Expenditure: We think the proposed 22% increase undermines fiscal consolidation. Kenyan Minister of Finance Robinson Githae presented a KES1.46trn (38% of GDP) budget for FY12/13 (July-June) on 14 June. This is an increase of 22% from the revised FY11/12 budget of KES1.2trn, by our estimate, and is much higher than the 6.4% increase proposed in the Medium Term Budget Policy Statement (MTBPS) presented in April.
Githae partly attributes the significant increase in spending to the implementation of the new constitution (13% of total expenditure) and partly to the government’s strategic interventions in various sectors, including education, healthcare, infrastructure, security and agriculture. Notably, two of the sectors intervened in, education and security, received the biggest allocations, of 16% and 11% of total expenditure, respectively.
In particular, security’s elevation in the budget reflects the government’s response to more “external-related security challenges”, particularly from Somalia. Recurrent spending of KES1.0trn (26% of GDP) is planned for FY12/13, equivalent to 69% of total expenditure. The remaining KES452bn (12% of GDP) will go on development expenditure, of which KES268bn (7% of GDP) will be directed towards infrastructure spending. Half of the infrastructure budget will go on roads, and one-third on energy, implying a 20% increase in infrastructure spending in FY12/13, compared with that allocated in the initial FY11/12 budget.
This is positive for growth, as it spurs fixed investment. However, most of the increase in spending is on the recurrent budget side, which is negative for inflation. Strong government spending growth is also negative for Kenya’s external balances, as recent history has shown; it partly translates into growing demand for imports, which is negative for the current account and the shilling.
Revenue: We think the government’s projection of 19% growth is optimistic. The government projects an almost 20% increase in domestic revenue collections to KES957bn (25% of GDP) in FY12/13. It also expects KES56.2bn in grants from donors, putting total revenue and grants at KES1.01trn, with grants at 6% of the total. The increase in domestic revenue is partly premised on the Ministry of Finance’s (MoF) growth projection of 5.2% for 2012. A projection we think is optimistic, given the performance of Kenya’s export industry, in particular, is likely to be subdued by weak demand from its biggest market, the recession-hit EU.
Notably, the MoF’s growth projection of 5.2% is significantly higher than that of the Ministry of Planning, National Development and Vision 2030 (3.4%). We are projecting growth of 4.6% in 2012, a modest increase from 4.4% in 2011. As we believe the growth is likely to be weaker than the MoF’s projection, we think revenue is likely to underperform in FY12/13. Revenues came in 3% below the revised FY12/13 budget projection, according to the MoF.
The budget deficit projected to move sideways; fiscal consolidation interrupted. The MoF projects a budget deficit of KES279bn (7.2% of GDP, on our estimates) in FY12/13. However, if a domestic debt rollover of KES170.5bn is excluded from expenditures, and an external debt repayment of KES26.2bn is reflected as a financing item, then total expenditure falls to KES1.26trn (33% of GDP) and the deficit decreases to KES250.3bn (6.5% of GDP). This implies a sideways movement in the budget deficit in FY12/13, from the ministry’s estimate of 6.9% of GDP in FY11/12. The budget deficit projection for FY12/13 is thus significantly wider than that projected in the MTBPS (4.3% of GDP) and is contrary to the fiscal consolidation programme.
We think there is upside risk to the FY12/13 budget deficit projection, given that the one-off expenditures on operationalising the devolved governments and on the elections have a high risk of exceeding expectations. Second, dampening economic activity due to the EU debt crisis is likely to weaken growth and thus undermine revenue collections. Third, we do not think the budget’s provision for the elections (KES17.5bn) takes into account the likelihood of a second-round run-off election.
One mitigating factor, in our view, is the likely underperformance of the development expenditure budget, which is typically worse during an election year. Of every KES10 underspent in 8M FY11/12, KES9 was from the development expenditure budget. Execution of development spending can be undermined by poor procurement planning, which we think will worsen in a year when there is expected to be transition in administrations and a change in the structure of the government. We project a budget deficit of 6.0-6.5% of GDP in FY12/13, which we believe will undermine the MTBPS plans to bring public debt down to 41.5% of GDP by FY14/15.
Financing: We a see a reversal in the strategy to move away from domestic borrowing. The government plans to finance 43% of the adjusted FY12/13 budget deficit of KES250.3bn with domestic borrowing (KES106.7bn) and 57% with foreign financing (KES143.6bn). This compares with 27% of the revised FY11/12 budget being financed with domestic borrowing and the remainder with foreign financing.
In 2Q FY11/12, the government elected to shift from domestic borrowing to foreign financing largely because of the sharp increase in local interest rates that pushed up debt servicing costs. This resulted in the share of the deficit financed with domestic borrowing dropping from 51% to 27% in FY11/12. The domestic financing share has increased to 43% in the FY12/13 budget, implying a reversal in this strategy. This explains the 72% increase in domestic borrowing to KES106.7bn in FY12/13, from KES62.1bn in the revised FY11/12 budget.
We think the projected fall in interest rates explains the increased take-up of domestic financing. But we believe the risk of a depressed shilling, partly due to a slowdown in tourism and export-related FX earnings, owing to weak EU demand, will reduce the attractiveness of foreign financing in FY12/13. Therefore, we think there is upside risk to the government’s domestic borrowing projection. We expect public debt to pick up and breach the YE target for FY12/13 of 44.1% of GDP.
Notably, public debt already increased to 46.8% of GDP at 8M FY11/12, from 45.1% of GDP at 1H FY11/12. This increase in public debt/GDP not only undermines the government’s goal of bringing it down over the medium term, but also implies rising yields during FY12/13.
Republished with kind permission from Renaissance Capital. For the full analysis, please contact Yvonne Mhango,