Abstract
This Selected Issues paper and Statistical Appendix addresses the question of how to interpret recent developments in the Kenyan consumer price index (CPI) properly to assess the current inflation pressure and extract signals about possible future CPI inflation trends. The paper discusses why Kenya’s exports have performed poorly over the past five years in spite of a more liberalized trade and exchange rate regime. The analysis shows that Kenya faces both price and nonprice constraints on export performance.
VII. FISCAL SUSTAINABILITY AND FISCAL RISK IN KENYA66
A. Introduction
167. This section analyzes fiscal sustainability and fiscal risk in Kenya. The framework used for this analysis takes into account the contingent liabilities of the central government and the fiscal burden of the HIV/AIDS pandemic.
168. The current fiscal position of the central government is very fragile. The level of indebtedness is high, and the overall magnitude of fiscal risks the central government assumes is also large.
169. The results of the analysis show that Kenya needs an extended period of rapid growth combined with an up-front fiscal consolidation in order to restore fiscal sustainability. Rapid growth can be achieved by implementing a strong structural reform program - including wide-ranging governance reforms—which would also encourage foreign concessional financing. A combination of strong growth, fiscal adjustment, and the availability of foreign concessional financing will allow the government to restore fiscal sustainability, to reduce and better manage fiscal risk, and to gradually increase the amount of resources available to finance new poverty reduction strategy paper (PRSP) priorities without endangering the quality and availability of core government services.
B. Macroeconomic Scenarios and Sustainability of Fiscal Policies
170. In order to provide a range for possible outcomes and to gauge the sensitivity of the results to underlying assumptions, the sustainability analysis presented here is carried out for two scenarios, called high-growth and low-growth scenarios.67
171. In the high-growth scenario, the government is assumed to pursue sound macroeconomic policies, including a strong fiscal adjustment at the beginning of the period, and ambitious structural and governance reforms. The economic program of the government is supported by adequate grant and concessional loan financing from international financial institutions and donors. Public investment is kept at an adequate level, while its efficiency is improved as a result of public finance and governance reforms. Structural reforms and credible macroeconomic policies attract an increasing amount of foreign and domestic private investment, thereby increasing the growth potential of the economy. The latter is further enhanced by reducing poverty and dealing with the HIV/AIDS pandemic. Fiscal policy is geared toward providing sufficient financing for these programs. The average real growth in the scenario is 4.5 percent per year, some 1.7 percentage points higher than the historical average for the last two decades, and some 2.8 percentage points higher than the average for the last decade. As Section VI suggests, such an increase in the growth performance is achievable through structural and governance reforms.68
172. In the low-growth scenario, it is assumed that the policies of the last decade are continued, resulting in a growth performance similar to that observed in the past. Average real growth is 1.7 percent per year, which is equal to the average growth between 1991 and 2001. In the absence of structural and governance reforms, foreign financing is low and gradually declining as the government’s credibility further erodes.
173. Fiscal sustainability is fully restored in the high-growth scenario (Table 21 and Figure 15). The net augmented debt-to-GDP ratio declines from above 75 percent in 2001/02 (July-June) to below 39 percent by 2014/15, the end of the simulation period. The interest cost is almost halved, allowing for a full accommodation of HIV/AIDS-related government expenditure without endangering the overall fiscal position.
Kenya: Central Government Net Augmented Debt, High-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, High-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, High-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Fiscal Sustainability High-Growth Scenario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
Central government.
Excludes payments on called guarantees.
includes payments on called guarantees.
