The KENYA INSTITUTE for PUBLIC POLICY RESEARCH and ANALYSIS No. 29/2023-2024 Thinking Policy Together Public Borrowing with Multiple Shocks: Status and Policy Options Hellen Chemnyongoi and James Ochieng Key Highlights per cent of the GDP. Moreover, the Government is keen to reduce its expenditure to below 22.3 Public borrowing is one of the sources of financing per cent of the GDP, by ensuring efficiency in fiscal deficit. This Policy Brief focuses on public public spending through the removal of low- borrowing during a period of multiple shocks that hit priority expenditures, removal of unsustainable the country since 2020, including COVID-19 pandemic, subsidies, reducing tax exemptions, and use of severe prolonged drought, and the effects of the public-private partnerships to finance projects. Russia-Ukraine war; and provides policy options. The Going forward, the Government should consider key highlights include: expediting the finalization of the Public Finance Management Regulations, 2022 that established (i) The effects of COVID-19 pandemic led to an the Disaster Management Fund. This will help in unexpected increase in government expenditure ring-fencing funds for shocks that can adversely in responding swiftly to safeguard lives and affect the economy. livelihoods. This was followed by a severe drought situation and the Ukraine-Russia war, which exerted more fiscal pressures. Introduction (ii) Economic activities were severely disrupted Kenya has faced a couple of shocks since 2020, during the COVID-19 period adversely affecting which mainly include the COVID-19 pandemic in 2020, households’ income and government revenues. drought in 2021, and the Russia-Ukraine war that With the drought, the food prices rose further, began in February 2022. These have had implications and this had a negative impact on households’ on government expenditures as the Government disposable income. Moreover, the Ukraine- worked towards safeguarding the lives and livelihoods Russia war caused a disruption of the global of citizens against the adverse effects. supply chain especially in the oil market, which further worsened the already existing The COVID-19 pandemic not only posed a serious risk predicaments. to public health but also interrupted international supply chains, affecting trade and the domestic economy. At (iii) To safeguard lives and livelihoods while the same time, persistent droughts have put a burden cushioning the economy from recession, on the nation’s agricultural sector, causing a shortage the Government sought enhanced funding of food and water and endangering the livelihoods of externally. This led to an increase in the country’s many Kenyans. Additionally, the Russian-Ukraine crisis public debt from Ksh 6.3 trillion in March 2020 had implications across the globe, altering geopolitical to Ksh 6.7 trillion (65.8% of GDP) in June 2020 dynamics and the stability of the world, largely affecting and further to Ksh 7.7 trillion (68.1% of GDP) in commodity prices internationally and domestically. June 2021. Further borrowing resulted in a debt These concurrent shocks highlight the interconnection increase to Ksh 8.6 trillion in 2022 and to Ksh of world affairs and the need for Kenya to navigate 10.2 trillion as of 30th June 2023. difficult times while ensuring that the citizens are cushioned from adverse effects. (iv) To cushion the country from adverse shocks, it is important for the Government to strengthen the Furthermore, the COVID-19 pandemic led to an fiscal buffers by sustaining fiscal consolidation. unexpected increase in government expenditure. It The Government is already working towards this resulted in unprecedented health challenges, which through tax reforms to increase revenue collection meant that the government had to act swiftly to minimize with a target to grow tax revenue to above 18 and contain the infection rates, morbidities, and mortalities arising from the pandemic. Related to this KIPPRA Policy Brief No. 29/2023-2024 1 was the loss in economic activities following the lock Further, the country was affected by a severe drought downs, travel restrictions, and closure of schools and which saw the government cushion the affected people learning institutions, among others, aimed