15 June 2008
Nairobi — Pundits had predicted that Kenya's Minister for Finance Amos Kimunya would introduce crippling taxes to raise enough money to get the economy out of the recessionary conditions created by the post-election violence the country experienced at the beginning of this year.
It had also been predicted that the minister would reduce petroleum taxes to pre-empt galloping inflation by ameliorating the pressure high global oil prices were exerting on price levels in the economy.
Indeed, Kimunya's budget was being seen against a backdrop of pessimism. Following the election violence and the creation of a Grand Coalition government, Kenya had put in place an unwieldy Cabinet composed of ministries and departments with overlapping functions.
The minister's challenge was how to raise the money to fund the expanded bureaucracy, reduce taxes to shield consumers from ravaging inflation, and still maintain macroeconomic stability.
As it turned out, the gloomy predictions were not fulfilled. Borrowing a chapter from Reaganomics, Mr Kimunya reduced the general level of taxation, allowing major tariff reductions on wheat imports while zero-rating VAT on rice, bread, motorcycles, and converters.
And, contrary to popular wisdom, the minister did not raise personal taxation. Indeed, the only major tax increases he announced were for cigarettes and alcohol.
On the expenditure side, Mr Kimunya unveiled a massive spending programme of Ksh760 billion ($12 billion) with lump allocations for roads, rural electrification, teacher recruitment, housing for the police force and recruitment of nurses.
Most significant in the minister's spending programme were expenditures on the youth, urban poor and other vulnerable groups - what is referred to in contemporary parlance as "pro-poor" expenditures.
He announced an allocation of Ksh2.4 billion ($38.1 million) to finance projects in the pastoralist region of northern Kenya, Ksh4 billion ($63.5 million) for a civil contingency fund and drought relief, Ksh4 billion ($63.5 million) for rural access roads, and Ksh1 million ($15,873) for sporting kit and balls for community soccer competition in all constituencies in Kenya.
Where will the money to finance this huge spending programme come from? Mr Kimunya belongs to the school of expansionary policy, of huge budget deficits and seeking to achieve high growth rates for the country by raiding the domestic financial markets to borrow money to fund infrastructure and consumption.
The budget that Mr Kimunya presented to parliament last week catered for a budget deficit of a massive Ksh127 billion ($2 billion) - equivalent to 5.3 per cent of GDP and one of the largest in the country's history of budgeting.
It will be made up by net external financing amounting to Ksh25.2 billion ($400 million) - leaving Ksh101.8 billion ($1.61 billion) to be financed through privatisation proceeds (Ksh8 billion, $127 million) and the issuance of infrastructure bonds amounting to Ksh52 billion ($825.4 million).
Out of the money from long-term bonds, Mr Kimunya plans to raise Ksh33.6 billion ($533.3 million) from a sovereign bond to be floated in the international markets and Ksh18.5 billion ($293.6 million) to be raised from domestic long-term bonds.
To close the gap, Mr Kimunya's budget has factored in a net borrowing requirement of Ksh36 billion ($571.4 million) - one of the largest in the recent years.
Clearly, the government has taken a risky gamble, counting on financing a huge budget deficit from doubtful sources.
Raising Ksh8 billion ($127 million) in privatisation proceeds may not be that easy in view of the fact that the closest privatisation candidate, the National Bank of Kenya, may not draw as much public interest as the recently concluded Safaricom IPO.
Having just come out of political turmoil, and with the country's credit-risk rating having plummeted, it is unlikely that the sovereign bond issue, from which the government has planned to raise Ksh33.6 billion ($533.3 million), will be as feasible as has been assumed.
Then there is the Ksh18.5 billion ($293.6 million) that the government plans to raise from the local market.
Granted, Kenya does indeed have a very deep capital market, one that has absorbed billions of shillings in government and corporate bonds.
Just how deep the primary capital markets are was recently demonstrated by the Safaricom IPO, which raised the government a total of Ksh50 billion ($793.6 million) and was still oversubscribed by 532 per cent.
But whether the government can raise Ksh18.5 billion ($293.6 million) of fresh money in long-term bonds within one year, and without disrupting the existing government bond programme is an open-ended question.
Deficit financing - whether achieved through printing money, aggressive issuance of Treasury-bills and bonds, or absorbing donor funds - creates excessive liquidity in the market, which fuels inflation.
And as long as the deficit remains large, the interest for servicing government debt will continue to rise.
Even in times of slow growth, large deficits crowd out the private sector from credit.
In terms of new ideas, and articulating Kenya's economic blemishes and possible solutions, Mr Kimunya's budget was truly extraordinary.
But whether the financing plan and assumptions stipulated in the budget are feasible or not is debatable.
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