Overview

Kenya has yet again tabled East Africa’s largest budget statement, targeting revenue collection of KES 1.358 trillion (20.8% of GDP) and overall expenditure and net lending of KES 2.002 trillion (30.7% of GDP), leading to a budget deficit. Of this, 1.28 trillion would be recurrent, while 721 billion would be development expenditure. The government of the day seemed to be buoyed by their creation of about 800,000 jobs (the informal sector created over 80% of these), reduction of the cost of living due to the reduction of the price of electricity and fuel (which was cancelled out by the increase in the prices of food and other consumables), completion of key projects in roads and energy, and rolling out the construction of the Standard Gauge Railway (SGR).

The Kenyan economy grew by 5.3% in 2014 (tied with Uganda for the lowest growth rate in the region), and is projected to grow at between 6.5% – 7% in 2015. The Finance Secretary attributed this growth to low inflation (Kenya’s rate of inflation is the highest in the region, at 6.9%), steadily declining interest rates (The Central Bank of Kenya (CBK) retained the Central Bank Rate (CBR) at 8.50% through the 11 months of the year but increased the rate to 10% to try stop the shilling’s depreciation), a broadly stable exchange rate (this can be argued to be false, the value of the shilling has dropped greatly in the past year) and a sustainable public debt position.

The tourism sector took a hit as a result of insecurity, and could be the reason we performed so poorly in terms of growth last year. This may continue in 2015 as well. To guard against shocks derailing its agenda, the government has a precautionary stand-by arrangement and a stand-by credit arrangement with the IMF of up to US$ 688.3 million to be drawn upon in the event of an exogenous domestic/external shock. Whereas the economy of world at large is expected to experience growth ranging between 3.5% – 3.8% in 2015, SubSaharan Africa’s projected growth rate is 4.5%, down from 5% in 2014 because of poor performance by Nigeria and South Africa.

The budget identified six key development areas that the government plans to focus on – infrastructure, agriculture, security, health, education, social protection and youth empowerment. Through this, they hope to boost growth, create jobs and enhance social equity. Other than insecurity and a sharp drop in tourism income, Kenya has experienced a drop in the prices of its agricultural produce. This, in combination with the marginal growth in sectors such as information and communication, transport and storage, construction, financial and insurance services reduced the impact of the growth created by the continued investment in infrastructure, especially the SGR, increased production in agriculture due to implementation of strategic interventions to revamp the sector, and increased activity in sectors such as manufacturing, retail and wholesale, construction, mining and quarrying, and financial intermediation. The growth in 2015/16 is expected to come from improved business environment, lower global oil prices, high public and private investment, increased consumer confidence and high agricultural productivity.

In 2014, revenue administration was streamlined further through measures such as rolling out of KRA’s iTax system, enactment of income tax in the extractive industry, re-introduction of capital gains tax, and introduction of VAT withholding. To analyze this budget further, we will focus on key topical areas.

Economic Analysis

This budget represents a 25% increase from the 2014/15 budget, and shows the government’s approach to economic stimulation: through increased spending. However, the government would need to ensure that this money can actually be absorbed where it is being spent so that the gains it seeks are realized, and that as little of it as possible is lost to corruption, both at national and county level. Key to the 7% economic growth projected in this budget is increasing the absorption of development expenditure, especially at county level.

While the informal sector created over 640,000 jobs in the past year, the formal sector only added over 106,000 jobs. Public administration, compulsory wage bill and education sectors were the largest employers in the public sector. Formal employment enhances productivity and increases household earnings, providing a way out of the cycle of poverty, and should be a focus of the government if it wants to reduce poverty.

In 2014, the government rebased our GDP estimates, leading to a 25% growth in the economy as compared to 2013. This also contributed to the 5.3% economic growth, which may have been lower otherwise. While our Eurobond issue was successful and boosted investor confidence in Kenya, the shilling took a hit against currencies such as the US Dollar, the Euro and the British Pound. This made imports more expensive, cancelling out the gains from the drop in energy prices.