at curbing through social protection schemes, distribution of food the spread of the disease. In addition, the government and water, treatment for acute malnutrition, livestock introduced various stimulus programmes that were offtake and livestock feed and enhanced school meals aimed at cushioning citizens and the economy at large programme. The government also introduced various from the adverse effects of the pandemic. This included subsidies amounting to Ksh 80.7 billion 1in 2021/22 a reduction of PAYE from 30 per cent to 25 per cent, a to minimize the impact of drought. They included reduction of turnover tax from 3.0 per cent to 1.0 per subsidizing pump prices, reduction in electricity tariff cent for all MSMEs, 100 per cent tax relief for those by 15 per cent to lower the cost of power, granting earning less than Ksh 24,000, temporary suspension of waiver of import duty for maize, subsidizing fertilizer listing on the Credit Reference Bureau, lowering of the to farmers, reduction of the VAT rate on liquefied Central Bank Rate, and lowering of the Cash Reserve petroleum gas from 16 per cent to eight (8) per cent, Ratio (CRR), among several other programmes. and subsidizing maize flour. The subsidies, therefore, reduced the revenue collected. In addition, the With the COVID-19 pandemic, revenues grew much government allocated Ksh 850 million to enhance slower than expenditures, which saw the government drought resilience and sustainable livelihood, Ksh 178 increase its borrowing to bridge the revenue gap. million towards Ending Drought Emergencies in Kenya Specifically, government revenue decreased by 1.0 and an additional allocation of Ksh 421 million for per cent between 2019/20 and 2020/21 whereas the Livestock and Crop Insurance Scheme to reduce government expenditures grew by 6.7 per cent during the vulnerabilities of Kenyan farmers to diseases and the same period (Figure 1a). Gross operating balance natural disasters in the 2023/24 budget. To protect the as a percentage of revenue also worsened from - 27.4 vulnerable, the government allocated Ksh 500 million to per cent in 2018/19, to - 37.3 per cent in 2019/20 and the National Drought Emergency Fund. further deteriorated to – 41.1 per cent in 2020/21. Further, fiscal deficit widened from Ksh 767.8 million in The outbreak of the Russia-Ukraine war saw the 2019/20 to Ksh 965.7 million in 2020/21 but has since recovery efforts disrupted, putting on more fiscal decreased to Ksh 833.9 million in 2022/2023. The lower pressure. The war disrupted the grain and oil markets, revenue achievements vis-à-vis increased expenditures which led to a rise in the prices of corn, wheat, and to contain the pandemic, therefore necessitating more crude oil. This pushed inflation up and spiked a rise borrowing by the government. in the cost of living, thus triggering the introduction of subsidies by the government to cushion the economy Figure 1a: Trends in fiscal indicators from extreme shocks caused by the price changes. The doubling of fertilizer prices due to the disruption of the 15,000,000 fertilizer market – with Russia being the leading exporter 10,000,000 of fertilizer in the world – caused the government to 5,000,000 introduce subsidies on fertilizer to farmers. These 0 subsidy programmes have been a contributor to government spending, which has in turn triggered more borrowing for the government and an increase in taxation measures to net in more revenue through taxes Financial Year to finance the deficit. Government Revenue Government Expenditure The government sought financial assistance during the period with shocks to cushion the citizens from adverse Total public Debt stock effects and provide budgetary control. This Policy Brief, (a) Trends in revenues, expenditures, and debt in Ksh therefore, focuses on public borrowing during the Million period of multiple shocks including COVID-19, severe drought, and disruptions of the global supply chain with 0 the Russia-Ukraine war while providing policy options. -200,000 Status of Kenya’s borrowing during -400,000 the COVID-19 pandemic period -600,000 (i) Public debt levels -800,000 The public debt stock stood at Ksh 6.3 trillion (65.6% -1,000,000 GDP) in March 2020. With the borrowing following