Balancing on the Debt Tightrope: Kenya's Debt Sustainability Analysis

Introduction

The Republic of Kenya has consistently grappled with budget deficits, driven by government revenues falling short of expectations and expenditures exceeding projections, due to economic challenges and increased spending on public services and infrastructure. Over the past decade, the fiscal landscape has undergone significant transformations, marked by a pronounced shift towards expansionary fiscal policies. The landmark 2010 Constitution of Kenya initiated a devolution process, resulting in the establishment of both central and county governments following the March 2013 general elections. This structural administrative overhaul significantly influenced fiscal dynamics, as both tiers of government embarked on ambitious infrastructural projects. A prime example is the construction of the 480 km Standard Gauge Railway (SGR) from Mombasa to Nairobi, which absorbed a staggering US$ 3.8 billion in borrowed funds [1]. From 2013 to 2023, Kenya's public debt (including publicly guaranteed debt to state-owned enterprises such as Kenya Power and Lighting Company, and Kenya Airways) witnessed an alarming rise.

As at 31 December 2013, Kenya's public debt [2] stood at Kshs 2.1 trillion (US$24.5 billion), equivalent to 50.7% of the country's gross domestic product (GDP)[3] . Fast forward to 31 December 2023, the total public debt escalated to Kshs 11.1 trillion, representing circa 69.1% of GDP (US$ 71.20 billion) [4]. Despite this alarming trajectory, the fiscal deficit improved, standing at 5.3% of GDP at the close of the fiscal year 2022/2023, a notable reduction from 6.8% of GDP in June 2013, largely attributed to enhanced revenue collection mechanisms. We note that the COVID-19 pandemic exacerbated the borrowing spree, as the Government of Kenya (GOK) sought additional loans to counter the sharp decline in domestic revenues owing to health-related challenges. The escalating debt levels have sparked concerns about sustainability and its implications for fiscal and macroeconomic stability. Over the medium term, Agusto & Co. expects the fiscal deficit to hover around 5% of the GDP, given the lower revenue projections resulting from the non-passage of the 2024 Finance Bill. This stance reflects the potential challenges in tax revenue generation and the economic uncertainties impacting fiscal stability.

Status of Kenya's Public Debt

Kenya's public debt has surged alarmingly, reaching Kshs 11.1 trillion as of December 2023 [5], a 21.8% year-on-year increase. This concerning trend underscores the nation's mounting fiscal challenges and the predominant reliance on external sources, which account for 52.2% of the public debt composition over the past five years (2019-2023). The depreciation of the Kenya shilling, particularly in 2023 when it lost 26.6% against the US Dollar, has exacerbated this reliance on external debt. However, subsequent to the 2023 year-end, the total public debt decreased marginally by 5% to Kshs 10.6 trillion [6] as of June 30, 2024, attributed to the full repayment of Kenya's inaugural Eurobond of US$2 billion issued in 2014.

Domestic Debt trajectory

Over the last five years, Kenya's domestic debt has predominantly comprised treasury bonds, making up 85.5% of the total domestic debt of Kshs 5.4 trillion as of 30 June 2024, while treasury bills, CBK overdrafts, and other domestic debt represented 11.4%, 1.1%, and 2%, respectively [7]. We note that this shift towards long-term debt instruments aligns with the government's 2024 Medium-Term Debt Management Strategy, aimed at mitigating rollover risks and reduce borrowing costs, reflecting Kenya's debt administration plan aimed at extending the debt maturity profile. Furthermore, commercial banks and pension funds hold a substantial portion of government domestic debt securities, accounting for 45.1% and 29.6%, respectively, as of H1'2024. Investments in government securities remain attractive to the banking sector due to their risk-free and liquid nature, constituting 24.1% of the banking industry's total assets in 2023, a 7% decrease compared to the previous year. The declining trend in commercial banks' holdings of government securities can be attributed to heightened credit risk management as banks continue to reduce their exposure while assessing the government's ability to meet its debt obligations. Conversely, other domestic investors have increased their holdings of government securities, driven by higher yields, with average interest rates on the 91-day treasury bills rising from 9.3% in 2022 to 15.3% in December 2023.

External Debt Trajectory

As at June 30, 2024, Kenya's external debt is estimated at Kshs 5.2 trillion, reflecting a complex composition that highlights the country's fiscal vulnerabilities. The debt profile is predominantly made up of multilateral lenders (51.5%), bilateral lenders (21.5%), sovereign bonds (18.3%), foreign commercial banks (6.5%), guaranteed debt (1.9%), and supplier credits (0.3%).