Kenya: Fiscal Sustainability High-Growth Scenario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
| 2001/02 | 2002/03 | 2003/04 | 2004/05 | 2005/06 | 2010/11 | 2014/15 | |||
|---|---|---|---|---|---|---|---|---|---|
| Budget deficit | |||||||||
| Primary revenue | 24.2 | 24.3 | 24.1 | 23.9 | 23.7 | 23.5 | 23.5 | ||
| Primary expenditure 2/ | 24.3 | 23.8 | 22.7 | 21.7 | 21.4 | 23.1 | 23.8 | ||
| AIDS-related primary expenditure | 0.0 | 0.1 | 0.2 | 0.3 | 0.5 | 1.7 | 2.0 | ||
| Other primary expenditure | 24.3 | 23.7 | 22.5 | 21.4 | 20.9 | 21.4 | 21.8 | ||
| Primary balance | −0.1 | 0.5 | 1.4 | 2.2 | 2.3 | 0.4 | −0.3 | ||
| interest costs 3/ | 3.8 | 3.5 | 3.7 | 3.8 | 3.4 | 2.1 | 1.8 | ||
| Overall balance | −3.8 | −3.0 | −2.3 | −1.5 | −1.1 | −1.7 | −2.0 | ||
| Financing | 3.8 | 3.0 | 2.3 | 1.5 | 1.1 | 1.7 | 2.0 | ||
| Foreign grants | 1.2 | 1.1 | 1.1 | 0.8 | 0.7 | 0.5 | 0.4 | ||
| Foreign borrowing | −0.1 | 0.2 | 0.5 | 0.8 | 0.8 | 0.3 | 0.1 | ||
| Domestic borrowing | 2.6 | 0.5 | 0.5 | −0.1 | −0.5 | 0.8 | 1.5 | ||
| Privatization receipts | 0.1 | 1.3 | 0.2 | 0.0 | 0.1 | 0.0 | 0.0 | ||
| Debt sustainability indicators | |||||||||
| Central government debt (end-of-year stock) | 75.8 | 74.8 | 73.0 | 69.4 | 64.8 | 46.4 | 38.4 | ||
| Net augmented central government debt (end-of-year stock) | 75.1 | 73.8 | 71.5 | 67.2 | 62.4 | 45.2 | 37.7 | ||
| Net augmented central government debt (as percent of own primary revenue) | 310.4 | 303.9 | 296.5 | 281.2 | 263.3 | 192.5 | 160.6 | ||
| Vulnerability indicators | |||||||||
| Central government gross borrowing requirement | 26.8 | 23.5 | 22.0 | 19.8 | 16.8 | 9.9 | 8.0 | ||
| Central government gross borrowing requirement, including renewal of | |||||||||
| short-term domestic debt | 67.2 | 57.2 | 51.1 | 42.4 | 33.0 | 12.2 | 8.0 | ||
| Gross borrowing requirement (as percent of primary own revenue) | 110.6 | 96.7 | 91.4 | 82.8 | 70.8 | 41.9 | 34.2 | ||
| Interest expenditure (as percent of primary own revenue) | 15.6 | 14.6 | 15.3 | 15.8 | 14.5 | 8.9 | 7.5 | ||
| Assumptions | |||||||||
| Real growth (annual percentage change) | 1.3 | 1.9 | 2.9 | 4.1 | 4.9 | 5.3 | 5.4 | ||
| Average effective nominal interest rate on total central government debt (in percent) | 5.4 | 5.3 | 5.7 | 6.0 | 5-8 | 5.1 | 5.4 | ||
| 90-day treasury bill rate (in percent) | 12.0 | 11.5 | 12.0 | 11.7 | 10.8 | 10.5 | 10.5 | ||
| Rate of real appreciation (CPI based; annual percentage change) | −1.0 | 1.0 | 1.0 | 0.5 | 0.4 | 0.0 | 0.0 | ||
Central government.
Excludes payments on called guarantees.
includes payments on called guarantees.
Kenya: Fiscal Sustainability High-Growth Scenario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
| 2001/02 | 2002/03 | 2003/04 | 2004/05 | 2005/06 | 2010/11 | 2014/15 | |||
|---|---|---|---|---|---|---|---|---|---|
| Budget deficit | |||||||||
| Primary revenue | 24.2 | 24.3 | 24.1 | 23.9 | 23.7 | 23.5 | 23.5 | ||
| Primary expenditure 2/ | 24.3 | 23.8 | 22.7 | 21.7 | 21.4 | 23.1 | 23.8 | ||
| AIDS-related primary expenditure | 0.0 | 0.1 | 0.2 | 0.3 | 0.5 | 1.7 | 2.0 | ||
| Other primary expenditure | 24.3 | 23.7 | 22.5 | 21.4 | 20.9 | 21.4 | 21.8 | ||
| Primary balance | −0.1 | 0.5 | 1.4 | 2.2 | 2.3 | 0.4 | −0.3 | ||
| interest costs 3/ | 3.8 | 3.5 | 3.7 | 3.8 | 3.4 | 2.1 | 1.8 | ||
| Overall balance | −3.8 | −3.0 | −2.3 | −1.5 | −1.1 | −1.7 | −2.0 | ||
| Financing | 3.8 | 3.0 | 2.3 | 1.5 | 1.1 | 1.7 | 2.0 | ||
| Foreign grants | 1.2 | 1.1 | 1.1 | 0.8 | 0.7 | 0.5 | 0.4 | ||
| Foreign borrowing | −0.1 | 0.2 | 0.5 | 0.8 | 0.8 | 0.3 | 0.1 | ||
| Domestic borrowing | 2.6 | 0.5 | 0.5 | −0.1 | −0.5 | 0.8 | 1.5 | ||
