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By Institute of Economic Affairs

1. Key messages 12. Introduction 33. Overviewof budget 2019/20 5

4. Expenditure analysis 85. Revenue analysis 156. Summary of finance bill 2019 17

GUIDEJune 2019

Key messages

From the expenditure side, there is a general signal that through Budget 2019/20, the Government of Kenya is committed to the “Big Four’ economic plan. Two points explain this fact. First, at least budgetary allocation is in line with priorities aligned to the Medium Term Plan III and indeed to the enablers of the big four projects. Secondly, overall fiscal deficits as a ratio of GDP narrowed by 1.3 percentage points in the period 2017/18 to 2018/19.

However to follow through on the fiscal consolidation agenda whose aim is to increase room for additional resources for improved service delivery, the government and the legislators should note the following:

Fiscal discipline: Efforts to contain expenditure and comply with fiscal responsibility principles

• Government did not adhere to approved Budget Policy Statement (BPS) ceilings as budget estimates went up by 4.3% (Ksh 80 billion). The journey to staying on the path of fiscal consolidation agenda start with keeping deviations between budget estimates and BPS ceilings as low as possible

• Deliberate follow through in implementation of austerity measures by cutting allocation to on non-priority expenditure items is key

• On debt policy management, implementation of Public Investment Management Regulations is welcome in order to ensure that there is proper appraisal, identification and selection of high yield projects to be funded through borrowing and mitigate cost overruns that may lead to contingent liabilities.

• Parliament should oversight borrowing by the government to ensure it is within set out medium term plans and targets.

Efforts to curb public wage bill

• There is need for elaborate collaboration between the national and county Governments to curb public wage bill.

• The National government should make public the strategy and timelines as well as progress reports on its commitment to curb public wage bill through a raft of measures including audit and cleansing of the payroll, integration of payroll system to the IFMIS amidst other staff rationalization measures for them to be held to account by the public.

Budget Highlights 2019/202

Efficiency in spending

• Habitual revision (supplementary) of the budget attributed to poor budget practices (weak link between plans and budgets) is a detriment to fiscal consolidation agenda.

• At the outset there is need enhance capacity on revenue forecasting and temper expected donor funds in order to address cash management and delays in release of funds.

• To enhance up take of development budget for improved service delivery the government should continuously build capacity to synchronize planning and procurement processes as well as address administrative capacity in regular monitoring and reporting of projects.

• Reports by the OCoB and the A-G cast a negative image on Kenya’s expenditure management framework which does not reflect prudence and accountability. Therefore implementation of findings from these reports to inform the budget process is critical to instill prudence in public finance management.

Domestic revenue mobilization

Sustained real GDP is essential in enhancing the ability of the economy to generate revenue for the servicingof the debt; a low inflation rate is key in safeguarding the value of the Kenyan shilling which stabilizes theexchange rate and a low deficit ratio is important in checking the growth of the debt. On this front, measuresto mitigate factors that may undermine economic growth including boost of private sector growth are critical.

Efforts to stimulate economic growth

Proliferation of Funds: Creation of Funds is often seen as a simple solution to address challenge of access to finances, yet it is often not evidence driven, lacks cost effectiveness and necessary feasibility and the implementation framework is done after the Funds have been rolled out. As a consequence this is what led to consolidation of Uwezo Fund and Youth and Women Enterprise Funds.

Revenue mobilization

• Delays in effecting tax policy measures will translate to delays in realizing expected benefits and revenues. To this end, parliament should prioritize fast tracking debate and approval of money bills due to potential they have on impact of service delivery.

• Certain tax related policy measures and actions should be accompanied by clear administrative, financial and implementation frameworks in order to facilitate smooth roll out.

• Unrealistic revenue projections is in part due to lack of appropriate model and skills but it is also driven by the incentive to moderate budget deficits due to government’s appetite to borrow. This calls for public and legislative accountability.

Budget Highlights 2019/20 3

1.0 Introduction

This analysis of Budget 2019/20 interrogates the extent to which it is aligned to the government’s fiscal consolidation agenda (narrowing budget deficits). In particular, it focuses on big ticket expenditure items, how the overall budget will be financed and alludes to overall effect on the “big four” economic plan1 under implementation by government for the period from 2018-2022.

In terms of organization, this analysis first presents an overview of the entire budget, then proceeds with expenditure analysis that looks at issues of mandatory spending and what this means to budget flexibility, implications of public wage bill and a brief on what is expected in terms of sectoral priorities. The final section focuses on how the overall budget will be financed and what this means.

It is expected that this information and analysis will contribute to catalyzing public debate and dialogue on the budget and ignite interest and civil society engagement in monitoring and tracking its implementation as a way of promoting overall transparency and accountability in the use and management of public funds.

1.2 Macro-economic context

Economic performance

Real GDP growth rate went up markedly to 6.3% in 2018 from a dip of 4.9% in the previous year, a clear indication of rebound in economic activities as shown in table 1. This growth was driven by significant recovery of agricultural output which increased from 1.6% to 6.4% from 2017 to 2018. Improvement in the agricultural performance sector which contributed 34% to GDP in 2018 was buoyed by favorable weather conditions.