Based on the last audited statements, county governments have been allocated KES 287 billion: KES 259.7 billion of shareable revenue along with KES 27.3 billion in conditional grants. This is 37% of government revenue. A major challenge to the absorption of development expenditure at county level has been that their budgets are not aligned to the County Integrated Development plan, and that many of their projects are not budgeted for, making them very unpredictable. The conditional grants seek to reward counties for adherence to key delivery standards, certain minimum conditions and fiscal responsibility. Collaboration between national and county governments is necessary to enforce development policy, generate additional revenue for counties, and create a conducive business environment for the private sector.

This budget has introduced protective measures for local industry, such as exemption of VAT on film making equipment and the increase on import duty for sugar from 10% to 25%. Investments in infrastructure and good governance measures should make it easier to do business in Kenya as well.

Direct Tax

The Cabinet Secretary has proposed a carry forward period of up to 10 years for corporate tax losses, up from four as per the Finance Act 2009. This will enable investors whose projects require huge capital injections early on while likely incurring tax losses to breathe easy, and will encourage more of them to invest here. This proposed amendment would apply retrospectively to tax losses accrued before 2015.

Capital gains tax was re-instated in 2014, however, there was a lot of haranguing over the antiquity of the 1986 Act, which does not take into account changes in the Kenyan economy. Stockbrokers were unhappy with the obligation that they withhold capital gains tax on the sale of their clients’ shares. To counter this, the CS has proposed a withholding tax of 0.3% on the sale of shares, making it a much easier affair to administer this tax regime. The other option, determining the capital gains for each sale, would have been far more complicated. For all other classes of goods as per the Act, capital gains tax will apply at 5% of the net gain.

Tax compliance from real estate has also been low, and to increase it, landlords making less than KES 10 million per annum (gross rental income) will now pay 12% as final tax. Amnesty has also been proposed for landlords who have not declared their rental income fully. They will be required to pay the principal tax for 2014 and 2015, and then all taxes, penalties and interest arising for all years prior to 2014 will be waived. Penalties and interest arising on the tax payable for the 2014 and 2015 year of income would also be waived.

To promote Kenya as a filming destination of choice, foreign actors and crews will no longer be subject to Kenyan withholding tax. This is meant to attract technical expertise, attract renowned personalities and enhance the quality of local productions.

To increase investments in the shipping industry, eligible tonnage for capital allowance has been reduced from 495 tons to 125 tons. The rate of investment deduction has also been increased from 40% to 100%. This is important given how much we are investing in port infrastructure.

To collect revenue from gaming, a gaming tax on gross gaming revenue has been introduced. It covers public lotteries which will be taxed at 5% of the lottery turnover and bookmakers at 7.5% of the gross betting revenues. All prize competitions where the costs of entry are premium shall also be taxable at 15% of the total gross revenue.

The CS has also proposed a tax rebate for apprenticeship (where a company engages at least ten graduates for a period of 6 -12 months during a year of income). The tax rebate would then be available in the subsequent year.

Non-resident mining sub- contractors will be subject to withholding tax at the rate of 5.625% (a final tax) on the gross amount of their service fees. This is in line the withholding tax rate on service fee payments to the petroleum exploration and production sector. Training fees paid to non-resident entities by a petroleum or mining company will be subject to a withholding tax rate of 12.5% on the gross amount payable, so as to be in line with the rate of withholding tax applicable to management or professional services. Resident entities will continue to pay 5%.

There was failure, however, to revise the income tax regime for individuals (which has been stagnant for ten years), which makes sense given the increased cost of living, 2013 VAT Act which increased the number of taxable goods, creating a wider tax base. The CS should have expanded the tax bands so as to safeguard low income earners, and tax high income earners more for greater equity. There should also have been incentives to encourage the best human capital to work from/in Kenya, such as easing the movement of labour.

Indirect Tax

We may finally see a roll-back of some of the changes introduced by the 2013 VAT Act which were bad for business. However, the move to make the said goods/services exempt as opposed to zero rated (to reduce the tax refund challenges experienced by KRA) is in itself harmful in the long run, as discussed here.

The CS has proposed to restrict the claims period to 12 months from the date the refund becomes due since the Act does not set a time limit. The CS also seeks to restore the zero-rating of goods in transit so as to increase the competitiveness of Kenyan transit companies and stimulate growth in the transport sector. The Act unwisely standard-rated goods in transit, then the Finance Act 2014 exempted them, both which led to an increase in prices.

