Fiscal Revenue and Economic Growth

In line with most growth theories, natural resources, human resources, capital enterprises and technology are all important for rapidly economic growth. Expenditures on human resources development via spending on education and research, provision of infrastructural facilities health care, housing and urban development, environment, quality of national statistics, securities and administration of justice are made possible or better still financed through the revenue gotten from the nation’s resources. These invariably lead to economic growth. This therefore posits that an efficient revenue allocation is of great importance in the equation of growth.

Similarly, successive governments do make provisions for human capital development and technological improvement through improvement in educating funding and expenditure on research because of the fact that these are necessary ingredients for economic growth and development it is often said that economic growth is possible even when an economy is deficient in natural resources. As pointed out by Lewis, (1990) “a country’ which is often considered to be poor in resources today may be considered very rich in resources at some later time, not merely because unknown resource are discovered, but equally because new users are discovered for the known resources” Japan is one such country which is deficient in natural resources but it is one of the advanced countries of the world because. It has been able to discover new uses for limited resources. Moreover, by importing certain raw materials and minerals from other countries, it has been successful in over coming the deficiency of its natural resources through superior technology, new researches and higher knowledge.

It is also important to note that capital accumulation is one of the factors than enhance economic growth. Capital means the stock of physical reproducible factor of production. When the capital stock increases with the passage of time this is called capital accumulation (or capital formation). The process of capital formulation is cumulative and self-feeding and includes three inter-related stages.

1. The existence of real saving and rise in them
2. The existence of credit and financial institutions to institution to mobilize savings and to divert them       in desired channels, and
3. To use these savings for investment in capital goods

There are various possibilities of increasing the rate of capital accumulation. Since the propensity to save IS low in most LDCs, Voluntary savings will not be forth coming in sufficient quantities. Therefore, the consumption and thereby release resources for capital formation.

The various methods of forced saving are taxation, deficit financing and borrowing. These now brings out the role of revenue allocation formula because of the simple fact that in LDCs, the government does the above. It is obvious that how the fund/resources from this forced saving is been shared and the expenditure pattern is of great importance when the talk of rapid economic growth. Moreso, capital formation helps in providing machines, tools and equipment for the rising labor force. The provision for social and economic overheads like transport, power, education etc in the country is through capital formation. It is also capital formation that leads to the exploitation of natural resources, industrialization and expansion of market, which are essential for economic progress.

For an economy that is open like ours, the issue of economic growth cannot be discussed without bringing in particular. It is important to note that international free trade has been regarded as the “Engine of growth” that propelled the developed of today’s economically advanced nations during the nineteenth and early twentieth centuries. Rapidly expanding export market provided an additional stimulus to growing local demands that led to the establishment of large manufacturing industries. Together with a relatively stable political structure and flexible social institutions, these increased export earning enables the developing country of the nineteenth century to borrow funds in the international capital market at very low interest rates. This capital accumulation, which is very important to growth in turn stimulated further production, made possible increased imports and led to a more diversified industrial structure.

Having gone through some of the importance economic actors of growth, it is important to note that there are some non-economic factors that are also crucial to rapid economic growth and development. It is sufficient to say that the final distinction between the historical experience of developed countries and the situation faced by contemporary developing nations relates to the nature of social and political institutions. One very obvious different between the now developed and the under developed nations IS that well before their industrial evolutions, the former were in dependent consolidated nations states able to pursue national policies on the basis of consensus toward modernizations.

Key economic sectors pay heavy price for high cost of borrowing

As interest rates soar to record levels and inflation continues unabated, economic growth is threatening to stall as major sectors that have been propelling growth begin to stumble. Further increases in interest rates are likely to spell catastrophic results for these pillars of the economy, say analysts.

CONSTRUCTION AND REAL ESTATE

The country has since the beginning of the decade enjoyed a vibrant property market hinged on increased purchasing power from a growing middle class and a growing economy. Banks and home loan lenders, alive to the huge potential for sustained growth in this sector, had announced substantial interest rate cuts, cutting mortgage rates by between 1.5 and 4.5 per cent in 2010. 
The appetite for these loans was reported by the Central Bank as having outpaced the growth in demand for credit to businesses and households in the year to June 2010, emerging as a new driver to the banking sector’s profitability.