Equally and contributing about 8% to GDP in 2018, the manufacturing sector’s growth picked up while that of the service sector which accounts for over half of GDP performance remained resilient. Of note is that performance of the service sector was mixed. For example, accommodation and restaurant in the service industry posted the highest growth, 17% with tourist arrivals for the first time hitting the 2 million mark. On the contrary finance and insurance services slowed down. Political calmness and improved business environment as well as household consumption were the other factors attributed to recovery in economic performance.

Table 1: Macroeconomic Indicators

2013 2014 2015 2016 2017 2018

Real GDP growth rate (%) 5.9 5.4 5.7 5.9 4.9 6.3

Agric. growth rate (%) 5.4 4.4 5.3 4.7 1.6 6.4

Mnfg. growth rate (%) 5.6 2.5 3.6 2.7 0.2 4.2

Services growth rate (%) 5.4 6.0 6.4 6.5 6.2 6.3

Real GDP per capita - (Ksh) 87,261 89,430 91,989 94,797 96,788 100,310

Population growth rate (%) 2.7 2.9 2.8 2.7 2.6 2.6

Avg. Annual Inflation rate (%) 5.7 6.9 6.6 6.3 8.0 5.7

Treasury Bill rates (nominal) % 9.4 8.6 10.4 8.6 8.1 7.5

Exchange rate (Kshs/USD) 86.3 90.4 102.2 102.1 103.1 101.9

Trends in Formal Employment share (%) 17.5 17.3 17.2 16.8 16.6 15.7Source: KNBS Various issues of Economic Surveys

1This plan by the government targets to create jobs and transform lives through value addition in the manufacturing sector, food security and nutrition, universal health care coverage and provision of at least 500,000 affordable new homes by 2022.


Inflation: Overall average annual inflation in 2018 eased to 5.7% from 8% in 2017 owing to general decline in food and energy prices thus remaining largely within the 5% upper bound target (+2.5). However in the course of early 2019 monthly inflation stood at 6.6% in April compared to 4.4% in March owing to significant rise in food inflation. Additional risks to the 2019 inflation outlook may manifest in high energy prices owing to residue effect of implementation of 8% VAT on petroleum products and from any unexpected rise in oil prices which in total would erode purchasing power, thus reduce consumption and in turn put breaks on economic growth.

Exchange rate: In the second half of 2018, the shilling continued to show less volatility and was relatively stronger against not only the dollar but also against the Euro and the Pound Sterling. Appreciation of the shilling was on the back of increased diaspora remittances and improved export earnings from tea and horticulture. CBK notes that the foreign exchange market has remained stable supported by a narrowing current account deficit, 4.5% in the 12 months to April 2019. Conversely foreign exchange reserves in May 2019 stood at 6.4 months of import cover buoyed by successful issuance of the third Eurobond of USD 2.1 million. Two factors, namely loan repayments and dismal trade performance may weaken the shilling going forward. Thus increased investment towards diversifying our export base through value addition in manufacturing is in part critical to forestalling this threat to the exchange rate.

Interest rate: The Central Bank of Kenya (CBK) has maintained the Central Bank Rate (CBR at 9% for the better part of 2018 and up to May 2019 as a signal for expansionary monetary policy. To this effect, the average 91-day Treasury Bills rate declined to 7.5% in December 2018 compared to 8.1% in December 2017. On a related point, the CBK shows that despite interest rate capping, private sector credit growth has picked to over 4% between April and May 20192. Nevertheless this may be disrupted in the latter part of 2019/2020 contingent of whether repeal of the capping goes through or not.

Employment: Unemployment rate in Kenya is 7.4% according to KIHBS 2015/16. There are doubts from the public that this is too low and that it is not a true reflection of the reality on the ground. In fact 2018 recovery in economic growth raised similar doubts from both the public and the media. On the contrary these groups felt that cases of layoffs have been on the rise hence this scenario was dubbed “growth without jobs”. However the trickle-down effect to various sectors of the economy is often associated with sustained high economic growth rate for a consistent number of years. For the last six years, GDP growth rate has averaged 5.7%, not substantially high enough. This is what perhaps explains this scenario of growth without jobs. Secondly, Kenya has a large informal sector, where increasingly over 80% of jobs are created. Jobs in the informal sector are characterized by low wages, poor terms and low job security and tenure. This is what explains the narrow tax base in the country.

Overall, the Government projects the economy to grow by 6.2% in 2019 as the anchor to the budget framework for 2019/20. Given that stable weather conditions are a driver to economic growth through agricultural production, delayed rains in between March to April, albeit rains that we are experiencing in latter part of May could dampen growth projection. Besides the Leading Indicators report3 for the first quarter 2019 already shows decline in tea production and vegetable exports. Among other issues, rise in pending bills (amounted to Ksh 29.3 billion in 2017/18 for the national government and Ksh 108.41 billion, approximately)4 and access to credit especially for the small and micro enterprises may curtail private sector activity due to cash crunch thus slowing demand which may dampen economic growth. Besides revenue collection will equally be slowed.The Cabinet Secretary (CS) for the National Treasury through the Budget Statement 2019/20 recognizes the need for measures to insulate the economy against shocks for it to continue on a growth trajectory as the basis for the budget framework for 2019/20. In addition, he makes a number of proposals towards unlocking private sector growth as a driver for job creation to stimulate growth.

