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September 19, 2018

Will the Budget Policy Statement for 2016-17 deliver Transformation?

TOUGH TASK: Treasury CS Henry Rotich outside the Treasury Building before presenting the 2015-16 budget to Parliament last year. Photo/File
TOUGH TASK: Treasury CS Henry Rotich outside the Treasury Building before presenting the 2015-16 budget to Parliament last year. Photo/File

The National Treasury has called on the public to submit proposals on economic policy measures for consideration in the preparing the National Fiscal Budget 2016/17.

The Budget Policy Statement that was released early this month seeks to re-emphasis the Transformation Economic Agenda that has been the hallmark of the Jubilee Administration over the last two years.

The highly optimistic statement makes far reaching assumptions with inflation expected to remain within target, interest rates to remain low and stable and the exchange rate competitive.

This comes in the midst of mixed signals in the business environment in 2015 where the economic growth was projected at 5.6 per cent even as the government implemented austerity measures including a freeze on employment.

The freeze on employment spilt over to the private sector as well, signaling subdued economic activity, even as the economic transformation agenda sought to minimise poverty through job creation.

Perhaps more telling is the fact that almost 30 per cent of listed companies -18 out of 65 - issued profit warnings to shareholders in 2015, indicating that they expect their profits to fall by at least 25 per cent.

This is a disclosure requirement from the Capital Markets Authority so that shareholders can be aware of the risk of reduced dividends and possible reduction in the value of the shares. The fact that the companies that issued profit warnings cut across the difference sectors of the economy means that the challenges were not confined to any particular sector.

Rather, these were economic factors that affected the business environment in general. There is no reason to believe that the challenges were only encountered by listed companies, many other business that are not listed faced similar challenges including SMES.

Consistent with the warnings was a fall in the share prices across most counters, with the 20-share index, that captures the performance of a basket of 20 key companies falling by more than 20 per cent.

More fundamentally, revenue targets suffered from lower corporation tax and reduced PAYE collections. It goes without saying that reduced company profits and a freeze on employment means the tax base is heavily diminished as well.

Among the reasons quoted by the companies were foreign exchange losses because of the depreciation of the Kenya shilling, high financing costs and competition from imports.

Another reason was the adverse stock market conditions and the falling of the share prices in most counters.

In the latter case, the losses arose from the accounting standards requirement that investments held for trading are marked-to-market.

In other words the value of investment in shares and bonds has to reflect the prevailing market price, rather than the historical cost, if the shares were held for trading.

Furthermore, the companies were not able to revise pricing to sufficiently recover the costs, simply because buyers did not have the capacity to absorb higher pricing.

Unless conditions change significantly to allow other means of cost savings, these companies will seek to roll out price increases gradually in the months to come, raising inflation.

The achievement of the six per cent economic growth rate projected by the Budget Policy Statement will depend to a great extent on how well the current challenges are handled first and foremost and secondly how resilient the economy maintains to emerging challenges.

There are two lessons this far that hopefully will guide the 2016/17 budget.

One is that revenue collection projections cannot continue rising amidst subdued economic activity. Expecting to collect more taxes when businesses are already struggling may be futile, and at worst can lead to liquidity challenges as experienced in the last quarter of 2015.

That said, it is legitimate to expect businesses to pay more taxes to accelerate investment in infrastructure so as to improve the business environment.

However, this will need to be balanced with the fact that businesses are already operating in a less than enabling business environment. Farmers are aware of the need to feed a cow first, before milking it to maximise productivity.

The second lesson is that government expenditure estimates cannot continue rising irrespective. Over the last two years government expenditure plans have risen by 25 per cent from Sh1.6 trillion to Sh2 trillion, leading to substantial growth in debt levels and inefficient absorption of funds through leakages of both wastage and corruption.

To the credit of the National Treasury, expenditure estimates for the 2016/17 budget at Sh2,071.9 billion are only a marginal increase of 3.5 per cent from Shs2,000.6 billion in the 2015/16 budget.

Furthermore, it is expected that the budget deficit - the extent to which the expenditures exceed the revenues - will reduce from Sh595.7 billion in the 2015/16 budget to Sh560.8 billion.

The budget deficit is the degree to which the government is planning to live outside its means, and this money comes from borrowings, both from the domestic market and externally.

More significantly, the borrowings accumulate from year to year, with the risk of becoming unsustainable growing in tandem.

The good news is that the deficit is reducing in 2016/17. The bad news is that because of the accumulation effect, the debt level is rising.

The National Treasury plans to finance the deficit mainly through external borrowing of Shs311 billion and to a lower extend local borrowing at Sh190 billion with the balance to be sourced from grants Sh60 billion.

While external financing may avoid crowding out local private sector borrowing, it carries significant foreign exchange risks.

Eventually, the foreign exchange risks impact not only the local private sector, that was meant to be protected in the first instance, but also infrastructure projects which rely on imported materials.

Furthermore, unless more focus is placed on growing exports, to provide the much needed foreign exchange to repay external debts, the risks of external borrowings may far outweigh any benefits.

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