Private sector, “blink twice if you need help”; Part 2

In 2003 John Gachora then a young investment banker who had come to visit Kenya from New York, met Dr David Ndii.

The current economic advisor to the Kenya Kwanza government was then working for scholarship and civil society and had written an impressive paper on Kenya’s economy. According to Dr Ndii, since only 15 percent of Kenya’s land was arable Kenya should stop investing in agriculture and instead invest in processing.

“The argument you told me was let Uganda and Tanzania which have more than half their land as arable be the food baskets of East Africa and Kenay will do all the processing instead of spending that money doing agriculture,” Dr Gachora said.

“Today you sit in a position you are the chief policy advisor in government, and the first policy you advise is to invest heavily in agriculture, doesn’t that go into contradiction,” Mr Gachora posed.

IMF expert advise

Dr Ndii said economics is complicated, but he has not changed what he said, agriculture right now is the only policy government can pursue because it does not need investments. It is the only low hanging fruit.

The Kenya Kwanza administration landed on the hot seat of fiscal crisis with loans sucking up all state revenues, recurrent bills running late even as pending bills piled up.

It turned to the International Monetary Fund for support. The IMF convinced the new government to use tax measures to restructure the economy by unplugging ancient companies with their entrenched interests and creating room for new companies to grow and western capital looking at the future African market to establish itself.

The Fund research showed Kenya has the largest share of agriculture raw materials in its exports relative to the comparators and it would make sense to focus on agriculture value chains.

The new government bought into the idea that it would replace the underperforming manufacturing sector through investment in agriculture focusing on milk production and oil crops. It is now making massive investments in oil crops to cut down on oil import bill and develop new value chains. It has drafted the Nuts and Oil Crops Development Bill, 2023, and launched aggregator centers across the country to make the sector profitable and sustainable. It has invested billions in seeds like sunflower to increase acreage from 4,000 acres to 200,000.

The damage

The government always knows that implementing the IMF structural adjustment programmes has a painful cost which it has had to bear to avoid default.

The government unleashed a raft of tax measures on the manufacturing sector accusing them of unfair tax lobbying.

But the impact may have been bigger than anticipated.

Expenditure on industrial materials, largely shipped in as intermediate goods to be used in factories, began falling by double-digit rates. It became clear the drop largely reflected a struggling manufacturing sector plagued by higher taxes and import costs amid dipping sales

Manufacturing is crumbling as the high cost of living, weak shilling, low activity, an unfavourable business environment due to high taxation and high fuel prices threatens operations. As a result companies are shutting down and cutting crucial jobs in a country heavily reliant on income taxes.

And the contagion started spreading to the financial sector as the manufacturers began defaulting. The sector's stock of non-performing loans (NPLs) jumped 59.2 percent to Sh133.7 billion in the nine months to September 2023 from Sh84 billion a year ago.

According to ratings agency Fitch the absolute amount of non-performing loans in the banking sector increased by 50 percent for manufacturing, building and construction in the first nine months of 2023.

According to the Kenya Association of Manufacturers (KAM) policies, particularly the doubling of VAT on petroleum products from 8 percent to 16 percent have had adverse effects on the manufacturing sector. Given that the sector heavily relies on energy, primarily derived from electricity and petroleum products, such increases in taxation have directly increased production costs.

“Our members are adapting to forex costs, high taxes, and interest rates by implementing diverse measures, including laying off staff, reducing production capacity/downsizing, and closing plants,” KAM said.

The Laffer curve

According to the Kenya Association of manufacturers, the government is squeezing them for every penny, yet they cannot pass the cost to consumers because most goods have breached the price elasticity.

Price elasticity is where an increase or reduction in price affects demand. Now economists believe that some goods like fuel are pretty inelastic  as drivers will continue to buy as much as they have to, as will airlines, the trucking industry, and nearly every other buyer. But in Kenya fuel consumption dipped to a five year low when the government introduced the  International Monetary Fund structural adjustment programmes. 

“Manufacturers have refrained from increasing prices of manufactured goods due to awareness that consumer demand is depressed, resulting in reduced margins received by manufacturers,” the Kenya Association of Manufacturers said in an emailed response.

KAM says Kenya cannot dream of becoming an Asian tigers if state policies undermine manufacturing that should ideally be the solution to the country’s current economic problems.

The lobby said themanufacturing sector has acted as a growth escalator in now-developed countries, and Kenya cannot be an exception.

“We have demonstrated that the manufacturing sector has the ability to create prosperity for the nation, if the right policies are implemented, including bolstering our economy and restoring the value of the weakening currency,” KAM said.