2CBK Monetary Policy Statement May 20193https://www.knbs.or.ke/data-releases/#4This is according to the 2nd quarter National Treasury Quarterly Economic and Budgetary Review 2018/19 and Annual Office of Controller of Budget County Government Budget Implementation Review Report 2017/18.


2.0 Overview of Budget 2019/20

Table 2 captures an overview of government of Kenya (GoK) budget for 2019/20. In absolute terms the proposed budget outlay for GoK in 2019/20 is Ksh 3.09 trillion up by 1.5% from the revised budget in 2018/19. However in relative terms and as a percentage of GDP, the proposed budget for 2019/20 reduced by 2.6 percentage points from the previous financial year.

It is commendable that this marginal reduction of the budget relative to the size of the economy (GDP) is a hint of government commitment towards fiscal consolidation agenda. Nevertheless this may not be followed through because of habitual revision of the budget (supplementary budgets) during implementation which often leads to increase in expenditure.

Revised 2018/19 Ksh Billion Estimates 2019/20 Ksh Billion % Change

Revenue

Total Revenue 1,901.10 2,154.70 13.34

Ordinary Revenue 1,852.60 2,115.90 14.21

Grants 48.50 38.80 -20.00

Expenditure

Total GOK budget/Expenditure 3,046.56 3,092.01 1.49

Discretionary 2,083.96 2,286.21 9.71

National Executive 1,654.53 1,841.30 11.29

Judiciary 16.09 18.88 17.34

Parliament 35.14 43.63 24.16

Table 2: Budget Overview, 2019/20

On these proposal noted in the Budget Statement, the Institute of Economic Affairs (IEA) – Kenya makes the following observations:

(i) On unlocking cash flow and liquidity for manufacturers and business community, the National Treasury has prioritized Ksh 10.9 billion of the verified pending bills to be settled before end of June 2019. First, there is need for a policy to address the recurring challenge of pending bills with regards to ensuring it forms a first charge to the Consolidated Fund. At the same time, there should be disclosure of the value of total pending bills and the medium term plan of how these arrears will be cleared. Observing fiscal discipline going forward including adhering to budget commitment controls (alignment of procurement plans to cash flow plans) is key to reducing pile up of pending bills.

(ii) On the national government commitment to pay suppliers within a maximum of 60days, a framework for collaboration with the county government will be key to the success of this commitment in order to fast track payment to suppliers. Besides this will not work without promptness in exchequer releases to the County government

(iii) Proliferation of Funds: The proposed consolidation of three affirmative action funds into one Biashara Kenya Fund to increase efficiency and eliminate overlaps is welcome. However, creation of Funds seems not to be evidence driven in terms of their cost effectiveness and neither is the operationalization of these Funds accompanied by prior implementation framework and regulations as well as appropriate monitoring and evaluation. Lack of these processes is what consequently leads to low uptake, policy incoherence and reversals among other challenges.


5 The total amount that will be allocated to the County government will only be known after approval of the Division of Revenue Bill currently under Intergovernmental Budget and Economic Council mediation.

County Governments 367.40 371.60 1.14

Contingency Fund 5.00 5.00 0.00

Equalization Fund 5.80 5.80 0.00

Non-Discretionary 962.60 805.80 -16.29

Consolidated Fund Services (CFS) 962.60 805.80 -16.29

Deficit Financing

Total deficit 607.90 607.80 -0.02

External Commercial Financing 298.90 213.10 -28.71

Project Loans 235.80 240.60 2.04

Programme Loans 2.50 2.00 -20.00

Foreign Repayments -250.30 -131.40 -47.50

Domestic Borrowing 317.10 289.20 -8.80

Domestic Financing Other than Borrowing 3.90 -5.70 -246.15

Table 2 also captures the different components of the proposed budget for 2019/20 compared to the revised budget for 2018/19 split broadly into discretionary and non-discretionary (mandatory) budget items. In addition it an overview of how the budget is to financed is also reflected in the table 2 but this will be discussed in the final section of this brief .

Translating part of table 1 provides an illustration of how the overall budget (see Figure 1) is proposed to be spent among the three arms of government at the National government level and separately for County governments. In addition the budget share for the Consolidated Fund Services (CFS)-mandatory expenditure and Contingency Fund at the national government level is also captured.

Compared to the budget for 2018/19 this proposed pattern of how expenditure will be split is more or less similar. The Counties will take 12% of the overall budget for 2019/20 whereas the combined estimated expenditure for both parliament and Judiciary constitute 2% of this budget. The difference from the previous financial year to what is proposed for 2019/20 is that the budget share to the national executive of about 60% is more by four percentage points. Conversely, the budget share to the CFS reduced from 32% in 2018/19 to 26% in 2019/20.


Figure 1: Total Expenditure allocation, 2019/20

Source: National Treasury | Budget Estimates, April 2019

Although debt service payment component of the CFS has been driving rise in spending in the recent past, at this point it is evident that for 2019/20 the culprit is the national executive. This is contrary to calls for the need to downsize the national public sector in compliance with principles of fiscal discipline.