the outbreak of the COVID-19 pandemic, the debt stock -1,200,000 increased to Ksh 6.7 trillion (65.8% of GDP) in June 2020 and further to Ksh 7.7 trillion (68.1% of GDP) in (b) Trends in fiscal deficit in Ksh Million June 2021. Notably, external debt grew by 24.5 per cent from Ksh 3.2 trillion as of March 2020 to Ksh 4.0 Data source: National Treasury (Annual public debt trillion in June 2021, whereas domestic debt stock grew reports and quarterly economic budget reviews) 1 World Bank (2022) 2 KIPPRA Policy Brief No. 29/2023-2024 Amount in Kshs 000' Amount in Ksh by 20.4 per cent from Ksh 3.1 trillion to Ksh 3.7 trillion Treasury bonds, which contribute 84.7 per cent of the during the same period. total domestic debt. As of February 2022, when the effects of the COVID-19 The stock of Treasury bonds increased from Ksh 2.1 pandemic were fading and the Russia-Ukraine war trillion in March 2020 to Ksh 3.4 trillion in September broke, total public debt stock stood at Ksh 8.4 trillion. 2021. By June 2023, the stock of Treasury bonds was at In June 2023, total public debt stock stood at Ksh 10.2 Ksh 4.01 trillion. On the contrary, the stock of Treasury trillion (66.3% of GDP). Domestic debt constituted Ksh bills declined over the period of analysis. Specifically, 4.8 trillion (31.3% of GDP), while external debt accounted it declined by 31.4 per cent from Ksh 921.7 million in for the remaining Ksh 5.4 trillion (35.1% of GDP). With March 2020 to Ksh 631.9 million in June 2023. The the rising public debt, the recent government’s agenda decline was aligned with the government’s objective of mobilizing more revenue to finance the expenditures of reducing the reliance on Treasury bills in domestic is timely as it will reduce the public debt burden. debt, aiming to minimize refinancing risks and ensure debt sustainability. A high proportion of Treasury bills In addition to the country’s borrowings during the can pose challenges in terms of restructuring and pandemic, there was also a change in external debt refinancing since they are short-term instruments stock by creditors during the same period as shown primarily used for cash management purposes. in Table 1. The largest of this change was by the IMF, whose debt stock increased from Ksh 110.61 billion in Figure 2: Trends of domestic debt by instruments 2019/20 to Ksh 804.6 billion in 2022/23, representing a (January 2020 to July 2023) change in the stock of Ksh 693.99 billion. Other changes witnessed were by the World Bank and Commercial 90 600080 loans. 500070 60 4000 50 Table 1: Change in external debt stock by creditors 300040 between 2019/20 and 2022/23 (Ksh billion) 30 2000 20 1000 10 Creditor 2019/20 2020/21 2021/22 2022/23 Change 0 0 in stock Overdraft at Central Bank Advances from Commercial Banks and others World Bank 921.43 1,126.13 - - 204.70 Treasury Bills Treasury Bonds Total Domestic Debt IMF 110.61 178.22 402.60 804.60 693.99 Commercial 1,102.29 1,187.44 1,181.33 1,357.17 254.88 loans Data source: Central Bank of Kenya, Monthly Economic Indicators Data source: The National Treasury and CBK Borrowing from the IMF The increased public debt stock also exerted pressure on the debt ceiling set at Ksh 9.0 trillion in 2019 when In April 2020, Kenya sought emergency financial Parliament scrapped the debt ceiling pegged to GDP. assistance under the IMF’s Rapid Credit Facility (RCF) This led to Parliament revising the debt ceiling to exogenous shock window to address the shocks Ksh 10.0 trillion in June 2022. The amendment was related to the COVID-19 pandemic. This led to a envisioned to create more room for external borrowing, single disbursement of US$ 739 million (SDR 542.8 as domestic borrowing crowded out private sector million) to help in financing the budget and balance borrowers, since the government is deemed to be risk- of payment deficit. In addition, Kenya requested for free with guaranteed returns. additional funding for budget support under a three- year programme of Extended Credit Facility (ECF - US$ In October 2023, Parliament replaced the numerical 577.26 million) and Extended Fund Facility (EFF - US$ public debt ceiling with a debt anchor set at 55 per cent 1,770.09 million) arrangements in March 2021. This of debt to GDP in present