| Privatization receipts | 0.1 | 1.3 | 0.2 | 0.0 | 0.1 | 0.0 | 0.0 | ||
| Debt sustainability indicators | |||||||||
| Central government debt (end-of-year stock) | 75.8 | 74.8 | 73.0 | 69.4 | 64.8 | 46.4 | 38.4 | ||
| Net augmented central government debt (end-of-year stock) | 75.1 | 73.8 | 71.5 | 67.2 | 62.4 | 45.2 | 37.7 | ||
| Net augmented central government debt (as percent of own primary revenue) | 310.4 | 303.9 | 296.5 | 281.2 | 263.3 | 192.5 | 160.6 | ||
| Vulnerability indicators | |||||||||
| Central government gross borrowing requirement | 26.8 | 23.5 | 22.0 | 19.8 | 16.8 | 9.9 | 8.0 | ||
| Central government gross borrowing requirement, including renewal of | |||||||||
| short-term domestic debt | 67.2 | 57.2 | 51.1 | 42.4 | 33.0 | 12.2 | 8.0 | ||
| Gross borrowing requirement (as percent of primary own revenue) | 110.6 | 96.7 | 91.4 | 82.8 | 70.8 | 41.9 | 34.2 | ||
| Interest expenditure (as percent of primary own revenue) | 15.6 | 14.6 | 15.3 | 15.8 | 14.5 | 8.9 | 7.5 | ||
| Assumptions | |||||||||
| Real growth (annual percentage change) | 1.3 | 1.9 | 2.9 | 4.1 | 4.9 | 5.3 | 5.4 | ||
| Average effective nominal interest rate on total central government debt (in percent) | 5.4 | 5.3 | 5.7 | 6.0 | 5-8 | 5.1 | 5.4 | ||
| 90-day treasury bill rate (in percent) | 12.0 | 11.5 | 12.0 | 11.7 | 10.8 | 10.5 | 10.5 | ||
| Rate of real appreciation (CPI based; annual percentage change) | −1.0 | 1.0 | 1.0 | 0.5 | 0.4 | 0.0 | 0.0 | ||
Central government.
Excludes payments on called guarantees.
includes payments on called guarantees.
174. Three important factors are at play in this scenario: high growth, sufficient foreign concessional financing, and a strong fiscal consolidation at the beginning of the simulation period. These factors reinforce each other, and it is their combined effect that leads to a dramatic decline in net augmented government debt. The lack of even one of these factors could well lead to increasing indebtedness69 and a high and rising level of vulnerability. While adequate resources are allocated to new PRSP priorities, in particular to HIV/AIDS-related public programs, real non-AIDS-related primary expenditure increases by 3 percent per year during the simulation period. Thus, in this scenario, fiscal consolidation and the reprioritization of budget programs do not have to result in a deterioration of traditional public services and welfare programs.
175. Although the level of indebtedness temporarily decreases in the low-growth-scenario, fiscal sustainability is not restored. The level of indebtedness increases towards the end of the simulation period, and the degree of fiscal risk reaches dangerous levels (Table 22 and Figure 16). As the pressing need for poverty-reducing and HIV/AIDS-related public expenditure forces the government to relax the fiscal position, the gains from the large up-front fiscal consolidation are eaten up, and, after a few years, the unsustainability of macroeconomic policies becomes evident. In this scenario, there is a clear conflict between the need for fiscal consolidation and financing for new budget programs, on the one hand, and the need to provide adequate finance for traditional public services and welfare programs, on the other hand. The average growth of non-AIDS-related real primary expenditure is 0.3 percent per year, which suggests a potentially serious conflict between new PRSP priorities and traditional budget programs.
Kenya: Fiscal Sustainability Low-Growth Senario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
Central government.
Excludes payments on called guarantees.
Includes payments on called guarantees.