A significant portion of this external debt - 67.9% - is denominated in US Dollars, which exposes Kenya to exchange rate risks, particularly given the recent appreciation of the Kenya shilling by 17.7% in the first half of 2024.

Journey of Kenya's Eurobonds

Kenya's entry into the Eurobond market began in 2014 with the issuance of its inaugural $2 billion bond. The proceeds were used to repay a 2012 syndicated loan and finance infrastructure and energy developments. Between 2018 and 2024, Kenya issued six additional Eurobonds totalling $6.5 billion, reflecting the country's reliance on external borrowing for financial obligations and development projects. However, this dependency has significant implications for Kenya's debt sustainability. Higher yields on recent bonds indicate increased borrowing costs, straining the national budget and increasing debt servicing pressures. In February 2024, Kenya returned to the international bond market to issue a $1.5 billion bond maturing in 2031, which was oversubscribed four times. Kenya's recent Eurobond issuance of $1.5 billion with a 9.75% coupon rate was a strategic move to address the impending repayment of its inaugural $2 billion Eurobond maturing in June 2024. The proceeds from this new bond were used to partially retire $1.44 billion (72%) of the maturing bond, alleviating concerns about default and the impact on the Kenyan shilling. The successful issuance and partial repayment led to an immediate appreciation of the Kenyan shilling by over 9%, reversing earlier depreciation caused by concerns over the adequacy of foreign exchange reserves for repayment. This appreciation highlights the positive market sentiment following Kenya's proactive approach to managing its debt obligations. Furthermore, the Government of Kenya repaid the outstanding portion ($560 million) of the $2 billion Bond on June 21, 2024, three days ahead of the maturity date. This repayment was made possible by leveraging loans from the IMF as well as reserves, demonstrating the government's commitment to fiscal responsibility and debt sustainability

Debt Sustainability Analysis

Over the past ten years, Kenya's GDP has grown at a compound annual growth rate (CAGR) of 3.9%, while total public debt has surged at a CAGR of 18.1%. This disparity highlights a concerning trend where debt is increasing at a much faster rate than economic growth. Despite efforts to manage public finances, the debt-to-GDP ratio remains above the International Monetary Fund's (IMF) recommended benchmark of 60%, indicating potential fiscal challenges ahead. Looking ahead, it is anticipated that Kenya's debt levels will continue to rise in the near to medium term. The government is likely to pursue further borrowing to finance its budget deficit, which has been exacerbated by the withdrawal of the Finance Bill 2024. This bill aimed to raise an additional Kshs 346 billion in tax revenue for the 2024/2025 fiscal year ending 30 June 2025.

Kenya's debt service to revenue ratio has significantly escalated, rising from 18.7% in June 2013 to 60% as of December 31, 2023. This increase is primarily due to the higher costs associated with domestic debt instruments, which constitute the largest share of the debt service obligations. This ratio is now double the International Monetary Fund's (IMF) recommended benchmark of 30%, underscoring the strain that debt servicing costs impose on the country's revenue. The substantial rise in Kenya's debt service to revenue ratio is alarming, as it underscores the mounting pressure on the country's revenue capacity to meet its growing debt obligations. During the fiscal year ending June 30, 2024, Kenya's total mobilised revenue grew by 11.1%, with the Kenya Revenue Authority collecting Kshs 2,407 billion. This performance represented a collection rate of 95.5% against the revised revenue targets [8]. Debt servicing charges in Kenya are projected to increase significantly by 40.8%, rising to Kshs 1,684.9 billion in FY 2023/24 from Kshs 1,196.8 billion in FY 2022/23. This escalation is driven primarily by the increasing uptake of treasury bills and the higher servicing costs associated with treasury bonds. Agusto & Co. forecasts that the debt service to revenue ratio could rise moderately to 62% by the end of FY 2023/24, reflecting the pressures of high domestic interest rates and the escalating costs of external debt amid tightening global financing conditions. Looking ahead, the debt servicing costs are expected to reach 63.5% for the fiscal year 2024/2025. This situation leaves the government with very limited resources to cover recurrent expenditures and infrastructure development, placing Kenya in a precarious position similar to other nations facing debt distress, such as Ghana, Ethiopia, Zambia, Argentina, Venezuela, and Greece.

