PUBLIC FINANCE

PUBLIC BUDGET & PUBLIC DEBT

OUTLINE

• Definition of public budget
• Balanced budget, Budget deficit and budget  surplus
• The budgetary process in Kenya
• Economic   Effects  of Budget   Deficits
• Meaning of Public Debt
• Public debt vs private debt
• Forms of debt obligations  and Classifications of public debts
• Reasons for public debt and methods of retiring  public debt
• Limits to public borrowing
• Implications   of  Public Debt on the  economy
• Public Debt Burden and future generations

•      A public budget is a government plan of expected incomes and expenditures for the upcoming fiscal year.

•      Balanced  budget: Total revenue= total expenditure

•      Budget Surplus   occurs whenever the government revenue exceeds government expenditure

•      Budget deficit is the amount by which government expenditures exceed government revenues in a given year.

Functional Finance- deficit and surplus budgeting

•      Some economists believe that government budget deficits and national debts do not harm the economy.

•      Budget is the fiscal instrument for achieving economic  stability.

•      Therefore the government should not worry about whether it is incurring deficits or surpluses so long as the economy is stable and growing

Effects of a budget deficit

Positive effects

-          Increases employment levels during recession(economic decline).

-          Increases aggregate demand .

-          It can result from increased government expenditure during the times of unemployment and recession so as to stimulate the economy.

The negative effects of deficit may include the following

-          Excessive spending by government may increase inflationary pressures.

-          Budget deficits have to be financed through government borrowing which will have the following effects:

i.            i)It may ‘crowd out private sector investment. Crowding out is where a rise in government borrowing displaces private investment spending.

ii.            ii) It increases the national debt which poses a problem of the interest payment burden.

Public Sector Budgetary process in Kenya-Kenya constitution, Articles 220-224 and Public Finance Management act,2012

The constitution requires  the budgets of national and county government to contain the following:

1.      Estimates of revenue and expenditure, differentiating between recurrent and development expenditures

2.      Proposals for financing any anticipated deficit for the period to which they apply; and

3.      Proposals regarding borrowing and other forms of public liability that will increase public debt during the following year.

National Government Budget Process

The budget process for the national government in any financial year comprises the following stages:

a)      Integrated development planning process which includes both long term and medium term planning;

b)      Planning and determining financial and economic policies and priorities at the national level over the medium term;

c)      Preparing overall estimates in the form of
the Budget Policy Statement of national government revenues and expenditures;

d)     Adoption of Budget Policy Statement by Parliament as a basis for future deliberations;

e)      Preparing budget estimates for the national government;

f)       The Cabinet Secretary  Submitting those estimates to the National Assembly for approval ,at least two months before end of financial year i.e by 30^th April

g)      Before the national assembly considers the estimates, parliament’s  budget committee discusses and reviews  the estimates  and make recommendations to the assembly.

The National assembly considers the estimates submitted by CS, together with estimates submitted by parliamentary service commission and by the Chief Registrar of the judiciary(both  estimates required  by 30th April).The PSC and CRJ should provide a copy of the estimates to the treasury.

In preparing the estimates the accounting officer for the Parliamentary Service Commission and the Chief Registrar of the Judiciary—should ensure that members of the public are given an opportunity to participate in the preparation process.

h)    The Cabinet Secretary submits to the National Assembly not later than the 15th May, any comments of the National Treasury on the budgets proposed by the Parliamentary Service Commission and the Chief Registrar for the Judiciary. The CS then publicizes those documents.

i)       Upon approval of the budget estimates by the National Assembly, the Cabinet Secretary prepares and submits an Appropriation Bill of the approved estimates to the National Assembly.

j)       Enactment of the Appropriation Bill and any other Bills required implementing the National government's budgetary proposals.

•      N/B Appropriations lapse if unspent at the end of the financial year.

Parliamentary Budget Office

The office known as the Parliamentary Budget is an office of the Parliamentary Service.

•      It’s meant to provide professional services in respect of budget, finance, and economic information to the committees of Parliament.

•      The Parliamentary Budget Office is required to observe the principle of public participation in budgetary matters.

Budgetary guidelines

Not later than the 30th August in each year, the Cabinet Secretary is required to  issue to all national government entities a circular setting out guidelines on the budget process to be followed by them in terms of:

1)      schedule for preparation of the budget indicating key dates by which various exercises are to be completed;

2)      the procedures for the review and projection of revenues and expenditures;

3)      key policy areas and issues that are to be taken into consideration when preparing the budget;

4)      procedures setting out the manner, in which members of the public shall participate in the budget process;

5)      the format in which budget information and documents shall be submitted; and

6)      any other information that, in the opinion of the Cabinet Secretary, may assist the budget process

Supplementary appropriation

 The national government may spend money that has not been appropriated if the amount appropriated under the appropriations act is insufficient and if money has been withdrawn from the contingencies fund.

