Assessing Public Sector Balance Sheet Vulnerabilities

International Monetary Fund. African Dept.

doi:10.5089/9798400264467.002.A002

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Assessing Public Sector Balance Sheet Vulnerabilities

Author: International Monetary Fund. African Dept.

Publication Date:: 17 Jan 2024

eISBN:: 9798400264467

Language:: English

Keywords:: Kenya economy; balance sheet approach; foreign exchange; Kenya's balance sheet; profit and loss

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“The National Treasury shall be the custodian of an inventory of national government assets, … strengthen financial and fiscal relations between the national government and county governments, and … manage the level and composition of public debt, guarantees and other financial obligations of government within the framework of this Act and develop a framework for sustainable debt control (PFM Act, 2012, amended).”

Abstract

Assessing Public Sector Balance Sheet Vulnerabilities^¹

A. Introduction

1. The focus of fiscal policymaking on national government flows—revenues, expenditures, and borrowing—poses challenges in achieving fiscal sustainability. Like most countries, Kenya analyses its fiscal policy on the dynamics of the central government’s leading flow indicators (revenue, spending, deficit) and liabilities limited to gross debt, recently set as a policy objective at 55 percent of GDP in present value. This approach can fall victim to illusory fiscal practices as governments can lower debt and deficits by reducing net worth (privatization increases revenue but reduces assets, cutting maintenance spending reduces deficit but also reduces the value of infrastructure, delaying payments reduce deficit but increase non-debt liabilities/future debts). Reducing debt at the expense of public assets can lead to lower future economic growth rates.

2. The National Treasury (NT) has taken significant steps to enhance fiscal analysis beyond simple measures of debt and deficits. Current legal framework provides for a broader coverage of fiscal analysis. The Public Financial Management Act (PFMA) 2012, amended in 2023, mandates the NT to be a custodian of government assets and manage the level and composition of public debt, guarantees, and other financial obligations for sustainable debt control. In response, the NT has been involved in diverse public financial management (PFM) reforms, resulting in improved fiscal reports (Box 1), the production of consolidated financial statements for almost all public sector entities, the establishment of a fiscal risk management framework, and the ongoing implementation of a treasury single account and accrual-based International Public Sector Accounting Standard (IPSAS). Last year, the NT established a Fiscal Risk Committee to identify, monitor, and manage fiscal risks across the public sector, and a fiscal risk register has been developed. With the support of the IMF, the NT has estimated its public sector size and composition in 2014 and 2018 with aim of enhancing transparency and strengthening fiscal analysis.^²

3. Kenya is well positioned to reap the benefits of the PFM reforms and enhance its fiscal policy analysis. The Kenya economy faces numerous challenges arising from an adverse global political and economic environment, as well as domestic economic issues (2023 Article IV consultation). While external factors are beyond its control, addressing domestic risks and seizing opportunities can yield substantial economic gains, particularly those originating within the public sector. For instance, an analysis of fiscal risks has revealed that public debt consistently exceeded its medium-term projections, with an annual rate of about 4 percent of GDP from 2014 to 2022. A large portion of these deviations were attributed to factors within the public sector, such as the realization of contingent liabilities from counties and the state-owned corporations, and other economic indicators also affected by the fiscal policy (interest and exchange rates).^³ Therefore, progress in PFM reforms offers policymakers the opportunity to adopt a more comprehensive approach, one that encompasses both public financial flows and stocks, to better understand and manage government interventions in the economy.

^{Box 1.}

Kenya: Fiscal Statistics

Kenya is in the process of migrating its fiscal framework to follow the GFSM 2014 concepts and presentation and implement accrual-basis IPSAS accounting standards. Since FY2017/18, the NT Quarterly Economic and Budgetary Review includes an annex with fiscal data based on the IMF’s Government Finance Statistics Manual 2014 (GFSM 2014) to allow fiscal policymakers and users to become familiar with this presentation. Progress has been achieved in preparation of consolidated financial statements for almost all public entities. Consolidated financial statements for Ministries, Departments and Agencies are prepared in accordance with cash-basis IPSAS. Semi-Autonomies Agencies prepare their financial statements in accrual IPSAs, and State Corporations follow the International Financial Reporting Standards (accrual-basis). However, government fiscal statistics cover only the budgetary central government units (BSGUs), which are used for policy analysis, and reported on GFSM 1986 basis. Since 2018, Kenya National Bureau of Statistics (KNBS) has published annual and quarterly BCGUs statement of operations (fiscal flow) data in accordance with GFSM 2014.

