ECONOMY

Why Kenya urgently requires foreign debt relief

With no corruption and good governance we expect a positive effect.

In Summary
  • Failure to pursue sound economic policies that could stimulate economic growth and reduce corruption, has resulted in economic decline.
  • Debt relief cuts down on transaction costs, this is a more important factor than generally recognised.

The National Treasury has somewhat admitted the country’s debt is beyond payment and soon it will start pushing lenders to cancel Sh3.6 trillion foreign debt. The crisis can be traced to various structural causes of indebtedness often exacerbated by weak macroeconomic policies.

Foreign debt relief efforts since President Moi’s era brought debt ratios down, but not to sustainable levels. The debt problem is an integral part of the poverty trap in Kenya, a vicious circle of low levels of private investment, low degrees of export diversification, high vulnerability, low growth and high debt ratios. The trap is exacerbated by further marginalisation in the wake of globalisation and the Covid-19 pandemic.

Failure to pursue sound economic policies that could stimulate economic growth and reduce corruption, has resulted in economic decline. Falling revenues and resistance to painful fiscal adjustments led to extensive borrowing to meet the deficit. More external borrowing may enhance growth, up to the point of optimal debt burden, say as a debt-to GDP ratio, determined by growth to be gained relative to the rate of interest rates. A debt higher than that easily becomes a constraint on growth and development.

 

Debt relief acts as de facto budget support, by enhancing government spending capacity; it supports the development of locally owned expenditure priorities and monitoring systems. Debt relief can be expected to spur economic growth by reversing the mechanism that make the debt overhang hamper economic growth. High levels of indebtedness lead to the government increasing its borrowing from domestic credit sources resulting in higher interest rates and the crowding out of local investors’ access to affordable credit.

With no corruption and good governance we expect a positive effect of debt relief on the domestic market, as well as attract foreign investment. Debt write-offs can relieve the pressure on domestic borrowing, increase the availability, and reduce the cost of domestic credit thereby spurring economic growth.

Debt relief cuts down on transaction costs, this is a more important factor than generally recognised. Aid can tie up government staff in endless negotiations, report writing and separate auditing procedures with an array of official donors.

Debt relief will contribute to poverty reduction, the requirement to develop and implement the country-owned poverty reduction strategy will be an important and beneficial outcome of the initiative. These strategies will tend to emphasise social sector spending rather than a more balanced approach to growth and poverty reduction.

Debt relief will improve local accountability and good governance, again in contrast to the side effects that aid flows often generate. Debt relief in the current context of locally owned poverty reduction strategies has the added benefit of increasing, and sometimes even kick-starting, political participation in decision-making over the management and distribution of public resources.

Managing partner, Watermark Consultants