Parliament has to approve the appropriation.

Annual Division and Allocation of Revenue Bills

At least two months before the end of each financial year, two bills are introduced in Parliament––

a)      a Division of Revenue Bill, which  divides revenue raised by the national government among the national and county levels of government in accordance with this Constitution; and

b)      a County Allocation of Revenue Bill, which  divides among the counties the revenue allocated to the county level of government .

On the basis of division of revenue bill passed by parliament, each county government prepares and adopts its own annual budget and appropriations bill.

The 2 bills above are introduced by national assembly budget committee chairman.

Establishment, purpose and composition of the Intergovernmental Budget and Economic Council (IBEC)

The council is established under section 187 of the PFM act. It comprises

a)      the Deputy President who is the Chairperson;

b)      the finance  Cabinet Secretary;

c)      a representative of the Parliamentary Service Commission;

d)     a representative of the Judicial Service Commission;

e)      the Chairperson of the Commission on Revenue Allocation or a person designated by the Chairperson;

f)       the Chairperson of the Council of County Governors;

g)      every County Executive Committee member for finance; and

h)      The Cabinet Secretary responsible for intergovernmental relations.

Functions of IBEC

Provide a forum for consultation and cooperation between the national government and county governments on—

a)      the contents of the Budget Policy Statement, the Budget Review and Outlook Paper and the Medium-Term Debt Management Strategy;

b)      matters relating to budgeting, the economy and financial management and integrated development at the national and county level;

c)      matters relating to borrowing and the framework for national government loan guarantees, criteria for guarantees and eligibility for guarantees; 

d)     agree on the schedule for the disbursement of available cash from the Consolidated Fund on the basis of cash flow projections;

e)      any proposed legislation or policy which has a financial implication for the counties, or for any specific county or counties;

f)       any proposed regulations to the PFM Act; and

g)      Recommendations on the equitable distribution of revenue between the national and county governments and amongst the county governments .

h)      any other matter which the Deputy President in consultation with other Council members may decide

N/B Section 8 of the PFM act requires that any bill dealing with county financial matters to also be referred to Senate budget committee to review and present to the senate .

County government budget process –Section 125 of PFM act 2012

The budget process for county governments in any financial year  consists of the following stages—

1.      integrated development planning process which include both long term and medium term planning;

2.      planning and establishing financial and economic priorities for the county over the medium term;

3.      making an overall estimation of the county government's revenues and expenditures;

4.      adoption of County Fiscal Strategy Paper;

5.      preparing budget estimates for the county government and submitting estimates to the county assembly;

6.      approving of the estimates by the county assembly;

7.      enacting an appropriation law and any other laws required to implement the county government's budget;

8.      implementing the county government's budget; and

9.      accounting for, and evaluating, the county government's budgeted revenues and expenditures;

The County Executive Committee member for finance should ensure that there is public participation in the budget process.

PUBLIC DEBT

•      It refers to the financial liabilities of a government

•      Public debt represents the total amount of money owed by the  government.

•      Article 214  of the constitution defines Public debt as - all financial obligations attendant to loans raised or guaranteed and securities issued or guaranteed by the National Government.

Public debt and private debt

Similarities

-Both government and private sector borrow either for consumption or for investment purposes.

-both pay interest on borrowings

Differences

1. A private economic unit cannot borrow internally, i.e. it cannot borrow from itself. However government can borrow from its own subjects and from within the country.

2. The government can repay debt through money creation while a private economic unit cannot.

3. Public debt/borrowings have profound effect on various dimensions of the economy-distribution, capital accumulation, economic growth, income and employment stability, and so on, unlike private debt.

Forms of debt obligations 

The debt obligations take different forms:

1.      Currency- dormant or inactive. The entire currency circulating in the market can be  be grouped under public debt if the central bank is classified under public sector. The government does not ‘pay them off’. At the most, one set of currency is replaced by another.

2.      Short term debt-obligations normally of a maturity of less than one year at the time of issue. E.g Treasury bills.

3.      Floating debt-has no specific maturity date but may be repayable subject to various terms and conditions. E.g provided funds, small savings, reserve funds and deposits.