The KNBS also submit annual data to the IMF Statistics Department for dissemination in the annual GFS database. It also compiles annual data for extrabudgetary units (EBUs) and local governments. These data are aggregated to arrive at totals for the extrabudgetary government subsector, central government, and general government, which are disseminated via the IMF’s Government Finance Statistics (GFS) database, with a time series extending back to FY2013/14 through FY2020/21 (lasted published data). The KNBS publishes also general government fiscal flow data in its annual Economic Survey publication but does not separate the extrabudgetary government subsector. Kenya does not yet produce a public balance sheet, despite the production of consolidated financial statements for public entities.

Source: Based on the CD Report on Government Finance and Public Sector Debt Statistics, David Bailey and others, June 2023, IMF’s Statistics Department.

4. Kenya public sector balance sheet (PSBS) offers abundant information for public finances analysis. The PSBS includes the national government, counties, semi-autonomous government agencies (SAGAs), and state corporations (SCs), including public funds and the central bank. The estimated public sector is larger than peers in the region, Ghana, Mozambique, and Uganda, but smaller than South Africa—with total assets of 101 percent of GDP in FY2022/23, on a consolidated basis. Public sector estimated financial assets and liabilities were 14 percent and 131 percent of GDP, respectively, corresponding to a negative net financial worth of 117 percent of GDP, and a net worth of minus 30 percent of GDP.

5. The paper is organized as follows. Section B provides an overview of the benefits associated with developing a balance sheet approach for Kenya. Methodology and estimated PSBS for Kenya is provided in section C. Section D discusses the ongoing fiscal policy reforms and their impact on Kenya’s public sector balance sheet. Section E concludes with some recommendations for improving the quality and use of Kenya’s PSBS.

B. A Public Sector Balance Sheet Approach

Basic Characteristics

6. Kenya’s fiscal analysis has a narrow focus. Fiscal statistics and analysis concentrate on the budgetary central government (BCG) units (Red cell in Figure 1), known as the national government. This leaves out other elements of the central government, such as extrabudgetary units and social security funds. Therefore, only a portion of the central government activity is reported and analyzed. As a result, fiscal policy focuses on the national government’s budget deficits and debt. Without comprehensive coverage, the fiscal stance may not be assessed accurately, unrecorded government liabilities are more likely to surface unexpectedly, incentives exist to circumvent the fiscal accounts, and the transparency of fiscal policy is impaired (IMF, 2007). For example, since FY2015/16, the national government’s budget deficit on cash basis has hovered around 8 percent of GDP, but deficits of the central and general governments have stood between 4 and 6 percent during FY2018/19-FY2020/21 (Figure 2). The difference comes mainly from accumulation of pending bills from extrabudgetary units and transferring a part of their revenues and transfers to financial assets (kept as cash in banks or deposits).

7. Public sector balance sheets provide a framework for conducting a thorough analysis of fiscal policies and risks. By consolidating the complete spectrum of assets and liabilities held by the public sector, balance sheets offer a more comprehensive fiscal perspective compared to focusing solely on debt and deficits. For instance, the Kenya’s balance sheet shows the assets owned, and the liabilities or obligations owed, by the public sector on behalf of current and future Kenyans. Expanding the analysis to include the entire public sector forms the foundation for enhancing fiscal management, boosting revenues, mitigating risks, and improving the formulation of fiscal policies.

8. Kenya’s fiscal policy analysis would improve by expanding the scope of fiscal analysis to encompass all assets and liabilities of the public sector. This extension would not only enhance transparency but also provide valuable insights for policymakers and the public, fostering a more comprehensive understanding of public finances. When fiscal data is limited to a subset of the general government, it can be misleading. For example, Kenya’s expenses on compensation of employees have declined for the national government (focus of fiscal policy), from 4.3 percent of GDP in FY2019/20 to 3.8 percent of GDP in FY2022/23. However, they have increased by 0.6 percent of GDP for SAGAs and SCs over the same period (Figure 3). For the entire public sector, compensation of employees has remained at about 8.4 percent of GDP, and for the general government^⁴ estimated at 7 percent of GDP in FY2022/23 or constituting 49 percent of tax revenues, surpassing some regional peers, marking the second highest within the chosen sample (Figure 4). Additionally, the PSBS will encompass assets and liabilities not included in current fiscal reports, such as natural resources, pension liabilities, Public-Private Partnership (PPP) contracts, and other claims and payables.

9. International experience shows that improved asset management can enhance both asset yields and government revenues, a principle applicable to Kenya as well. Analysis of international experience indicates that revenue gains from improved management of non-financial public corporations and government financial assets alone could potentially reach to 3 percent of GDP annually (IMF, 2018). In Kenya, public corporations, SAGAs and SCs, collectively hold assets worth of 67 percent of GDP as of the end of June 2023. While authorities have yet to establish a clear distinction between commercial and non-commercial entities, in line with the IMF’s Government Finance Statistics Manual 2014 (GFSM 2014), commercial corporations are estimated to manage half of these assets. The obvious question is whether these assets are yielding adequate returns for the national government in the form of taxes and dividends. Table 1 shows that the dividends and taxes paid by SCs are insignificant. On average, dividends from these entities averaged 0.3 percent of GDP from FY2015/16 to FY2022/23, with a minimal contribution through taxes at 0.13 percent of GDP in FY2022/23.

