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The outlook seemed to be brightening for emerging markets that had been on the brink of a debt crisis in recent years. Several developing countries defied expectations by avoiding default and gaining access to international capital markets. But violent clashes between protesters and police in Kenya last week showed the tensions that lie beneath.
Kenyans took to the streets to oppose a radical tax increase proposed by President William Ruto. They argued that the proposal, designed to meet fiscal targets required for an IMF loan, would cause undue harm to struggling citizens through steep increases in everyday items such as bread and sanitary pads. Public dissent was met with force, including the use of live ammunition. After days of unrest and 39 deaths, the Ruto administration withdrew the bill.
In truth, this was a poorly designed fiscal policy. It is not advisable to significantly increase taxes on basic commodities in an economy with an official poverty rate of 38.6%. The implementation of the wave of new levies simultaneously demonstrates a lack of political insight and a disregard for the plight of impoverished Kenyans.
The unrest also reflects deeper corruption. Runaway borrowing and economic mismanagement have pushed Kenya’s debt to more than 70% of output. Debt-servicing costs have risen to 32% of annual government revenues — money that would be better spent on climate resilience and public services.
The Ruto government struggled to meet a $2 billion Eurobond payment due in 2014. In another era, the option might have been to default and seek debt relief. After seeing the costly restructuring processes in Zambia and Ghana, the Ruto team took another route. They used IMF funds and issued $1.5 billion in new debt at the high price of 10.375 percent to pay off the bond.
Kenya’s success in trying to access the capital market appeared to many to be a sign of economic strength. However, the fact that Ruto had to swap a 6.875 percent Eurobond for a higher coupon to avoid default – essentially delaying payment and passing on a higher cost to Kenyans through tax increases – is a symbol of how dysfunctional the global debt architecture has become.
The G20 Common Framework for Debt Treatments of 2020 has failed to bring together the competing interests of bilateral and private creditors, plus China. The result is lengthy and costly restructurings that damage economies and hamper development. Ruto, who has to deal with a host of private creditors and a large Chinese loan due in 2025, is understandably trying to avoid that fate.
Internal improvements At the IMF, delays have been reduced, but more needs to be done. Lawmakers in New York, where nearly half of emerging market bonds are regulated, Proposed legislation This would penalize uncooperative private creditors and encourage comparable treatment between them and sovereign lenders. Since the latter had been a sticking point for China, this could speed up the process and help bring Beijing to the negotiating table.
The IMF should recognise that a flawed system requires more appropriate fiscal recommendations, which could include guidance on ways to close fiscal gaps beyond tax increases. It could also go further and advise countries on when to reprofile their debts, rather than refinance them at higher rates.
As for Kenya, the way forward is unclear. Better fiscal management is desperately needed, but options are limited. Ruto’s decision to favour government cost reductions rather than tax increases is sensible, but it will not be enough to cover the financial shortfall. He may have to borrow more, further limiting his room for manoeuvre among creditors and an angry population.