Storm clouds gather: Anxiety as economy flies into turbulence

Kenya’s economy has gone through an interesting week. Treasury Cabinet Secretary Henry Rotich appeared in Parliament last week, and has another date with lawmakers on Thursday to explain why the Government is in a cash crunch.

The day before Mr Rotich’s presentation, Central Bank of Kenya (CBK) Governor Patrick Njoroge was in a day-long meetings with commercial bank stakeholders, trying to forestall a panicked run on small-tier banks after Imperial Bank was put under receiver management.

At about the same time and on the opposite end of town, his counterpart, Kenya Revenue Authority (KRA) Commissioner General John Njiraini, was in front of taxpayers justifying the most aggressive tax mop-up efforts the authority has ever executed in its 20-year history.

And then the World Bank, in a report released last Thursday, revised Kenya’s growth projections downwards by 60 base points, with the bank’s senior economist, John Randa, telling journalists and economists that the title of the 12th edition of the Kenya Economic Update was changed at the last minute.

The original title was supposed to be Enabling Citizen Participation. The new title reads Storm Clouds Gathering, a revision necessary to reflect the country’s economic situation, Mr Randa said.

Between the World Bank report, Rotich’s address to Parliament and CBK policy reports over the last 10 months, it has emerged that Kenya’s current financial crisis is a result of a combination of global currency pressures, lack of prudent financial planning of scarce resources and plain bad luck.

In the course of the first half of this year, the strengthening of the US currency had a knock-on effect on global currencies, including the shilling on account of the country being heavily reliant on imports paid for in dollars.

This was made worse by the uncertainty around whether the US Federal Reserve would raise interest rates for the first time in seven years, with ratings agency Moody’s cautioning that Kenya is one of the countries that would be adversely exposed if a hike were effected.

Empty Coffers

At the same time, the country increased its importation of capital goods and transport equipment for infrastructure developments, widening the current account deficit and piling more pressure on the shilling.

The local currency began a worrying free fall, depreciating by 7 per cent between February and May 2015, where it went from trading at Sh90 to the dollar to Sh98, a three-year low.

Over the same period, month-on-month inflation rose from 5.5 per cent to 7.1 per cent, largely on account of increases in prices of food.

With the currency teetering on the brink of the psychological 100-mark to the dollar, and eyes trained on keeping inflation within target, CBK’s Monetary Policy Committee (MPC) held its June sitting of bi-monthly meetings a week earlier to issue a policy directive.

The result of the meeting was a hike in the base lending rate by 150 base points — the largest hike in more than two years. A month later the MPC made a similar increase, bringing the base lending rate to 11.5 per cent from 8 per cent in less than six weeks.

This was expected to slow the currency’s depreciation, a painful lesson derived from a similar depreciation on the local currency experienced in 2011. It did not, with the shilling hitting a high of 106.10 to the dollar in September, before settling down to 102.50 on Friday.

Further, businesses and individuals have shied away from borrowing over the higher interest rates, impacting consumer spending and corporate investments.

The depreciating shilling further eroded Kenya’s anticipated gains from a fall in international oil prices.

Despite Brent crude oil costs going down by an average of 50 per cent over the past 18 months, little of the savings were passed on consumers.

“Households were supposed to benefit from lower oil prices, which were supposed to trickle down to consumers and raise real income and increase aggregate demand,” explained the World Bank in its latest update on the Kenyan economy.

Part of the blame for this has also been placed on the country’s bureaucratic fuel pricing mechanisms that see little transmission of savings when international crude prices go up, but fast transmission of price hikes when the reverse happens.

New levies and a weaker shilling have also helped keep fuel costs much higher than anticipated.

The lull in the economy has led to depressed revenue collections, a headache for KRA.

“The first quarter of each year is usually very slow, as revenues usually peak towards the end of the financial year,” Rotich explained in Parliament last week.

“This time, the issues of the first quarter were compounded by the raising of lending rates as a means of strengthening of the shilling.”

Since 2013, the pressure on KRA to meet revenue collection targets has grown heavier each year. After all, the country was building the structures of one of Africa’s most elaborate devolved systems of government, completely from scratch in some areas, funded by taxpayers.

Almost simultaneously, the implementation of close to Sh4 trillion worth of infrastructure development projects, funded by debt, began.

As a result, for the first time ever, KRA has this year scaled up its annual taxpayers’ week to a taxpayers’ month.

The taxman has further increased efforts to reach taxpayers, with commissioners making physical visits to corporate taxpayers, and investing hundreds of millions of shillings in IT infrastructure to make tax filings by individuals as convenient as possible.

Devolving Wastage

At KRA’s tax summit last week, Mr Njiraini told taxpayers he had raised concerns during the constitution review process, pointing to the cost of establishing and running 47 counties.

“I raised the issue of cost, but I was told good governance has a price, and I was also told that those who were raising issues about the cost were trying to scuttle the process,” he said.

“Now it has caught up with us and now we have to discuss that, but societies always go through this process.”

Josphat Mwaura, a partner at audit firm KPMG, added: “When we say we want to pay the teachers better and we still want to have free primary education and a devolved government, we need to understand that these things come at a cost.”

Wastage, low absorption levels and unqualified expenditure in many counties has made financial management in the devolved units complicated and caused friction between the central and county governments.

In fact, KRA continues to unsuccessfully try to wrest the function of revenue collection from governors and senators.

The chairman of the Commission on Revenue Allocation (CRA), and former CBK governor, Micah Cheserem, agrees that it would be prudent to allow KRA collect revenue on behalf of counties, but there is a catch.

“KRA does have the capacity and mechanism to collect revenue on behalf of counties but they have to do this on invitation of the relevant county administration,” he said.

Mr Cheserem, however, believes that the bigger cause of fiscal distress in counties is the fact that the central government delays releasing cash transfers to them.

“The Government needs to release money to the counties faster and in time, and the counties will absorb 100 per cent of this,” he said.

“There are some challenges with accountability and wastage in some counties, but devolution has worked wonders in counties that have seen almost zero development expenditure since independence.”

Kenya’s purse strings are further strained by its execution of major transport, energy and urbanisation infrastructure projects, bringing the country’s fiscal policy into question.

“We cannot have our cake and eat it. While infrastructure development is good for economic gains in the short term, the economy is exposed to vulnerabilities and there is a need to re-evaluate this spending pattern,” said Randa.

“Further, I think if you look at the Budget, there are so many things that can be removed or postponed from 2015 to 2016 or a later date to reduce the fiscal headache for the 2015-16 financial year.”

Some of the areas the Government has been advised to look at for respite include walking the talk on reducing the cost of doing business to foster the growth of the private sector.

IMF’s resident representative to Kenya, Armando Morales, added: “It is always ideal to identify priority sectors and provide resources to these sectors. But because resources are finite, you can delay expenditure in some areas, even though they might be positive for the economy. Even if you have the best project, you need to ensure that you have the liquidity at each point in time to act on it.”

Innovative manufacturing

The World Bank further states that the country’s manufacturing sector, which has seen moribund growth over the last decade, needs to get innovative, particularly in the wake of increased Chinese imports.

In 2015, China’s imports to Kenya increased by 41 per cent from 10 per cent last year. The heavy reliance on imports is not only crippling the manufacturing sector locally, but also crowding out local goods in the East African market.

“If you walk into any supermarket in the city, you will find that almost everything is imported. Some of the imports are completely unnecessary, and their collective impact to the economy is significantly destructive,” said Randa.

With the uncertainty around the effects of the El Niño rains, high interest rates and the Government’s relentlessness to follow through its fiscal expansionary policy, the future looks stormy.

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