Borrowing plans, crowding out, high debt stock: Economic policy is unforgiving and continues to chalk merciless lessons for Kenya’s new regime on both sides of the policy isle – fiscal and monetary.
Insatiable borrowing and deficit-ridden spending plans have prompted the World Bank to caution repeatedly in its Kenya Economic Updates that the consequences of fiscal dominance – neglect of private sector potentials to grow the economy – equals inappropriate and prolonged crowding out of the private sector in the local debt market, despite growth potential.
The fiscal side is not delivering an uptick in aggregate demand while economic shocks and contraction persist.
Traditionally, among Kenya’s banks, credit flows to growth of investments, revival of employment, output and GDP growth remain relatively unsupported. And with the Finance Act 2023 now muddied in the courts, the IMF has also shone a light on CBK governance and safeguards in the use of borrowed funds following a recent experts’ review.
Add to that the Auditor-General’s finding that public debt lacks audited financial statements, counties resorting to expensive bank overdrafts to pay delayed salaries, and the Controller of Budget’s flagging, in June 2023, of KSh5.7 billion plundered outside payroll.
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Another example of shortcomings is the Finance Act 2023 under litigation. A fiscal deficit of KSh718 billion (4.4 per cent of GDP) including grants, disproportionately leans on domestic borrowing at KSh586.5 billion (3.6 per cent of GDP), compared with external borrowing of KSh131.5 billion (just 0.8 per cent of GDP).
This narrows the road to private sector-led growth, while the majority of non-performing loans that banks report to the CBK reflect pending bills of government, putting a brake on private sector growth.
Had former President Uhuru Kenyatta on November 23, 2015, followed through with his pronouncement to establish a professional Office of Management and Budget (OMB), designed in my time at the Executive Office, to work with the existing and highly professional Parliamentary Budget Office (PBO), there would by now be a mechanism to reign in the disarray in public finances.
Without that, the current dilemma finds government hamstrung on borrowing domestically and abroad, primarily caused by jitters on the size of its deficits and the challenge of debt repayments.
It gets much worse because this opens a spell where the tenacity of CBK will be sorely tested on controlling nominal money growth. A squandering government could challenge the CBK’s powers to create money. The CBK needs to anticipate the consequences of ceding its mandate of reigning in and controlling inflationary tendencies in the economy; meeting governance stringencies for funds borrowed through it (as a fiscal agent); as well as the accelerated depreciation of the shilling that would ensue. It is the trajectory of money creation that is the greatest scare.
Borrowing options: Good, bad, ugly
There are two options for governments in borrowing from central banks, one of which could ruin the economy unless supported by output growth. Government can borrow just like you and I, and even issue securities – TBs and bonds attracting market-determined rates (domestically and abroad) and which anyone can purchase and redeem. Or it can do what you and I can’t do: take powers to create money, powers that in Kenya belong to the CBK. This is called monetising government debt. This type of monetary loosening, called printing money, could ruin the economy with hyperinflation if the CBK lost control of inflation, with too much money chasing too few goods and services.
Recent TB and bond Issues demonstrate the looming hiatus and dilemma for both government and the CBK. The domestic market tries to whet the current government’s appetite for borrowing but may not offer up the massive amounts proposed in the problematic Finance Act 2023 (KSh586.5 billion – that is 3.6 per cent of GDP) at anywhere near the CBK monetary policy rates.
Banks are already averse to the credibility of monetary policy along with financial stability. With the uncertainties, pickings declined in the first Quarter of 2023. Average interest rates for the 91-day, 182-day and 364-day TBs increased to 9.62 per cent, 10.06 per cent, and 10.62 per cent respectively in February 2023, from 9.44 per cent, 9.88 per cent and 10.42 per cent in January 2023, to induce buyers. Average time to maturity also declined.
In subsequent offerings, some cancelled, and offtakes plunged from proposed borrowing amounts at CBK auctions, even from traditionally compliant banks that now look for premiums as cover for Kenya’s teetering public finances. The outlier and surprise results dated June 19, 2023 came from the Seven-Year Treasury Bond Issue No. IFB1-2023-007.
