Is the IMF fuelling flames in Kenya?

Kenya is at a crossroads. A swathe of Parliament-approved tax increases for 2024/2025, compounding many in recent years, broke  the camel’s back, catalysing weeks (so far) of unprecedented protests nationwide, led by Gen-Zs.

With a heavy-handed official response dismissing them as “anarchists”, the protesters’ agenda quickly widened to fundamental governance.

So even a dramatic U-turn by President William Ruto vetoing the tax rises failed to restore calm. At least 50 protesters have lost their lives; many more have been injured or “disappeared”.

And as the tax rises were all driven by an International Monetary Fund (IMF) programme since 2021, that too is now in the cross-hairs.

The antecedents run far deeper than Covid and Ukraine: three decades of per capita growth well short of Kenya’s best global peers; after two decades of swingeing IMF-mandated fiscal stringency, the exact reverse in the 2010s also with an IMF nod, driving debt and interest rates up and the exchange rate deeply into overvaluation territory by decade’s end; deeply skewed land ownership, a colonial legacy, underpinning an oligarchy and cramming most into residual marginal areas and slums; sustained rises in global interest rates post Covid and in food prices post unprecedented droughts and Ukraine —  and then, equally unprecedented nation-wide floods in April. So real wages, already low, have been falling fast, especially at the low end, for four years.

Nothing about this says “raise taxes”. But that is what the IMF demanded, and demands.

Far from getting everything wrong, as the global covid recovery gathered steam, the IMF was right in 2021 to see that Kenya needed a programme which should be centred on fiscal consolidation — not least given a huge bullet maturity on a Eurobond in 2024 — which should be prosecuted within Kenya’s prevailing Monetary Framework.

But beyond that, little else of what it mandated made or makes sense.

Declining private investment ratios

Its diagnostic errors began with judging the exchange rate as within range of fair value. This core error reflected boiler-plate application of its standard metrics of misalignment.

That process ignored the compelling counter-evidence from Kenya’s declining private investment ratios (and much else) since the early-to-mid 2010s and that if investment goods dominate imports, as in Kenya, the standard mis-alignment diagnostic toolkit has to be recalibrated.

Given that core diagnostic error, the IMF backed a back-loaded fiscal consolidation, giving the Central Bank of Kenya no scope to cut interest rates and so lead exchange rate correction to drive exports.

Instead, the IMF left the currency overvalued and oriented fiscal policy squarely on getting public debt ratios onto a downward track over the medium term.

In pursuing that to the exclusion of almost all else, the IMF targeted medium-term primary balances of the government budget which would not only take it far above revealed best practice globally for countries in Kenya’s GDP per capita neighbourhood but also back towards the swingeing territory that had done such damage to Kenya’s growth for two decades to 2010.

And in doing so, it demanded the aforesaid tax rises to “support government activities”, overlooking that several of Kenya’s best peers prospered with tax ratios considerably lower than Kenya’s and that tax rises would inevitably rouse deep and fully warranted public suspicion of corruption and waste.

Then, when the context deteriorated substantially with droughts and Ukraine, the IMF again essentially ignored both, demanding that the primary balance be kept “on target” regardless, implicitly telling Kenyans to “just tough it out”.

And worse still, with the IMF treating the food price shocks as an inflationary phenomenon rather than as a supply shock, it has insisted on over-tight monetary policy throughout, resulting latterly in month-on-month non-food inflation now running well below the Central Bank of Kenya target range.

Compensatory tax rises

This serial misdiagnosis and mis-prescription is reflected, among much else, in real GDP in 2024 fully 3 per cent below the level projected for it at program’s outset, a shortfall in just three years equivalent to half normal annual growth. And as tax revenue has fallen short alongside, this has sent Kenya into a doom loop of growth and revenue shortfalls and compensatory tax rises compounding growth shortfalls and on and on to uprising.

Markets have not been oblivious. Yield spreads of Kenya vs global benchmarks now stand well above pre-program levels, and recently Moody’s downgraded Kenya deeper into junk.

There are times when public protest rails at painful but necessary macroeconomic adjustment. But at other times, such protest informs IMF macro-economists—if they will hear—that they are in error. That is the case now, and Kenyan Gen-Z’s have, rightly, simply had enough.

After vetoing the 2024/2025 tax rises he had just railroaded his own MPs into approving, President Ruto     signalled that the originally IMF mandated consolidation of some 1 percent of GDP would be rephased into subsequent years.

But that rephased demand for further budget consolidation just continues IMF mis-prescription. With underlying (non-food) inflation already below target, there is no macroeconomic case for a fiscal tightening now or later. Instead, given that the primary balance outturn for 2023/2024 was already close to best peer practice, it should be left unchanged.

Alongside, monetary policy should be relaxed immediately and significantly to prevent a sustained undershoot of the underlying inflation target, and to secure Shilling correction.

Application of this package is not only macro-economically sound, but it would ease both immediate political pressure and risk that it will simply reappear next year should the IMF-mandated non-best practice consolidation resume then.

But if, as may be, neither the President’s latest plan nor our preferred framework calms market and pubic disquiet, the fundamental implication is that Kenya’s public debt needs to be significantly written off. Given these underlying economic imperatives, only the IMF’s Executive Board’s collectively- approved but dysfunctional arrangements to resolve Sovereign Insolvencies stand in the way.

But by doing so, the IMF, as it has done since 2021 and even if now with a symbolic rephasing of the budget targets, is merely adding yet more fuel to the flames.

Kwame Owino is the Chief Executive Officer of the Institute of Economic Affairs.

Maureen Barasa Is the Programme Officer in the Popular Economics Programme of the Institute of Economic Affairs.