10. SAGAs and SCs remain a strain on the budget. In FY 2022/23, 242 SAGAs/SCs incurred losses amounting to 0.7 percent of GDP, marking an increase from the previous fiscal year when 183 entities faced losses equivalent to 0.5 percent of GDP in FY2021/22 (Figures 5 and 6).^⁵ While pension funds, belonging to contributors and not remitting dividends to the budget, and Central Bank of Kenya (CBK) profits have shown improvement, but a substantial portion of the CBK profit is attributed to unrealized gains from exchange rate depreciations. As a result, the dividends remitted by CBK and profitable SCs, totaling 0.29 percent of GDP (Table 1), fall short of covering the losses incurred by the remaining SAGAs/SCs. This implies that SAGAs/SCs either require support from the budget or will accumulate payables, reduce their equity, and increase non-equity liabilities. For instance, in FY2022/23, 18 SAGAs/SCs reported negative equity, totaling 1.5 percent of GDP, from 1.2 percent of GDP in FY2021/22. Moreover, given that most SAGAs are primarily financed from the budget, these losses remainGivingCapaign2023E1willwin! as obligations for national government, necessitating additional budget transfers in the future.

^{Table 1.}

Kenya: Dividends and Taxes Paid by SAGAs and Public Corporations

(Percent of GDP)

Source: Kenyan National Treasury, Fiscal Tables and Consolidated Financial Statements of SAGAs and State Corporations.

^{Table 1.}

Kenya: Dividends and Taxes Paid by SAGAs and Public Corporations

(Percent of GDP)

	FY 2015/16	17/18	18/19	19/20	20/21	21/22	22/23	Average
Investment Income (CBK)	0.00	0.00	0.01	0.11	0.07	0.04	0.03	0.04
Investment Income – Others	0.36	0.27	0.27	0.33	0.33	0.25	0.26	0.30
Taxes paid	n.a.	n.a.	n.a.	n.a.	0.24	0.13	0.13	0.18
Total					0.64	0.42	0.42	0.52

Source: Kenyan National Treasury, Fiscal Tables and Consolidated Financial Statements of SAGAs and State Corporations.

^{Table 1.}

Kenya: Dividends and Taxes Paid by SAGAs and Public Corporations

(Percent of GDP)

	FY 2015/16	17/18	18/19	19/20	20/21	21/22	22/23	Average
Investment Income (CBK)	0.00	0.00	0.01	0.11	0.07	0.04	0.03	0.04
Investment Income – Others	0.36	0.27	0.27	0.33	0.33	0.25	0.26	0.30
Taxes paid	n.a.	n.a.	n.a.	n.a.	0.24	0.13	0.13	0.18
Total					0.64	0.42	0.42	0.52

Source: Kenyan National Treasury, Fiscal Tables and Consolidated Financial Statements of SAGAs and State Corporations.

11. The strength of a country’s PSBS matters for both macroeconomic stability and economic growth. Economies with robust public sector balance sheets experience shallower recessions and tend to recover faster after economic downturns (IMF, 2018). Stronger balance sheets offer governments greater flexibility to employ countercyclical policies, such as increasing spending during economic downturns. Furthermore, empirical studies show that financial markets account for government assets and net (financial) worth when pricing sovereign bonds (Yousefi (2009)).

12. Another reason for Kenya to consider adopting the PSBS approach is that it would help mitigate and manage fiscal risk analysis. Expanding policy analysis on both assets and non-debt liabilities, in addition to debt, would include a considerable size of fiscal operations that are conducted outside of the national government, particularly by SAGAs, social funds, state corporations, and PPP contracts. A PSBS would provide the NT a complete picture to estimate the impact of government policies and mitigate potential fiscal risks within the public sector. The Kenya Fiscal Transparency Evaluation Update 2020 shows that the fiscal risks from counties and state corporations have materialized considerably during the last decade.

13. Focusing on balance sheet indicators, particularly net financial and net worth, offers a more comprehensive and rigorous assessment of the state of public finances. In times of economic challenges, when government revenues are declining, there is often a tendency to cut maintenance and capital spending and postpone payment obligations as an initial response. While these policy actions might not increase budget deficit and public debt, they will contribute to a decline in the public infrastructure stock and the net worth. The reduction in assets can have more far-reaching and harmful consequences than simply diminishing net worth. It can lead to lower future economic growth rates, impact negatively the private sector, and result in systemic issues with public service delivery. A focus only on public debt and deficit would not be able to provide a comprehensive picture of fiscal policy. In the context of Kenya, excluding non-debt liabilities such as pending bills, unpaid tax refunds, and legal claims weakens the assessment of the nation’s public finances. These non-debt liabilities essentially act as zero-yield assets (inflation adjusted, negative yield) for the private sector.

