East African countries face a budget deficit of $6 billion in the next financial year amid narrowing funding options due to the region’s high debt levels, limited revenue sources and unpredictability of key donors.

Kenya, Tanzania, Uganda and Rwanda face $3.4 billion, $2.2 billion, $311 million and $261 million respectively in budget deficits. The total deficit equals about 15 per cent of the region’s $40 billion budget. The four countries have budgets of $20 billion, $12 billion, $5.5 billion and $2.2 billion respectively.

READ: East Africa rolls out budgets to spur growth, boost trade

The huge deficit, coupled with weak economic growth outlooks and the historical underperformance of tax authorities in the region, has raised concerns over its ability to implement key infrastructure projects in the next financial year.

Kenya is pegging its hopes on improved economic performance and efficient tax collection to finance its budget. But there is already concern that the country may not grow as fast as was predicted due to rising insecurity, which has affected tourism — a key foreign exchange earner for the country.

The agricultural sector, another key driver of the economy, is also underperforming due to the vagaries of the weather. Tea prices have hit rock bottom — a result of oversupply in the international market.

In the next financial year, the Kenya Revenue Authority is expected to collect Ksh1.18 trillion ($13.56 billion) to finance 83.6 per cent of the budget. Last year, the authority collected Ksh800 billion ($9.2 billion) against a target of Ksh881 billion ($10.1 billion).

READ: Financing concerns for Kenya’s $20b budget

In Tanzania, the revenue authority collected only 82.3 per cent of the $4.17 billion it had projected to net in the first nine months of the 2013/14 fiscal year.

Experts are already concerned since governments, when unable to fully cover their deficits, will normally slash capital spending so as to free up cash for recurrent expenditure and miscellaneous demands.

“We are concerned that development expenditure is the biggest casualty of fiscal deficits in Tanzania. This is likely to slow down the economic growth that has been fairly strong in the recent past,” said analysts at Stralink Africa, a financial research firm.

READ: Tanzanian households to fork out more for $12b budget

In Kenya, John Mbadi, a member of the Parliamentary Budget and Appropriations Committee, said it will be difficult for the country to fully meet its development expenditure.

“We are banking on the economy to perform better in order for us to meet the revenue targets, but the rising insecurity is messing up business and limiting investment opportunities,” said Mr Mbadi.

However, Finance Cabinet Minister Henry Rotich has stressed that the government’s borrowing plans remain anchored in the medium-term debt management strategy, which aims at ensuring public debt sustainability.

“While external financing will be largely based on concessional terms, we will continue to diversify our financing sources through access to commercial sources of financing, including issuance of the Eurobond and international financing instruments. The government will ensure that the level of domestic borrowing does not crowd out the private sector given the need to increase private investment to accelerate economic expansion,” said Mr Rotich.

A bulk of the development budgets in the EAC countries are expected to go to infrastructure, mainly roads, railway lines, ports and energy projects. These are the projects experts fear could suffer.

Still, local borrowing may not be advisable. This is because borrowing from the domestic market crowds out the private sector, and in a market like Kenya, where yields on indicative 91-day government securities are averaging nine per cent, loans become expensive.

Banks use this rate as the benchmark in pricing loans. This makes individuals and companies shy away from borrowing, which eventually affects growth.

Kenya plans to raise at least Ksh190.8 billion ($2.24 billion) from the domestic market while Rwanda will raise $158 million (Rwf107.6 billion) from international markets and $102.6 million from the local market.

In Tanzania, the International Monetary Fund resident representative in the country, Thomas Baunsgaard, is alarmed by the debt accumulation and has urged governments to balance between revenues and loans.

Striking a balance

“It is not wrong to continue borrowing, but there is a need to strike a balance between borrowing and internal generation of revenue in order to avoid debt problems. The government should abandon short-term and expensive loans and stick to long-term and concessional loans, which are not expensive,” said Mr Bainsgaard.

According to Nikhil Hira, a tax partner at Deloitte and Touche, many countries are in the situation East African countries have found themselves in. “If we have to borrow locally to fund the deficit then credit for the private sector could be squeezed,” said Mr Hira.

He added that governments should borrow but ensure that the debt levels remain manageable, adding that East African countries need to widen the tax net and bring in more taxpayers to bridge the deficit gap.

Mr Mbadi agreed, saying the Ksh190 billion ($2.18 billion) that Kenya plans to borrow in the next financial year could crowd out the private sector.

Even before the presentation of the budget estimates, Uganda had announced it would increase its domestic debt in the 2014/2015 financial year to cater for its growing demands. The country plans to borrow up to Ush2 trillion ($794.7 million) from the domestic financial markets in the next financial year.

According to Fred Muhumuza, economic advisor to the Minister of Finance, despite the international bond markets being cheaper, payment can be cumbersome as institutions have to pay all the borrowed money at once, leaving domestic borrowing as the only option.

However, with the option of raising taxes becoming increasingly unfavourable due to both social and economic effects, governments are looking for new options for raising revenue, and choosing to focus on scrapping tax breaks, reforming tax laws and tapping into international markets for financing.

Uganda is betting on changes to its VAT, Excise and Financial Bills to help raise cash, given the unpredictability of donor funds.

READ: Ugandan taxman cracks down on VAT defaulters

Tanzania, for example, in its 2014/15 budget proposed to scrap all tax exemptions and remove the power to offer the same from the Ministry of Finance.

Kenya has indicated it will include clauses in its Excise Tax Bill to be tabled in parliament in the next two months, scrapping exemptions. Tanzania is also conducting a review of all tax exemptions granted over the past five years.

While Kenya has already reformed its VAT regime, Tanzania’s VAT Bill 2014, Tax Administration Act 2015 and Finance Act 2014 are before parliament. Uganda and Burundi are also expected to makes changes to their tax laws. Doing so is expected to make it easier to pay taxes and boost collection.

By Emmanuel Muga, Peterson Thiong’o, Alex Ngarambe, Scola Kamau and Dicta Asimwe