How the Treasury can get Kenya out of debt distress

Treasury Minister John Mbadi is working under extremely precarious conditions.

As he seeks to simplify Kenya’s financial landscape, he should not lose sight of the fact that any reference to the rejected 2024/2025 Finance Bill may anger Generation Z who thwarted its implementation in June this year.

However, the country cannot continue in a situation where more than 10% of its national budget is financed from external sources.

Such a situation not only erodes the country’s sovereignty and national dignity, but also undermines development, as a large portion of domestic revenues is used to pay off foreign debts.

Currently, Kenya uses more than Sh6 out of Sh10 of treasury revenue to pay its debts, leaving a measly Sh4 or less for development and recurrent expenses. This is not sustainable.

No wonder, then, that the country is struggling to meet its domestic obligations. Districts are operating on razor-thin budgets as university students, programs and teachers go without funding for months. The story is the same in many other sectors across the public service. This is a shame for the country.

It is unfortunate that the phenomenon of a cash-strapped economy did not begin with the administration of President William Ruto. Kenya has been teetering on the brink of defaulting on its international debt obligations for nearly a decade.

The country has been affected by this unfortunate situation through financial indiscipline under the Uhuru Kenyatta administration.

The government maintained a huge deficit in its budget cycles to finance ambitious infrastructure development projects. Critics assert that these infrastructure projects served as huge conduits for corruption through murky procurement.

An estimated 30 percent of the budget was lost to irregularities, according to former President Kenyatta, who painfully lamented that corrupt government officials pocket at least Sh2 billion a day in secret transactions.

Budget corruption during the Uhuru administration was therefore responsible for the widening of the budget deficit that brought the country back into the grip of the World Bank and the International Monetary Fund.

Before this unfortunate turn of events, the late President Mwai Kibaki was skillfully navigating the Kenyan financial ship, at one point managing to secure up to 95% of the national budget using locally mobilized resources.

Kibaki’s beautiful legacy of prudent fiscal management was quickly torpedoed by the Kenyatta administration through a combination of raw appetite for money and incompetence.

We have on the authority of the Auditor General that as much as Sh1.13 trillion of foreign loans cannot be returned to the Kenyan economy. In other words, at the time of the audit, the Treasury could not confirm to the Auditor-General whether money had been transferred into the economy and, if so, exactly what it had been used for. In short, Kenya’s looming debt distress is self-inflicted.

The situation did not improve due to the crooked way in which the external loan portfolio was managed.

Once again, the Auditor General reported on numerous occasions the reluctance of Treasury officials to examine Kenya’s loan portfolio, raising doubts about whether Kenyan taxpayers were repaying the odious debts that went into the pockets of corrupt officials.

Unsavory debt causes the dual pain of increasing the tax burden on citizens, while at the same time pushing the country toward default on real loans. Officials give priority to fictitious loans from which they extract special interest under the guise of repaying foreign loans.

The Ruto administration thus took over an economy that had been severely choked on cash and development by the previous regime, which the Auditor General described as greedy and corrupt.

By December 2023, the Ruto regime had realized, somewhat painfully, that the Sh10 trillion debt ceiling was too low for a country that was literally unable to cope with its pressing domestic revenue needs.

Thus, the National Assembly provided a debt anchor of 55 percent of the country’s GDP to enable the Treasury to access more funds from external sources to keep the economy afloat. Even now, the country is still trying to find its financial impact.

But it is interesting to note that the current administration has pledged to review its debt portfolio to determine the exact amounts the country owes to domestic and foreign lenders. Once the loan books are cleaned, hopefully the country will have a clearer vision on how to manage its external debt and budget deficit.

Unfortunately for Mr. Mbadi, he does not have the luxury of time. He took over the Treasury in the wake of the violent rejection by Gen Z of the Finance Bill 2024 over increased tax measures. The draft law was considered insensitive, because the country was already reeling under the weight of the tax burden, which had significantly eroded the purchasing power of citizens and harmed their well-being.

The country is therefore waiting with bated breath, hoping that the new tax measures to be introduced by Mr. Mbadi will improve its situation. There lies a difficult situation for him.

The growing volume of external debt is already threatening to push the country into the black book of defaulters. A default on foreign debt lowers a country’s credit rating and sends negative signals to capital markets. This complicates a country’s future access to soft, low-rate loans.

Kenya cannot afford to go down the path of loan default at a time when revenue performance is not exactly impressive, and the country may continue to look for external financing to shore up the budget unless it radically changes its fiscal course.

