Fiscal Consolidation Constraints And Budget Imbalance Dynamics In Kenya

Abstract

Kenya needs substantial and sustained fiscal consolidation to create fiscal space for financing the government‟s election pledges (the Big Four Agenda), the Vision 2030 development projects, and sustainable development goals. This calls for optimal allocation of the limited resources to create a platform for the realization of the set goals. However, the government has found it hard to sustain its fiscal consolidation attempts. This study investigates the fiscal consolidation constraints and the budget imbalance dynamics in Kenya. The study consists of three papers. The first paper examines the fiscal consolidation constraints that act through the persistent rise in public recurrent expenditure using four Auto-regressive Distributed Lag (ARDL) error correction models. The second paper acknowledges that economic growth creates an environment conducive for sustainable fiscal consolidation and assesses the economic growth effect of public recurrent and development expenditure using Pooled Mean Group (PMG) estimator. The third paper investigates the fiscal consolidation constraints in Kenya that act through the budget imbalance dynamics. The paper employs the Olivera-Tanzi effect approach. The study covers the period 2000 – 2015 using panel data in the second paper, and time series data in the first and third paper. The main data sources for the study were the United Nations Conference on Trade and Development, the World Bank, Kenya Revenue Authority, Kenya National Bureau of Statistics and Central Bank of Kenya as well as the reports of Annual Estimates for Development Expenditures and Recurrent Expenditure from the Kenya National Treasury. The first paper shows that in Kenya, the fiscal consolidation efforts constraints are persistent public sector wage adjustments and committing much of the tax revenue collections to fund recurrent expenditure with the intent of borrowing to finance development expenditure. The paper points out that the fiscal adjustment efforts are not effective in limiting the rise in recurrent public expenditure. In the second paper, the study concludes that the persistent increase in the sectoral recurrent public expenditure retards economic growth whereas the sectoral public development expenditure improves economic growth in Kenya. However, this is only evident in the long term. The third paper also indicates that inflation, minimum wages adjustment, rise in perceived level of corruption in the public sector and political budget cycle worsen the budget imbalances (deficits) thus constrain fiscal consolidation efforts in Kenya. The paper also shows that the Olivera-Tanzi propositions partly explain the budget imbalance dynamics in Kenya. Finally, the study provides policy implications that include how to carry out credible fiscal consolidation and control the persistent rise in public recurrent expenditure. Other recommendations are on enhancing chances of successful fiscal consolidation, and reducing the fiscal imbalance gap. The recommendations affirm that the government should focus on significant expenditure reforms to signal its commitment to fiscal management and sustainability, and strictly enforce the principles of financial responsibility as provided in the Public Finance Management (PFM) Act of 2012. Measures to reduce the fiscal imbalance gap in Kenya are proposed in this study. The measures include controlling both supply and demand side inflationary pressure and dealing with rent-seeking behavior in the public sector. JEL Classification: E60, E61, E62, H62, J38 Keywords: Non-Wage Recurrent Expenditure, Budget Imbalance Dynamics, Fiscal Consolidation, Compensation of Government Employees, Public Recurrent Expenditure