To encourage assembly of electronic devices (with the goal of enhancing the use of ICTs among our school-age children), inputs for assembly have been exempted from VAT. Plastic bag biogas digesters have also been proposed to be made exempt from VAT so as to encourage the use of biogas for cooking and lighting in rural households.

The CS has proposed exemption from VAT for film making supplies, as well as a fund to provide rebates for the expenses of producers. This is intended to increase growth in the industry. There is also a proposition to exempt taxable supplies used in the construction of infrastructure works in industrial and recreational parks of 100 acres or more in Nairobi, Nakuru, Kisumu, Mombasa and Eldoret. This is meant to spur industrialization and create jobs.

A new Excise Bill has been tabled so as to simplify the current regime. Excise duty would move from its current hybrid structure to being based only on quantity. The focus would also be on goods considered harmful, such as alcohol, tobacco, motor vehicles, sweetened beverages and fossil fuels. This would increase tax collection by up to KES 25 billion per annum.

Customs Duty

Cross-border supply of goods will be more efficient and transparent once KRA implements Kenya National Electronic Single Window System (Tradenet) on which all importers and exporters will be required make their Customs declarations.

There is a proposed increase in the duty rate on imported sugar from USD 200 to USD 460 per metric tonne while maintaining the ad valorem rate at 100% to protect the sector from unfair competition from imports. Import duty rate for gas cylinders is to be increased from 0% to 25% to protect local manufacturers of gas cylinders. It is also proposed that import duty rates on plastic tubes for packing toothpastes and cosmetics be increased from 10% to 25% to protect local manufacturers.

It is proposed that the Common External Tariff (CET) rates on paper and paper board be reduced to 10% (from 25%) to lower the cost of packaging materials for the manufacturing sector. To encourage local production of pasta, gazette manufacturers will be granted full duty remission on Semolina (the raw materials).

To deter smuggling of raw hides and skin out of the country and encourage in-country beneficiation across the EAC countries, export duty rates have been harmonized across EAC at 80% of Free On Board (FOB) value or USD 0.52 per kg, whichever is higher.

It is proposed that customs duty on nylon yarn be reduced from 10% to 0% to encourage local manufacturers of fishing nets. This would be coupled with an increase of import duty on ready to use fishing nets from 10% to 25%, to protect the local fishing net industry. To encourage and protect the local production of aluminium milk cans, it is proposed import duty has be increased from 10% to 25% on importation of these cans.

Prison authorities have been added to the duty exemption schedule to enable them import materials, equipment and other supplies for their official use duty free.

Levies

To expand the existing road network, an additional road maintenance levy of KES 3 per litre of fuel will be collected and deposited in a Road Annuity Fund. To harmonize Import Declaration Fee (IDF) across the EAC, it has been lowered from 2.25% – 2%.

The Miscellaneous Fees and Charges Bill, is proposed to cater for levies which were previously anchored in the Customs and Excise Act, CAP 472. The levies covered by the new law shall include IDF, Railway Development Levy (RDL) and export levies.

Vision 2030/Infrastructure

Resource utilization and absorption of expenditure are key for the success of this focus area. Infrastructure projects continue to receive huge budgetary allocations due to their ability to increase economic growth and create jobs. However, it is key that the government ensure that this expenditure is well absorbed, otherwise the gains will be reduced.

Over KES 330 billion has been allocated to capital projects, infrastructure and energy. The SGR will be fast-tracked for completion by end of year 2017, receiving an allocation of KES 143.9 billion. KES 40 billion will go towards enhancing access to energy and absorption of the 280 MW generated from the target of 5,000MW. This will further reduce the cost of energy leading to a lower cost of production/manufacturing. New road infrastructure and maintenance of existing infrastructure will cost KES 132 billion. The Lamu port will be prioritized financed through Public Private Partnerships (PPPs). An allocation of KES 1.3 billion will go to finance new ferries.

Since there will be a mandatory policy requiring 40% of the inputs be sourced locally, this produces increased gains for our economy. However, these gains can easily be wiped out because the other 60% will likely be imported, and the value of the shilling has been weakening in relation to major currencies, especially the dollar. The government needs to have a stronger focus on strengthening the shilling, which is perhaps why the proposed governor of the CBK comes from an IMF background.