14. Balance sheet analysis comes with limitations (IMF, 2018). First, data quality can be an issue. The veracity of central and general government information will depend to some extent on the quality of the public financial management regulations and systems and adherence to them. For public corporations, the reliability of their financial information rests heavily on the implementation of sound accounting principles verified through external audits. Second, valuation can be a challenge particularly for nonfinancial assets that are not traded. Third, the public sector consists of many different entities, each facing its own constraints and risks, often requiring analysis of specific entities.

15. Recognition of assets on the government balance sheet does not eliminate the vulnerabilities associated with high public debt (IMF, 2018). Assets such as roads and ports are illiquid and not available to meet rollover or deficit financing needs. Also, asset valuations such as those applied to natural resources can be highly correlated with the economic cycle––meaning their value can be at their lowest when financing needs are most pressing.

16. An increasing number of countries are adopting the balance sheet approach, some with support from the IMF outreach emerging from the 2018 Fiscal Monitor. The Georgian and Indonesian governments have employed this approach to assess the sustainability of fiscal policies, guide decisions on public investments, and enhance the management of fiscal risks, particularly those associated with state-owned enterprises. Australia and New Zealand have a more extensive history of managing their public wealth using balance sheets. Uruguay has introduced a balance sheet approach to debt management. Annex I briefly presents the balance sheet approach used in the United Kingdom. Moreover, the private sector is also actively involved in this endeavor. For instance, McKinsey published the Global Balance Sheet 2022 report in December 2022, providing an overview of the wealth and health of the global economy by examining the assets and liabilities of households, corporations, governments, and financial institutions.^⁷

C. Methodology and Coverage for Kenya’s PSBS

17. Compiling a PSBS is a complex and data-intensive process that requires advanced accounting systems. It involves the collection and consolidation of data from diverse sources to compile a comprehensive overview of all assets and liabilities controlled or owed by the state. PSBSs are developed within the framework outlined in the GFSM 2014, which advocates the reporting of accrual information and balance sheets. As a result, they include financial flows and stocks of assets and liabilities held by all resident institution public units. In the case of Kenya, the PSBS encompasses the national government (BCG units), SAGAs, counties (local governments), social securities, and state corporations (public financial and non-financial corporations). In addition to the historic and current picture of the public assets and liabilities, referred to as the static PSBS, balance sheets can determine the long-term intertemporal net worth effect of current policies by combining the discounted future flows of revenues and expenditures with the static balance sheet. This is referred to as an intertemporal PSBS (Figure 7).^⁸

18. Fiscal reports in Kenya provide sufficient information to estimate its public sector balance sheet. Kenya does not produce a PSBS, however, consolidated financial statements for different perimeters of public sector enable to estimate it. Combined with information used for estimating the PSBS FY2017/18 by the two previous IMF capacity development missions and Alves, De Clerck, and Gamboa-Arbelaze (2020), we have estimated the static PSBS for PSBS FY2022/23. Annex I provides the estimated PSBS and methodology and data sources. The estimated PSBS shows that the current focus of fiscal policy leaves out a considerable size of fiscal operations that are conducted outside the national government.

19. In June 2023, Kenya’ public sector had an estimated net worth of minus 30 percent of GDP (Figure 8). Public sector assets were estimated at 101 percent of GDP, while liabilities reached at 131 percent of GDP. Due to the absence of a classification system for SAGAs and state corporations according to the GFSM 2014, it is not currently possible to estimate the balance sheet of the central and general government. The main components of the Kenya’s public sector balance sheet are as follows:

Non-financial assets, estimated at 87 percent of GDP, encompass infrastructure, buildings, public land holdings, as well as the fixed assets and equipment held by SAGAs and state corporations.
Financial assets, estimated at 14 percent of GDP, consist of cash and deposits (3.1 percent of GDP), debt securities (1 percent of GDP), equity investment (2 percent of GDP) and receivables (7.9 percent of GDP).
Liabilities, estimated at 131 percent of GDP, consist of government debt securities and loans (70 percent of GDP), debt securities from SCs (6 percent of GDP) currency and deposits owed by the CBK and financial corporations (6 percent of GDP), actuarial pension obligations (33 percent of GDP), and pending bills and other payables, including PPP contracts, totaling 16 percent of GDP.