A year later and the tables having turned. Prevailing interest rates have now shot up to 26 to 30 per cent with even mortgage loan providers having revised their rates to around 19 per cent. Aware of a possibility of increased number of loan defaulters, banks have also tightened their lending criteria to discourage further borrowing.

However, as mortgage-financed buying stalls and some homeowners lose their homes on defaults, the bigger impact is being felt by developers. Developers face increased costs for construction materials, but are also now proving unable to refinance projects they have begun. Banks are likewise no longer lending to developers for new projects, on the basis that returns are unlikely to cover the prevailing interest rates and the property sales outlook is weak.

The Nairobi City Council (NCC) has already recorded a dip in the number of approved building plans this year, down by 9.7 per cent on last year as a result of developers postponing projects. Developers who are already building are meanwhile factoring in their own higher costs of debt servicing into increased property prices, which the market seems unlikely to support.

This outpricing of high and middle-end homes, and the greater cost and scant finance for self-building, is putting more pressure back into the middle and lower end rental market, and might see some rent rises at that end of the market.

Combined with curbs on other infrastructure spending, this impending standstill in real estate is set to have a huge impact on employment. The construction industry currently employs about one million people with an estimated annual wage bill of Sh3.2bn.

Already, the Kenya National Bureau of Statistics has reported a sharp decline in the quantity of cement sold, a key indicator in the construction sector, with sales down by 7.4 per cent between August and September. A slowdown in the construction industry, say analysts, could have a ripple effect throughout the economy, affecting other sectors related to the industry like transport.

TOURISM

Even as the Ministry of Tourism embarks on an aggressive marketing campaign abroad to paint a picture of Kenya as the best tourism destination, the moves to curb domestic economic growth are knocking the sector back.

Tourism Minister Najib Balala noted in June 2011 that arrivals to Kenya rose to 549,083, up 13.6 per cent from the same period last year and the highest in years, with the sector bringing to the economy Sh40.5bn shillings in revenue, up 32 per cent from Sh30.7bn in the same period last year.

However there are strong indications that the hope of record tourist numbers will not now be achieved in the second half. 
The global recession had seen a huge dip in international arrivals with UK and US tourists shying away as they covered other spending priorities. Some were being drawn back by the weakening of the shilling. However, the renewed strengthening of the shilling coupled with the ongoing travel advisory due to the recent attack on tourists in the rather serene Lamu Archipelago has dwindled profit margins for the sector.

At the same time, “there is worry that domestic tourism might be affected by increased inflation,” said Tourism Minister Najib Balala at a recent press conference. The minister has said there are now plans to showcase “pocket friendly” destinations where Kenyans can tour.

But the impact is already being felt. Tourism employs over 500,000 Kenyans in the formal sector and an additional 700,000 in the informal sector. The government will also lose millions through taxes, duties, license fees and park entry fees charged to tourists.

“We have already prepared our staff in case of further eventuality. It’s the first time we have delayed their salaries for two months as we try to cover the other costs. Things have gone up, but we are not seeing an influx of tourists like we usually do. At peak time we are fully booked usually, but the booking is dismal. Any higher and we can’t hang on any more,” said Flavio Mwendwa a proprietor at the Beezako Group of hotels in Mombasa that employs some 500 workers.

Tourism is closely connected to other major sectors of the economy. Its high multiplier effect stimulates growth in other economic sectors such as agriculture, manufacturing, transport and handicrafts. A dip in tourism equally has a grave effect on these other sectors.

MEDIA

With business costs and finance costs both rising, businesses are introducing austerity measures with a straight line impact on the previously outperforming media industry. Media businesses are driven by advertising revenue. But companies that were spending sizeable budgets on marketing and advertising are now scaling back that spending to cover other immediate business needs.

“Some of the companies who have been advertising with us have already come to us telling us that though they still need to advertise with us, the advertising budget has been scaled down significantly as the interest rate takes its toll on them. We have anticipated a situation where we might lose a lot of advertising revenue and this has meant us going back to the drawing board and introducing our own cost cutting measures,” said an HR and marketing manager at a leading media house.