value terms. It was noted that led to the first installment disbursement of US$ 307.5 the numerical public debt ceiling constrained public million in April 2021 aimed at supporting the country funding of projects while not considering the effects in addressing debt vulnerabilities and supporting of external shocks on the economy. The debt ceiling response to the COVID-19 crisis. The second set at 55 per cent of GDP is in line with internationally disbursement was made in June 2021 of US$ 407 accepted conventional practice and is envisaged to million (about SDR 285 million). In July 2023, the IMF’s entrench accountability and transparency in public Executive Board successfully concluded the fifth review debt management while ensuring that debt remains under both the EFF and ECF arrangements for Kenya. within sustainable levels. This completion led to an immediate disbursement of US$ 415.4 million (SDR 306.7 million), adding to the (ii) Public debt structure total disbursements under these arrangements, which Domestic debt stood at approximately US$ 2.04 billion (SDR 1.51 billion as of July 2023 (Table 2). During the COVID-19 period, the stock of domestic debt maintained an increasing trend, growing from Ksh On 23rd August 2021, the IMF offered the fourth and 3.1 trillion in March 2020 to Ksh 4.2 trillion in February largest allocation of SDR 456.5 billion (equivalent to 2022 and Ksh 4.8 trillion in June 2023 (Figure 2). The US$ 650 billion). Of that allocation, Kenya received SDR increase was mainly due to an increase in the stock of 520.2 million (about US$ 740 million or approximately KIPPRA Policy Brief No. 29/2023-2024 3 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 May-22 Jul-22 Sep-22 Nov-22 Jan-23 Mar-23 May-23 Jul-23 Ksh 80.84 billion), equivalent to the 542.8 million SDR concurrently aiding key policy and institutional reforms. quota Kenya has at IMF. The 2023 Budget Policy The allocation serves Kenya’s immediate agenda of Statement (BPS) noted that part of the IMF’s SDR fiscal consolidation and aligns with its over-arching allocation of about Ksh 40.8 billion formed part of aspiration for sustainable, inclusive growth with a focus government borrowing and was utilized in financing on environmentally friendly practices. the fiscal deficit in 2021/22. The SDR allocation thus funded about 28.6 per cent of the government’s foreign Borrowing from the International Financial Market financing. These funds were used to cushion the poor from the adverse effects of the COVID-19 pandemic and The National Treasury further successfully raised US$ formed critical interventions, including the purchase of 1.0 billion through the issuance of a 12-year Eurobond COVID-19 vaccines, social protection, education, and in the international financial markets, following a health. successful three-day virtual Eurobond Roadshow. The bond was over-subscribed with over US$ 5.4 Kenya was among the first African countries to benefit billion offered by investors. It was listed on the London from the new IMF Resilience and Sustainability Facility Stock Exchange. Table 2 provides a summary of the (RST)2. It was approved by the IMF in July 2023 and borrowings. aims at boosting resilience to the effects of climate change. Additionally, this is expected to strengthen Table 2: Summary of external borrowings between macroeconomic stability during the transition to 2019/20 and 2023/24 renewable energy. The reform measures with the Time Creditor Amount IMF include incorporating climate risks into fiscal planning and investment framework; mobilizing IMF Loans climate revenue while strengthening climate spending April 2020 IMF-RCF US$ 739 million efficiency; and enhancing the effectiveness of Kenya’s April 2021 IMF-ECF-EFF (1st Tranche) US$ 307.5 million existing frameworks to mobilize climate finance and June 2021 IMF-ECF-EFF (2nd Tranche) US$ 407.0 million strengthening disaster risk reduction and management. The IMF’s RSF financial support to Kenya amounts to August IMF SDR Allocation US$ 650.0 billion SDR 407.1 million (75% of quota; about US$ 551.4 2021 million). The disbursement is based on meeting the December IMF-ECF-EFF (3rd Tranche) US$ 258.1 million agreed reform measures over the 20-month period of 2021 the RSF