The high levels of both the debt-to-GDP ratio and the debt service-to-revenue ratio raise significant concerns about Kenya's fiscal health and debt sustainability. As of December 31, 2023, the debt-to-GDP ratio reached 69.1%, while the debt service-to-revenue ratio surged to 60%. These elevated ratios indicate that a substantial portion of government revenue is being allocated to servicing debt, which limits the government's ability to invest in critical sectors such as health, education, and infrastructure. This situation poses a risk to long-term economic growth and development. The Government of Kenya must implement deliberate measures to manage the costs associated with public governance and effectively finance fiscal deficits without relying on unsustainable borrowing practices. While short-term relief may be provided by international organisations such as the World Bank and the International Monetary Fund (IMF), long-term solutions are essential. Prioritising sustainable fiscal policies, prudent debt management strategies, and enhancing revenue generation will be critical to ensuring the country's long-term financial health and stability. Without such measures, Kenya risks increased debt distress, which could adversely impact investor confidence and overall economic stability, mirroring the experiences of other nations facing similar challenges.

Government's Interventions

As a response to the rising public debt and attendant servicing costs, the Government of Kenya has taken several proactive measures to manage its escalating public debt profile and sustainability. Based on the National Treasury's Budget Policy Statement for the FY 2024/25, the Kenya Revenue Authority is expected to improve revenue collection by utilising the ongoing reforms on tax policy, through a mix of factors including widening of the tax base and improving tax compliance. The reforms are part of the Government's Medium-Term Revenue Strategy (MTRS), which is expected to raise the revenue-to-GDP ratio to 20% by the end of FY 2026/27 from 14.3% in FY 2022/23. In addition, the government is implementing stringent anti-corruption policies, improving oversight, and increasing penalties for corrupt practices. Cutting wastage at all government levels is another critical intervention, which involves streamlining government operations, reducing redundant expenditures, and optimising resource allocation to ensure that public funds are used effectively and efficiently.

Transparency and accountability in fiscal management are being bolstered through the adoption of open government initiatives, which promote public access to information on government spending and debt. Enhancing debt sustainability also involves broadening the tax base, improving tax compliance, and leveraging technology to boost revenue collection. By implementing these measures, Kenya aims to create a more sustainable fiscal environment and manage its public debt more effectively.

Conclusion

Kenya's journey toward debt sustainability necessitates a collective effort from all stakeholders at both national and county levels. This approach could encompass stringent budgetary controls, the reduction of expensive governance structures, a comprehensive public debt audit, prudent financial reporting, and rigorous fiscal discipline.

Agusto & Co. views the audit of Kenya's public debt as crucial for providing a clear and accurate assessment of the nation's financial obligations. Such an audit would help identify inefficiencies, uncover discrepancies, and highlight opportunities for debt restructuring, thereby facilitating informed decision-making and effective debt management. Moreover, Kenya's public debt accounting system needs greater transparency. Transitioning fully to the International Public Sector Accounting Standards (IPSAS) accrual-based system from the previous cash-based system would enhance financial transparency, improve asset and liability management, and bolster fiscal discipline, offering a more accurate picture of the country's financial health. Additionally, the government could consider debt-for-climate swaps as a strategic intervention. These swaps could potentially reduce the debt burden while promoting sustainable environmental practices.

Overall, achieving long-term debt sustainability and economic stability for Kenya will require a combination of strategic debt management, enhanced fiscal discipline, and reductions in governance costs. By addressing the underlying issues contributing to high debt levels and implementing sound financial practices, the government can establish a more resilient and sustainable fiscal framework for the present and future.

[1]https://www.railway-technology.com/projects/mombasa-nairobi-standard-gauge-railway-project/
[2]Public debt refers to the amounts owed by the government (both domestic and external borrowings) used to finance public deficits resulting from a higher level of program spending to budgeted income.
[3]Kenya's National Treasury & Economic Planning - Monthly Debt Bulletin, December 2013
[4]Kenya's National Treasury & Economic Planning - Monthly Debt Bulletin, December 2023
[5]Central Bank of Kenya
[6]Kenya's National Treasury & Economic Planning - Monthly Debt Bulletin, April 2023
[7]CBK weekly bulletin - 5 July 2024, Agusto & Co. Research
[8]https://www.kra.go.ke/news-center/press-release/2122-kra-records-11-1-growth-in-revenue-collection