It raised KSh220 billion, achieving that amount only by sweetening gross rates (inclusive of tax exemptions) calculated at about 20-22 per cent.
While this resuscitated government borrowing, it removed potential lending to the real economy, with taxpayers up picking the costly tab for higher margins or premiums payable to lure lenders. In the meantime, government borrowing in external capital markets has dried up.
In rating Kenya, financial markets pose challenges to reputation and/or creditworthiness to access borrowing without punitive rates. How far can the margins offered domestically stray from the prevailing CBK policy rates, and what are acceptable yields in the case of external borrowing, before the CBK loses credibility, or before the borrowing appetite graduates to debt monetisation and hyperinflation?
When inflation begins to gallop towards hyperinflation, its footprints are an escalation to rapid, excessive, out-of-control price levels that are hard to reverse and return the economy to sustainability and economic recovery. It can disrupt economic activity and plunge transactions to money illusion, especially after a rate of about 50 per cent. Economic activity and normal public finances check into ICU.
The main winner in the ensuing casino is the government which then pays its debts but triggers the start of hyperinflation. Other winners are holders of Kenya shilling debt, as well as holders of non-cash assets like land and real estate, whose prices escalate.
The general public loses massively, caught in the crossfire because hyperinflation taxes all the cash in their pockets. It hammers the poor and widens poverty as it does the spending power of private sector wage earners, including those that hyperinflation regroups in higher tax brackets (a process called bracket creep), public servants, savers, people liable to capital-gains tax, and hoarders of cash who hope prices will later trend downwards.
That is why, under Article 231 of the Constitution, if the CBK were to stray into printing money in collusion with the government, it would be treading in money creation unconstitutionally or ‘under the gun’. Money creation increases government’s real (inflation adjusted) revenues and lowers its real debt repayments. Hyperinflation has two key drivers: the inflation tax (that taxes all cash, without formal taxation or spending proposals passed in Parliament through the Finance Bill and Act, or even payments passing into the Consolidated Fund); and seignorage, a key macro-ingredient in monetary theory of hyperinflations: simply, the nominal money created, deflated by the price level, defining the real (decreasing) revenue government gains from money creation as nominal money growth accelerates inflation.
The diagnosis above would risk inflicting on Kenya the long-term scars that hyperinflations impose on former ICU patients, countries that lived to tell the tale. Ask Germany, where 1US$ equalled 1 trillion Marks in 1923, and a wheelbarrow of Marks could not buy a newspaper; or Zimbabwe from 2007, when the daily rate of inflation had reached 98 per cent by 2009; or Argentina, Hungary. Bolivia in recent times displays starkly the studied consequences of hyperinflation over the tax system.
It collapsed in only five years from about 9 per cent of GNP in 1981 to 1.3 per cent in 1985. The seignorage tax did not prevent the dramatic shrinking of tax revenues that followed from a shrinking economy failing to fund pent-up public sector and social spending, failed stabilisation attempts that were overturned in public protests of key constituencies of government, and risk-averse investor perceptions of government policies.
The scars in macro variables persist for decades after discharge from ICU. There is a pattern to hyperinflation when government resorts to printing money, thinking it can sidestep conventional orthodoxy in economic management, only to fall into a trap. Kenya must not succumb to the disease of money creation despite its predicament of poor access to both domestic borrowing, and external capital.
Sidestepping hyperinflation
First, engage a credible deficit reduction and cut, cut spending and wastage. Second, create a to-do list to right the wrongs that bedevil the top echelons of key institutions involved, e.g., recruit, train, and hoist the best skills at CBK and the National Treasury, reestablishing top professionalism and defending it- from the CS, CBK’s Monetary Policy Committee, Governor, Deputies, and senior staff.
Third, between the NT and CBK, monetary policy and treatment of public debt and addressing the deficit should be coordinated. Fourth, all parties need to recognise a division of labour in coordination: fiscal policy influences aggregate demand and monetary policy targets inflation and setting of interest rates. Coordination to achieve the interests of the nation combined in short/medium term strategies do not mean supremacy wars but applying skills for the good of the nation.
Dr Wagacha, an economist, is a former Central Bank of Kenya chairman and adviser of the Presidency