Media industry analysts say further rate rises, through their secondary impact on media revenues, will lead to media houses rolling out deep cost savings, reduced volumes, and staff layoffs, as well as reduced budgets for costly content production.

Costly loans, high inflation leave CBK in a tight spot

When the Monetary Policy Committee meets in Nairobi on Thursday morning, it will have to make some difficult, but critical, decisions under the watchful eyes of nervous investors and angry consumers- even as it takes stock of the strengthening shilling.

(Also read Banks extend loan payment periods to avoid mass defaults )

The MPC meeting, which comes one month after the last one that took the unprecedented decision of jerking interest rates up by more than five percentage points, will have to balance its declared war on inflation and exchange rate turbulence against the high cost of borrowing for government, the slowdown in consumption of goods and the danger of stifling growth that comes with it.

To many investors and consumers, the November 1 decision to steeply raise interest rates amounted to a classic failure of the domestic policy making mechanisms to address the real challenges facing its constituency in favour of easy cut and paste solutions from the International Monetary Fund (IMF).

The MPC has for instance come under heavy criticism for staying too long on the loose end of monetary policy, ignoring warnings from partners such as the IMF and independent economists who started pushing for an interest rate increase in April.

“There is now considerable expectation that the CBK has to tighten (monetary policy) more – if not to ensure positive real interest rates, then at least to prevent real rates from becoming even more negative,” Razia Khan, the Standard Chartered’s lead economist for Africa, wrote in a note in March after inflation jumped from 6.5 per cent to 9.2 per cent.

The MPC ignored such counsel and many others in the subsequent months arguing strongly that such a move would negatively affect fragile growth. The decision to stay put in the face of all these signals lay in Kenya being able to internally generate the resources it needed to finance the mega infrastructure projects it had started just before the global economy went into recession in 2007.

And with the onset of the global economic crisis in September 2008, the dogma in the ‘developmental monetary policy’ that Central Bank Governor Njuguna Ndun’gu had chosen to pursue became even more imperative. Interest rates had to be kept low to make borrowing less painful for the government and consumers alike.

That was to help drive consumption in the economy and prop up growth that risked withering in the face of a severe global financial crisis.

The full impact of this policy is, however, that the government used the window to take in huge amounts of domestic debt raising the pile from Sh334.9 billion in 2008 to Sh795.4 billion in September this year.

The fact is, however, that while borrowing from the domestic market has enabled the government to raise billions of shillings for the big infrastructure projects, it has to pay in foreign currency.

Whether it is paying the Chinese contractors, importing the machinery or materials, the currency of payment has been mainly in the dollar, euro or yen – a challenge that many developing nations have managed to overcome only by growing exports.

The value of Kenya’s imports rose from Sh770.6 billion in 2008 to Sh951 billion for nine months to September from export earnings that were nearly static having grown from Sh344.9 billion in 2008 to Sh374 billion in the year to September.

This, combined with acute supply shortages in key areas such as food, is what has hit many consumers in the form of high priced goods, the shilling’s slide from an average of 86 units to the dollar in January to the record low of 107 units to the dollar in October – and ultimately high cost of borrowing.

Though aggressive tightening of monetary policy has since seen the shilling regain more than 10 per cent of its value in the past three weeks, it has remained difficult to explain to a large constituency of the population whose borrowing costs have risen steeply even as the cost of living continues to rise.

Many analysts expect that this morning’s meeting will therefore have to carefully walk the tightrope in the quest to balance its attack on inflation that has began to decelerate and responding to public expectation for a signal that things will begin to look up this Christmas.

That expectation is hinged on the fact that the CBK’s mandate remains to formulate and implement a monetary policy that keeps overall inflation at the official target of nine per cent, while maintaining adequate liquidity in the market to facilitate higher levels of domestic savings and private investment to support economic growth, higher real incomes and increased employment. 

Its recent radical departure from this script has no doubt rescued the shilling from the October battering but its implementation has removed liquidity from the market, and is likely to deliver growth and job creation only if Kenya finds the way to defy all global precedents.