20. The balance sheet encompasses approximately 44 percent of GDP, representing crossholdings of assets and liabilities across various public sector segments. This includes government equity claims on SAGAs/SCs (35.6 percent of GDP), government and SAGAs/SCs deposits at the CBK (4.8 percent of GDP), government securities held by SCs and the CBK (1.7 percent of GDP), and receivables/payables (1.4 percent of GDP). The financial statements do not provide detail information on the receivables and payables, so their magnitude could be higher than presented. Usually, SAGAs/SCs build receivables and payables through their business interactions among them, especially in the case of pending bills related to utilities recorded as receivables in entities that provide the service and as payables in entities receiving it. While the crossholdings themselves do not have a net impact on the PSBS, they can serve as a channel through which risks are transmitted from one sector to another, potentially affecting the entire public sector.

21. Kenya’ public sector liabilities are comparable with many countries that publish their balance sheets (Figure 9).^⁹ With total liabilities of 131 percent of GDP, Kenya is on par with its peers in the region, such as South Africa and Senegal, and comparable with many countries that have an estimated PSBS. As almost all countries in the sample, Kenya public debt is substantially lower than total liabilities of the public sector.

22. Kenya’s public sector holds significantly fewer assets than most countries, making it vulnerable to external shocks. In many other countries, substantial non-financial and financial assets (managed by sovereign wealth funds) are largely attributed to natural resources, which were not considered in Kenya’s balance sheet due to the relatively limited presence of natural resources and minimal activity in this sector.^¹⁰ Furthermore, Kenya’s financial assets were much smaller, at only 14 percent of GDP, compared to debt levels of 70 percent of GDP and the total liabilities of 131 percent of GDP. Consequently, this putts the government in a difficult position with insufficient liquid assets to meet its gross financing needs, leading to the accumulation of spending arrears and delayed tax refunds. Additionally, there is a significant foreign exchange exposure, with foreign exchange-denominated assets accounting for about 5 percent of GDP, while foreign exchange liabilities amount to about 40 percent of GDP. This implies that further currency depreciation could have adverse budget impact.

D. Public Sector Balance Sheets and Fiscal Policy Analysis

23. The net worth of Kenya’s PSBS has deteriorated in recent years, reflecting the effect of the pandemic and the reduction of public investment. Public sector net worth had been reduced by 25 percent points of GDP compared with the FY2017/18 level (Figure 10). This reflects the reduction of infrastructure due to lower investment to offset amortization of infrastructure. Financial assets had been reduced reflecting the weakening of financial performance of SAGAs and SCs. On the other side, liabilities increased with 10 percent points of GDP, reflecting increase of public debt and non-equity liabilities of SAGAs and SCs and pending bills of national government and counties.

24. Fiscal policy choices impact public sector net worth. Borrowing to cover primary deficits diminishes public sector net worth, especially when these deficits exceed the acquisition of public assets. However, borrowing for investment purposes makes sense when it yields benefits such as direct dividends (in the case of equity investment) or indirect revenues from a larger economy through increased tax revenue. In Kenya, authorities have implemented or announced various policy measures that will influence the composition of the public sector’s assets and liabilities, designed to contribute positively to public sector net worth. These measures encompass alterations in fiscal policy and the implementation of structural reforms.

25. The implementation of the medium-term tax strategy (MTRS) will strength Kenya’s PSBS. The MTRS focuses mainly on enhancing tax compliance, expanding the tax base, and improving tax administration. It anticipates generating an additional revenue equivalent to about 5 percent of GDP. These extra funds will enable the government to strengthen its balance sheet, less reliance on debt-financing, and allocate increased spending to support social policies.

26. Clearing government arrears, particularly pending bills, will strengthen PSBS, particularly in the medium term. Settling these arrears not only prevents future penalties but also strengthen the balance sheets of SAGAs and SCs. If part of the improvement in tax revenue is channeled toward settling pending bills, or they are settled through expenses cuts, it would immediately improve financial net worth of the PSBS. If the clearance will be carried out through borrowing or securitization, the short-term effect on the balance sheet would be neutral, but this will avoid future penalty payments. Arrears, being contractual obligations, could lead to higher budget costs than their face value. For example, arrears of employees’ contributions to their respective pension funds incur substantial daily interest charges and additional fees.

27. The pension reform, introduced in January 2021, is anticipated to yield positive outcomes. The decision to convert all defined-benefit schemes in the public sector to a defined-contributory scheme aligns with best practices in the retirement industry. This reform, while enhancing equity and linking pension benefits to contributions, will concurrently decrease pension obligations of the national government, estimated at about 1 percent of GPD annually for next 30 to 35 years. Despite the absence of a direct government obligation, pension obligations could pose an indirect (implicit) cost in the event of bailouts. Hence, the implementation of this reform requires proper monitoring governance, periodic evaluation, and mitigation of potential risks. However, government entities could be the source of these risks as they withhold statutory deductions and contributions on behalf of employees. As of the end of June 2023, SAGAs and SCs had pension arrears amounting to KSh.46.8 billion, equivalent to 55 percent of the total assets of the new contributory scheme or 12 percent of the combined total assets of the National Social Security Fund and the Public Service Superannuation Fund (new scheme).