programme. July 2022 IMF-ECF-EFF (4th Tranche) US$ 235.6 million December IMF-ECF-EFF (5th Tranche) US$ 447.39 million Borrowing from the World Bank and African 2022 Development Bank (AFDB) July 2023 IMF-ECF-EFF (6th Tranche) US$ 415.4 million In May 2020, the World Bank and AfDB also approved World Bank, AfDB and Eurobond US$ 1.0 billion (comprising of US$ 750 million credit May 2020 World Bank (budget US$ 1.0 billion from the International Development Association (IDA) support - COVID-19 and a further US$ 250 million loan from the International Response) Bank for Reconstruction and Development (IBRD) June 2021 World Bank (Development US$ 750.0 million and EUR 188 million, respectively targeting reforms Policy Operation -DPO) that help advance the government’s inclusive growth agenda, including in affordable housing and support March 2022 World Bank (DPO - US$ 750.0 million to farmers’ incomes and budget support. Towards economic transformation) the close of the financial year in June 2021, the World May 2023 World Bank (DPO) US$ 1.0 billion Bank approved US$ 750 million for development May 2020 AfDB (COVID-19 response) EUR 188.0 million policy financing to support policy reforms that would June 2021 AfDB-CERSP US$ 95.0 million strengthen transparency and accountability in public procurement and promote efficient public investment November AfDB (for infrastructure) US$ 217.0 million3 spending. Around the same time, in June 2021, the 2021 AfDB Board of Directors approved a US$ 95 million July 2022 AfDB (economic recovery) EUR 89.0 million loan to Kenya. The funds were for boosting the July 2022 AfDB (seeds production) EUR 63.0 million government’s economic recovery efforts under the June 2021 Commercial (12-year USD 1.0 billion Competitiveness and Economic Recovery Support Eurobond) Programme (CERSP). The efforts included the adoption of an electronic government procurement system to encourage transparency and efficiency, strengthen Data source: The National Treasury, IMF, World Bank industrial development, and enhance social and (iii) Debt service payment arrangements economic inclusion. In July 2022, the AfDB approved EUR 89.0 million to support economic recovery and a Kenya participated in the Group of Twenty (G20) further EUR 63.0 million to support cereals and oil seeds Debt Service Suspension Initiative (DSSI), which was production. In May 2023, the World Bank authorized facilitated by the World Bank and IMF in November US$ 1.0 billion to Kenya through the Development Policy 2020 to free some resources to mitigate the impact of Operation (DPO) window. This substantial financial COVID-19. This resulted in a six-month debt service support aims to offer low-cost budget financing while suspension from the Paris Club and China worth Ksh 3 On the AfDB Loan, USD 75 million was non-concessional while US$ 2 IMF Staff Report, July 2023 142 million was concessional. 4 KIPPRA Policy Brief No. 29/2023-2024 32.9 billion and Ksh 27 billion, respectively. The Paris Policy Options for Improving Public Club extended the DSSI relief to the end of December 2021, as agreed by the G20 in April 2021. The freed Borrowing during Emergencies cash was expected to be used to mitigate the impact of the COVID-19 pandemic. In addition, a temporary To manage public borrowing during emergencies and suspension of debt servicing was envisioned to offset pandemic periods, the government can consider the the increase in public debt servicing. following recommendations: Nevertheless, the public debt service in Kenya has (i) Ensure adequate fiscal buffers all the time been on the rise mainly driven by the dominance of The government should build adequate fiscal buffers domestic debt service, which carries relatively higher that can sustain fiscal pressures, with natural disasters costs (Figure 3). The share of external debt service to and other unforeseen shocks. This can be achieved total revenue increased significantly from 43.9 per cent through finalizing the setting up of the National Disaster/ in June 2018 to a peak of 56.8 per cent in June 2019. Emergency Fund. Adequate fiscal buffers would reduce During the same period, total external debt service dependence on uncertain external donations, ensure as a proportion of exports