How high interest rates may make or break economy

After years of political commitment to enabling economic growth, the Kenyan government performed an about-turn on economic policy from September, to implement a monetary policy of a severity rarely seen worldwide.

As the shilling weakened this year, inflation rose exponentially, climaxing at 17.32 per cent in September.

That led to Central Bank raising the Central Bank Rate (CBR) to 7.00 per cent on September 15, 2011. The increase was aimed at stabilising domestic prices and easing the pressure on the exchange rate.

However, the Kenyan exchange rate did not react as expected and continued to depreciate rapidly.

On October 5, 2011, CBK lifted the CBR by 400 basis points to 11 per cent. The Kenya shilling started to strengthen a week after the CBR was increased. But the CBK then moved to raise the CBR a further 550 basis points on 1st November to 16.5 per cent.

With the economy now reeling from this doubling in finance costs, Kenya has struck out on a path almost unprecedented globally for the severity of its monetary tightening.

The Reserve Bank of India (RBI) is also currently trying to reduce stubbornly high inflation, which has stayed above 8 per cent for the past 18 months. This saw the bank raise rates by 0.25 per cent this week, to 8.5 per cent.

Since March last year, India’s central bank has raised interest rates by 3.75 per cent, in the fastest round of monetary tightening in its 76-year history.

But this has already seen growth slow, to 7.7 per cent in the three months to June, the slowest pace in two years. The policy has had little impact as yet on inflation.

The reluctance of certain types of inflation to ease on raising interest rates has been similarly witnessed in other economies.
In the 1970s, the US experienced several years of rising interest rates, implemented to tackle double digit inflation.

But the rate revisions had little impact on inflation, while also delivering a significant dampening in economic growth.

At their peak in 1975, US rates hit 20 per cent, but were then cut to 7.7 per cent, marking the end of a policy era that was later labelled “stop-go monetary policy”.

The 1975 reversal marked the abandonment by the Federal Reserve of extreme rate changes and a move towards managing inflation expectations instead. Since then, US rates have remained in a range from two to five per cent.

However, the parallels for Kenya, in using interest rates to support the currency and government debt are strongest in looking at the policies rolled out in Russia prior to its 1998 financial crisis, known as the “Ruble crisis”.

The crisis ultimately saw the Russian government devalue the ruble and default on its debts, but was preceded by an artificially high exchange rate aimed at avoiding public turmoil, and supported by soaring interest rates.

In effect, the interest rate rises were pushed – eventually as high as 150 per cent on government bonds – to stem the flight of capital as the overvalued currency and ballooning government deficit bit into all areas of the economy. At the time, the government had funded a war in Chechnya, and couldn’t cover its spending with tax receipts.

By the end of 1997, despite the extraordinarily high interest rates, Russia had to effect public spending cuts, across every area from pensions to public transport. It got emergency funding, devalued its currency and converted many of its government bonds, which it couldn’t repay, into Eurobonds.

But the economic struggle over ballooning public debt saw inflation rise eventually to 84 per cent and created a year of empty shelves, queuing consumers and massive economic disruption.

Some economists have even argued that the moves to keep the currency high diminished Russia as a geopolitical power.

However, even in less extreme circumstances, the impact on economic growth of rate rises has been demonstrated repeatedly.

The Philippines raised rates twice in quick succession in April and May this year, although very marginally, with the second rise being by just 0.25 per cent – as it sought to keep inflation that was moving towards 4.5 per cent at its target of 3.5 per cent.

However, even this measured intervention led quickly to a slowing in growth, down to 3.2 per cent in the third quarter of this year, compared with 7.3 per cent a year earlier.

For Kenya, the CBK’s mandate remains to formulate and implement a monetary policy with the aim of keeping overall inflation at the government target of five per cent, while maintaining adequate liquidity in the market to facilitate higher levels of domestic savings and private investment and therefore lead to improved economic growth, higher real incomes and increased employment.

The current radical departure in its implementation has removed liquidity in the market, and will deliver growth and job creation only if Kenya can now find the way to defy all global .