As Kenyans continue to interrogate the numbers in the Finance Bill that was presented by Treasury Cabinet Secretary Njuguna Ndung'u on June 15, it is imperative that they do so from an informed position. Otherwise, they might become easy fodder in the course of political sparring between Kenya Kwanza and Azimio political formations.
Njuguna Ndung'u finds himself in a most unenviable position where he has to raise taxes to finance his budget whether Kenyans like it or not. Whichever way the CS finally chooses to raise funds (if modifications are made to the budget proposals that he presented to parliament), he will inevitably be raising taxes to either pay offshore creditors or create an enabling environment for local investors to commit more resources to the domestic economy. So, the choice is not whether or not to raise taxes. That is not an option. The choice is who will benefit from the raised taxes, that is, the domestic economy or foreign lenders.
Kenya finds herself in a tight corner as far as raising budget finance is concerned. But, politicians had better tell citizens what they want to hear rather than what they ought to hear. It needs no gainsaying that politicians exist to take power, and political parties or formations are mere vessels for achieving that goal.
Therefore, citizens are advised to listen less to politicians and interact more with facts and data, for statistics don't tell lies. Let us plough into some of the pertinent issues of this debate, and try to make sense of them. An informed citizenry is better placed to meaningfully engage with politicians and bureaucrats on issues that affect them.
Kenya needs money to finance its Sh3.6 trillion national budget for the Financial Year 2023/24. There are two broad sources of revenue for budget support, namely domestic and external. It is critical for Kenyans to appreciate that each of the sources has its pros and cons. The externally sourced revenue mainly comes in the form of loans.
External loans can be obtained from bilateral or multilateral sources. A bilateral credit or a term loan is a facility provided by a single lender. Bilateral lending is suitable for those funding requirements that can be met by a single lender.
It is instructive that a budget of Sh3.6 trillion would expose a single lender to huge risks in the event of delayed or renegotiated repayment arising from economic difficulties or changing priorities of the borrower, in this case, Kenya. The country has competing demands for financing that are necessary for the country to sustain its transformation agenda.
A key attribute of bilateral lending is that it is generally smaller than a multilateral facility, much less complicated, and, thus, less expensive for the borrower. Large bilaterals are often funded through loan participation, also known as indirect syndication. A credit or term loan facility provided to a borrower by more than one lender on uniform terms and conditions using common documentation is multilateral financing. It is typically provided in order to diversify the credit and distribution risk of the financing among the participating lender institutions.
Multilateral financing is used by large non-bank corporations, financing institutions and government entities when the required amount of funding is beyond the capabilities of any one of the borrower's relationship banks. Typically, multilateral lending is syndicated lending. Most critical, however, is the fact that lending institutions evaluate borrowers on the basis of their ability to repay the loans in time.
Lending institutions, whether bilateral or multilateral, operate like commercial banks. There are many ways of measuring the ability to repay a loan. However, for developing countries such as Kenya, more often than not, the Debt to GDP ratio is used. With a Debt to GDP ratio of about 60 per cent, Kenya is already nearing the threshold of the red zone.
It has been argued that the country's grim debt situation has been exacerbated by the aggressive investment in external debt-funded physical infrastructure over the last ten years. The onset of repayment of the debts are falling due during President William Ruto's tenure.
Lenders are keen to glean if additional credit to Kenya could lead to debt distress. Debt distress is a situation where a country is either unable to honour its debt obligations when they fall due, and seek rescheduling, or repay the offshore loans together with interests at the expense of critical welfare-enhancing expenditures at home.
When the former happens, the country compromises its international credit rating and may face practical difficulties in securing future loans from both bilateral and multilateral lending institutions. The alternative would be very expensive commercial loans which exacerbate a country's indebtedness to foreigners. Indebtedness to offshore lenders undermines a country's sovereignty and national pride.
When a country resorts to repaying its offshore loans at the expense of domestic expenditure requirements, it might be forced to borrow further to meet its domestic obligations. Either way, the country will increase its level of indebtedness to offshore institutions, whose painful consequence is that more tax revenues will be required to offset the loans. The funds used to repay foreign loans will not be available for use in the country.
Thus, taxing Kenyans less in the short run, and resorting to offshore financing to plug the budget deficit will inadvertently lead to higher taxes in the long run to repay the loans. So, demanding less taxation now and plugging the difference with borrowed money is simply postponing the problem. To make it worse, the bulk of the tax revenues will be going towards meeting offshore credit obligations instead of being channelled to expenditures that benefit taxpayers.
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The other option available to CS Njuguna Ndung'u is domestic revenue which mainly comprises exchequer revenues, appropriations-in-aid, and domestic borrowing. Appropriations-in-aid refer to own source revenues mobilized by government ministries and departments such as fees, fines, licenses, permits and proceeds from the sale of services and products. Examples include court fines, local government permits, and furniture sold by the Prisons department.
The government can borrow from the domestic market through open market operations or direct borrowing from financial institutions in order to control inflation or get revenues for government expenditures.
Open market operations refers to the practice where the government issues Treasury bonds and bills to the public, with a specific maturity period and interest rate. The important thing to note with regard to this practice is that for it to be attractive to lenders, the government must raise interest rates above the rate that commercial banks can pay on customers' deposits. The effect of high-interest rates on Treasury bills is that the government crowds out (starves) the commercial banks and other lending institutions of deposits, thus undermining the performance of the financial sector. With less money available to individuals and households for investment, the country's capacity for capital accumulation is compromised.
At the same time, money that is borrowed by the government in such a manner has to be paid back (redeemed) with interest to the domestic lenders upon maturity, at which point the supply of money in the economy surges. An increase in the money supply in the economy creates inflationary pressure. Domestic borrowing, though retains the money at home, is not entirely without its side effects.
In a situation such as Kenya's where external sources of finance are fast drying up, and the debt levels are hovering around the red zone, exchequer revenues take preference in the pecking order. The country requires adequate exchequer revenues (customs duty, income tax, VAT, excise tax) to not only underwrite domestic needs but also pay off offshore loans. The beauty of exchequer revenues is that the government is not required to pay them back to the citizens except through service delivery. To get enough tax revenues for government expenditures requires a robust fiscal policy and innovative tax administration practices.
CS Njuguna Ndung'u has to undertake a very delicate balancing act of ensuring that his taxation proposals fetch adequate revenues to underwrite his ambitious budget of 3.6tr while avoiding the temptation to make it too intrusive. The sticky issues in the Finance Bill should be interrogated and discussed openly before it is converted into an Act of Parliament.
As Kenyans interrogate the budget proposals, they should bear in mind that there is very little latitude available to excise large portions of the bill without providing viable alternative revenue sources. That is to say that it is going to be very difficult for CS Njuguna Ndung'u to accede to the demands of the opposition to reduce taxes by a significant proportion without helping him to identify domestic sources of revenue that can plug the shortfalls.
On their part, the National Treasury should intensify the sensitisation of Kenyans to enhance their financial literacy. An informed citizenry is better placed to discuss tax matters and discharge the civic responsibilities including embracing a progressive taxpaying culture.
Professor Ongore teaches at the Technical University of Kenya