Kenya should look for a better way of formulating debt ceiling policy


Concept of IMF tranche.

In recent years, Kenyans have wrestled to take away the bitter chalice associated with high public debt. Pundits have analysed the economic effects of rising debt and the public has debated the moral contours of the high taxation regime required to sustain it.

However, little has been mentioned on how best to formulate a realistic public debt ceiling that can guide economic policy. In October 2019, lawmakers voted to raise the debt ceiling from Sh6 trillion to Sh9 trillion, but that did little to slow down the country’s debt stock from approaching the new statutory ceiling.

The Treasury is once again preparing to table changes to the Public Finance Management Law for another round of approvals by legislators to once again raise the cap on debt. This certainly cannot be a sustainable approach and policymakers will need to consider other techniques of containing public debt.

The first step in finding a better approach would be to consider the more scientific approach used by the Central Bank of Kenya (CBK)in managing inflation.

In this methodology, an explicit inflation target of 5 percent is adopted with an upper bound of 7.5 percent and a lower bound of 2.5 per cent. CBK thereafter ensures that all the tools of monetary policy are effectively deployed to ensure inflation is always contained within this narrow band. It is for this reason that CBK has succeeded in achieving its primary mandate of price stability for several years.

Fiscal policy under the National Treasury can borrow from this targeting methodology and develop a “yield targeting” approach, in which the desired yield in government securities is explicitly stated and actively targeted.

Assuming the yield target on the 10-year government bond was set at 5 per cent, only investors who are comfortable with this yield would participate in the auctions, ultimately creating a natural debt ceiling.

The situation we face today whereby yields on government securities go as high as 13 percent, nearly three times the inflation rate, and in the process adding extra debt burden to the public purse, would quickly come to an end.

The long-term benefit of employing precise targeting tools to manage economic outcomes will be to place Kenya at par with trends in the global economy whereby yields on government securities are closely aligned to inflation. In the United States, for example, yields on the 10-year bond are at 1.59 per cent - way below the 4.2 per cent inflation rate.

In the United Kingdom bond yields are at 0.80 per cent which is notably lower than the inflation rate of 0.90 percent, and the same applies to Australia which has bond yields of 1.68 percent which is slightly above the inflation rate of 0.6 percent.

The upside of having a unified fiscal and monetary policy for Kenya will not just be limited to effective management of public debt but also the stability and the prosperity that comes with a balanced, innovative, private sector led economy.


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