“The time has come” the Walrus said,
“To talk of many things:
Of shoes—and ships—and sealing wax—
Of cabbages— and kings—
And why the sea is boiling hot—
And whether pigs have wings.”
Lately, the public has been led to believe that the economy is doing exceptionally well.
This is not just by the Jubilee propaganda machine, but also by sloppy forecasts from respectable institutions like the World Bank and Bloomberg.
In its most recent economic update, the World Bank projected that Kenya’s economic growth would accelerate to between six and seven per cent this year, while Bloomberg put out a forecast predicting that Kenya would be the third fastest rising economy in the world, growing by six per cent.
Six per cent growth would not rank anywhere near the fastest growing economies.
To be among the 10 fastest growing economies in the world in any given year, an economy has to grow by at least 7 per cent.
There were 16 countries in that list last year, nine of them in Africa (Chad 9.6, Cote D’Ivoire 8.5, Mozambique 8.5, Ethiopia 8.2, Sierra Leone 8.0, Ghana 7.4, Tanzania 7.2, Nigeria 7.0).
Our 5.3 per cent growth puts us in position 46 globally, and fourth out of the five East Africa Community countries, outperforming only Burundi, and not by much.
These optimistic growth forecasts are predicated on the massive infrastructure investment drive.
Growth in the order of 5 per cent suggests that excluding the infrastructure investment, the rest of the economy cannot be growing by more than 4 per cent.
We must then ask the question: why is the infrastructure not delivering?
Readers of this column will know my take on mega infrastructure projects. To answer this question, it is helpful to restate my contention with a simple analogy.
Think of two maize farms, Kilimo and Mijengo as neighbouring economies.
They produced 10,000 bags each last year, valued at Sh2,000 each.
This year, Kilimo ploughed more land and increased production by 10 per ent to 11,000 bags, while Mijengo farm build a warehouse valued at Sh2 million.
Both Kilimo and Mijengo economies grew by 10 per cent, from Sh20 million to Sh22 million.
Infrastructure investment counts as output growth in GDP calculation, for indeed it has been produced, but like Mijengo’s warehouse, it does not expand productive capacity.
Mijengo’s warehouse might make more money by selling maize when price is high, or even storing Kilimo Farm’s surplus production for a fee, but it does nothing to increase productive capacity.
The mega infrastructure investment drive is predicated on the belief that it will crowd in productive investment. That when we build a road, railway or electric power line, factories and farms will follow.
I am afraid it is not happening. Total investment has grown by an impressive 7.6 per cent per year over the last five years, but break down that figure and it’s a different story.
As infrastructure investment (buildings, structures and transport equipment) has surged, non-infrastructure investment has decelerated sharply.
Overall, infrastructure investment has grown by 12 per cent per year, and non-infrastructure investment has contracted by 4 per cent per year.
Far from crowding in productive investment, our infrastructure binge is doing the opposite— crowding out productive investment. Why?
Suppose Mijengo embarks on a major building project, say, a shopping mall on the farm.
There happens to be a hitherto useless quarry on Kilimo and Mijengo needs lots of building material.
Instead of ploughing, Kilimo invests in a stone crusher and trucks to supply Mijengo’s shopping mall project.
In economics, we call this “Dutch Disease”, a phenomenon where windfall fuelled construction and consumption boom suck resources out of the productive economy.
One of its consequences is to choke exports. And so it is. Our exports have stagnated.
Our merchandise (goods) export earnings can barely finance a third of imports, down from 43 per cent five years ago, while both goods and services can only finance 54 per cent, down from 66 per cent five years ago.
In most cases, Dutch Disease is caused by natural resource boom, but any huge sudden inflow of money into the country, such as aid, remittances and portfolio investment can cause it.
We have not had a surge in any of these—why do we have symptoms of Dutch Disease? Debt is the answer. We are borrowing our Dutch Disease. It is made in China.
Unlike resource windfalls, debt has to be repaid. Moreover, when the Chinese finance a turnkey project, no money comes into the economy.
They bring in materials and construction services, that is, the Chinese have simply given us goods on credit.
When it comes to payment, it is our tax shillings and export dollars that pay. In effect, the projects are sucking money out of the economy.
We are not like resource-rich countries where the new infrastructure is linked to increased production and export of minerals.
They are trading minerals for infrastructure, but we are borrowing in kind and paying in cash.
FLAWED REVENUE FORECAST
By crowding out productive investment, the infrastructure binge is eroding the government’s revenue base.
The government made its revenue forecast on 7 per cent economic growth but in reality, the productive economy that yields revenue is growing by 4 per cent at most.
The rest of the growth is infrastructure “work in progress.”
It should not surprise that the Kenya Revenue Authority (KRA) is not meeting tax collection targets.