28. Increasing PPP contracts will expand the PSBS, and their effect on net worth will depend on the productivity of assets and the effective containment of fiscal risks. Authorities are actively exploring the option of procuring large public investment projects through PPP contracts, with several projects already in operation or under construction. PPP contracts, due to their long-term nature, may create the illusion of additional fiscal space, as short-term budget outflows are exchanged for future payments or foregone income from user fees (IMF, 2021). However, these projects entail fiscal risks, attributed to explicit or implicit contingent liabilities, often arising from asymmetric information between the government and contractors, especially in complex projects. So, their effect on the budget and economy will depend on the balance between the efficiency the private sectors bring and realization of fiscal risks. Therefore, managing their fiscal risks is a fundamental function for a successful PPP program. To ensure the success of a PPP program, managing these fiscal risks is principal. A centralized framework is necessary to integrate PPP projects within the national public investment and budget framework. Some countries have implemented limits on the size of their PPP portfolios as a safeguard for public finances (IMF, 2021)—a practice that Kenya could consider.

29. Reforms aimed to rationalize SAGAs, improve the governance of SCs, and privatize selected public entities will strengthen Kenya balance sheet. The number of SAGAs and SCs have increased substantially during the last four fiscal years, rising from 350 in June 2020 to 526 in June 2023, primarily due to the expansion of vocational education and training colleges. However, authorities are in the process to review and rationalize them in line with their service delivery. On the other side, a new ownership policy for government owned enterprises will enable to put in place an enhanced governance framework for commercial SCs, aiming to improve their service delivery and profitability. Additionally, a strategic privatization program is anticipated to generate revenue streams for the government, curtail transfers to non-profitable entities, and alleviate the overall cost of capital. Public sector assets incur continuous costs, referred to as the cost of capital, encompassing borrowing expenses, tax revenues for capital acquisition, maintenance costs, and potential expenses associated with materialized risks when assets fail to meet expectations.^¹¹ These measures create an opportunity for the national government to implement distinct governance and monitoring approaches for public entities funded by the budget, extra-budgetary units, as opposed to those operating on a commercial basis

E. Caveats

30. The public sector balance presented in this paper is based on published statistics and few estimates. The data are based on consolidated financial statements of MDAs, counties, and SAGAs/SCs for FY2022/23 and other official sources. The fixed assets of MDAs have been estimated for FY2022/23. Authorities believe that the value of fixed assets is higher than the PSBS estimates, and the non-inclusion of natural resources underestimate fixed assets. Data regarding crossholdings of assets and liabilities are likely to be higher as financial statements do not provide detail disclosure, however, not effecting financial and net worth. The value of liabilities is highly to reflect the true value, as they are based on national government debt, pending bills, and the liabilities of SAGAs/SCs reported by the NT and presented in their consolidated financial statements. Liabilities related with PPP contracts are based on the World Bank database but presented only half of their stock based on discussion with the government officials.

31. Pension obligations are based on an early actuarial valuation and are not complete. The government administers two pension schemes, one non-contributory (defined benefits) and a contributory scheme introduced in January 2021. Regarding the non-contributory scheme, the recent actuarial valuation available is reported in a World Bank study from 2016, estimating pension liabilities at 30 percent of GDP (IMF, 2020). The 2020 Kenya Fiscal Transparency Evaluation Update included in its estimated FY2017/18 PSBS an actuarial obligation (liability) to the social security sector of 3.3 percent of GDP. Due to a lack of data, we have included an estimated value of 3.3 percent of GDP. Additionally, some SCs manage their own defined benefit schemes for employees, which are typically held in independent trustee-administered funds. In their balance sheets, these schemes are presented as net values (value of assets minus actuarial obligations). For example, the CBK reports a net asset of Ksh.5.0 billion against a fair value of scheme assets of Ksh.29.8 billion as of end-June 2023. So, assets of these schemes are presented in net value in the PSBS as reported on the consolidated financial statements of SAGAs/SCs. Some state corporations have transitioned from defined benefit schemes to contribution schemes, such as the Kenya Power and Lighting Company, which closed its defined benefit scheme in June 2006, and the Kenya Electricity Generating Company, which closed its scheme in December 2011.