“For instance, consider the East Asian growth miracle countries. About 60 years ago, South Korea was one of the poorest countries in the world, with a GDP per capita of no more than US$ 87. In comparison, Kenya had a GDP per capita of US$ 107 at the time, indicating better performance than South Korea. However, in 2023, Kenya’s nominal GDP is circa US$ 110 billion, while South Korea’s GDP stands at US$ 1.7 trillion. Given this background, Kenya can retrace the economic growth pathway and perhaps, emulate the South Korean development model by shifting our policy stance in favour of export-oriented policies and moving onto high-growth trajectories,” KAM said.

We warned the IMF

The manufacturers say that they had warned the International Monetary Fund that pursuing the aggressive tax moves will collapse the nascent manufacturing sector.

KAM officials met the IMF staff twice last year where they raised concerns about the proposed introduction of minimum tax, the review of VAT exemptions and zero-rating, and the introduction of VAT on insurance services, which would increase the unit cost of labour for manufacturing companies.

Additionally, KAM addressed the introduction of surtax, an additional charge or tax that companies add to the cost of goods or services at the point of sale on behalf of the government.

“Policies, particularly the doubling of VAT on petroleum products from 8 percent to 16 percent, have had adverse effects on the manufacturing sector. Given that the sector heavily relies on energy, primarily derived from electricity and petroleum products, such increases in taxation have directly increased production costs,” KAM said.

Hustler revolt

At fuel stations in Kenya today, the attendants will ask you to check the gauge before they begin filling your tank. This is partly to exonerate themselves from accusations of theft when your fuel gauge does not move an inch but is also a marketing ploy as fuel consumption dips.

Sustained taxes and currency depreciation have pushed up fuel prices in Kenya over Sh200 a litre and beyond the reach of most consumers in the country.

As a result, consumption of super petrol dropped five percent to 1.01 billion litres from 1.074 billion litres last year while that of diesel fell four percent to 1.31 billion litres compared to 1.36 billion in the same period, according to the Energy and Petroleum Regulatory Authority (EPRA).

As fuel prices become prohibitive, transport sector growth decelerated from a growth of 5.1 per cent in the third quarter of 2022 to 2.8 percent during the third quarter of last year, partly attributable to high cost of petroleum fuels.

To survive, some fuel stations have introduced discounts, shaving off a shilling or two from the highly regulated petroleum sales to keep market share while some have gone for customer relations.

From offers to clean your windshield, and check your hood if ‘mbele iko sawa’ to push sale of lubricants, the stations are doing everything to grapple with the sales dip.

Others have to rely on BodaBoda to survive, the motorcycle riders often take a quarter to half a litre for short trips, at times funded by their customers before setting out.

The boda boda who had shouted Hustler loudest are now angriest against President William Ruto’s regime.

The number of motorcycles units imported into Kenya fell 90 percent to 12,939 in the third quarter of the 2023 indicating the impact of dissipating demand against increasing cost of commodities on tax and currency collapse.

Even as less units enter the market, those in circulation are being randomly repossessed by creditors souring the tongues of President William Ruto’s massive hustler base.

Plea to change government approach

But with the Eurobond paid out, the collapse of political support, financial shocks and potential crisis may force the government to reconsider.

Manufacturers say the contradictory outcomes of state policies are indicative of the consequences of neglecting key economic sectors such as manufacturing and agriculture, and imprudent fiscal policies.

Federation of Kenya Employers Ms. Jacqueline Mugo, said the government should have worked with the private sector on the reforms from the word go, rather than alienate them.

“The private sector is resilient and adaptable. However, the success of structural adjustment programs depends on a well-coordinated effort between the government and private sector. FKE encourages a consultative process to ensure that any adjustments, especially in agricultural value chains, are implemented with a thorough understanding of the sector's dynamics, and that private sector concerns are taken into account,” Ms. Mugo said.

The FKE boss said while she recognizes the government's need to meet its fiscal responsibilities, including, commitments to international financial institutions, they were advocating for a careful and balanced approach to taxation that considers the impact on businesses and economic growth.

“The government should assess the overall economic landscape and consult with key stakeholders before making decisions on tax policies at the end of the IMF program. We advocate for a program that ensures at least 70 percent of mobilized tax revenues remain in the country for development. The current scenario of where 70 percent of of revenues go to pay foreign debt is not helping the country,” she said.

Read Also: Private sector, “blink twice if you need help”; Part 1