Subsidy economics, a policy tool employed by governments to achieve various socio-economic objectives and influence market dynamics, has been a subject of both praise and criticism in Kenya.
Like many developing countries, Kenya has implemented subsidies in various sectors with the aim of achieving economic growth, poverty reduction, and social development. The subsidies have played a crucial role in shaping the nation’s economic landscape, affecting industries, consumers, and the government budget.
The effects are complex, often a double-edged sword that requires careful consideration and strategic implementation.
There are no easy answers…
Subsidy Challenges
The biggest challenge with subsidy programs is that they lead to budget constraints, market distortions, corruption and inefficiencies, dependency, and behavioral changes.
Take for example the fiscal year 2021/22 alone. The government spent an estimated Ksh100 billion on fuel subsidies, Ksh5.7 billion on fertilizer subsidies, and Ksh471 million on cooking gas subsidies.
The result – both fiscal imbalance and contribution to the current government debt. This led the government to borrow money to finance its budget deficit, increasing the country’s debt burden.
The numbers tell the story. In the fiscal year 2021/22, the government’s budget deficit was estimated to be Ksh869.7 billion, or 8.3% of GDP. The cost of subsidies was a major factor contributing to this deficit, accounting for about 12% of the total deficit. The cost of subsidies has been a major factor contributing to the increase in public debt, accounting for about 1.5% of the total debt.
In fact – while subsidies are meant to make goods and services more affordable, they can distort market dynamics. Artificially lowering prices can discourage local production by making imported goods more attractive, potentially harming domestic industries and job creation in the long run. For example, the government of Kenya provides a subsidy of KSh2,400 per bag of maize flour.
Also Read: Ruto Clarifies Return of Fuel Subsidy
This means that the cost of maize flour to consumers is lower than it would be if there were no subsidy. This can make imported maize flour more attractive to consumers, even if the quality of the imported maize flour is lower than the locally produced maize flour.
In addition, subsidies can create opportunities for corruption and mismanagement. Inefficient distribution systems, and lack of transparency, can result in the benefits of subsidies not reaching the intended beneficiaries, exacerbating inequality, and eroding public trust.
For example, subsidies for maize flour may be given to wealthy farmers who do not need them, while poor farmers who do need them may not receive the subsidy.
And finally, continuous reliance on subsidies might discourage innovation and self-reliance among both individuals and businesses. Consumers may become accustomed to lower prices and could struggle to adapt if subsidies are reduced or removed, potentially leading to adverse economic impacts.
Is there a place for subsidies?
Yes, there is! One of the primary intentions behind subsidy programs in Kenya has been to alleviate poverty and improve the living standards of the population. Subsidies for essential commodities such as food, fuel, and energy can directly benefit low-income households, reducing their financial burden and ensuring access to basic necessities.
And since Agriculture is a vital sector in Kenya, subsidies can incentivize farmers by providing them with reduced costs for inputs such as seeds, fertilizers, and pesticides.
This support aims to increase productivity, enhance food security, and boost rural incomes.
Take for example, the Kenya Kwanza government program that is subsidizing fertilizer for farmers during the just concluded planting season. This is in line with the 2023 allocation of Ksh3.55 billion to subsidize 71,000 Mt (1.42 million x 50 kg bags) of fertilizer, for growing food crops during short rains season.
Extending to healthcare and education sectors, government intervention subsidies can lead to improved access for vulnerable populations. Subsidized healthcare services and education can contribute to better overall well-being and a more educated workforce, promoting sustainable development.
Striking the Balance is key – for subsidy economics to yield positive outcomes in Kenya, a balanced well-targeted approach is crucial. This should include implementing a gradual phase-out strategy that can help prevent sudden shocks to the economy and allow beneficiaries to adapt. It should also in my view include transparency in the allocation and distribution of subsidies.
Finally, if robust monitoring and evaluation mechanisms, introduction of digital systems to track the distribution of subsidies like fertilizer, conducting of regular audits for any subsidy program, and strengthening the capacity of government distribution institutions like NCPB as they implement subsidy programs are put in place- these are some interventions that go a long way in reducing corruption and mismanagement and ensuring that the intended benefits of subsidy programs are reaching the right people.
Also Read: Ruto Brings Back Fuel Subsidy as EPRA Announces Pump Prices
Case Study – The Fuel Subsidy Program
The fuel subsidy program introduced in 2008 and implemented by the Energy and Petroleum Regulatory Authority (EPRA) is aimed at cushioning Kenyans at the pump.
The way it works is simple – Kenya imports oil through a tendering system. Once the oil has been received in Kenya, its distributed via the network of the state-owned Kenya Pipeline Company to other marketers according to their demand.
EPRA sets the retail price of fuel, and the government then provides a subsidy to oil marketers to cover the difference between the retail price and the international price of oil. The amount of the subsidy varies depending on the international price of oil.
In 2021/2022 period, the subsidy was estimated to be KSh100 billion. Official records show that in 2021 the country imported 6.149 billion litres of refined petroleum worth US$3.48 billion. The imports came mainly from the United Arab Emirates (US$ 1.41bn) and Saudi Arabia (US$1.14bn). Other sources included India, the Netherlands and Kuwait.
While the program has cushioned Kenyans at the pump, helped to reduce the cost of transportation for consumers, supported the reduction of inflation and boosted economic growth, it has been criticized by international donor communities like the IMF because of the cost to the government, its susceptibility to fraud and abuse, its distortion of the market for fuel and the many opportunities for encouraging wasteful consumption of fuel.
In September 2022, under pressure from IMF, which had argued that the subsidy was unsustainable and was contributing to the country’s budget deficit, the government removed the fuel subsidy. The removal of the fuel subsidy led to a sharp increase in the price of fuel.
Fuel Subsidy Effects
The price of petrol rose by 12.7%, diesel by 17.8%, and kerosene by 16.4%. This increase in fuel prices has had a significant impact on the cost of living for Kenyans, especially those who rely on public transportation.
The extended effect of the removal of the fuel subsidy over and above the increased cost of living has included social unrest – sparking protests and demonstrations in some parts of Kenya. These protests met with a strong response from the police, which led to further tensions.
To cushion Kenyans from the rising cost of living, the government has as of August 16th, 2023 – returned the fuel subsidy program terming it as a fuel compensation program and not a subsidy.
This highlights the double-edged sword that the government must address when dealing with subsidies. While it’s uncertain how the government will deal with subsidies, the government will need to carefully weigh the potential benefits and drawbacks before deciding.
