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<p>PUBLIC DEBT IN KENYA THE BENEFIT TO THE COUNTRY </p> <p>A SEMINAR PAPER PRESENTED BY JUSTUS MUSILA</p> <p>ACKNOWLEDGEMENTI wish to acknowledge my supervisor Dr Omboi Bernard for his articulate professional guidance and patience with my pace during this study. May you enjoy the blessings of God as you guide many more students in this University. I would also like to acknowledge my classmates for the encouragement and support we have found in each other during this period.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>2</p> <p>DEFINATION OF KEY TERMSDefinition of Key Terms Debt Overhang A hypothesis which states that current stock of external debt will slow down the economic growth Bilateral agencies These are governmental agencies in a single country which provide aid to developing countries External debt External debt (or foreign debt) is that part of the total debt in a country that is owed to creditors outside the country. The debtors can be the government corporations or private households. Liquidity constraint A hypothesis which states that an increase in external debt servicing leaves less avenues for developing countries to service their debt. Multilateral lenders Multilateral lenders consist of the International Monetary Fund, the World Bank, the regional development banks (RDBs, which include the Inter-American Development Bank), and other smaller institutions. Multilateral lenders offer concessional finance and aid as well as finance at non concessional ratesalthough in general these rates are still lower than market rates paid on commercial debt.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>3</p> <p>ABBREVIATIONSCBK- Central Bank of Kenya DGIPEDepartment of Government Investments and Public Enterprises DMD-Debt Management Department DMO-Debt Management Office DSA- Debt Sustainability Analysis ERD- External Resources Department MoFMinistry of Finance GDPGross Domestic Product HIPC- Heavily Indebted Poor Countries IDAInternational Development Association IMF- International Monetary Fund MDRIMultilateral Debt Relief Initiatives PRSPPoverty Reduction Strategy Paper WB- World Bank</p> <p>Public debt in Kenya - The benefit to the country</p> <p>4</p> <p>EXECUTIVE SUMMARY This paper covers studies on the level of public debt, composition of</p> <p>public debt and the effect of public debt in the country. The benefit of public debt in the country has been interpreted in terms of the economic gains attributable to public debt. The paper has explored the benefit of public debt in line with both debt overhang and liquidity constraints hypothesis. necessarily increase economic development, the proper utilization may minimize the debt overhang and liquidity constraint hypothesis. Also it proposes that a sound policy framework and debt management strategy is key to debt sustenance. composition of public debt from June 1996 to June 2010. The paper has also considered the theoretical and empirical literature on the effect of public debt on economic growth in line with debt overhang and liquidity constraint hypothesis. There is also a consideration of the effectiveness of the public debt management strategies.Public debt in Kenya - The benefit to the country 5</p> <p> This seminar paper proposes that though public debt does not</p> <p> This paper has reviewed literature on public debt history, the level and</p> <p>EXECUTIVE SUMMARYCONTD The discussions and findings in this study show that public debt affects</p> <p>economic growth positively only up to a certain threshold after which negative results begin to set in. The study also notes the major shift in debt composition from June 1996 to June 2010. The public debt highly inclined on external financing in 1996 and reduced to almost 50:50 in June 2010.</p> <p> The paper concludes that public debt promotes economic development</p> <p>and the level of public debt needs to be regulated by sound debt management policy to avoid the effects of debt overhang and liquidity constraint theories. There is remarkable improvement in public debt management over the period under review and the country can expect to operate on a sustainable public debt. threshold which is ideal to ensure public debt promotes economic growth and mitigates the effects of debt overhang and liquidity constraints.</p> <p> The study suggests that more studies need to be done in establishing the</p> <p>Public debt in Kenya - The benefit to the country</p> <p>6</p> <p>CHAPTER ONE INTRODUCTION1.1 Background Information Public debt (also known as Government debt, national debt) is money (or credit) owed by any level of government; either central, federal government, municipal government or local government. Public debt can be categorized as internal debt, owed to</p> <p>lenders within the country, and external debt, owed to foreign lenders.. Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be one year or less, long term is more than ten years. Medium term debt falls between these two boundaries.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>7</p> <p>1.1 Background InformationContdWhy do Governments raise public debt? Governments borrow to cover the deficits in their budgets. Sometimes there are wars or natural calamities in which</p> <p>case Governments are forced to incur much larger expenditure and hence running into debt.</p> <p> Governments may also borrow to achieve set</p> <p>development and economic objectives (Bhatia, 2006).</p> <p>Public debt in Kenya - The benefit to the country</p> <p>8</p> <p>1.1 Background InformationContd The Kenyan Government is no exception and this is why it has</p> <p>borrowed. The public debt has grown over the years in the country for example Kenyas public debt increased from Kshs 466,294 million (or 67.8 percent of GDP) at the end of June 1996 to Kshs 1.225 billion in June 2010 (Ministry of Finance Annual public debt management report, 2006 and Kenya monthly economic review, November 2010). This paper seeks to find out whether public debt in the</p> <p>country is related to GDP growth and whether the debt management strategies in place are effective for public debt sustenance.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>9</p> <p> CHAPTER TWO LITERATURE REVIEW2.2 Theoretical Literature Review 2.2.1 The history of public debt The history of public debt is the very history of national power: how it has been won and how it has been lost. The history of public debt is intimately tied to the evolution of the state itself. 2.2.2 Public debt in Kenya 1996-2006 According to the MoF Annual Public Debt Management Report (March 2007), Kenyas public debt increased from Kshs 466,294 million (or 67.8 percent of GDP) at the end of June 1996 to Kshs 789,076 million (50.5 percent of GDP) at the end of June 2006.Public debt in Kenya - The benefit to the country 10</p> <p> CHAPTER TWO LITERATURE REVIEW - Contd2.2.3 Kenyas public debt 2006-2010 The Annual Report on Public Debt Management (May 2009) indicates that Kenyas public and publicly guaranteed debt increased from Kshs 805,686 million or 43.8 percent of GDP in June 2007 to Kshs 1.225 billion or 48.1 percent of GDP in June 2010. 2.2.4 Public debt management Over the years, public debt management in Kenya was characterized by weak institutional arrangements with debt functions spread across departments at the MoF and CBK.Public debt in Kenya - The benefit to the country 11</p> <p> CHAPTER TWO LITERATURE REVIEW - Contd2.3 Empirical Review The empirical literature has found mixed empirical support for the debt overhang hypothesis. Relatively few studies have econometrically assessed the direct effects of the debt stock on investment. In middle-income countries, Warner (1992) concludes that the debt crisis did not depress investment, while Greene and Villanueva (1991), Serven and Solimano (1993), Elbadawi, Ndulu, and Ndungu (1997), Deshpande (1997) and Chowdhury (2001), on the other hand, find evidence in support of the debt overhang hypothesis. Fosu (1999), in his empirical study of thirty-five sub-Saharan African countries, also finds support for the debt overhang hypothesis. In contrast, Savvides (1992) finds that the ratio of debt to GDP has no statistically significant effect on growth. Djikstra and Hermes (2001) reviewed a number of studies on the debt overhang hypothesis and concluded that the empirical evidence is inconclusive. Furthermore, few studies give a clear idea of the level of the debt-to-GDP ratio at which debt overhang effects come into play.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>12</p> <p>CHAPTER 3 DISCUSSION AND FINDINGS3.1 Public debt and economic growth High levels of debt can depress economic growth in low-income countries. This is consistent with the debt-overhang hypothesis which states that the current public debt stock will slow down economic growth. However, debt has a deleterious effect on growth only after it reaches a certain threshold level. The liquidity constraint hypothesis is consistent with the literature reviewed which explained that the Government of Kenya shifted its focus from external debts to domestic borrowing in the period 1996 to 2006. This further put pressure on domestic borrowing which was mainly composed of the 91 day treasury bills and few treasury bonds. This increased the cost of domestic borrowing and the eventual crowding out effect. In 2001, the Government introduced the long term treasury bonds to lengthen the maturity of the debt.