Furthermore and from a technical point of view, about 88% of this budget will remain at the National Government level. This denotes that despite increasing public interest in County Government budgets, public accountability of the National Government spending and management of funds for public service delivery is imperative.

Figure 2: Economic Classification of the national expenditure 2018/19 (Ksh 1.65 Trillion) – 2019/20 (Ksh 1.84 Trillion)



Presented in a different way and with a focus on the national government budget, economic classification of the expenditure shows how funds are to be spent (in salaries, as transfer payment to parastatals, and so on) which is crucial for accountability of budget management. Both charts to a large extent follow a similar pattern of breakdown in the national budget for the two financial years.

Salaries and wages to public officers through compensation to employees and current transfer to government agencies dominate the budget, taking slightly over a half of Ksh 1.84 trillion in 2019/20. What is noticeable is the increase in current transfers to government agencies/state corporations’ budget share from 26% to 28% between 2018/19 and 2019/20. This is what explains the substantial rise in national executive budget. It is safe to conclude that almost 45% of the total national budget will go to payment of salaries putting to question government efforts to contain growth of public wage bill

Capital investment for infrastructure related projects and operations and maintenance (use of goods and services) which is critical for service delivery accounts for 22% and 9% of the 2019/20 national budget respectively. This is what determines the extent to which we will realize national priorities and development needs including the big four agenda.

3.0 Expenditure Analysis

The following section looks at the big ticket spending areas and their implication on Budget 2019/20. Part of the analysis looks at the implication of CFS as mandatory expenditure and the public wage bill in an attempt to interrogate whether anticipated expenditure is in line with the medium term fiscal consolidation path.

Furthermore, this brief analyses allocation to MDAs organized by the different sectors in order to understand the shift and focus of spending in 2019/20 and whether in line with approved Budget Policy Statement 2019.Generally government expenditure in absolute terms has persistently been on an upward trend since 2013/14 to 2018/19 owing to rise in spending used to close infrastructure gap (SGR, roads, energy projects) and for debt service payment. However, spending in relation to GDP eased off towards 2017/18 and 2018/19 resulting to narrowing of budget deficits from 7.8% to 6.5% of GDP (see figure 3). As noted earlier, this implies a hint of government’s commitment to fiscal consolidation agenda that is however in part attributed to growth in the size of the economy.

Figure 3: Trends in the budget deficit as a % to GDP and evolution of public debt (RHS chart)


The approved Budget Policy Statement projects that for 2019/20 deficits will reduce further to 5.6% of GDP towards fiscal consolidation path. Staying on this path was premised on the budget estimates matching approved ceiling but they are however above by 4.3% (Ksh 80 billion). Besides as earlier noted, routine budget revisions (in 2018/19 there were three supplementary/revised Budget) may end up increasing actual recurrent spending further derailing the country from this fiscal consolidation path. For example, in 2019/20 this may arise from the census exercise and the need to import food to cover shortages due to delayed rains. Moreover to ensure that government commitment to realization of the EAC fiscal deficit target of 3% by 2022/23 more deliberate efforts in undertaking austerity measures will be required.

Years of expansionary fiscal policy have led to increased government borrowing which as a consequence has resulted to steady rise of Kenya’s stock of debt as depicted by figure 3. The period 2012 to 2018, saw a surge in stock of debt almost four fold from Ksh 1.5 trillion to Ksh 5.28 trillion. As a ratio of GDP, public debt rose from about 42.1% to 59% in the same period. Although debt as a percent of GDP has somewhat stabilized in the last two financial years of 2017/18 and 2018/19 the pace at which we have accumulated debt is worrisome.Further assessment of the structure and composition of Kenya’s public debt portfolios reveals an “unhealthy” public debt mix. External debt to domestic debt ratio changed from 59%:41% in 2002 to 51%:49% in 2018 against medium term debt strategy target mix of 60%:40%. Increased borrowing from domestic market not only crowds out private sector but also destabilizes interest rates.

Conversely Kenya’s graduation into a lower middle income country has limited our access to concessional funding. To this end, significant portion of external debt is increasingly non concessionary and market/commercial based. For example, about 34% of total external debt is commercial based. Kenya has made forays in the international markets to refinance our external debt. With the most recent one being in May 2019 where the government successfully issued a USD 2 billion Eurobond III whose proceeds are expected for development infrastructure, general budgetary expenditure and refinancing earlier bond of Ksh 75 billion? This came in the wake of Eurobond II of USD 2 billion (USD 1 billion @ 7.25 for 10 years and USD 1 billion @ 8.25 for 30 years) that was issued in March 2018. Overall these events have not only raised the costs (reduced average maturity period for both domestic debt and external debt and high interest rates) but also increased attendant risks. This is manifest in table 3 of the CFS trends. It captures items or expenses which are a first charge to the Consolidated Funds and it is largely driven by debt service payment. The other notable CFS expenses are payment of pension’s obligations.

