The IMF and Kenya's Public Finance Deadlock - 2

The IMF and Kenya`s Public Finance Deadlock - 2 / 1 - 3

The International Monetary Fund should seek to achieve its mandate working with the political system of the 2010 Constitution rather than with a non-existent one they would like to see. This article continues from Part 1 published here.

Kenya as a member of the IMF

Kenya is a member of the International Monetary Fund (IMF), an organsiation it joined in February 1964. The IMF is a voluntary association, a bit like a credit union where members pool resources to bail each other out in times of trouble and for the greater good of all. The specific purpose of the IMF is to promote international cooperation on monetary affairs by enabling members to consult and collaborate on international monetary problems with the aim of bringing about "balanced growth of international trade, orderly economic growth and employment, with reasonable price stability", including exchange rate stability. Cooperation also seeks to avoid a repetition of the competitive devaluation that contributed to the great depression in the 1930s. As a member of this credit union, Kenya knowingly submitted itself to play by its rules.

To ensure that its members comply with their obligations, the IMF is mandated by Article 4 of its Constitution to conduct periodic surveillance on their economic and financial policies and to provide advice on corrective measures. This is the so-called Article 4 Review. Countries may take or leave the advice, unless you are borrowing from it. Rich countries often politely acknowledge the advice and politely ignore them or if they feel annoyed enough, may even tell the IMF off as the George Bush era politicians in the US tended to do regularly. However if a country is borrowing from the Fund, their flexibility to ignore advice is constrained by conditionalities which the Governments undertake to fulfill. The undertaking, called a Letter of Intent which is often drafted by IMF staff is signed on behalf of the country by the Minister of Finance and the Central Bank Governor. Violating these conditions can be costly, including paying a fine. It can also be costly in terms of the country's credit rating as the IMF plays the role of a credit rating agency for the poorest countries for whom the big private credit rating agencies find too unattractive to border with. Kenya is into one year of a 3-year loan from the IMF and is therefore bound by conditionalities they committed to.

The Needs and worries of the IMF in relation to the management of public finance

The IMF has a legitimate need to ensure that countries do not build up unsustainable imbalances. These are: the government's fiscal balance (expenditure-revenue); the monetary balance(money demand-money supply) and the foreign balance (imports-exports). These 3 accounts feed into each other. Deficits in the fiscal account will have to be financed often from borrowing. Government borrowing from domestic sources can lead to unsustainable domestic debts, or contribute to inflation or may even undermine private investment and ultimately orderly economic growth. Inflation does not only lead to hardships it also drives up the cost of loans and the cost of paying back loans through the effect on interest rates or the exchange rate, although mild inflation can also be good for domestic producers. Massive government deficits, according to IMF analysis, can also spill over into imports and if imports grow faster than exports (which is often the case in the short run), the Balance of Payments (BOP) deteriorates.

The deficit in the BOP will need to be plugged, usually through external borrowing, which if not kept within reasonable limits can risk a sovereign debt crisis of the type we are witnessing today in the United States and the European Union or of the type Africa witnessed in the heady days of structural adjustment programmes. When governments can't pay their debts and do not wish to anger their creditors or risk not having access to further loans in the short run, they ultimately call in the IMF to help bail them out. Governments may also borrow from the IMF to boost their foreign reserves so as to protect the value of their currencies, sustain imports in times of unexpected dip in export earnings and assure creditors that they can pay their debt.

The IMF and Kenya's Public Finance Deadlock - 2 - 2

• The Fund's Concerns

Ultimately, the IMF's concerns are that: a country is able to pay its debts to its foreign creditors; that its domestic prices are stable in order to protect the value of foreign capital (among others) and that foreign capital has the freedom to move in and out. It is in relation to the first concern (ability to pay debts) that governments are made to prioritise external debt servicing in their budgets. It is in relation to the second objective (low inflation) that the IMF and others have pushed for Central Bank Independence and Central Banks have been encouraged to narrow down their policy objectives mainly to managing inflation sometimes at the expense of growth and employment. It is in relation to the 3rd objective (free capital movements) that the IMF has encouraged the liberalization of the capital account and privatization of state enterprises in many countries.

It must be added that although there is some consensus among economists on what needs to be avoided - unsustainable debts, very high inflation and sustained inflationary expectations, too much control of capital and foreign exchange etc. - there are hot disagreements on the details of how much of what is bad or even how best to get to what may be good. The IMF has not always got it right – perhaps too many times. That much they have admitted also many times. The IMF has changed its tune on policy matters also too many times . For example we have seen the IMF's prescription of how to address economic and financial downturns change radically when it came to addressing the crisis of rich countries. Above all it must be understood that macroeconomic and structural policy options are not always benign the create differential impacts in society necessitating public debate and social impacts assessments in the same way you will do to minimize the environmental impact of investment projects.