F. Conclusion and Recommendations

32. The estimated PSBS highlights the importance of a comprehensive approach to fiscal policy analysis in Kenya. A narrow focus on the national government’s performance undermines the financial health of the rest of public sector, posing potential risks to fiscal sustainability. The FY2022/23 PSBS reveals significant non-debt liabilities accumulated over the years, necessitating improved management of assets and the implementation of policy measures to either contain or improve the net financial worth position. Analysis of the PSBS indicates that the improvement of fiscal indicators of the national government has partially been achieved at the expense of the rest of public sector, evident in increased wage bill expenses and accumulation of pending bills in SAGAs and SCs. Additionally, the estimated PSBS offers enhanced transparency of public policies, providing policymakers with valuable insights to formulate effective fiscal policies. This, in turn, can contribute to higher economic growth and an improved fiscal space.

33. Progress in financial reporting provides foundation for compiling public sector balance sheets for policy analysis. The consolidated financial statements for MDAs, counties, SAGAs and SCs offer abundant information sufficient to produce annual PSBS estimates. To make these statements more effective for policy analysis, there is room for improvement in both their content and coverage, aligning them more closely with the perimeters of the public. A potential alteration involves producing separate consolidated financial statements for non-commercial SAGAs/SCs and commercial corporations. This approach will enable the generation of balance sheets and fiscal indicators for both the central government and the general government. This will allow the preparation of balance sheets and fiscal indicators for the central government and general government. Also, the notes of the financial statements can be enriched by adding more detailed information, especially concerning crossholdings among various public entities. This additional detail contributes to a more comprehensive understanding of the financial relationships within the public sector.

34. The performance of SAGAs and SCs underscore an urgent need for reform. In total, these entities manage assets worth of about 70 percent of GDP, yet only a few of them contribute to the national budget. Nearly half of these entities have operated at a loss over the last two fiscal years, amounting to over 1 percent of GDP or approximately half of the revenues from the value-added tax on domestic goods and services in FY2022/23. While the government has initiated various reform measures, including privatization, a crucial first step towards establishing an efficient asset management framework involves categorizing SAGAs and SCs based on different portfolios—such as policy and service delivery versus commercial operations—and further differentiating them in financial and non-financial terms. Moreover, there should be a specific focus on entities within the social sector, including those with pension obligations. Conducting an actuarial evaluation for the defined-contribution scheme is imperative, followed by rigorous monitoring of the new scheme to ensure its effectiveness.

35. Finally, the PSBS analysis underlines the need for additional measures to strengthen the PFM system. Issues such as the accumulation of pending bills, delays in tax refunds, and a lack of budget credibility reveal vulnerabilities of the PFM system that pose risks to fiscal sustainability. To address these risks, implementing measures to ensure the preparation of realistic budgets, introducing multi-year commitments for investment projects, executing budgets in accordance with parliamentary appropriations, enhancing the digitalization of PFM systems, and strengthening procurement processes are paramount. These measures are anticipated to form integral components of the new PFM reform strategy currently being developed by the NT. A credible PFM system is essential for supporting the achievement of the debt anchor set at 55 percent of GDP in present value and preventing the accumulation of non-debt liabilities. Additionally, transparency in fiscal indicators becomes even more crucial when striving to meet this anchor, with fiscal statistics expected to encompass at least the central government and provide comprehensive reporting on public sector liabilities.

Annex I. HM Treasury, United Kingdom: Public Sector Balance Sheet Framework

1. The Balance Sheet Review (BSR) was launched in 2017 to identify opportunities to dispose of assets that no longer serve a policy purpose, improve returns on retained assets and reduce the risk and cost of liabilities. As well as strengthening balance sheet management, these opportunities will release resources for further investment in public services and improve the sustainability of the public finances.^¹ The BSR was undertaken in line with the government’s balance sheet management principles, which are to:

secure maximum value for taxpayers from the government’s assets and liabilities;
enhance transparency over the government’s balance sheet management decisions;
optimize the management and mitigation of balance sheet risks;
safeguard overall public sector net worth; and
strengthen fiscal sustainability.

2. These principles guide the HM Treasury’s fiscal and public spending decisions by: (i) dividing public sector assets and liabilities into three portfolios (policy, financial, and commercial portfolios); (ii) outlining long-term management objectives, governance arrangements and exit strategies for each portfolio to optimize portfolio management; and (iii) identifying portfolio management opportunities for similar assets/liabilities within each portfolio to improve the management of risk and returns. The Annex I. Figure 1 provides further details on the framework and visualizes the public sector balance sheet in line with this approach. The framework is aligned with international best practice from New Zealand, and parallels global accounting standards, as well as the IMF’s functions of government classification standards. Going forward, the government will:

update its central guidance in line with this framework to create a sound basis for managing risk and optimizing returns for taxpayers;
apply this framework to help evaluate the case for proceeding with significant future asset sales and wider balance sheet transactions;
apply this framework to inform how credit risk should be managed across different asset portfolios;
draw on this framework to inform the mandates of future institutional vehicles tasked with delivering specific policy priorities;
identify management economies of scale within each asset portfolio to optimize performance; and
consider opportunities to further develop the framework, including through the development of an investment strategy to provide clear future performance expectations for individual public sector assets and liabilities.