Kenya: Fiscal Sustainability Low-Growth Senario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
| 2001/02 | 2002/03 | 2003/04 | 2004/05 | 2005/06 | 2010/11 | 2014/15 | |||
|---|---|---|---|---|---|---|---|---|---|
| Budget deficit | |||||||||
| Primary revenue | 24.2 | 24.3 | 24.1 | 23.9 | 23.7 | 23.5 | 23.5 | ||
| Primary expenditure 2/ | 24.3 | 23.8 | 22.7 | 21.7 | 21.4 | 23.1 | 23.8 | ||
| AIDS-related primary expenditure | 0.0 | 0.1 | 0.2 | 0.3 | 0.5 | 1.8 | 2.3 | ||
| Other primary expenditure | 24.3 | 23.7 | 22.5 | 21.4 | 20.9 | 21.2 | 21.5 | ||
| Primary balance | −0.1 | 0.5 | 1.4 | 2.2 | 2.3 | 0.4 | −0.3 | ||
| Interest costs 3/ | 3.8 | 3.6 | 3.8 | 4.0 | 3.8 | 3.8 | 6.7 | ||
| Overall balance | −3.8 | −3.1 | −2.4 | −1.8 | −1.5 | −3.4 | −7.0 | ||
| Financing | 3.8 | 3.1 | 2.4 | 1.8 | 1.5 | 3.4 | 7.0 | ||
| Foreign grants | 1.2 | 1.0 | 1.0 | 0.7 | 0.5 | 0.2 | 0.1 | ||
| Foreign borrowing | −0.1 | 0.1 | 0.4 | 0.6 | 0.0 | −0.9 | −1.0 | ||
| Domestic borrowing | 2.6 | 0.6 | 0.8 | 0.5 | 0.9 | 4.1 | 7.9 | ||
| Privatization receipts | 0.1 | 1.3 | 0.2 | 0.0 | 0.1 | 0.0 | 0.0 | ||
| Debt sustainability indicators | |||||||||
| Central government debt (end-of-year stock) | 75.8 | 75.2 | 74.5 | 72.9 | 71.2 | 65.6 | 73.0 | ||
| Net augmented central government debt (end-of-year stock) | 75.1 | 74.2 | 73.0 | 70.7 | 68.6 | 64.1 | 72.0 | ||
| Net augmented central government debt (as percent of own primary revenue) | 310.4 | 305.3 | 302.8 | 295.7 | 289.3 | 272.6 | 306.5 | ||
| Vulnerability indicators | |||||||||
| Central government gross borrowing requirement | 26.8 | 23.6 | 22.6 | 21.2 | 19.3 | 25.5 | 44.8 | ||
| Central government gross borrowing requirement, including renewal of | |||||||||
| short-term domestic debt | 67.2 | 57.5 | 52.5 | 45.8 | 39.7 | 68.7 | 151.4 | ||
| Gross borrowing requirement (as percent of primary own revenue) | 110.6 | 97.1 | 93.6 | 88.7 | 81.5 | 108.4 | 190.7 | ||
| Interest expenditure (as percent of primary own revenue) | 15.6 | 14.8 | 15.7 | 16.7 | 16.2 | 16.2 | 28.6 | ||
| Assumptions | |||||||||
| Real growth (annual percentage change) | 1.3 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | ||
| Average effective nominal interest rate on total central government debt (in percent) | 5.4 | 5.4 | 5.7 | 6.1 | 6.0 | 6.6 | 10.9 | ||
| 90-day treasury bill rate (in percent) | 12.0 | 11.7 | 12.0 | 11.7 | 10.8 | 10.9 | 15.7 | ||
| Rate of real appreciation (CPI based; annual percentage change) | −1.0 | 1.0 | 1.0 | 0.5 | 0.4 | 0.0 | 0.0 | ||
Central government.
Excludes payments on called guarantees.
Includes payments on called guarantees.
