As public debt continues to swell, a question that begs to be answered is: will Kenya contain its expenditure and record growth in the near future?
In the financial year 2005/6, Kenyan government collected revenue of Sh326 billion and borrowed Sh40 billion, bringing total revenue and debt to Sh366 billion in the year – the figure is proportionate to Sh1,317 billion today when inflation is factored in. The government total expenditure budget for that year was Sh509 billion (Sh1,834 billion today when adjusted for inflation).
In the financial year 2022/23, government collected revenue of Sh2,166 billion and borrowed about Sh988 billion, giving it a total revenue and debt of Sh3,154 billion in the year, with a total budgeted expenditure for that year hitting Sh3,384 billion.
In real terms, this implies that the Government has a combined revenue and debt of Sh1,550 billion in excess of what it was collecting in 2005/6. Over the same period, the annual average GDP growth rate was 4.76%, the annual average inflation rate was 7.43% and the annual average growth in the national budget was 12.3%. Of these three metrics it is clear that the GDP growth rate is lagging behind. That is why in the last 15 to 20 years, the country is yet to record any growth spurts or sustained periods of high growth.
The highest GDP growth rates we have had are 8.1% in 2010/11 and 7.6% in 2021/22. Both periods were preceded by years of low GDP growth rate. While the growth rate in 2010/11 was preceded by the post-election violence in 2007/2008 that created a very low growth period, the 2021/22 one was led by the Covid-19 period.
Of the 4.76% average annual GDP growth rate in the last 18 years, more than 1% can be attributed to government spending. This would reduce the average annual growth rate to below 3.76% per annum. This is a very low growth rate considering that the country’s population in the last 20 years, has increased from around 35 million in 2004 to 55 million today, which is a growth of 57%.
With a growing population, it is expected that the nominal GDP will grow as well as inflation. A growing economy, with a growing population, should have a GDP growth rate of 7.5% + per year. But that is not the current state of affairs in the Kenya Kwanza regime, thus the question that begs is, is a rising government budget and heavy borrowing good or bad for the economy?
To answer this question, it is prudent to understand the interaction between taxes and the economy, government borrowing and the economy, and the sources of borrowing. With a growing economy and a growing population, the masses will generally expect that the government will collect more taxes in order to fund services like education, or health, and improve infrastructure that the growing population demands.
As long as the government invests the additional taxes in these two areas, in the long run, this is good for the economy and will create economic growth downstream. What we have seen in Kenya over the last twenty years is a mixture of this, and imprudence in managing finances marked by excessive borrowing.
Excessive government borrowing is bad for the economy, especially when the funds are not well invested. This is because future taxes are used to pay off loans and interest on loans as opposed to improving services and infrastructure. This is where our country is now, higher government revenue growth, improperly managed leading to poor economic outcomes.
On the other hand, we have government borrowing, and this has had more significance for our economy. Government debt as at December 31, 2021 was Sh9.12 trillion, structured as Sh4 trillion internal debt and Sh4.2 trillion external debt. To understand the effect of debt to our economy, we have to ask ourselves where does our government borrow from? A large part of the Sh4 trillion local debt is from pension funds and commercial banks. As at June 30, 2022 pension funds held 1.22 trillion of government bonds and banks held Sh1.71 trillion in government bonds. Why is this an issue?
The economy grows largely due to capital allocation, what governments provide is a policy framework within which the capital allocators operate. The government has very little to do with growing an economy beyond providing the policy framework. The largest capital allocators in Kenya are banks and pension funds and their choice of where they chose to invest (allocate funds) has significantly effects on our economy. The two capital allocators combined have invested approx. Sh 2.9 trillion in government bonds, a larger part of these funds should have been invested actively in the economy.
The opportunity cost of capital allocators buying government bonds is the foregone benefit of investment in the real economy (agriculture, manufacturing, IT). Out of the Sh2.9 trillion invested by these two capital allocators, Sh1.64 trillion was invested in the last four years (2018 to 2022). If 50% of the Sh2.9 trillion (Sh1.45 trillion) was invested in the economy over the last 10 years, we would have had better economic outcomes and more jobs created.
This choice of investment is normally driven by short term ambition by the banks to maximize profits in an asset class that is almost “risk free”. Investment in the real economy requires more due diligence and prudence in selecting projects and bears a higher risk. The other motivation is fear, where the capital allocators are afraid that if they fail to invest in government bonds, there is the risk that the Government could default in debt payments, this puts a risk of them losing their existing investment.
The parties are caught in a sunk cost fallacy trap where it is safer for them to buy an additional Sh300 billion of bonds today to enable the government to meet its debt payments than it is to lose the Sh2.9 billion already invested. The latter will be the larger part of their motivation going forward. The risk of the government defaulting on its debt repayments is a total collapse of the private capital structure of the country (banks, pension funds and insurance companies).
For a decade and a half, we have seen increased government spending funded through taxation and borrowing. Whereas increased taxation was necessary to fund an increase in demand for government services, the increased borrowing has been at the expense of economic growth.
Looking at our demographics, we will face tougher years in the near future, especially if the economy fails to improve.