Uhuru adopts borrow and spend strategy

Pundits had predicted that with a sluggish economy and dwindling revenues, Finance minister Uhuru Kenyatta would introduce crippling taxes to fund his Sh867 billion Budget. The minister confounded the pundits. He did not announce any new tax increases, preferring in most cases to maintain last year’s levels.

Throughout his speech, the minister concentrated on doling out concessions. So where will the money to fund the huge Budget deficit come from? Indeed, for the first time in many years, this year’s Budget deficit of Sh190 billion is the largest in the history of budget-making. The deficit is equivalent to 6.6 per cent of the Gross Domestic Product, namely, all the wealth produced in the country in a year.

Part of the deficit will be financed by privatisation proceeds. But the largest chunk — Sh109 billion — will be borrowed from the local market. So, despite the fact that Mr Kenyatta’s Budget is fully-funded, the big question is whether the borrowing plan will be sustainable.

Great success

The domestic capital market has demonstrated a great deal of depth as was proved by the success of last year’s infrastructure bond where the government easily raised Sh18.5 billion from the market. The massive oversubscriptions of the KenGen in 2006 and Safaricom IPOs last year also demonstrated a great dealt of depth of the domestic market.

However, Sh109 billion may be a challenge for capital market still in its infancy. There is also the fact that at this massive level of borrowing, private sector institutions that will adopt the same practice will be crowd the market. In the past budgets, the trend had been to tax and spend. Mr Kenyatta’s Budget is about how to borrow and spend.

Mr Kenyatta has justified the high borrowing on the grounds that even after the Sh109 billion domestic borrowing level, Kenya will still be far from being considered as a high-risk indebted country. Last year, the country went through a debt sustainability test by the World Bank, which demonstrated that the country was not too badly indebted.

According to the minister’s calculation, the country will in terms of indebtedness still be at 45 per cent of GDP which, he argued, was still tolerable.

Donor community

Still, chances are that Mr Kenyatta is quietly counting on receiving much more money from the donor community. Because of significant disruptions in aid flows in terms of budgetary support in recent years, which negatively affected execution of the Budget, and hence forced the government to borrow from the domestic market in an unplanned manner, the Kibaki administration has been following a fiscal strategy that does not factor non-project aid in the annual Budget.

When former Finance ministers David Mwiraria and Amos Kimunya touted the fact that they had not factored donor money in their budgets, it was not as if the government did not need it. The truth of the matter is that all those budgets absorbed a great deal of money in terms of project finance. It was just the prudent way out of dealing with uncertainty of donor inflows of cash for Budget support.

Mr Kenyatta would appear to have adopted the same fiscal strategy: namely, prepare the markets for as large a domestic borrowing requirement as possible even as you negotiate budget support with willing donors. If in the middle of the financial year you get some of the donors to commit and disburse funds, the money can be used in bringing down the domestic borrowing requirement.

Thus, going forward, the likelihood is that the government will be mounting an aggressive diplomatic campaign with multi-lateral and bilateral donors for aid.