Concept of the IMF tranche.
In recent years Kenyans have struggled to take away the bitter goblet associated with the high national debt. Experts have analyzed the economic impact of rising debt and the public has debated the moral contours of the high tax system required to maintain it.
However, little has been said about how best to formulate a realistic sovereign debt ceiling to guide economic policy. In October 2019, lawmakers voted to raise the debt ceiling from Sh6 trillion to Sh9 trillion, but that did little to bring the country’s debt stock near the new legal ceiling.
The Treasury Department is preparing again to submit amendments to the Public Finance Management Act for another round of legislative approval to raise the debt ceiling again. This certainly cannot be a sustainable approach and policymakers must consider other techniques to contain sovereign debt.
The first step in finding a better approach would be to consider the more scientific approach taken by the Central Bank of Kenya (CBK) to inflation management.
This methodology assumes an explicit inflation target of 5 percent with an upper limit of 7.5 percent and a lower limit of 2.5 percent. CBK then ensures that all monetary policy instruments are used effectively to ensure that inflation is always kept within this narrow range. For this reason, the CBK has been able to fulfill its primary mandate of price stability for several years.
The financial policy of the National Treasury can benefit from this targeting methodology and develop a “yield targeting” approach in which the desired yield on government bonds is explicitly stated and actively targeted.
Assuming that the target return on the 10-year government bond is 5 percent, only investors who are satisfied with this return would participate in the auctions, which ultimately creates a natural debt ceiling.
The current situation, in which the yields on government bonds rise to 13 percent, almost three times the inflation rate, and the public budgets are also in debt, would quickly come to an end.
The long-term benefit of using precise targeting tools to control economic outcomes is that Kenya can catch up with trends in the global economy, thereby closely aligning government bond yields with inflation. In the United States, for example, the 10-year bond yields 1.59 percent – well below the inflation rate of 4.2 percent.
In the UK, bond yields are 0.80 percent, well below the 0.90 percent inflation rate, and the same is true in Australia, with bond yields of 1.68 percent, slightly above the 0.6 percent inflation rate.
The benefit of a unified fiscal and monetary policy for Kenya will be limited not only to effective government debt management, but also to the stability and prosperity that come with a balanced, innovative, private-sector-led economy.