Item 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 % age

Public Debt Servicing 331.17 324.92 417.20 466.51 649.40 870.62 696.6 -20.00

Pensions 28.15 32.36 43.00 55.69 71.90 86.25 104.5 21.14

Salaries & Allowances 3.72 4.07 4.44 4.00 4.15 4.19 3.96 -5.44

Miscellaneous Service 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.00

Subscriptions to Int'l Org's <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 0.00

Guaranteed Debt 1.18 1.01 0.94 1.02 1.29 1.37 0.64 -0.53

Total 364.35 362.49 465.71 527.35 726.86 962.56 805.8 -16.3

% Total Public Spending 23.20 24.64 19.81 21.09 27.50 31.94 26.06

Table 3: Trends in Consolidated Fund Services (CFS), Ksh billion

Source: Various issues of Estimate of Recurrent Expenditure


As shown in the table 3, debt service payment increased from Ksh 331 billion in 2013/14 to a peak of Ksh 870.6 billion in 2018/19, a growth of 163%. In 2018/19, out of every Ksh 100 that was set aside as mandatory payments at least Ksh 90 was used for public debt service payment. Furthermore, findings also show that public debt servicing relative to total government spending has been increasing; from 23.2% to 31.94% over the five year period.

Of importance to note is the reduction in debt payment by 20%, from Ksh 870.6 billion in 2019/20 to Ksh 696.6 billion in 2018/19 which is a welcome relief for taxpayers. Although interest payment will increase from Ksh 399.98 billion to Ksh 441.5, repayment of principal will significantly drop by almost a half from Ksh 470.6 billion to Ksh 255.1 billion. This is explained by a number of maturing loans including the syndicated loan and international sovereign bond as well as debt rescheduling. Overall this will create some fiscal space to allow funds to be channeled to other priorities.

Debt Sustainability

Although the government insists that our debt remains manageable, there are however questions about our debt stress levels given how fast debt has been rising. On this point coupled with rising debt servicing costs are concerns about debt sustainability6. The latest Debt Sustainability Analysis report for Kenya by IMF which is based on rating assessment using four key liquidity indicators as shown in table 4 indeed confirms that Kenya’s debt is sustainable. The first indicator of present value (PV) of public debt for the period 2016 to 2019 projections is below the threshold of 70%.

Nevertheless the assessment reveals symptoms of debt distress especially in terms of debt servicing costs in relation to both revenue and exports. Moreover overall analysis shows that our debt risk level has increased from low to moderate especially in meeting payment obligations that are falling due.

Table 4: Debt Sustainability Assessment, October 2018

Indicator Threshold (%) 2016 Act. 2017 Est. 2018 Proj. 2019 Proj.

PV of public debt to GDP ratio 70 50.6 55.4 60.6 59.9

PV of public debt to revenue ratio 300 275.9 285.0 299.6 292.9

Debt service (Total) to revenue ratio 30 36.3 42.7 44.8 49.4

Debt service (External debt) to exports ratio

21 9.0 16.5 19.9 26.2

Overall risk level Low low moderate moderate moderate

6 Debt sustainability- is the ability of a country to meet future payment of debt obligations but still be in a position to access more credit/ without disrupting its budget implementation/without requiring debt relief or accumulating arrears (The National Treasury, 2019)

Source: IMF Country Report No. 18/295, October 20187

Public wage bill

Statistics from the KNBS show that public sector wage bill rose from Ksh 413.4 billion in 2014 to Ksh 604.3 billion in 2018. In the period 2017 to 2018, the highest rise, by 12.1% in the wage bill was recorded by MDA including Judiciary, Parliament and Independent Offices (from Ksh 108 billion in 2017 to Ksh 121.1 billion). Overall public sector wage bill was attributed to both increase in number of employees and rise in average

7 https://www.imf.org/~/media/Files/Publications/CR/2018/cr18295.ashx


wage earnings per employee. For the five year period of 2013 to 2018, average wage employment grew by 18.1% while average earnings per employee went up by 36.5%. At the County government level in 2017/18, only 15 Counties had adhered to the fiscal responsibility principle of maintaining their wage bill to less of equal to 35% of their total revenue.

Non-priority spending

The national government level spent Kshs.8.6 billion spent on domestic travel, Kshs.6 billion on rentals and rates for non-residential buildings, Kshs.4.8 billion on hospitality, Kshs.3.6 billion of foreign travel and Kshs.3.3 billion on legal fees and arbitration by the end of 2017/18. All these expenditure items accounted for about 3% of recurrent spending in that year.

8IFMIS –Integrated Financial Management Information System

Given the above scenario, the CS for National Treasury outlined various bold actions towards containing expenditure for 2019/20 that will go further to reduce the deficit. To this end, the IEA-Kenya notes the following:

• Certainly containing recurrent expenditure through the proposed streamlining of public sector by limiting recruitment to key personnel, extension of service for those soon to retire after 60 years, cleansing of the payroll and expediting migration of payroll system to IFMIS8 Human Resource module is indeed long overdue. If indeed the government is committed to undertaking these actions, they need to publicize progress report and timelines in which they can be held to account.

