Fiscal Policy Sustainability in Kenya

Abstract

Fiscal policy sustainability is key for medium to long-term growth of any economy. Maintaining fiscal sustainability aids to create enough fiscal space to mitigate economic shocks. The fiscal space in Kenya has been constrained by rising government expenditures, widening the fiscal deficit further. As such, concerns have arisen on the sustainability of fiscal policy in Kenya, motivating this study. Using Johansen cointegration technique and the two-step Engle-Granger approach the study assessed the sustainability of fiscal policy in Kenya. Empirical findings indicate that fiscal policy in Kenya is weakly sustainable. However, the economy adjusts fast in instances of disequilibrium caused by various shocks. To ensure fiscal sustainability in the long run, the study recommends a reduction in the share of salaries and wages which is the largest component of recurrent expenditures. Similarly, retiring short-term and expensive commercial debt by increasing the share of concessional loans in financing fiscal deficit is key. A review of the relevance and costs of multiple exemptions including those on Value Added Tax (VAT) and other incentive schemes such as deductibles and investment allowances under corporate tax to reduce revenue forgone is paramount.