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Do we owe too much? Can we go on merrily borrowing? When is debt unsustainable?

Saturday June 11 2016

The past couple of years have seen increasing disagreement about whether Kenya’s debt is growing too fast (or becoming “unsustainable”). This kind of debate is important for the public: debt is a decision about when and how to pay for public investments that can change the course of development.

Although it is shrouded in pseudo-science, debt is, like much of global finance, strongly influenced by perception. Apparently reasonable debt burdens one day, become unsustainable the next; apparently unsustainable debt levels have in fact been sustained for decades.

The most famous and recent attempt to quantify when debt levels were likely to lead inexorably to distress (by economists Carmen Reinhart and Ken Rogoff) was ultimately undone by data errors; there is no one specific level at which debt can be said to become unsustainable.

Does this mean that we should simply ignore debt levels? What questions can a responsible citizen concerned about debt issues ask under such circumstances?

It is probably easier for citizens to focus initially on the deficit, which is decided every year in a reasonably transparent fashion. The deficit can be connected more easily to spending choices in that year than can accumulated debt. Since the deficit ultimately determines the debt burden, this is still part of the same conversation.

What has been happening over time to Kenya’s deficit? Like many questions about the budget, it is not easy to get consistent and reliable answers for any extended period of time. But here are a few observations. These calculations are based on the deficit excluding grants.

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There are other ways of calculating the deficit that yield different numbers, but broadly similar trends. The figures are drawn from the Budget Policy Statements and Budget Review and Outlook Papers from 2013 to 2016.

First, deficits have been rising over the past few years, both in terms of what is projected and what is actually realised. In February 2014, the projected deficit for the coming year (2014/15) was Ksh367 billion. In October 2014, the deficit projected for 2015/16 was Ksh448 billion. By February 2015, the deficit projected for 2015/16 was Ksh533 billion.

The actual deficit in 2012/13 was Ksh266 billion. In 2013/14, the actual deficit was Ksh326 billion. By 2014/15, the deficit had grown to Ksh534 billion. That is a doubling of the deficit in just two years.

Because the economy and overall budget tend to grow each year, looking at the deficit alone without considering changes in the size of these items can be misleading. If we look at the deficit as a share of GDP, however, we can see that it grew from about 6 per cent of GDP in 2012/13 to 6.5 per cent in 2013/14 and then to 9.4 per cent in 2014/15.

While there is again no hard science on the size of the deficit, a general rule of thumb is that if your deficit is consistently larger than GDP growth, it is not sustainable. After all, you will pay back the debt you accumulate from that deficit through the increase in GDP over time. (The logical defence of a deficit is that it allows you to invest in parts of the economy that generate growth and allow you to repay your loans.)

During the period under consideration, Kenya’s deficit grew by 100 per cent, but GDP grew by 27 per cent. Should this worry us? The deficit in any given year is not necessarily a concern, but the trend over time can be. And in assessing that, much turns on the credibility of promises about the future.

There are reasons for both pessimism and optimism.

The pessimists would point out that projected deficits for the same period keep rising as we get closer to that period. For example, the projected deficit for 2015/16 in February 2014 was Ksh378 billion. By October 2014, it was Ksh448 billion. By February 2015, it was Ksh533 billion.

The same is true for the projected deficit for 2016/17. That was projected at Ksh395 billion back in February 2014. It had risen to Ksh542 billion by October 2015.

The budget read last week put it at Ksh762 billion (excluding grants). Since 2015, Treasury has tended to predict a high deficit for the coming year, and then falling deficits after that. Are these projected declines credible?

The optimists would point out that Kenya must comply with the East African Community Monetary Union Protocol of a deficit (inclusive of grants) of three per cent of GDP by FY 2020/21. Meeting that target next year would require us to have a 2016/17 deficit of approximately Ksh467 billion less than what has been budgeted.

As usual, everything hinges on perception: Will we be able to restrain our deficit by half a trillion in four years if we cannot do so now?

Jason Lakin is the Kenya country manager for the International Budget Partnership. E-mail: [email protected]

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