Kenya's main fiscal risk lies in unfunded public pension liabilities

What you need to know:

  • The reasoning goes that added debt is not a major risk now because these investments are bound to generate sufficient growth and thereby pay for themselves in due course. 
  • While the very detailed Debt Sustainability Analyses and the papers issued by the Treasury show that the debt-to-GDP ratio for Kenya is presently below 50 per cent, it is evident that neither addresses the unfunded pension liabilities held by the Government of Kenya.
  • It is clear that pensions debt cannot be shifted in any way and will only shrink once the nascent contributory pensions system established by the government is fully in operation.

One result of the recent rebasing of Kenya’s Gross Domestic Product (GDP) is that the level of public debt as a share of GDP came down by nearly ten percentage points.

This meant instant relief for the managers of Kenya’s public debt, for two reasons. First that it showed the degree of indebtedness was lower than the previous GDP estimates allowed, and second, that there was scope for expanding borrowing before the threshold for unsustainable debt was reached.

It is unsurprising, therefore, that the Treasury has prepared a proposal to seek authorisation from the Legislature to expand the limits for external public debt as required under Article 211 of the Constitution.

This policy measure is an exceedingly important one. Treasury contends that raising the debt limit from Sh1.2 trillion to Sh2.3 trillion is necessary to afford investments in infrastructure as contemplated in Vision 2030.

The reasoning goes that added debt is not a major risk now because these investments are bound to generate sufficient growth and thereby pay for themselves in due course. 

The International Monetary Fund (IMF) carried out a Debt Sustainability Analysis for Kenya in April 2013 and the publication seems to give Kenya an unqualified good rating in terms of risks for external debt distress. Simply put, there is no major risk related to external debt for Kenya.

While the very detailed Debt Sustainability Analyses and the papers issued by the Treasury show that the debt-to-GDP ratio for Kenya is presently below 50 per cent, neither addresses the unfunded pension liabilities held by the Government of Kenya.

To be fair, unfunded pension liabilities are not conventional debt because they are not the result of a specific exchange of funds with a promise to pay on certain terms.

NO DEDICATED FUND

However, these liabilities emerge from a historical practice in which public sector workers received pension payments from direct revenue through the Consolidated Fund Services (CFS) on retirement. 

Because a large number of workers took up retirement before government established the contributory pension scheme for its employees, there are outstanding liabilities for the pensions of all these employees.

This liability is maintained and cannot be transferred elsewhere because of the promise to pay, added to the fact that service was rendered. Many retired workers are owed pension payments, a cost for which there is no dedicated fund. This promise is equivalent to public debt.

Whereas this liability has not been quantified, it is possible to estimate its lower bound from the size of the pensions paid from the appropriations that Parliament made for Consolidated Fund Services (CFS) for the financial year starting July 01, 2014.

'CANNOT BE SHIFTED'

Bear in mind that these CFS payments have priority over all budget expenditures and are covered first before any discretionary spending occurs.

While the CFS constituted 20 per cent of all proposed spending, the provision made for pensions will comprise Sh32.4 billion, accounting for 2 per cent of all public spending.

Analysis by the Institute of Economic Affairs shows that the pensions component grew by 15 per cent compared to the previous year, confirming that liabilities for unfunded pensions in Kenya are significant.

It is clear that pensions debt cannot be shifted in any way and will only shrink once the nascent contributory pensions system established by the government is fully in operation.

In the meantime, all signals show that the this debt will continue to grow, primarily because any changes in the public sector that lead to retirement of staff will create immediate demand for payment of their pensions.

NO EASY SOLUTION

This presents a dilemma for ongoing staff rationalisation in the public sector, especially because previous staff retirement in the public sector has been deferred because of government's inability to meet the immediate and longer-term costs of pension payments. 

There is no easy solution to the question of unfunded pensions liability in Kenya, but it is imperative to start with an actuarial valuation of the true size of that liability because this then makes its existence necessary to admit. 

As Parliament considers the proposal by Treasury to expand the limit for external borrowing, it would help to bear in mind that an unfunded pensions liability is also a claim on public resources.
The debt-to-GDP ratio would look very different if this were borne in mind, and future statements on debt should include the unfunded pensions liability for the notice of Kenya’s Parliament.  

Kwame Owino is the chief executive officer of the Institute of Economic Affairs (IEA-Kenya), a public policy think tank based in Nairobi. Twitter: @IEAKwame