That the Treasury is surprised by that suggests that they are clueless about what is going on in the economy.
A flawed revenue forecast has been compounded by government’s inability to borrow domestically.
The Government closed last financial year with Sh1.38 trillion of outstanding Treasury bills and bonds.
As at end of the first week of October, this was down to Sh1.31 trillion, meaning the government has paid back Sh67 billion of domestic debt.
Net repayment of domestic debt was not in the budget. On the contrary, the government has budgeted to increase domestic borrowing by Sh227 billion.
Even if KRA had met its revenue target for the quarter, the government would still be in a crisis.
Coming down on KRA is the administration’s all too familiar buck-passing and clutching at straws.
Why is the government unable to borrow long? I pointed out not too long ago that the budget and external deficits we are running are a recipe for trouble.
It was not going to be long before the markets reacted to unsustainable deficits.
The markets expect that to restore macro-economic balance, the shilling will have to depreciate or interest rates to rise, or a combination of the two.
When interest rates rise, the value of bonds in the secondary market falls.
Selling bonds in the secondary market means making a capital loss.
The only way for bond-holders to make a good return is to hold the bond to maturity.
The foreign portfolio investors are redeeming their maturing bonds and making for the exit, putting further pressure on the shilling.
The domestic bond-holders are redeeming theirs and holding onto cash.
This is the dynamic that has pushed the government into distress borrowing, jerking up short-term interest rates from 13 per cent to 23 per cent in just two weeks.
In the fortnight preceding the hike, the government’s bills and bonds exceeding three months maturity were undersubscribed by 35 per cent, Sh17.4 billion shortfall.
In the subsequent three weeks, the government had borrowed a total of Sh63 billion at interest rates over 20 per cent, half of it from three month Treasury Bills.
The government is refinancing cheaper medium and long-term with very expensive short-term debt.
In short, it is charging a credit card to make mortgage payments.
The men in-charge are in denial. Treasury Cabinet Secretary Henry Rotich confidently told parliament the other day that government will continue borrowing and, therefore, he does not expect interest rates to come down soon.
If interest expectations don’t change very quickly, the government would borrow Sh300 billion at an average of 25 per cent by Christmas, and that is a best case scenario.
That’s an interest cost of Sh75 billion. It will eat up the syndicated loan they’ve just borrowed. When in a hole, you are supposed to stop digging.
His PS Kamau Thugge assures us that our debt is sustainable.
Citing the IMF, his former employer, he throws out some fancy ratios and confidently asserts that we have plenty of debt headroom.
Imperial Bank’s solvency ratios were perfect before CBK took it over.
Here are some telling numbers the PS did not cite.
Our external debt service to export earnings ratio has tripled under Jubilee administration, from 3 per cent to 10 per cent, and our foreign debt service more than doubled last year, from Sh45 billion to Sh98 billion.
Most borrowers will know that debt affordability depends not just on amount but also on terms and purpose.
The monthly repayment of a one-year Sh1 million car loan at 20 per cent interest is Sh96,000.
A person earning Sh150,000 cannot afford it.
The repayment on the same amount over 10 years at 5 per cent is a little over Sh10,000— a person earning Sh30,000 can afford it especially if it is a mortgage. I think we are on our own.
What’s the way out of this?
The good news is, economic mismanagement is a fairly common and curable affliction—in fact we’ve had it before.
The not so good news is that the cure is painful and humbling. It comes in three doses.
The first dose is macro-economic stabilisation to turn market expectations on interest rates and exchange rate and more generally restore confidence and credibility of our macro-economic policy regime as well government’s creditworthiness.
The surest, probably the only way of achieving this now is an IMF bailout.
The IMF is the only institution with the amount of money required and the clout to infuse sobriety and impose much needed discipline into the Jubilee administration’s heads.
The second dose imposes fiscal discipline.
The target is usually a balanced budget at the minimum.
Achieving this will entail limiting discretionary spending to essential operations and maintenance outlays—no fanciful development projects, no workshops, no junkets, no extraneous allowances.
It will also require a total overhaul of the government’s financial management. Heads will have to roll.
The third dose downsizes government. This will entail retrenchment, parastatal reform, including privatisation and winding up several of them (what exactly does Kenya National Trading Corporation do?), rationalising public investment.
Thankfully, most of these are in the Jubilee administration’s stated policy agenda.
I cannot think of a more fitting epitaph for the Jubilee administration’s reign of hubris and blunder, plunder and squander, than the rest of the term spent savouring copious helpings of humble pie in an IMF straightjacket. Choices do have consequences. Sobering.
And on the pedestal these words appear:
“My name is Ozymandias, King of Kings:
Look on my works, ye Mighty, and despair!”
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare
The lone and level sands stretch far away.