2 July 2011

Kenya: Why Tanzanian Economy is Hanging On a Thin Line

A few weeks ago, before the budgets were read, I trawled through the IMF's Article IV report on Tanzania. Tanzania did relatively well in the aftermath of the global financial crisis for several reasons: high gold prices, more diversified export markets, strong regional demand, some financial support from the IMF - and like in Kenya and Uganda, the government spent more to provide a stimulus to the economy. The financial crisis eventually abated, but Tanzania's spending increases didn't (also like Kenya and Uganda). 2010 had been an election year, so there had naturally been little appetite to roll back spending. But common sense (or your mum) tells you that you can't go on spending more year after year unless your revenues increase at the same speed.

In this case, the IMF told Tanzania: In the past fiscal year, 2010/2011, revenue collection has not achieved the overly optimistic targets. Recurrent expenditures have gone up from 14.9% of GDP in 2007/2008 to 18.8% in 2009/2010. This was partly because of the fiscal stimulus to counteract the effect of the global financial crisis, but not entirely: the IMF notes that spending had been on an upward trajectory even before.

At the same time, revenue collection has stalled at 15% of GDP, which the IMF considers well below potential: Tanzania's corporate income tax collection is only at half of the level of the sub-Saharan Africa, VAT compliance is markedly lower, and excise rates are lower than in the other EAC countries. Revenues from the mining sectors are still limited as mining firms were given extensive tax holidays to encourage investments in the nascent mining sector. There has also been resistance to cancelling tax exemptions that are estimated to cost Tanzania's treasury up to 3% of GDP per year.

Tanzania's fiscal deficit has risen from a tame 1% of GDP in 2007/2008 to 6.9% in 2009/2010. To fill this widening gap, Tanzania could no longer rely on grants, but has used more concessional (i.e. cheap), but also non-concessional borrowing. Alarmingly, recurrent expenditures (ie. money you need to spend just to keep things going) exceed what the IMF calls reliable sources of funding, i.e. domestic revenue collection and budget support, by around 20%. So Tanzania has ended up in a situation where it is effectively borrowing to cover its recurrent expenditures. It also means that funds for investments are limited, and it is not clear how much the state can actually invest.

If spending and revenue collection remain unchanged, the IMF projects that Tanzania's deficit would expand by another three to four percentage points by the middle of the decade, and in order to finance it, Tanzania's public debt would rise to 66% of GDP in 2014/2015, with considerably higher debt servicing costs as donor aid will remain stable or possibly fall. Tanzania would eventually have to rely on fully commercial funding, which is a lot more expensive.

There are a couple of interesting points here. For one, Tanzania is structurally dependent on foreign aid: this is expected to peak at 10% of GDP this year. Like many other developing countries, Tanzania was included in the Multilateral Debt Relief Initiative in 2005, which was added on to an earlier debt write off process, and had the bulk of its debt written off. But what nobody has really figured out is how to wean developing countries off subsidised borrowing. Tanzania's example is actually a good pointer of how this still goes wrong: It is argued that Tanzania needs to keep borrowing so that it can invest and achieve a higher growth rate. Except in this example, it doesn't: part of the borrowing is for recurrent expenditures, and will therefore push Tanzania back into rising debt. And even if funds are used for investments, this does not always work out either: in an environment with entrenched corruption, there are plenty of examples of how money allocated for infrastructure and other investments is stolen or badly spent.

And finally, donors have a role to play as well since they influence what aid recipients spend money on: social spending - healthcare, water, schools etc - is often high on the agenda. And this drives up recurrent expenditures. You might say that such recurrent expenditures are really an investment in a country's human resources, but the fact is that a country will usually rely on donors to finance such an expansion in the public sector. This entails hiring staff, expanding organizational structures: not something you can roll back quickly (although you can make spending more efficient - ask Prof Ongeri a question or five about where DFID's primary education funds went).

So where is Tanzania headed? GDP growth is expected to slow down a little this year, and you don't want to exacerbate that by cutting spending. Revenue projections have become a little more realistic, but the treasury plans to increase spending on infrastructure and energy substantially. Better infrastructure and power supplies are good - except there is little to indicate that the country has become better at managing such large-scale public investments.

Andrea Bohnstedt is the publisher of Ratio Magazine, an East Africa online business magazine, and works as an independent country risk analyst for several international firms. Andrea has an established track record in country analysis, having worked for Global Insight (now Global Insight IHS), one of the largest international country intelligence providers, as Africa analyst for three years.

Since leaving Global Insight, Andrea has written on business, economic and political risk issues for, amongst others, Dun and Bradstreet, Africa Practice, African Business, Africa Investor, Afrika-Wirtschaft, Control Risk Group, Oxford Analytica, Risk Advisory Group, and MarketWatch. Occasionally, Andrea gets asked what she thinks by media like BBC, CNBC, NTV, ITN, Bloomberg, and others.

Andrea holds a first degree is in business studies, and an MSc in development studies from the London School of Economics (LSE).

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