• Both the Office of the Controller of Budget (OCoB) and the Auditor General (A-G) have raised questions regarding rise in domestic and foreign travel spending as well spending in fuels. Expenditure in these areas is not only used as an avenue to augment public servants incomes, often at inflated rates, but also lacks supporting documents especially for foreign travel as flagged by in the A-G reports. Therefore, the proposal for government transport policy that will utilize electronic system to cut cost may be a useful approach. However there are questions and gaps around feasibility of the systems, its procurement and details of how it will be implemented.

• There was no mention of implementation of Capacity Assessment and Rationalisation of Public Service (CARPs) report as well rationalization of parastatals (take up nearly a quarter of the entire national government budget) yet significant resources were used to come up this report. In fact lack of reference to such exercises may contribute to wastages in resources or raise value for money question.

• Parliament should oversight borrowing by the government to ensure it is within plans set out in the medium term debt strategy.

• Proper appraisal and approval process should inform selection of projects to be funded through borrowing to ensure high yield and mitigate cost overruns that may lead to contingent liabilities. Therefore Public Investment Management Regulations are welcome in debt policy management. This is important in regard to ensuring that there is proper link of debt to investment.

• In the short to medium term debt renegotiation on the terms and conditions of existing loans should be explored towards stretching repayment periods balanced by refinancing of debt from commercial loans with loans that have favorable terms.


3.1 Sectoral Priorities

This section looks at anticipated change and shift in sector priorities by the government in 2019/20 relative to 2018/19. It also provides a high level assessment of whether the focus is aligned to Medium Term Plan III 2018-2022. From the two top charts in figure 4a, the total MDAs budget including the judiciary and the legislature is anticipated to increase from Ksh 1,705 billion in 2018/19 to Ksh 1,902.9 billion in 2019/20, representing 11.6 % growth.

Specifically for the MDAs excluding the Judiciary and the legislature out of an estimated budget of Ksh 1.84 trillion, about 63% will be used for recurrent expenditure and the balance 37%, amounting to Ksh 684.1 billion will used for capital projects. Notably, about 42% of total development expenditure will be donor financed. On this point, heavy dependence on external funding invariably has implication on implementation that often leads to delays in completion of projects as will be discussed later.

On one hand the Teacher Service Commission under the Education sector, the National Treasury and the State Department of Interior under Public Administration and International Relations (PAIR) sector and Defense under the National Security sector account for the bulk, over half of recurrent budget. On the other hand about a half of the development budget will go to the infrastructure related sectors including the Energy, Infrastructure and ICT and the Ministry of Water and Sanitation.

National government investment priorities in 2019/20 by sectors have not changed but remained largely similar to those in 2018/19 with bulk of the budget, 26% allocated to the education sector. This is followed closely by Energy, Infrastructure and ICT and at a distant third by the PAIR sector with 23% and 15% budget shares respectively.

Figure 4a: Sectorial Classification of the national budget, 2018/19 – 2019/20



Figure 4b: Percentage Change in the Sectorial Budget allocation, 2018/19 – 2019/20


The third chart in figure 4b shows that in 2019/20 the national government will significantly shift its focus to the social protection, culture and recreation sector on the basis of budgetary allocation. The budget to this sector is anticipated to go up by 30% compared to the previous approved budget. Most of the additional allocation to this sector will go to the State Department of Sports to among other things be used for refurbishment of sport facilities. The other big component will be used for social protection and pension obligations.

With the exception of the general economic and commercial affairs sector, the rest of the other sectors are expecting positive increase in budget allocation with the other top three being the PAIR and Environment protection, water and natural resources.

Reports show that the budget for the Big Four projects earmarked for 2019/20 is Ksh 450.9 billion accounting for 14.6%. Out of this budgeted funds, Ksh 76.7 billion will go to the drivers or projects in agriculture towards food and nutrition security, affordable housing and universal health coverage. Moreover and as seen from the investment priorities the larger part Ksh 374 billion will be going to the enablers of the Big Four including investment in following areas, quality education, infrastructure and technology development, security and in governance.

Budget Credibility and Execution

Beyond allocation, budget implementation is critical to public service delivery outcomes. As such, the question of public expenditure management, that is, how to improve efficiency in public spending and reduce wastages is pertinent to the government. On this point the government has over the years routinely struggled with the challenge of low uptake/absorption particularly of the development budget.

By the end of six months into 2018/19, about Ksh 55.2 billion was not spent by MDAs out of a target total expenditure of Ksh 1.13 trillion9. This underperformance was mainly with regard to domestic and foreign payment, wages and salaries, pensions, operation and maintenance and AiA. Quarterly reports from the Office of the Controller of Budget indicate that the National Treasury did not consider budget performance in

9National Treasury 2nd Quarter Economic and Budgetary Review 2018/19


preparation of supplementary budget 1 which resulted in reduction of some budget provisions below the level of expenditure already incurred which affected implementation.

On the other hand, looking at budget implementation for 2017/18 the same challenge of low uptake especially for development budget, on average 71% was noted. The main culprits, those whose absorption rate was below the average rate included, health, general economics and commercial affairs and energy, infrastructure and ICT in that order from the lowest. Another big challenge for 2017/18 and common in past budget performance is delay in release of funds to the MDAs by the National Treasury. On this point, actual exchequer issues for both recurrent and development expenditure affected implementation of planned activities. The situation was made worse by the frequent IFMIS downtime which affected timely access of funds and processing of payment.