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>13</p> <p>CHAPTER 3 DISCUSSION AND FINDINGS3.2 Public debt management It is noted that in the country, the World Bank had a leading role in the establishment of a sound debt management policy and strategy. This lead to formation of the Debt Management Office (DMO) domiciled in the Ministry of Finance. In the pursuant of sound public debt management strategy, the Central Bank of Kenya Act (Cap 491 Laws of Kenya) was amended to limit the Government overdraft from Central Bank of Kenya to 5 percent of the latest Government audited revenue. There was no limit on this overdraft before.Public debt in Kenya - The benefit to the country 14</p> <p>CHAPTER 4SUMMARY, CONCLUSION &amp; RECOMMENDATION4.1 Summary This study has analyzed the level of public debt from 1996 to 2010. It has been noted that public debt grew from Kshs 466 million in June 1996 to Kshs 1.225 billion in June 2010. In terms of debt composition, domestic debt increased from 25.8 % in June 1996 to 53.9 % in 2010 whereas external debt decreased from 74.2% in 1996 to 46.1% in June 2010. It is noted that high levels of debt can depress economic growth in low-income</p> <p>countries. As indicated by the debt-overhang hypothesis, however, debt has a deleterious effect on growth only after it reaches a threshold level. This threshold level is not easily measurable and may require further studies.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>15</p> <p>CHAPTER 4SUMMARY, CONCLUSION &amp; RECOMMENDATION Contd4.1 Summary contd The countrys public debt according to the Kenya Monthly Economic Review, November 2010, Kenyas public and publicly guaranteed debt on November 2010 stood at Kshs 1,309 billion, equivalent to 51.8 percent of GDP. This implies that the overall debt is still sustainable, given the 60.0 percent threshold for the total debt to GDP ratio given by the Maastricht Treaty of the European Union in collaboration with the Commonwealth Secretariat and the Debt Relief International. Though there was weak institutional framework on debt management and that</p> <p>debt management functions spread departments at the MoF and CBK, there is now a well documented debt management strategy, a better institutional framework and an established Debt Management Office (DMO) domiciled in the Ministry of Finance. The established Debt Management Office (DMO) came in to document operations manuals for the business processes as well as build a complete public debt register.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>16</p> <p>CHAPTER 4SUMMARY, CONCLUSION &amp; RECOMMENDATION Contd4.2 Conclusions It is evident that public debt promotes economic development and the level of public debt needs to be regulated by sound debt management policy to avoid the effects of debt overhang and liquidity constraint theories. Developing countries Kenya included will require external financing to cover their budget deficits and boost economic growth. Public debt in the country has been linked to economic growth over a limited period with high external debt servicing reducing the resources for public investment. The public debt management strategies reviewed over time and the policy framework ensures insulation from political interference in the effective debt management. There is remarkable improvement in public debt management over the period under review and the country can expect to operate on a sustainable public debt.Public debt in Kenya - The benefit to the country 17</p> <p>CHAPTER 4SUMMARY, CONCLUSION &amp; RECOMMENDATION Contd4.3 Recommendation Though the countrys debt is said to be sustainable according to the 60.0 percent threshold for the total debt to GDP ratio, given by the Maastricht Treaty of the European Union in collaboration with the Commonwealth Secretariat and the Debt Relief International; the country needs to establish its own threshold suitable and applicable to our own macroeconomic factors. 4.4 Suggestion for further research More studies should be conducted in the area of the relationship between domestic debt and economic development especially in the country. Further studies should also be conducted to establish the threshold at which</p> <p>public debt spurs economic growth especially in developing countries.</p> <p>Public debt in Kenya - The benefit to the country</p> <p>18</p> <p>Public debt in Kenya - The benefit to the country</p> <p>END</p> <p>19</p> <p>THANK YOU !</p>