The financing options that may be available to the state – if they are available at all – are expensive commercial and syndicated loans. The Chancellor of the Exchequer has a lot of homework to do if he wants to get his budget proposals through Parliament.

First, there must be broad public participation and citizen consent in order to create the critical mass needed to legitimize budgeting processes.

Once legitimacy is achieved, it will be difficult for late converts among Generation Z to muster sufficient numbers to derail the process.

Second, the Treasury must step down from the ivory tower and reach out to citizens, telling them the actual situation, what is going on, and the sacrifices they must make to get the economy back on track. In this way, the government will create certainty and stability in the economy.

Likewise, the Central Council must also deal decisively with the apparent financial irresponsibility, which constitutes the greatest burden that the current regime inherited from the previous one. Mbadi is not new to the phenomenon of budget corruption.

In fact, as a legislator and Chairman of the National Assembly’s Public Accounts Committee, he was at the forefront of identifying numerous instances of odious debt and fictitious budget items. Now he has the opportunity to fill the gaps he so brilliantly identified as an opposition lawmaker.

Most importantly, the CS must not lose sight of the fact that the Kenya Revenue Authority plays a crucial role in getting the country out of the debt trap.

The Agency needs support to continue modernization, putting it in a good position to carry out its mandate efficiently and effectively.

The twin situations that Kenya’s tax administration has been dealing with for decades are the small tax base and low taxpayer compliance rates. The behavior of the tax administration has a lot to do with taxpayer compliance. The lack of creativity in tax administration leads to an undue focus on a small number of compliant taxpayers, while leaving non-compliant ones roaming around the country tax-free.

The biggest drawback in terms of compliance is that when a taxpayer voluntarily declares additional income and taxes, rather than supporting such a move, the tax administration responds by conducting an in-depth audit believing that there is still more for the taxpayer to hide.

This routine mistreatment of good taxpayers reverberates throughout the economy, as compliant taxpayers choose to return to their hideouts rather than incriminate themselves to tax officials.

Many companies operate under the radar because KRA has not yet invested in studying the changing landscape and emerging business models. The result is that tax collectors are largely oblivious that there are many potential taxpayers out there.

In this regard, CS Mbadi must ensure that KRA deepens its use of technology-based tax administration solutions to not only enhance service delivery to taxpayers, but also to link KRA’s systems with those of various service providers. This would help facilitate the matching of taxpayer information with the KRA database to create certainty in tax administration.

Furthermore, the Revenue Agency urgently needs to overhaul its training approach, make it more vibrant by reintroducing the defunct two-year graduate trainee programme, and infusing it with modern skills, knowledge and attitudes in tax administration.

For the past ten years or so, tax consultants have had a field day, dealing mainly with untrained revenue staff. There are three factors responsible for the poor skill level among KRA officers.

First, between 2001 and 2022, the KRA was headed by Commissioners-General JP Maunge, MJ Wauru, JK Njereni and Githi Mburu, all accountants.

These gentlemen, without exception, were under the mistaken impression that accountants were necessarily familiar with matters of tax administration. As a result, they filled the ranks of KRA’s revenue staff with accountants who were not trained in revenue management.

Second, the Kenya School of Revenue Administration, the training wing of the KRA, has lost focus on its mission of training staff primarily in tax administration responsibilities.

The school brought in university lecturers who had neither been trained nor exposed to tax administration operations, to lead the training of revenue officers. The program gradually lost its artistic touch and was thus reduced to a mere academic course.

Third, in recent years KRA has hired untrained personnel or transferred staff from support departments and deployed them to revenue management positions. With weak technical skills, revenue officials are easily outperformed by tax consultants, many of whom are former KRA officials. The result is a lower revenue yield.

Finally, the CS needs to urgently align the KRA governance structure with global best practices. It is worth noting the tendency of the Chairman of the Board of Directors to interfere in management responsibilities.

It should be reiterated to the Chairman that he is the Chairman of the Board, and not the Chairman of KRA. While the latter confers executive power, the former is a nominal position with non-executive powers, and its interaction with the rest of the organization is through the chief executive, the Commissioner-General.

Therefore, the Chairman of the Board should limit himself to the operations of the Board of Directors, and allow the CG to perform his executive duties of managing the revenue agency.

Professor Ongori teaches at the Technical University of Kenya (TUK). He is a former Principal Director at Kenya Revenue Authority (KRA). Email: (email protected)