Part 2 on the BUDGET SERIES: Which way forward for Kenya’s economy? Highlights of Kenya’s economic outlook and proposed recommendations

February 12, 2021 - 5 minutes read

The Kenyan economy is currently facing significant challenges as a result of the COVID-19 (C19) exacerbating an already grim situation. Despite having attained a lower middle income status in 2014, Kenya has failed to adequately address institutional and structural inadequacies that have continued to hinder broad-based economic development.

Kenya’s fiscal policy has been on an expansionary trend since FY2013/14 with Government spending increases on infrastructural projects in road, rail and energy aimed in boosting economic growth. Conversely, revenues have been underperforming leading to expenditure that is increasingly supported by expensive debt. Public debt stock amounted to Kshs. 7.12 trillion as at the end of September 2020, accounting for 65.6% of GDP and 79% of the PFM debt ceiling. This has largely informed the direction taken towards fiscal consolidation as a key Government policy.

With concerns mounting with regards to growing debt levels to unsustainable levels, this has led to the National Treasury’s setting of seemingly unrealistic revenue targets. Case in point the target set for revenue collection on the newly operationalized Digital Service Tax (DST) at five billion shillings to be realized within six months!

In instances where revenue targets are unrealistic, as has been for the last four years, numerous in-year revisions to expenditure plans have to be done which result in unrealized policy objectives. This is evidenced by the deviation between actual tax revenue and printed revenue estimates increased from 5 % in 2016/17 to 21 % in 2019/20.

According to data from the Parliamentary Budget Office (PBO), in 2014, the size of the Kenyan economy was estimated at $55.1 billion; a 25% increase from a previous estimation of $44.1 billion in 2013. Over the same period, per capita GDP went up by $252 to stand at $1,246 – leading to reclassification of the economy as ‘lower middle income’. Over the past decade, the economy has grown by 5.6%, on average. However, the country continues to face significant challenges such as poverty and rising inequality, weak private sector investment and vulnerability to internal and external shocks. This is in part, according to the PBO, evidenced by:

  • Increased levels of household indebtedness taken up to sustain the purchasing power of the middle class estimated at 44.9% of the population. Whereas in most instances high purchasing power of the middle-class is a key indicator for high economic growth, In Kenya this narrative has been called into question owing to the apparent income uncertainty and instability of the income group. Moreover, the loans being taken up typically only solve short term liquidity problems for the individuals and small enterprises.
  • Low capital investment- the contribution of public and private investment to economic growth has been significantly low and in some instances, negative.
  • At 10.9% of GDP over the last decade, Kenya’s level of savings is significantly lower than that of its peers which partly explains its low investment efforts. A wide savings- investment gap is partly the reason for the moderate growth rates experienced over the last decade despite the intentions by the government to achieve higher growth levels. The low level of savings means that the country is unable to invest adequately due to lack of resources and is therefore unable to comprehensively develop the ‘value-producing’ engines of growth such as manufacturing and exports. While consumer demand can boost growth, it does not necessarily translate to value adding activities and employment as investment would. Such growth is therefore weak and unsustainable.
  • The low level of investments has negatively affected the country’s level of productivity. The contribution of capital to GDP growth has declined steadily over the past decade; attributable to use of obsolete technology, low innovation and poor adoption of technological advancements. Investment is generally approached from a narrow perspective, for instance, there has been significant investment in roads infrastructure but very little focus on industries that would benefit from such investments. According to a World Bank study, though the innovation rate is high in Kenya, the ‘degree of innovativeness’ is low. Most Kenyan firm-level innovations are hardly new to the market and are mainly small improvements on existing concepts/products/processes
  • The contribution of labour to GDP growth appears to have stagnated over the past decade with significant decline within the last three years. Indeed, labour is concentrated in low productivity sectors, notably in the agriculture sector, which accounted for 55% of total employment in 2019. Such low productivity sectors offer low income and little job security. There is a high incidence of youth unemployment, estimated at 15.5% in the 15-34 age bracket, which implies that Kenya is not reaping enough demographic dividends from its highly youthful population. Skills constraint is also a significant factor limiting labour productivity with basic skills proficiency among workers considered generally low. Furthermore, the cost of labour in Kenya is considerably higher than that of its peers; relative to labour productivity which is reportedly lower in Kenya compared to many of its African peers. Thus enhancing labour productivity will require a targeted approach to educational investment in order to enhance skills and innovation.
  • In terms of sectoral contribution to GDP growth, the service sector has been the main contributor to the economy over the past decade. This includes accommodation and restaurants; information and communication; transport and storage; financial and insurance services; and real estate services among others. In 2020, the sector experienced significant contraction because of the COVID pandemic and this had had a significant adverse impact on economic growth. The most affected sub-sectors include accommodation and restaurants as well as transportation and storage.
  • The agricultural sector is the second largest contributor to growth even though the sector is still weather dependent and continues to be adversely affected by erratic weather patterns as well as low level of investments both at the national and county level. The sector however continues to play a significant role in the economy. In 2020, the sector shielded the economy from further decline during the second quarter of 2020 by registering reasonable growth even as many other sectors experienced growth contraction – notably the Services sector. Thus, any meaningful growth strategy has to prioritize agricultural investments
  • The industrial sector is yet to pick up and its contribution to economic growth has been lagging behind. In particular, the contribution of manufacturing to GDP has been declining steadily, denoting a reduction in the manufacturing capacity of the country. Food and beverages accounts for the largest share of manufacturing products implying the dependence of the industry on agriculture whose productivity has remained significantly low. Key challenges facing the sector include inadequate skills, barriers to entry, insufficient FDI, low innovation, high cost of doing business, bureaucracy and corruption among others. To diversify manufacturing to other sectors beyond agriculture, serious innovations are required in order to compete effectively on a global scale. Indeed, the non-agro-based manufacturing sector is highly dominated by the informal sector whose main outputs include furniture and metal works and the production is domestically oriented. Manufacturing is among the key pillars of the big four agenda but unless there is enhanced project prioritization and implementation is carried out decisively and aggressively, the outcome for the sector and the economy will remain poor.