4.      Permanent or funded debt-loans with maturity of more than one year, usually matures in 3-30 yrs. Some of them may even be non terminable(or perpetuities)so that the government is only to pay the interest on such debt without ever repaying the principle amount 

5.      External loans-obligations owed to foreigners-governments, Institutions, firms and individuals.

Classification of public debts

1.      Internal (domestic/local creditors)vs External debts(foreign creditors)

2.      Marketable (can be sold to others) vs non marketable(cannot be sold)

3.      Interest bearing  vs Non interest bearing

4.      Productive(used to acquire income earning asset or projects)  vs Non-productive

Why public debt? why should governments borrow?

i.            To cater for budget deficits.

ii.            Emergencies e.g. drought, famine, other natural calamities which forces a government to incur more expenditure than planned.

iii.            Unexpected rise in costs due to increase in prices e.g oil prices.

iv.            misappropriation of funds

v.            Mismanagement of activities which are funded by loans and and therefore the returns from the activities cannot service debt.

Economic effects of public debt

•      Public debt and economic growth

i) Contribution to the financial system of the economy.

-          The government contributes in the financial system through its financial assets- treasury bills and bonds. These assets have a low default rate and are an expression of confidence in the economy.

-          The existence of government debt is a prerequisite for the existence of a developed financial system of the economy which can aid economic growth.

ii) Contribution to the saving effort of the economy.

-          Borrowing from the market results in an increase in the rate of savings as the consumption level is reduced. These savings are invested in capital goods which helps in economic growth.

Public debt and inflation

•      Public debt can contribute to inflation in the following ways:

-          Borrowings for war activities ,natural calamities and other relief measures  are most likely to be inflationary in their impact because they are basically consumption oriented.

-          If public debt does not add to aggregate demand then it may contribute to inflation because the economy’s productive resources get diverted from the production of consumption goods into that of capital goods which have a long gestation period.

Public debt as a means of regulating the economy

•      The financial system can be regulated through variations in the volume, composition and yield rates of public debt.

•      Open market operations (OMO)change the volume of outstanding debt in the market therefore influencing the banking credit.

•      OMO is an activity by central bank to buy or sell government securities  in the open market .OMO is the primary means of implementing monetary policy.

•      When government buys the securities, they will be increased money supply in the economy and stimulate growth and viceversa

Public debt and taxation

•      The merits and demerits of tax and debt finance are often debated.

•      However ,no definite preference can be established for one method under all circumstances.

•      The choice depends upon the attendant situation and the over-all long term implications of the economy.

Cases for debt financing

Under some circumstances debt financing becomes either necessary or preferable.

•      For example, under war and other emergencies,when suddenly large funds are needed and additional tax revenue cannot be raised,debt financing has to be resorted to.

•      Where actual tax receipts are falling much below the anticipated volume.

•      Where debt is meant for particular projects which can generate income to repay the debts

Limitations of debt financing as compared to tax financing

1.      Public debt has to be serviced. Principle and interest has to be paid. This adds to the future budgetary commitments of the authorities.

2.      It is a medium for redistributing income in favour of the rich, unless counter balanced by taxation measures.

3.      Keeping inflation under check is more troublesome under debt financing than under tax financing.

4.      Sometimes  the  projects chosen for debt financing may not be really run efficiently enough to generate surpluses to pay off their costs

Limits to public borrowing

The limits can be:

1.      Specific legal restrictions on public borrowings. For example Kenyan Parliament had in January 2013 raised the ceiling for external debt from $10 billion (Sh800 billion) and set it at $14 billion (Sh1.2 trillion).In December 2014,through  sessional paper no.14 of 2014,Parliament increased ceiling for external debt to sh.2.5 trillion.

Domestic debt has become dominant in debt portfolio.

As at June 2013, public debt stood at KES 1.9 trillion, of which:

Domestic: KES1.1 trillion

External: KES 0.8 trillion

2.      Higher interest rates can act as a deterrent.

3.      Self –imposed limitation that all borrowings must be for ‘public purposes’.

•      Kenya requires at least Sh5.7 trillion to fund mega projects, including the Sh327 billion standard gauge railway, Lamu Port and South Sudan Ethiopia Transport project, generation of 5,000MW of power, the Galana Irrigation Scheme and the crude oil pipeline from Turkana to Lamu.

•      Other initiatives are the Northern Corridor integration projects, the second container terminal and berth, power transmission lines and the tarmacking of 10,000 kilometres of roads.

•      The Annual Public Debt Report released in December last year(2014) by treasury , shows that the debt to gross domestic product (GDP) has been growing steadily since June 2013 from Sh1.8 trillion or 42 per cent of the GDP to Sh2.4 trillion last year(2014), (47.9 per cent).

Public Debt burden

•      It  is the cost of servicing the public debt.

-          If the debt is held externally it will result in external interest transfers.

