Kenyan Protests, Part Two: How not to clean up a fiscal mess

This is the second of a three part series on the current economic and political crises in Kenya. Part One addresses the political foundations of the crisis. Part Two will tackle the real economic challenges that the current administration inherited, and arguably made worse. Finally, Part Three will conclude with some thoughts on the set of bad options on the table for the administration.

I: The making of a fiscal mess

On July 11, 2024 President William Ruto dissolved his Cabinet following weeks of protests against his administration. As discussed in the previous post, the immediate trigger of the countrywide popular revolt was a raft of tax increases in the 2024 Finance Bill. But the grievances were deeper. Ruto came into office with a legitimacy deficit that has proven difficult to shake off. His Cabinet was one of the weakest in Kenya’s history and had come to symbolize the out-of-touch incompetence and arrogance towards the public associated with the administration. Real incomes were in decline, squeezed by a stagnating economy, inflation, and higher taxes. And the quality of public services (especially in education and health) had deteriorated for years even before Ruto came into office.

The expected changes in the Cabinet might buy Ruto political breathing room — especially if he appoints a competent set of Cabinet Secretaries. However, it is unclear if he will choose the path of competence and effective service delivery. So far all indications are that he will go for a “unity government” that brings in individuals from across the political divide and consolidates intra-elite collusion in opposition to the structural reforms demanded by protesters.

Such a move will only fuel popular anger at the entire political class and likely result in more protests.

The fundamental problem for Ruto is that he faces a very difficult fiscal crisis (see image below) at a time when the old playbook of Kenyan politics doesn’t work anymore. People want effective service delivery and a working economy. To be blunt, you cannot deliver on either of those objectives by merely crafting an ethnically representative Cabinet.

Let’s be clear, Kenya’s current fiscal crisis is bigger than Ruto and reflects the challenges of executing infrastructure-led development without paying deliberate attention to broad-based job creation and effective delivery of public services. Especially under President Uhuru Kenyatta (2013-2022), Kenya’s debt accumulation outpaced the rate of revenue growth because the government borrowed money for recurrent expenditures and (graft-laden) infrastructure projects that didn’t yield the projected household-level economic impacts. The economy expanded, but the benefits mostly accrued to the very top earners and politically-connected firms that got tax exemptions. Meanwhile, the quality of public services deteriorated and informality continued to dominate the private sector.

The entire Kenyan economy ($113b) supports barely 3 million wage jobs. An astonishing 67% of Kenyans under 34 lack stable jobs. The “Kenyatta economy” expanded by over $50b but without much improvement in the annual rate of wage job creation.

Furthermore, there is actually very little to show for the Kenyatta era debt binge. To paraphrase The Economist, Kenyatta mostly started projects to get loans, and not the other way round. Besides the SGR — which without reaching Uganda and beyond will remain commercially unviable — gross capital accumulation as a share of GDP peaked in 2014 and declined thereafter. The infrastructure boom under President Mwai Kibaki (2003-2013) was followed by a period of corruption-fueled dealmaking that paid scant attention to projects’ commercial viability or their economic impact. Kenyatta inherited a debt stock of about $22b and added a staggering $51b to it. When he left office, there were still more than 400 stalled projects that had cumulatively gobbled up billions of shillings.

President Kibaki started the infrastructure boom. However, the massive spending on infrastructure was accompanied by broad-based economic growth and an increase in revenue collection. Therefore, even as deficits rose, the proportion of revenues that went to debt service and the Debt/GDP ratio remained fairly flat (see below).

Kenyatta upended this model in two important ways. First, he relaxed tax administration by awarding all manner of exemptions to cronies and being quick to buy political support with subsidies. Tax expenditures (roughly, taxes foregone due to exemptions) as a proportion of GDP soared to just under 3%, and the overall tax/GDP ratio reduced from 18% to under 14%. Second, he increased the share of foreign borrowing from commercial lenders to about a third of total foreign debt. Unlike multilaterals and bilaterals, these commercial lenders came with no strings attached, much higher interest rates, and their loans were often used to roll over debt and not tied to specific projects (which facilitated pilfering). Increases in debt as a share of GDP, the share of revenues allocated to debt servicing, and bigger deficits followed.

Attempts to plug holes with increased domestic borrowing crowded out credit to the private sector, putting a limit on private sector growth. Domestic credit to the private sector (as a % of GDP) steadily fell from its peak in 2015.