Why debt ceiling is a poor tool to cut public borrowing

A debt ceiling is a statutory limit on the amount of debt that a government can borrow. [iStockphoto]

The debate on the debt ceiling as a tool for public debt management is not unique to Kenya.

The US commenced the use of the debt ceiling in 1917, after the First World War to manage the ballooning public debt at that time.

Since then, the ceiling has been raised by over 100 times with the latest being in December 2021 when they raised it by $2.1 trillion (Sh244) to $31.4 trillion (Sh3,642.40 trillion).

A debt ceiling is a statutory limit on the amount of debt that a government can borrow.

Several countries use this tool to manage their economy. The most unique case is that of Poland with a constitutional limit set at 60 per cent of GDP.

Denmark - the only other country in the West with a debt ceiling, passed the Debt Limit Act in 1993 and placed it at Danish Kroner (DKK) 950 billion.

It has been amended several times with the latest being in 2008 when it was raised to DKK 2 trillion. The country’s debt stands at 20 per cent of GDP well under the EUs recommended 60 per cent. Back in Kenya, the Public Finance Act 2012 set the debt ceiling to Sh6 billion.

It was adjusted to Sh9 billion in 2019, and currently, Treasury is keen on pushing it up to Sh13 billion. It recently increased it to Sh10 trillion. The begging question is, how effective has it been in containing the public debt?

In principle, the debt ceiling is a downstream tool - a stop gap at the end of a process of fiscal management that includes budgeting, taxation, and deficit financing.

By the time the State is asking for an increase in the debt ceiling, naturally, parliament would have already approved the expenditure. What remains is spending or in some cases, money has been spent already. Expecting the debt ceiling to stop the growing debt at this stage is akin to trying to stop diarrhoea with a bandage.

There is a myth that the debt ceiling checks government spending and borrowing.

Nothing could be further from the truth. In many cases, Parliament is usually held at ‘gunpoint’ to increase the debt ceiling or preside over a statutory default.

The political backlash is usually too much and Parliament yields to Treasury’s requests.

Parliament will be forced to up the debt limit to Treasury’s desired level as they have chosen to play a passive role in budgeting. This makes the debt ceiling more of a feel-good political tool than a public finance tool, as it is ineffective in fiscal management.

It follows that the best way to manage the large public debt is to reduce the deficits at the budgeting stage. The best approach would be to ensure parliament puts a ceiling on the deficits.

-The writer is the CEO of Elim Capital

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