Kenya: Fiscal Sustainability Low-Growth Senario, 2001/02-2014/15 1/
(In percent of GDP, unless otherwise indicated)
| 2001/02 | 2002/03 | 2003/04 | 2004/05 | 2005/06 | 2010/11 | 2014/15 | |||
|---|---|---|---|---|---|---|---|---|---|
| Budget deficit | |||||||||
| Primary revenue | 24.2 | 24.3 | 24.1 | 23.9 | 23.7 | 23.5 | 23.5 | ||
| Primary expenditure 2/ | 24.3 | 23.8 | 22.7 | 21.7 | 21.4 | 23.1 | 23.8 | ||
| AIDS-related primary expenditure | 0.0 | 0.1 | 0.2 | 0.3 | 0.5 | 1.8 | 2.3 | ||
| Other primary expenditure | 24.3 | 23.7 | 22.5 | 21.4 | 20.9 | 21.2 | 21.5 | ||
| Primary balance | −0.1 | 0.5 | 1.4 | 2.2 | 2.3 | 0.4 | −0.3 | ||
| Interest costs 3/ | 3.8 | 3.6 | 3.8 | 4.0 | 3.8 | 3.8 | 6.7 | ||
| Overall balance | −3.8 | −3.1 | −2.4 | −1.8 | −1.5 | −3.4 | −7.0 | ||
| Financing | 3.8 | 3.1 | 2.4 | 1.8 | 1.5 | 3.4 | 7.0 | ||
| Foreign grants | 1.2 | 1.0 | 1.0 | 0.7 | 0.5 | 0.2 | 0.1 | ||
| Foreign borrowing | −0.1 | 0.1 | 0.4 | 0.6 | 0.0 | −0.9 | −1.0 | ||
| Domestic borrowing | 2.6 | 0.6 | 0.8 | 0.5 | 0.9 | 4.1 | 7.9 | ||
| Privatization receipts | 0.1 | 1.3 | 0.2 | 0.0 | 0.1 | 0.0 | 0.0 | ||
| Debt sustainability indicators | |||||||||
| Central government debt (end-of-year stock) | 75.8 | 75.2 | 74.5 | 72.9 | 71.2 | 65.6 | 73.0 | ||
| Net augmented central government debt (end-of-year stock) | 75.1 | 74.2 | 73.0 | 70.7 | 68.6 | 64.1 | 72.0 | ||
| Net augmented central government debt (as percent of own primary revenue) | 310.4 | 305.3 | 302.8 | 295.7 | 289.3 | 272.6 | 306.5 | ||
| Vulnerability indicators | |||||||||
| Central government gross borrowing requirement | 26.8 | 23.6 | 22.6 | 21.2 | 19.3 | 25.5 | 44.8 | ||
| Central government gross borrowing requirement, including renewal of | |||||||||
| short-term domestic debt | 67.2 | 57.5 | 52.5 | 45.8 | 39.7 | 68.7 | 151.4 | ||
| Gross borrowing requirement (as percent of primary own revenue) | 110.6 | 97.1 | 93.6 | 88.7 | 81.5 | 108.4 | 190.7 | ||
| Interest expenditure (as percent of primary own revenue) | 15.6 | 14.8 | 15.7 | 16.7 | 16.2 | 16.2 | 28.6 | ||
| Assumptions | |||||||||
| Real growth (annual percentage change) | 1.3 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | ||
| Average effective nominal interest rate on total central government debt (in percent) | 5.4 | 5.4 | 5.7 | 6.1 | 6.0 | 6.6 | 10.9 | ||
| 90-day treasury bill rate (in percent) | 12.0 | 11.7 | 12.0 | 11.7 | 10.8 | 10.9 | 15.7 | ||
| Rate of real appreciation (CPI based; annual percentage change) | −1.0 | 1.0 | 1.0 | 0.5 | 0.4 | 0.0 | 0.0 | ||
Central government.
Excludes payments on called guarantees.
Includes payments on called guarantees.
Kenya: Central Government Net Augmented Debt, Low-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, Low-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, Low-Growth Scenario, 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.C Fiscal Risk
176. Budgets are exposed to several types of risks that endanger fiscal policy implementation. It is thus important to consider a wide variety of fiscal risks when analyzing the sustainability of fiscal policies, and to try to gauge their magnitude. Depending on the starting position and the fiscal policies pursued, the nature and size of the fiscal risks faced by different countries may be markedly different. Four types of fiscal risk are analyzed in this paper: exchange rate risk, interest rate risk, refinancing risk, and risk originating from supply shocks. As most of the foreign debt is long-term concessional debt, only domestic interest rate risk is analyzed. The sizes of the shocks that the model is subjected to are calibrated based on historical data.