Figure 4c: Absorption rates by sectors, 2017/18

Source: Controller of Budget

Investment in infrastructure development to unlock growth potential is an enabler of the big four plan. Therefore poor absorption of funds undermines realization of some of the big four initiatives and in particular projects in manufacturing, agriculture and health sectors. In this regard the IEA-Kenya recommends lasting action in relation to moderating expected donor funds, focusing spending on the on-going projects as a priority and improvement in administrative capacity in regular monitoring and reporting of projects to address delays in release of funds.

Other implementation challenges that may impact negatively on service delivery have also been pointed out in the A-G reports. In particular, in the health sectors, the leasing of medical equipment project whose purpose is to scale up health infrastructure development especially for specialized health treatment is already facing numerous implementation challenges. The A-G reports for County governments have pointed out that some of the equipment under the leasing of medical equipment project are lying idle in some Counties due to various reasons including: lack of power and/or personnel to run them, or even completely unused due to lack of space.


By and large value for money questions have been associated with this project whose initial objective was to create fiscal space to meet other health needs. It is therefore important that parliament factors findings from the A-G reports in their scrutiny and approval of the budget to deter wastage of public resources.

4.0 Revenue Analysis

The BPS 2019 notes that the budget framework for 2019/20 will be underpinned by on-going fiscal consolidation agenda which aims at narrowing budget deficit so as to stabilize Kenya debt position and provide some flexibility for fiscal policy interventions. This brief therefore attempts to interrogate how enhancement of domestic revenue mobilization can support medium term fiscal consolidation plans as noted in the BPS. The Budget Summary shows that the Budget 2019/20 is to be financed through domestic revenue including AiA of Ksh 2,115.70 billion (19.7 % of GDP) of which ordinary (tax) revenue is projected at Ksh 1.877.20 billion. Part of this amount is expected to come from additional Ksh 37 billion that will be generated from the taxation proposals mentioned by the CS, National Treasury (see summary of the Finance Bill, 2019 annexed). Thus total revenue including expected grants of Ksh 38.8 billion works out to Ksh 2,154.7 billion. This information is captured in table 1 of this brief.

Realization of projected revenue is predicated on economic growth and on-going reforms in tax policy and administration measures. However for the last decade government has missed its revenue targets often due to setting of unrealistic projections. For example, six months into the financial year 2018/19, total revenue performance was 7.1% short of target, that is, Ksh 794.7 billion against a target of Ksh 855.7 billion despite rise in collection by 10% over the same period in 2017/18 . The biggest underperformance was with income tax other than PAYE, excise duty and trade taxes as well as VAT on imported goods and services.

Although revenue performance has been on an upward trend in absolute terms, it has however stagnated as a ratio of GDP, oscillating between 18.5% and 19.5% for the period 2014/15-2018/19. This points to the fact that without significantly broadening the tax bracket domestic resource mobilization through taxation may be reaching it limits.

Deficit financing options

From table 1, given that projected revenue are not enough to meet estimated expenditure, the expected deficit is Ksh 608 billion. This will be financed through domestic borrowing of Ksh 289 billion and and external borrowing of Ksh 324 billion reflecting a ratio of 47%:53%. Despite a reduction in external commercial loans in keeping diversification of deficit financing option, there is need to increasingly limit domestic borrowing so as not to crowd out the private sector thus affect overall savings and investment due to squeeze on private sector credit.

The following are additional emerging issues in relation to revenue projections for 2019/20;

• Any shock to economic outlook especially from slowdown in agricultural production, inflationary pressures and private consumption will affect revenue collection as projected owing to the strong positive correlation with economic growth. Therefore policy interventions to mitigate against such shocks are imperative.

• Over optimistic domestic macro-fiscal projections and increasing spending levels have contributed to a high fiscal deficits. On one hand this if attributed to lack of appropriate revenue forecasting tools/model

10National Treasury (May 2019) Quarterly Economic and Budgetary Review, 2nd Quarter for the FY 2018/19

11Comprises commercial financing of Ksh 298.9 billion, project loans of Ksh 235.80 billion, programme loans of Ksh 2.5 billion and foreign repayment of Ksh (250.3 billion)


and skills but on the other hand unrealistic projections are driven by the need to artificially reduce the deficit due rise in borrowing appetite to meet expenditure pressures.

• Delays in effecting anticipated tax policy measures and incentives as proposed in the Finance Bill, 2019, for instance the rebate on deduction 30% of total electricity bill from corporate profits as well as the formation of a Committee to clear VAT refunds will in turn lead to delays in expected benefits.

• Low performance in VAT and income tax affects overall domestic revenue mobilization as they comprise about 70% of total tax revenue (see chart above). It is therefore important that the government reviews the exemption regime of both VAT and corporate tax which are often obfuscate but also not always serving their intended purposes of equity and incentivizing businesses.


Annexe: Summary of Finance Bill, 2019

A. Income Tax Proposals

The Income Tax Bill is soon to be tabled in parliament. Its intention is to modernize income tax legislation by simplifying tax compliance as well as alignment of income tax regime to international best practice so as to boost revenue mobilization.