The focus on PPPs to implement projects, such as the 5,000 MW plan, road projects and construction of university hostels is apparent, as the CS has been clear that public sector resources are not enough to finance infrastructure. However, is the private sector willing, able and incentivized to take on such projects? Are the risks too high? Other means of financing include taxation, domestic and external financing and the stand-by arrangement with the IMF. It is critical to weigh the risks vs the benefits of all these proposed means of financing.

Financial Sector

The CS has proposed to progressively increase the minimum capital requirements for banks and insurance companies. Banks will be required to hold KES 5 billion by December 2018 (up from the current KES 1 billion). Insurance companies will be required to hold KES 600 million and KES 400 million by June 2018 for life and general insurance companies (up from the current KES 300 million and KES 150 million) respectively.

Out of the 44 banks, only 20 meet these requirements. Out of 25 life insurers and 39 general insurers, only six and ten respectively have met these capital requirements based on recently financial statements. This may lead to consolidation to create larger, more stable financial institutions.

CBK can now issue non-renewable, perpetual licenses for banks so as to reduce the administrative headache caused by renewal of annual licenses. They will conduct risk based monitoring and periodic inspections and will be able to withdraw licenses.

Trustees at pension schemes will not be allowed to serve more than two three-year terms. This will lead to better governance. Pension schemes will also be required to submit audited accounts within 3 months after year end, and this responsibility will fall on the trustees.

The Sacco Societies Regulatory Authority (SASRA) will vet directors and key officers of deposit taking Sacco societies so as to align with the practice adopted by other financial services regulators.

The introduction of the M-Akiba bond will allow Kenyans to purchase government securities with as little as KES 3,000 using their mobile phones.

Technology

Based on our ICT master plan, launched in 2014, Kenya aims to become a regional, and global, ICT hub. Technology will be used to improve service delivery and revenue collection, addressing insecurity, enhancing transparency in government, investing in education and innovation, and enhancing growth in the private sector.

The Government plans to move all payments to the digital platform eCitizen. It will ensure that payments to government are made electronically so as to significantly reduce administrative costs, minimize leakages and expand access to payment points. KES 2.5 billion has been allocated towards increasing the number of Huduma Centres. By the end of this financial year, the government aims to have rolled out an additional 23 centres, bringing the total number of to 46.

IFMIS (Integrated Finance Management Information System) has been allocated a budget of KES 1.9 billion. Through IFMIS, the eProcurement module is being rolled out to MDAs (Ministries Departments and Agencies) and counties so as to have a fully inbuilt active price reference and ensure Government does not procure any supplies above market prices. They will use it to manage and account for their budgetary allocations.

There will be a focus on making the CCTV surveillance systems operational, and the setup of a command and control centre to enhance security. The allocation to security organs of KES 223.9 billion this year is also much higher than last year.

KES 17.58 billion has been allocated towards ICT learning devices, digital content, building capacity of teachers and computer laboratories. This is aimed at improving the quality of education through e-learning. Necessary for this to succeed is that all schools must have access to electricity, internet and their devices must be kept safe.

The Kenya National Electronic Single Window System is aimed at the private sector, and should be operational in the next financial year. It will facilitate trade by reducing delays and lowering costs associated with clearance of goods. It will also enhance transparency, accountability and improve revenue collection.

The Konza Techno City project has been allocated KES 0.8 billion (which is insufficient given its scale). However, the government seeks to leverage on PPPs to realize it. The project is focused on education, life sciences, telecom, BPO and Information Technology Enabled Services (ITES), all which will contribute to the growth of this sector.

KES 0.25 billion has been allocated for the Presidential Digital Talent Programme (PDTP), which aims to enhance the ICT capacity of Government through management trainee programmes for graduates. This will transform how ICTs are utilized for efficient and effective service delivery. The government has also introduced a tax rebate scheme for employers to encourage corporates to engage fresh graduates in acquiring relevant experience and ICT skills through internship and apprenticeship programs. This is to increase private sector participation in the PDTP programme.

Conclusion

This is a very progressive budget, and it should be able to kickstart Kenya’s growth engine, if only we do not “misplace” vast sums of money as a result of corruption, if implementation is taken seriously, and if absorption of resources is made a key priority.