There are two key points here. First, the IMF has a legitimate right to take measures to ensure that governments manage their public finance in a manner that is consistent with their obligations as members of the IMF. The second is that, be that as it may the steps it takes must satisfy 2 conditions. The first condition is that those steps are squarely within its mandate. The second condition is that the steps taken or proposed must be proportional to the Fund's purpose. Under Kenya's 2010 Constitution, there is a 3rd precondition which is that the decision making process must be transparent and participatory.

I will argue that in relation to the manner in which it intervened on the power relations issues in the management of Kenya's public finance under the 2010 Constitution, the IMF may have stepped into or even beyond the grey area of its mandate and that many of the recommendations of its technical mission which have guided Treasury's position on the PFM bill, may also have over-stepped the boundaries of proportionality.

IMF's role in governance and political issues – a very grey territory

The IMF's role in "governance" matters is contentious, so much so that an Executive Board Guidance had to be established in 1997 to guide the Fund in its dealings with member governments. In this Guidance Note the Board upheld the view that the primarily concern of the Fund is with macroeconomic stability, external viability, and orderly economic growth in member countries. Therefore, the Fund's involvement in governance should be limited to economic aspects of governance. The contribution that the Fund can make to good governance should be in relation to 2 areas: (1) improving the management of public resources through reforms covering public sector institutions (e.g., the treasury, central bank, public enterprises, civil service, and the official statistics function), including administrative procedures (e.g., expenditure control, budget management, and revenue collection); (2) supporting the development and maintenance of a transparent and stable economic and regulatory environment conducive to efficient private sector activities (e.g., price systems, exchange and trade regimes, banking systems and their related regulations).

"Within these areas of concentration, the Fund should focus its policy advice and technical assistance on areas of the Fund's traditional purview and expertise i.e. issues such as institutional reforms of the treasury, budget preparation and approval procedures, tax administration, accounting, and audit mechanisms, central bank operations, and the official statistics function. Similarly, reforms of market mechanisms would focus primarily on the exchange, trade, and price systems, and aspects of the financial system. In the regulatory and legal areas, Fund advice would focus on taxation, banking sector laws and regulations, and the establishment of free and fair market entry (e.g., tax codes and commercial and central bank laws).

The Guidance Note was categorical that "the Fund's judgments should not be influenced by the nature of a political regime of a country, nor should it interfere in domestic or foreign politics of any member".

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In the context

Applied to the Kenyan case, the Fund clearly had the mandate to give advice on all the aspects of public finance management above. It should give that advice in the political context in which it operates. That political context, as defined by the constitution, includes a unique situation of 2 levels of government each independent of the other, and none subjugated to the other but who must collaborate and cooperate t bring about responsible management of public finance based on the principles outlined in Chapter 12 of the constitution. The IMF team failed to appreciate this uniqueness and therefore sought actively to create a political regime different from that outlined in the constitution. The IMF team may have over-stepped their boundaries but actively seeking to re-write power relations among different parts of government as well as entities created by the constitution. Their advice tantamount to promoting centralization of decision making and central control over public resource against the Constitutional ethos 's of devolution and participation.

Could the IMF's desire for fiscal prudence and stability be achieved in the context of devolved power? There is no reason why not. The devolution taskforce provided one mechanism to achieve that which is the Inter-governmental fiscal relations Act – the body that brings together the key actors in the management of public finance to agree parameters, define reporting and coordinating and collaborating mechanisms for the larger good. There is no particular reason to assume that consensus could not be reached through this structure favouring prudent management, including the management of debt whilst being consistent with the letter and spirit of the constitution. The IMF Mission that advised Treasury chose the lazy route of not engaging with the political structure as it is but rather seeking to create a political structure which the people rejected but which seems consistent with their values of financial management.

Is there the need for more than one Act to regulate public finance management? In my humble opinion, the answer is YES for the simple reason that the County Government Structure is new. It requires new structures, new ways of doing things, new planning and budget processes that are consistent with the expectations of participatory and accountable governance. The management of money is what will make or break the devolution process and the expectations of Kenyan citizens for transparent, participatory and service oriented government. How to deliver these expectations whilst ensuring prudent resource management takes detailed and careful crafting. This is what the Devolution PFM Bill delivers rather impressively. The difficulty of simply trying to pull the 2 Bills together is the fact that they are derived from different mind-sets about governance – one is centralizing power the other is dispersing power. Something has to give and as is clear in the draft Integrated Bill, centralization trumps.

If government based on devolution and the dispersal of power is to be given a chance, the IMF needs to return to the drawing board to offer advise based on what the political system is according to the 2010 Constitution rather than what the IMF desires it to be.