177. Exchange rate risk is one of the most important sorts of fiscal risk in developing countries. A low-income, primary goods-exporting economy is exposed to large fluctuations in the terms of trade, resulting in a volatile real exchange rate. The volatility of the real exchange rate is further increased by other exogenous factors, such as drought, and by poorly designed macroeconomic policies and uneven implementation of structural and governance reforms. Therefore, it is of considerable importance to quantify the degree of foreign exchange risk the government assumes. The two upper panels of Figures 17 show the impact of a 10 percent real depreciation of the Kenya schilling against the U.S. dollar for two years relative to the paths assumed under the two scenarios. As the upper left panel of Figure 17 shows, even though the share of foreign debt in total debt increases under the high-growth scenario, the overall impact of an exchange rate shock is declining over time because the overall level of indebtedness is reduced dramatically under this scenario.
Kenya: Central Government Net Augmented Debt, The Impact of Various Shocks on Indebtedness 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, The Impact of Various Shocks on Indebtedness 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Central Government Net Augmented Debt, The Impact of Various Shocks on Indebtedness 2000/01-2014/15 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.178. Domestic interest rate risk is of considerable importance for fiscal policy implementation because of the large size and short average maturity of domestic debt at the start. The two middle panels of Figures 17 show the impact on the level of indebtedness of an increase of 300 basis points in the domestic real interest rate (relative to the path assumed in the scenarios) for two years. In the high-growth scenario (left middle panel of Figure 17), the impact of an interest rate shock in the beginning of the simulation period is small, but persistent; however, it almost completely diminishes after five years. This outcome is explained by the reduction under this scenario of gross domestic borrowing from 22.9 percent of GDP in 2001/02 to 12 percent in 2006/07. At the same time, the average maturity of newly contracted debt is increased from 0.7 year in 2000/01 to 3.2 years in 2011/12, thereby substantially reducing the sensitivity of total interest cost to short-term fluctuations in market rates. Trends in this regard are dramatically different in the low-growth scenario, under which the size of this kind of fiscal risk is much greater and increasing over time.
179. Droughts and other exogenous supply shocks are frequent in Kenya and result in a marked slowdown in the economy for two-three years. The strong pressure such supply shocks put on the budget is another important form of fiscal risk. The two lower panels of Figures 17 quantify the size of this risk in the two scenarios, showing the impact of zero real GDP growth for two consecutive years on indebtedness. The impact is greater in the high-growth scenario because the size of such a shock is considerably larger than in the low-growth scenario.
180. Refinancing risk is an important and frequently neglected type of fiscal risk in a highly indebted economy with a sizable stock of short-term debt. The two scenarios presented here differ most dramatically in the degree of refinancing risk the budget is subjected to (see Figure 18). The starting position is difficult, as the government’s relatively large stock of domestic debt with a very short average residual maturity (less than six months at the end of 2000/01) results in a very large gross refinancing need. In the high-growth scenario (left panel of Figure 18), however, the ratio of gross financing need to revenue, the indicator of refinancing risk used here, falls dramatically from over 100 percent to below 35 percent over the 2001/02-20014/15 simulation period. This is a combined result of a fast reduction in domestic debt (which has a shorter average contractual maturity) and a rapid increase in the average contractual maturity of new domestic borrowing. The latter reflects increasing confidence in government policies on the part of domestic investors and an growing presence of foreign investors in domestic securities markets. In the low-growth scenario, after a modest improvement, the average contractual maturity of new borrowing starts to decrease rapidly as gross domestic borrowing increases and confidence in government policies evaporates (right panel of Figure 18). It is in fact the magnitude of the refinancing risk that is perhaps the most important factor rendering the low-growth scenario implausible, because that risk reaches an unmanageable level towards the end of the simulation period.
Kenya: Gross Borrowing Requirement, 2000/01-2014/15 1/
(In percent of revenue)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Gross Borrowing Requirement, 2000/01-2014/15 1/
(In percent of revenue)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.Kenya: Gross Borrowing Requirement, 2000/01-2014/15 1/
(In percent of revenue)
Citation: IMF Staff Country Reports 2002, 084; 10.5089/9781451821062.002.A007
Source: Staff estimates.1/Fiscal year ending June 30.D. Conclusions
181. The main conclusion of this analysis is that Kenya needs an extended period of rapid growth to restore fiscal sustainability and to reduce fiscal risk to a manageable level. Under the high-growth scenario, characterized by high growth and the availability of foreign concessional finance, both goals are achieved. Government indebtedness and fiscal risk are greatly reduced. As a result of good policies and sufficient foreign support, public finances become much more resilient: in fact, none of the stress tests performed for the high-growth scenario suggests that even a large exogenous shock could endanger government solvency.