Annex II. Estimated Public Sector Balance Sheet Methodology and Source of Data on Kenya

1. The initial estimated PSBS FY2022/23 for Kenya is based on data published by the National Treasury, Office of the Controller of Budget, Kenya Bureau of Statistics, Central Bank of Kenya, IMF Government Financial Statistics Database.^¹ IMF Technical Assistance (TA) Reports, and World Bank database on PPP and The Changing Wealth of Nations 2021. The methodology is based on Alves and others (2020).

2. The Kenya Fiscal Transparency Evaluation (FTE) TA mission report, published in January 2020 and conducted in August 2019, includes an estimated PSBS for FY2017/18. Another AFRITAC East (AFE) TA mission report—Improving the Quality of Fiscal and Public Debt Data in Kenya—published in April 2021 and delivered in October 2019, has also included a preliminary PSBS for FY 2017/18. These reports were used as a reference.

3. The main source of data for the PSBS are consolidated financial statements for MDAs, Counties, and SAGAs/SCs, which include public funds and the Central Bank of Kenya: https://www.treasury.go.ke/accountant-generals-desk/. There are only few items estimated:

Non-financial assets for the MDAs and Counties. While financial statements provide information for inventories and machineries, there is no evaluation of infrastructure assets. So, this is estimated based on estimation provided in the FTE for FY2017/18 plus fixed asset transactions published by the NT in the quarterly bulletins. An amortization rate of 2 percent annually is applied to the stock of assets. However, the NT has created a team to evaluate government infrastructure assets, which will be available soon.
Pension obligations (non-contributory pension scheme) are assumed the same as FTE 2020 in percent of GDP, 30 percent of GDP for the national government and 3.3 percent for SAGAs/SCs. The actuarial projections of pension liabilities are not available. However, based on the NT Fiscal Framework FY2023/24 and medium-term, there are projections of pension expenses until FY2030/31. Discounted at 5 percent, their stock in FY2020/21 was 16.6 percent of GDP. The 30 percent of GDP provides a good estimation, considering the scheme will operate for at least 35 years.
PPP portfolio is based on the World Bank database but reduced with 50 percent, now estimated at 2.2 percent of GDP. This was based on discussions with the authorities that the estimated stock of the World Bank is high.

^{Annex II. Table 1.}

Kenya: Public Sector Balance Sheet, FY2022/23

(In percent of GDP)

Source: IMF Staff calculations.

References

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Prepared by Sybi Hida (FAD).

Kenya Fiscal Transparency Evaluation Update, International Monetary Fund, January 2020.

Establishing Fiscal Risk Committee, IMF Technical Assistance Report (unpublished), November 2022.

This consists national government, counties, and extra-budgetary units. Data on extra-budgetary units are based on the consolidated financial statements of SCs, SAGAs, and Public Funds. Those entities that report in accordance with IPSAs are considered extra-budgetary units.

As of June 30, 2023, there were 526 SAGAs/SCs, from 500 entities as of end-June 2022, of which 16 have not been included in the consolidated financial statements (11 in FY2021/22).

https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/global-balance-sheet-2022-enter-volatility

The intertemporal PSBS adds the net present values of all future fiscal balances to the static PSBS. The computation requires many assumptions to construct the future fiscal path, discount factor, and age-related spending. Kenya’s intertemporal balance sheet is not estimated in the paper.

Few countries publish their PSBS data, but IMF has estimated balance sheets for additional countries and has published estimated PSBS for 55 countries on the PSBS website.

IMF PSBS methodology for estimating stock of mineral and energy resources correspond to the present value of the expected pre-tax cash flows resulting from their commercial exploitation. Kenya has almost nonexistent nonrenewable natural resources (The World Bank, 2021). The Changing Wealth of Nations 2021: Managing Assets for the Future). However, the Economic Survey 2023 by the Kenya Bureau of Statistics reports that in 2022 there were 63 official oil exploration blocks, of which 22 were under exploration contracts.

New Zealand, Ministry of Finance (2011). 2010 Investment Statement of the Government of New Zealand.

Source: HM Treasury, The Balance Sheet Review Report: Improving public sector balance sheet management, November 2020: https://www.gov.uk/government/publications/the-balance-sheet-review-report-improving-public-sector-balance-sheet-management

http://data.imf.org/GFS

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