Charting the path to Kenya’s fiscal and debt sustainability

These discussions come in the aftermath of political upheavals related to the Finance Bill 2024, which precipitated a governance change, including the appointment of John Mbadi to oversee the fiscal policy docket.

Listening to the media and civil society discuss these issues of debt, often eliciting strong emotions, raises an important question: What does the media perceive about the existing fiscal setup, and how does this differ from an economist’s perspective? In the biblical context, when God asked Jeremiah, “What do you see?” the intent was to elicit convergence in views.

This convergence is critical; it must be well understood as fiscal sustainability.

Fiscal outlook and sustainability

Fiscal outlook is a major component of sound policy analysis at the macroeconomic level, encompassing revenue performance, expenditure trends, and public debt management.

A critical aspect to examine in the fiscal sphere is sustainability. This vital element is often overlooked in news bulletins that focus on ballooning public debt, the rising cost of living, liquidity crunches, exchange rate volatility, and general price levels.

Ultimately, fiscal sustainability encapsulates the economic challenges we face today.

Simply put, fiscal sustainability asks if we can continue with our current levels of expenditure, revenue collection, and economic growth without making significant adjustments or facing the threat of default on debt service obligations.

In essence, are we solvent or bankrupt? While the answer is somewhat technical, it ultimately hinges on whether we can meet our debt obligations without compromise.

A quick introspection of the debt trend shows an accelerated accumulation over the past 12 years. These trends are mirrored for both domestic and foreign debt, with a preference for domestic debt until 2015.

Such increases may not seem alarming, as cumulative debt stock is not the sole indicator of fiscal sustainability.

Various factors contribute to this trend, including the growing size of government, a permanent expenditure displacement effect caused by government policies, a persistent savings gap, and an overall increase in the economy's size.

Economists rely on more informative indicators to gauge the fiscal status of the economy, typically categorised into liquidity indicators and solvency indicators.

Understanding fiscal indicators

Liquidity indicators compare debt to key sources of financing, such as debt to export earnings or debt to ordinary revenue.

In contrast, solvency indicators take a longer-term view of sustainability, incorporating the present value of debt to GDP or debt to export earnings.

Economists analyse fiscal sustainability from a solvency perspective: to sustain fiscal policy, we must stabilise the debt-to-GDP ratio over a finite time horizon. This can only happen if we do not run a primary deficit indefinitely.

A primary deficit is the difference between total revenue and primary government expenditures, excluding debt service expenditures.

When public debt increases without a foreseeable primary surplus, concerns about debt sustainability arise. Analysing debt dynamics helps us find the primary balance necessary to stabilise our debt, considering key macroeconomic factors.

The need for public debt

It is also essential to understand why we incur public debt in the first place. This often relates to key macroeconomic imbalances.

For example, our economic absorption exceeds our domestic production capacity, meaning we consume more than we produce.

This situation finances our current account deficit, characterised by more imports than exports and a negative net foreign investment position.

Read: Scrutiny of the public debt register urgent

Additionally, public debt reflects a country’s small savings relative to large investments. When a country’s savings fall short of its investment needs, it must rely on external borrowing.

Analysing fiscal policy sustainability

Is our fiscal policy sustainable? According to the Debt or Fiscal Sustainability Analysis (DSA) conducted by the International Monetary Fund in 2023, the outlook indicates sustainability.

The DSA evaluates how our current debt-to-GDP ratio relates to debt servicing costs, economic growth rates, real exchange rates, historical debt-to-GDP ratios, and current primary balance to GDP.

A significant concern arises if the interest rate on servicing debt surpasses the economic growth rate or if we encounter substantial exchange rate depreciation, worsening our debt dynamics and heightening our vulnerability.

Way forward

One variable we have complete control over as policymakers is the primary deficit.

To achieve a balanced approach, we must adjust it to a debt-stabilising level, which can be done by growing revenues or reducing primary expenditures.

The latter is often an easier target and has been shown to be more feasible in practice.

Growing revenues, aside from administrative or tax policy adjustments, is closely tied to economic growth, necessitating an expanded tax base before increasing revenue.

Striking a balance between revenue growth and minimising the burden on taxpayers is essential, and enhancing compliance efforts presents a promising opportunity.

It is encouraging to observe that the Cabinet secretary is dedicated not only to enabling the revenue collection agency to optimise its operations through technology but also to motivating staff—a crucial aspect that cannot be overlooked.

Equipping personnel with the right tools and fostering a supportive environment are vital for effective tax compliance.

The writer is a Research Economist, Kenya Revenue Authority