182. Both scenarios involve a period of fiscal consolidation at the beginning of the simulation period, which is also an important factor at play. In the absence of an up-front fiscal consolidation, even strong growth and adequate foreign concessional finance may not be enough to restore fiscal sustainability.
183. Without implementing a strong structural reform program that would enhance growth and encourage foreign financing, the budget will remain extremely vulnerable. After a period of decline, the level of indebtedness will start to increase rapidly as the primary position has to be relaxed to accommodate the additional expenditure required to cover the costs of HIV/AIDS- and poverty reduction-related budget programs. As the level of indebtedness starts to increase, the vulnerable of the budget will rise and, by the end of the simulation period, it will become more vulnerable than it is now.
Haacker, Markus, 2001, “Providing Health Care to HIV patients in Southern Africa” IMF Policy Discussion Paper 01/3 (Washington: International Monetary Fund).
Horvath, Balazs, and Istvan P. Szekely, 2001, “The Role of Medium-Term Fiscal Frameworks for Transition Countries: The Case of Bulgaria” IMF Working Paper 01/11 (Washington: International Monetary Fund).
Republic of Kenya, 2001, AIDS in Kenya (Nairobi: National AIDS Control Council and AIDS Control Unit of Ministry of Health, 6th edition).
Annex I. Framework For Analysis
184. This analysis is based on the framework developed by Horvath and Szekely (2001). Net worth of the government is measured by net augmented debt, which includes financial liabilities, financial assets that can be liquidated without endangering core government functions, guaranteed debt, contingent liabilities of the government, and the present value of future privatization receipts.70 A fiscal policy is regarded as sustainable if the net augmented central government debt-to-GDP ratio is stabilized at a sufficiently low level during the simulation period and the overall magnitude of fiscal risk that the budget is exposed to is manageable.
185. Owing to data availability, the analysis is limited, at this stage, to the central government, with the exception of contingent liabilities in the banking sector, which is included for the entire public sector, and the borrowing of the central bank from the IMF, which is treated as guaranteed debt. Future work in this area should concentrate on compiling a reliable database for the financial assets and liabilities of the social security fund and subnational governments to make the analysis more comprehensive.
186. The sustainability analysis is carried out for the two scenarios described below. Under the low-growth scenario, fiscal policy is assumed to be unchanged,71 but the pricing behavior and portfolio allocation of domestic investors is treated as endogenous. The real interest rate demanded by domestic investors is assumed to have a unit elasticity to the share of government gross domestic borrowing in GDP,72 and a higher level of borrowing is assumed to induce a shift toward short-term instruments.
187. To gauge the extent of fiscal risks, a number of vulnerability indicators are introduced and a series of stress tests is performed. The degree of refinancing risk is measured by the annual gross borrowing requirement of the central government, calculated as a share of GDP and own primary revenue.73 Three stress tests are carried out to measure exchange rate and interest rate risks. The first test measures the impact of a 10 percent increase74 in the real exchange rate for two years on the fiscal sustainability indicator. The second test traces the impact of an increase of 300 basis points in the domestic real interest rate75 for two years. Finally, the third test quantifies the impact of having no real GDP growth for two consecutive years.
188. As the impact of such shocks is changing over time, three different starting points are chosen for the tests: the first year of the simulation period, and five and ten years later, respectively. In our interpretation, fiscal sustainability is fully restored when such shocks do not result in an increasing net augmented debt-to-GDP ratio in the longer run.76
ANNEX II. Special Factors
189. AIDS is a major human health and development problem in Kenya (see Box 1 in the staff report). The latest projections show that adult HIV prevalence will reach about 14 percent of the adult population by 2005 (Republic of Kenya, 2001). The recent PRSP process has identified the combating of the HIV/AIDS pandemic as one of the highest PRSP priorities. Based on this projection and the cost estimates for treatments (Haacker, 2001), we estimate that HIV/AIDS-related public spending is likely to have to reach some 2 percent of GDP in the high-growth scenario in order to provide basic coverage for treatment. This level is reached in the simulations by the end of the period, as the resources are assumed to become available gradually. In the low-growth scenario, the same level of services will require somewhat lower real expenditure77 but a larger share of total primary expenditure, as economic growth will be considerably slower.
190. The potential fiscal cost of bank consolidation in Kenya limits fiscal policy choices and has a strong influence on debt dynamics. Section V provides a description of the current state of the banking sector in Kenya. In this section, we concentrate on the fiscal implications of bank consolidation.
