Violent demonstrations a threat to Kenya’s financial stability

Kenya cannot afford disruptions to its economic activities. Our financial outlook is not impressive at the moment, with credit rating agencies assigning it a ranking of between Caa1 and B-.

This poor rating adversely affects borrowing costs as it is used by lenders to assess the country’s creditworthiness. A lower rating generally leads to higher interest rates on borrowed funds.

Kenya has been driven to its near-junk state by more than a decade of policy mis-steps that neglected productive sectors – manufacturing, mining, farming, building and construction and tourism.

Poor investments in the productive sectors resulted in lacklustre capital formation, slow growth of GDP, low incomes and underperformance of tax revenues. With a sub-optimal tax revenue performance, the country cannot comfortably underwrite its cost of governance and at the same time ensure timely repayment of domestic and offshore debts.

Kenya’s model of public finance management that relies almost exclusively on tax revenues is no longer sustainable. According to the Organisation for Economic Cooperation and Development (OECD), a realistic tax to GDP ratio should be about 30 per cent.

Generate more revenues

Kenya’s ratio is between 16.2 to 18 per cent. This means Kenya needs to generate more revenues from domestic sources to improve its financial independence and sovereignty. This is difficult to achieve without sufficient investments in the productive sectors.

At the same time, the country’s debt to tax ratio has surpassed 70 per cent. In other words, for every Sh10 of ordinary revenue – customs duty, income tax, VAT and excise – more than Sh7 goes towards debt repayments, leaving less than Sh3 for recurrent and development expenditure.

This is hardly enough to create any meaningful capital stock to generate incomes and tax revenues, leading to a perennial situation of fiscal gap. In an attempt to bridge this gap, the government has traditionally relied on two options – additional tax raising measures and loans. But the tax option has been curtailed by the Gen-Z protests, leaving the government with additional credit as the only option.

Domestic borrowing leads to interest rate surges, thus constricting borrowing by investors. The government crowds out the private sector from performing its traditional role of growing the economy.

The effect is under-performance of enterprises, which ultimately compromises income generation in the economy, leading to poor job creation and low tax revenues.

On the other hand, the country’s increasingly high credit risk makes it difficult to access concessionary loans.

The costly syndicated loans seem to be the only options open to Kenya. As the country relies more and more on syndicated loans, the debt obligations increase due to the credit costs.

The debt to tax ratio is likely to go up, leaving less and less tax revenues to underwrite governance obligations. Clearly, Kenya’s current public finance structure render it impracticable for the country to rely on tax revenues to sustain itself.

There must be a radical paradigm shift in Kenya’s public finance management approach for the country to achieve its objective of transforming into a middle-income economy by 2030.

A number of options may be considered. Securitisation of sovereign loans can help the country by converting pending bills into debt instruments tradeable on the Nairobi Securities Exchange. This will reduce pressure on the government to avail resources to retire Treasury bills and bonds, and pay contractors.

Pending bills

Once the pending bills are cleared, contractors will have more money to invest and pay taxes. With more tax revenues available, interest rates will fall, and more investors will access credit for productive activities. Liquidity will improve in the economy.

Second, the government should consider reinstating tax incentives for venture capitalists to invest private equity into start-ups and small businesses with high potential for income generation. The objective is to broaden the tax base by providing capacity to firms to generate taxable incomes to benefit the economy.

Last, Kenya should aggressively pursue capital formation initiatives by restructuring domestic and foreign loans to alleviate the looming debt distress. The capital formation should be driven by private equity participants targeting specific high potential firms in private and public sectors.

Unlike typical equity participation where investors can take over firm ownership, capital formation does not change ownership structure of the company. Instead, investors inject private equity into selected firms to grow a country’s capital stock and only share in the profits.

In the case of Kenya, this may require injection of private equity into about 60 or more firms to grow them to the level of Safaricom. The objective is to give these companies the capacity to generate adequate incomes to expand the GDP and move the country to its desired middle-income status. The resurgence of violent protests targeting private property is systematically reducing Kenya’s appeal as an investment destination.

Kenya needs to develop an alternative mechanism for resolving its political contestations without harming the economy. Politicians should be reminded that tranquility is the greatest assurance to investors regarding safety, growth and sustainability of their capital. Kenya cannot afford to squander the opportunity to lift millions of its youthful population out of poverty at the altar of needless political sparring.

Prof Ongore is a public finance and corporate governance scholar based at the Technical University of Kenya. [email protected]