• Proposed Amendments to the Income Tax Act (ITA) to initiate:o Exempt registered youth members into the Ajira Digital Program and who pay a registration fee of Ksh 10,000 from regular taxation for a period of 3 years with effect from January 2020.

• Enhance equity and fairnesso Increase capital gains tax rate on transfer of property from 5% to 12.5%o Exempt from CGT the transfer of property that is necessitate by restructuring of corporate entities for enhanced efficiency and market penetration

• Broaden tax baseo Expand scope of application of withholding tax (WHT) to cover services including security services, cleaning and fumigation services, catering services offered outside hotel premises, transportation of goods excluding air transport services, sales promotion, and marketing and advertising services.o Introduce measures to tax income generated from the digital economy

• Tax incentive to boost green economyo Lower the corporation tax rate for investors in plastic recycling plants to 15% for the first 5 years

• Tax amnesty o Tax amnesty on penalties and interests on outstanding taxes for SMEs listed on the Growth and Enterprise Market Segment (GEMS) on the Nairobi Securities Exchange (NSE) two years prior to listing

B. Value Added Tax Proposals

o Reduce VAT withholding tax from 6% to 2%o Amend the current VAT refund formula per the VAT regulations for the determination of the amount of refund payable to taxpayers who supply both Zero rated and standard supplies.o Exempt from VAT locally manufactured computer motherboards and all inputs used in their manufacture.o Exempt from VAT all services and inputs for use in the set up and operation of plastic recycling plantso Exempt VAT to all services offered to plastic recycling plants and supply of machinery and equipment used in the construction of these plants

Key message

The first two VAT proposals are intended to address cash flow constraints faced by exporters and suppliers, thus stimulating private sector growth. Other proposal are aimed at a mix of things, protection of local manufacture and promotion of green economy.


C. Import Duty Proposals

o Retain ad valorem rate of import duty to 25% on iron and steel productso Grant stay of application of import duty rate of 25% on paper and paper boards for another one year periodo Reduce import duty on raw timber from 10% to 0%o Retain ad valorem rate of import duty of 25% on timber and furniture industry.o Reduce Import Declaration Fee (IDF) on intermediate goods and raw materials from 2% to 1.5% and an increase of the IDF rate on finished goods from 2% to 3.5%.o Increase Railway Development Levy for finished products from 1.5% to 2%o Impose export levy of 10% on tanned and crust hides and skins

Key message

Most of the import duty proposals are geared towards protecting the local industries mentioned (timber and furniture, steel, and paper industries) from unfair competition, spur the manufacturing sector and create jobs. There are debates about protectionism policy and questions around whether for example; the steel industry meets local demand. Although protectionism tendencies lead to job creation in the short run, they end up weakening competitiveness in the long run.

D. Excise duty proposals

Item New Rate Old Rate IntentionBetting stakes 10% 0% Overall aim is to boost tax revenue

but at the same time deter consumption of harmful goods and services as well as promote protection of the environment (correcting negative externalities). To safeguard against loss of revenue due to inflation the CS, National Treasury clarified that adjustments would be effected on 1st October of every year.

Cigars, cheroots, cigarillos, containing tobacco or tobacco substitutes

Ksh 12,098 per Kg Ksh 10,000 per Kg

Electronic cigarettes Ksh 3,629 per unit Ksh 3,000 per unit

Cartridge for use in electronic cigarettes Ksh 2,420 per unit Ksh 2,000 per unit

Cigarette with filters (Hinge lid and soft cap) Ksh 3,025 per mille Ksh 2,500 per mille

Cigarette without filters (plain cigarettes) Ksh 2,177 per mille Ksh 1,800 per mille

Other manufactured tobacco and manufactured tobacco substitutes; “homogenous” and “reconstituted tobacco”; tobacco extracts and essences

Ksh 8,469 per Kg Ksh 7,000 per Kg

Wines including fortified wines, and other alcoholic beverages obtained by fermentation of fruits

Ksh 181 per litre Ksh 150 per litre

Spirits of under natured ethyl alcohol; spirits liqueurs and other spirituous beverages of alcoholic strength exceeding 10%

Ksh 242 per litre Ksh 200 per litre

Imported motor vehicles of cylinder capacity exceeding 1500cc 87.04

25% 20%

100% electric powered motor vehicles of tariff 10% 20%


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The Institute of Economic Affairs is a civic forum which seeks to promote pluralism of ideas through open, active and informed debate on public policy issues. It is independent of political parties, pressure groups and lobbies, or any other partisan interests.

© 2019 Institute of Economic Affairs

Public Finance Management Programme5th Floor, ACK Garden HouseP.O. Box 53989 - 00200 Nairobi, Kenya.Tel: +254-20-2721262, +254-20-2717402Fax: +254-20-2716231Email: [email protected] Website: www.ieakenya.or.ke

Written by:John MutuaRaphael MuyaNoah Wamalwa

Board of Directors:1. Charles Onyango-Obbo - Chair2. Raphael Owino3. Albert Mwenda4. Geoffrey Monari5. Sammy Muvellah6. Brenda Diana Okoth

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