So which way forward?

The Budget Policy Statement (BPS) was published on 25th January 2021 for the Medium-term Expenditure Framework FY 2021/22 – 2023/24 budget. It contains:

  • an assessment of the current state of the economy including macroeconomic forecasts;
  • the financial outlook with respect to Government revenue, expenditures and borrowing for the next financial year and over the medium term;
  • the proposed expenditure ceilings for the National Government, including those of Parliament and the Judiciary and indicative transfers to County Governments;
  • the fiscal responsibility principles and financial objectives over the medium-term including limits on total annual debt; and
  • Statement of Specific Fiscal Risks.

As would be expected, it was noted that it was prepared against a background of a contracting global economy occasioned by the outbreak and the rapid spread of the Covid-19 Pandemic. The global economy is said to have contracted by 4.4 percent in 2020. In Kenya, the economy is said to have contracted by 5.7 percent in the second quarter of 2020 from a growth of 4.9 percent in the first quarter of 2020 largely due to significant contractions in the services and industry sub-sectors. Despite this, the National Treasury has noted that the economy continues to register macroeconomic stability with low and stable interest rates and a competitive exchange rate that supports exports.

However, whereas it is true that Covid 19 did occasion contraction, fact remains that the economic outlook was already and continues to be adversely situated as a result of structural inadequacies and mentioned above. Under the prevailing circumstances and assuming no significant change in policy, the economy is estimated to grow by 1.3% only in 2021 and 4.3% in 2022. However, this may be affected by political uncertainty as economic growth is likely to be muted during the electioneering period; erratic weather patterns which will have an adverse impact on crop production; and fiduciary risk including poor planning, misapplication and misappropriation of funds.

Based on the foregoing, and in consideration of the recommendations by fiscal analysts at the PBO, it is hereby proposed that:

  • A re-appraisal of all projects in the budget be undertaken. This will weed out all non-performing projects where the country is not getting value for money and redirect funds to high-returns projects. In addition to this, the Government should continue with the expenditure prioritization policy as proposed by the National Treasury with a view of minimizing costs through elimination of duplication and inefficiencies. In addition to this, a Project Management Unit (PMU) should be put in place to undertake regular monitoring and evaluation of projects as well as put in place checks and balances that guarantee quality of investments.
  • Reduce the net domestic borrowing to zero coupled with increase in concessional financing – this will reduce the incremental effect of domestic borrowing on debt and concessional external debt be used to replace/buyout expensive domestic/external debt.
  • Medium term debt service expenditures must be reduced to no more than 3.4% of GDP as per the BPS 2018–Debt servicing expenditures are set to cross the Kshs. 1 trillion mark in FY 2020/21. Targeted reduction of debt servicing expenditure alongside reduction of non-core recurrent expenditures, will have a higher effect of easing fiscal space. This should however be guided by a clearly laid out policy.
  • Revision of an arbitrarily set debt ceiling- the debt ceiling as designed creates a regulatory flaw as it is delinked to the rest of the economy. Choice of a ratio would provide a debt limit that is more responsive to both liquidity and solvency concerns and lead to prudent debt management practice.
  • Address regulatory challenges and barriers to market entry for businesses that may hinder activities of foreign investors.

With the National Treasury expected submissions of the BPS to the Legislature on the 15th of February, 2021, it is imperative that we all participate in the budget making process. Public participation is provided for in the Constitution of Kenya, 2010.

Parliament will have fourteen (14) days after the BPS is submitted to table and discuss a report containing its recommendations and pass a resolution to adopt it with or without amendments. The Cabinet Secretary of the National Treasury and Planning shall consider resolutions passed by Parliament in finalizing the budget for the FY 2021/22. 

To facilitate this engagement, Oxygéne MCL through its Regulatory Affairs department will in partnership with the Institute of Public Finance (IPF-K) be undertaking a step-by-step sector based in-depth analysis of the BPS so as to develop a more inclusive business-centric and outward looking approach to the current budget making cycle of the FY 2021/22- 2022/23. The first series of engagements will be held on 17th February 2021. If interested, kindly get in touch with us via Magdalene.Kariuki@oxygene.co.ke

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