunt for revenues?

The proof is easy to find that our economic policies do not fail for lack of expertise. Kenyan economists competing for international jobs had reached the top tier when I chaired interview panels. If we accept anything International Monetary Fund (IMF), World Bank or the US (for trade talks), among others, welcome to find it.

But sometimes, they are ideas other countries sidestepped in the past and prospered.

The topsy-turvy structural reforms of the 1990s left a graveyard of corrupted policies that hold our country back despite untapped growth potential.

After widening our fiscal side with debt, wastage, and corruption, coronavirus should have tested the subservience.

Instead, current Budget proposals inflict fresh scars. We focus here on the Treasury tax on retirees even National Social Security Fund (NSSF) in a hunt for revenues, and by extension the underlying weakening of an already weak financial system.

The push to suspend interest income on pension funds’ holdings of government securities to shore up Covid-19 projects seemed game. In the 2020/21 Budget, it morphed into a home-cooked U-turn on retirement incomes with the Treasury slapping a tax. An English idiom goes: You cannot run with the hares and hunt with the hounds.

Risky portfolios

This opportunistic economic policy during coronavirus outbreak queues behind another trend — the all-consuming ambitions of the political class to make political hay for 2022 while the sun of Covid-19 scorches people to death.

We say a U-turn to highlight real-economy risks the proposal of the actuaries and the pensioners’ taxation proposal trigger but focus on the financial sector, which could die slowly except for bank shareholders. First, Covid-19 spending is perpetuating a semi-permanent structural impediment and policy weakness that drains deposits from the liabilities of the commercial banks to government securities at the expense of financial intermediation (credit to the private sector on the assets side) retarding the growth of investment.

Called the fiscal-dominance trap, the strategy sustains otherwise insolvent governments. Covid-19 narrows the policy options to opt out of the trap. Yet, licensed fund managers have long ridden the bandwagon. Most of their assets under management are in government securities, with predictable earnings.

The 2020 first quarter Capital Markets Authority (CMA) statistical bulletin reports 52.8 percent of the Sh76.1 billion of assets under management. With equities held in the Nairobi Securities Exchange at 12.1 percent, much of the rest is bank deposits.

Some 81.1 percent of assets under management (Sh61.5 billion) is in combined government securities and bank deposits. Guess what? Banks holding some 54.6 percent of government total domestic debt — fed from pooled liabilities owned mostly by bank customers, including deposits of assets under management — then convert the assets under management resources to government securities in their investment portfolios.

Banks rake in super-profits in Kenya, even by world standards. The assets under management exposure to government securities are thus closer to 90 percent of total assets under management of Sh76.1 billion. Upshot? Our commercial banking system is under capture by government securities absorbing key assets of pensions, institutional investors, and bank depositors. Lending to the real economy stalls, even with falling interest rates at a 29-year low.

For our development, the strategy of piling domestic debt in the financial system stands exhausted and unfit for purpose. Yet, public spending under Covid-19 and fund managers who direct personal savings and investments of public and pensioners in the same securities will only deepen the problem.

No matter how the Central Bank of Kenya’s Monetary Policy Committee directs policies to guide credit, it breeds an ineffective monetary policy — an under-funded private sector.

Numbers may clarify magnitudes on how pensioners and a bigger mosaic of private funds fall in this trap.

Pension funds in Kenya hold assets under management at Sh1.3 trillion, a ratio of 13.4 percent to gross domestic product (GDP). These cover about 20 percent of the working population with about 40 percent invested in securities (Treasury bills and bonds) and earning about Sh60 billion annually in interest income to enhance pensioners’ accumulations.

The Unclaimed Financial Assets Authority (UFAA), NSSF, National Hospital Insurance Fund, and other institutional investors also need innovation to change the negative built-in feature of our financial system.

The UFAA holdings — private assets meant to be subjected to measures aimed at facilitating reunification of unclaimed financial assets with their rightful owners, as envisioned in the enabling legislation — reached an estimated Sh241 billion as of October 2018, unclaimed by a potential 477,000 assets holders in Kenya. Actual holdings recouped at the UFAA are Sh40 billion. The NSSF holds more than Sh230 billion in assets.

Fund Managers

Fund managers earn living meeting targets on returns for pensioners and other institutional investors. If they find fit to offer other peoples’ money (interest income) for Covid-19 projects, it is because they are beholden to our moribund strategy.

They expose pensioners to the same risks government debt does.

Apart from inequity, the illegality of their proposal or the so-called earmarked funds of such projects teems with opaqueness.

The US Congressional budget long ago mocked them as pork-barrel spending, meaning corrupt, wasteful spending on personal agendas. The US banned them.

The Bias and Risks

The sanctity of pensions has some history in Kenya. During the 2020/21 Budget, Sh123 billion or 3.9percent of the budget is pensions or other similar payments mandatory and nonnegotiable as per Article 214 of the Constitution, where public debt is a claim on the Consolidated Fund.

The government should scrap the tax not just to safeguard the commitments, but because of collateral damage to Kenya’s risk and creditworthiness. Evidence is already accumulating.

With commercial banks awash with liquidity, subscriptions to CBK auction target of Sh50 billion on May 5 for a five-year fixed coupon issue failed spectacularly.

Markets brushed off the CBK’s revamped liquidity in which Cash Reserve Ratio fell from five percent to 4.5 percent on March 23. Moody’s then downgraded Kenya’s sovereign debt risk to negative from stable in May. It further downgraded commercial banks holding domestic debt from stable to negative on risk exposure in their holdings of government securities in their asset portfolios.

This links creditworthiness of banks to that of government debt. The IMF also calibrated Kenya’s risk of debt distress to high, from moderate, despite its analytical flip flops.

Kenya’s borrowing costs will rise with higher yields just when prudent external borrowing would be a lifeline from pandemic-induced economic contraction. Costs could well exceed amounts reaped from pensioners.

A long-term view

As a footnote, consider pension benefits since Kenya’s Independence in 1963.

So important are moral rights to pensioners that the bulk of employees who held pensions from service to the colonial government — mostly white civil servants, including regional civil servants — stand guaranteed by statute, still paid by the post-colonial governments. For the 2019/20 financial year, budgeted outlays tagged Sh104 billion.

Dr Wagacha was the senior economic adviser, Executive Office of the President (2013-2018) and former acting chair, board of Central Bank of Kenya.