191. Negative equity in banks, in particular in large, state-owned banks, constitutes contingent liabilities for government. The precise valuation of such liabilities is extremely difficult, as the quality of assets can change very quickly. Moreover, the actual cost to the public sector depends to a large extent on the specific approach taken to addressing the problems of the banks concerned. Liquidation is often the cheapest approach, although politically difficult.78 Full cash recapitalization is typically the most expensive solution, as it protects all deposits.
192. The total cost to the public sector shows up in the balance sheets of different parts of the public sector. Thus, depending on the coverage of the fiscal sustainability analysis, certain components of the total cost may not be captured. In the present case, as the analysis covers the central government, cash outlays by the Deposit Protection Fund (DPF)79 and losses recognized by the central bank (written-off liquidity loans) and the National Social Security Fund (NSSF) will not immediately show up in the balance sheet of the central government. However, losses of the central bank will translate into smaller transfers from the central bank, and losses of the NSSF will create new contingent liabilities of the central government. Because our analysis is based on the concept of net augmented debt of the government, which includes contingent liabilities, the distribution of cost among different parts of the public sector is largely irrelevant.
193. For the purposes of this particular exercise, it is assumed that the total amount of government contingent liabilities in the banking sector may have reached about 5 percent of GDP at end-2000. It is assumed that the necessary intervention takes place in 2002–03, with costs equally distributed between the two years, and that the remaining contingent liabilities are converted into government debt in 2004–05. Government payments are assumed to be made with ten-year market interest bonds. The actual timing of the intervention and the realization of contingent liabilities has an impact on the gross borrowing requirement of the government, but it does not change its net augmented debt.80
Prepared by Istvan P. Szekely.
For a description of the framework used to this analysis and the special factors that were incorporated see Annexes I and II,
In fact, Kenya had a period of rapid growth in the second half of the 1980s, when average real growth (between 1985 and 1990) reached 5.5 percent per year. Experiences of other African countries also suggest that good polices and ambitious reforms do result in sustained high growth and macroeconomic stability.
If the fiscal adjustment assumed in the high-growth scenario is not carried out, that is, if the share of primary expenditure (including HIV/AIDS-related expenditure) in GDP remains unchanged, the net augmented debt-to-GDP ratio rises above 80 percent, up from 75 percent at the beginning of the simulation period. It is questionable whether in such circumstances the high rate of growth assumed in this scenario can be maintained. A more realistic assumption on the average rate of real GDP growth would most likely result in a continuously increasing net augmented debt-to-GDP ratio.
This is used as a proxy for the value of government real assets that can be liquidated without reducing the capacity of the government to perform its core functions.
Unchanged policy is defined as unchanged share of primary central government expenditure in GDP. The overall elasticity of revenue is assumed to be one.
Relative to a threshold that is set equal to the peak value of this ratio at the beginning of the simulation period. A 1 percent (not percentage point) increase in the share of government gross borrowing over the threshold results in a 1 percent (not percentage point) increase in the domestic real interest rate. The yield curve is assumed to shift out but not to tilt.
The indicators show the share of GDP or primary revenue the government would have to devote to repaying its maturing debt in the year concerned if it could not roll over its maturing debt obligations.
A 10 percent depreciation of the real exchange rate of the local currency against the U.S. dollar, compared with the original path of the real exchange rate, and returning to it after two years.
Compared with the original path of domestic real interest rate, and returning to it after two years. The yield curve is assumed to shift out but not tilt, that is, the premium on longer maturities assumed to be unchanged. As the pricing behavior and portfolio allocation of domestic investors are endogenized, an increase in the domestic debt stock may induce a further increase in domestic interest rates and may change the maturity profile of newly issued domestic government debt.
In the short run, it may increase.
Reflecting lower real wages in the health care sector as a result of slower economic growth. Two-thirds of the total cost is assumed to be wage cost and the real wage increase is assumed to be proportional to the rate of real GDP growth. Nonwage cost is assumed to be the same in the two scenarios.
Among other things, the considerably lower cost of liquidation in Kenya is explained by the fact that deposit insurance is limited to K Sh 100,000 (about. US$1,265) per depositor.
As long as DPF is properly capitalized and deposit insurance fees and charges are adequately set to replenish the fund.
Contingent liabilities are indexed using the average interest rate for government borrowing. If a delay results in a deterioration of asset quality or outright asset stripping, timing becomes a critical factor.