rose from 40.5 per cent to quick disbursement for recovery and relief efforts, 60.1 per cent. The increase in 2019 can be attributed minimize disruption of pre-existing spending plans to substantial principal payments made to commercial on health, education, and infrastructure, and provide creditors and sovereign bondholders, particularly flexibility in addressing post-disaster liquidity needs. for the five-year bond issued in 2014, which matured in 2019. Further, total debt service as a share of tax ii) Establish an institutional framework for revenue increased to 55.0 per cent in 2019, before distributing emergency funds slightly decreasing to 50.4 per cent in 2022. An effective institutional framework is necessary to ensure the effective utilization of emergency funds, High total debt service as a share of tax revenue especially natural disaster funds, and enhance implies high public debt and related costs leaving transparency and accountability of the funds. In view scarce resources for development. Notably, total debt of this, a well-designed framework needs to first be service declined significantly in 2019/20 due to reduced consolidated with budget information to allow the debt service obligations for the 2019/20 following the assessment of the overall fiscal situation; at a minimum, COVID-19 pandemic, and a decrease in bilateral debt the fund balance should appear in financial statements. service payments resulting from the debt service Secondly, there ought to be a standing appropriation suspension extended to Kenya under the G20-Debt that allows for spending immediately after a certain Service Suspension Initiative (DSSI). trigger event, such as a declaration of a disaster Figure 3: Public debt service, as of 30th June (%) emergency by the Executive. Lastly, the fund should generally apply normal Public Finance Management 120.0 70.0 (PFM) rules and be limited to responding to disasters 100.0 60.1 60.0 with large fiscal impacts. 50.0 80.0 40.5 37.4 40.060.0 34.5 36.5 30.0 40.0 20.0 20.0 10.0 0.0 0.0 2018 2019 2020 2021 2022 Share of Domestic Debt Service Share of External Debt Service Total External Debt Service (% of Exports) Total Debt Service (% of Revenue) Total Debt Service (% of Tax Revenue) Data source: National Treasury, Annual Public Debt Report (Various) KIPPRA Policy Brief No. 29/2023-2024 5 Share of debt service Total debt service (% of revenue, exports & tax revenue) References Heinemann, F., Moessinger, M. D. and Yeter, M. (2018, “Do fiscal rules constrain fiscal policy? A meta- Aguiar, M., Amador, M., Farhi, E. and Gopinath, G. regression-analysis”. European Journal of (2015), “Coordination and crisis in monetary Political Economy, 51: 69-92. unions”. The Quarterly Journal of Economics, 130 (4): 1727-1779. Lozano-Espitia, I. and Julio-Román, J.M. (2020), “Debt limits and fiscal space for some Latin American Andersen, T. M. (2019), “Intergenerational conflict and economies”. Latin American Journal of Central public sector size and structure: A rationale Banking, 1(1-4): 100006. for debt limits?” European Journal of Political Economy, 57: 70-88. Rivetti, D. (2021), Debt Transparency in Developing Economies. Campos, E. L. and Cysne, R.P. (2021), “Estimating debt limits for emerging countries”. International Uchida, Y. and Ono, T. (2021). “Political economy of Review of Economics and Finance, 76: 836- taxation, debt ceilings, and growth”. European 855. Journal of Political Economy, 68: 101996. 6 KIPPRA Policy Brief No. 29/2023-2024 KIPPRA Policy Brief No. 29/2023-2024 7 About KIPPRA Policy Briefs For More Information Contact: KIPPRA Policy Briefs are aimed at a wide dissemination of the Institute’s policy research findings. The findings are Kenya Institute for Public Policy Research and Analysis expected to stimulate discussion and also build capacity Bishops Road, Bishops Garden Towers in the public policy making process in Kenya. P.O. Box 56445-00200, NairobiTel: 2719933/4, Cell: 0736712724, 0724256078 KIPPRA acknowledges generous support from the Email:admin@kippra.or.ke Government of Kenya, and development partners who Website: http://www.kippra.or.ke have continued to support the Institute’s activities over @KIPPRAKenya the years. 8 KIPPRA Policy Brief No. 29/2023-2024