-          When debt is held externally, it may cause a depreciation in the exchange rate.

-          High public debt may also cause higher taxes which distort work incentives

Lessening the burden

•      The burden of debt may be lessened by favourable terms of trade to the debtor country.

•      It is also reduced by yields from productive investments undertaken by the debtor country.

The burden of debt and future generations

•      Debt financing of current expenditure can  lead to a burden on future generations if the current generation does not reduce its savings and the government does not add to the capital stock and productive capacity of the country.

Debt redemption

•      Debt redemption means clearing a debt.

There are several ways of retiring debt:

1.      Repudiation of debt-it’s the refusal by state to acknowledge a contract or pay debt. It involves rejecting, disowning or disclaiming as invalid.

This is however wrong since it hits the credit of the government and creates difficulties for future borrowing programmes.

2.      Sinking fund-a fund where government regularly puts in some money and uses the accumulated fund for periodic and partial retirement of debt.

3.      Regularly retiring a small portion of the debt every year.

Other methods involve currency printing and converting maturing loans into new ones of longer maturity.

PUBLIC DEBT MANAGEMENT REGULATIONS IN KENYA-PFM ACT 2012

Responsibilities of the Cabinet Secretary and functions of the national government with respect to grants and loans

1.      Setting Conditions for receiving grants and donations by national government or its entities or third parties. Receipt of grants have to be approved by CS for the national treasury.

2.      Regulations on grant administration-to be approved by parliament.

3.      Authority for borrowing by the national government-the CS is allowed to borrow on behalf of the national government.

4.      Obligations and restrictions on national government guaranteeing and borrowing-CS looks at costs, risks and sustainability

5.      The guarantee of debt to be done in terms of criteria agreed with the Intergovernmental Budget and Economic Council and prescribed in regulations approved by Parliament.

6.      Parliament to provide for thresholds for the borrowing entitlements of the national government and county governments and their entities.

7.      Establishment of public debt management office within the national treasury.

8.      The national government may borrow money only for the budget as approved by Parliament and the allocations for loans approved by Parliament.

9.      At the request of a County Treasury, the Public Debt Management Office to assist the county government in its debt management and borrowing.

10.  Money paid by the Cabinet Secretary on a guarantee, including any expenses incurred by the Cabinet Secretary in respect of the guarantee, to—

a)      be a debt due to the national government from the borrower whose loan was guaranteed; and

b)      be recoverable from the borrower as a debt due to the national government by—

i.            proceedings brought in a court of competent jurisdiction; or

ii.            Withholding a transfer of money in terms of Article 225 of the Constitution (gives CS power to withhold transfers), if the borrower receives appropriations.

11.  Money payable in respect of a guarantee to be a charge on the Consolidated Fund

12.  The national government is authorized to lend money but only in accordance with terms and conditions prescribed by the regulations approved by Parliament.

13.  A national government entity to obtain the approval of the Cabinet Secretary for its intended program of borrowing, refinancing and repayment of loans.

14.  A national government entity to also obtain the approval of the Cabinet Secretary before making any changes to its program of borrowing, refinancing and repayment during a financial year

15.  The national government is not liable to contribute towards payment of any debt or liability of a national government entity, unless the national government has guaranteed the debt or liability.

16.  The recipient of a grant or donation from a development partner to record the amount or value of the grant or donation in its books of accounts.

17.   The Cabinet Secretary or any person designated by the Cabinet Secretary in writing is authorized to execute loan documents for borrowing by the national government.

N/B The authority of the Cabinet Secretary to borrow money includes the authority to borrow money by issuing national government securities.

18.  Establishment of the office of the registrar of the National Government Securities which is an office under the Public Debt Management Office.

The Registrar to establish and maintain a register,  known as the Register of the National Government Securities in which is recorded details of all securities issued by or on behalf of the national government.

19.  The Cabinet Secretary may guarantee a loan of a county government or any other borrower on behalf of the national government and that loan to be approved by Parliament.

Money payable on a guarantee shall be paid only if the payment has been authorized by the Controller of Budget.

20.  A county government may borrow ONLY IF the national government guarantees the loan and with the approval of the county assembly

Functions of public debt mgt office`

•      Carry out the government’s debt management policy of minimizing its financing cost;

•      Maintaining a reliable debt data base for all loans taken by the National government, county governments & their entities;

•      Prepare & update the annual medium term debt management strategy including debt sustainability analysis;

•      Prepare & implement the national government borrowing plan including servicing of outstanding debts;

•      Acting as the principal in the issuance of Government debt securities on behalf of national treasury;

•      Monitor & evaluate all borrowing & debt related transactions among others