Domestic borrowing is a bitter but necessary pill for Kenya

However, the World Bank recommends no more than 50 per cent, or Sh8.95 trillion, a figure that Kenya exceeded in December 2023 when the debt burst its seams to a new high of Sh10.1 trillion. The current public debt-to-GDP ratio is about 67.4 per cent, gobbling up almost 70 per cent of ordinary revenues (customs duty, income tax, VAT and excise duty), and severely undermining public service delivery. Put simply, out of Sh10 collected by the Kenya Revenue Authority (KRA), about Sh7 goes towards loan repayments.

Kenya’s public debt has surged significantly over the last decade from approximately Sh1.6 trillion, where the Kibaki-Raila Grand Coalition government left it, to its current level. It is projected that Sh1.8 trillion will be spent on debt servicing in the current financial year, out of which Sh1.1 trillion is the domestic component while Sh700 billion relates to offshore debt obligations.

Another major strain on public finances is interest payments, which are expected to top Sh1.09 trillion in the current financial year, with a whopping Sh851 billion being channelled to domestic lenders. Currently, Kenya requires approximately Sh5 billion daily to manage its financial obligations. The bulk of the public debt (approximately Sh7 trillion) was accumulated in the decade between June 2013 and June 2022, mainly to finance mega infrastructure projects.

Low-interest concessional loans

In addition, when Kenya attained a “Lower Middle-Income” status in 2014, the country lost access to most low-interest concessional loans. Consequently, the government turned to international capital markets, issuing several Eurobonds with high interest rates (7–8 percent) and shorter repayment periods.

These sovereign instruments have been a subject of frequent audit queries, with the Auditor General and Controller of Budget reporting their inability to authenticate whether the proceeds of the Eurobonds actually benefited the Kenyan economy. The implication is something akin to “double jeopardy”, in that the Eurobond proceeds never benefited the economy, yet taxpayers continue to bear the burden of repaying them.

Had the proceeds been applied to productive sectors of the economy, such as agriculture, tourism, manufacturing, ICT and financial services, the economic returns would have been sufficient to repay the loans.

The last decade has also seen government expenditure consistently outpace revenue collection, resulting in an average fiscal deficit above 7 percent of GDP, primarily plugged through more borrowing.

Read: How Government borrowed Sh95 billion in four months

Other factors that have led to the burgeoning of public debt to its current unsustainable levels include currency depreciation, external shocks and the Covid-19 response, and support for underperforming state-owned enterprises such as Kenya Airways. This situation has been exacerbated by the fact that about 62 percent of Kenya’s external debt is denominated in the US dollar, making repayment highly sensitive to exchange-rate fluctuations and raising the risk of default.

As part of Kenya’s debt management strategy, the government has accelerated repayments of certain external debts to reduce pressure on future repayments. Further, the government is exploring currency redenominations, such as converting the Sh3.5 billion SGR loans owed to China Exim Bank to yuan, a strategy that is expected to save the country about Sh27.8 billion annually starting in 2026.

A major policy shift in the ongoing fiscal consolidation strategy is the emphasis on domestic borrowing to reduce reliance on volatile offshore loans, diversify exchange risks, foster the growth of local financial markets and control fiscal deficits. The strategy is expected to cause a shift from short-term to longer-term bonds in order to foster fiscal stability.

Reliance on foreign debt exposes Kenya to high repayment costs whenever the shilling depreciates relative to major world currencies in which the country’s external loans are denominated. Previous offshore borrowing on commercial terms led to high debt distress, making external financing less viable and more expensive due to risk factors and rising interest rates.

Change tack

It is only logical, therefore, that the government should change tack by shifting from short-term Treasury bills to medium- and longer-term bonds, which promote better management of financing risks. Recent history is, however, replete with unpleasant experiences with domestic borrowing.

Evidence shows that a handful of commercial banks frequently benefited from preferential allocation of 91-day Treasury bills at interest rates that were far higher than what economic fundamentals could support. Consequently, the private sector was crowded out. High government borrowing typically absorbs available credit, potentially raising interest rates and limiting access to loans by private enterprises and households.

The result was stunted capital formation, negatively affecting income generation and revenue collection. At the same time, taxpayers raised revenue to redeem the Treasury bills upon maturity, essentially shifting the tax burden from the rich to ordinary citizens. Regarding debt sustainability, it is noteworthy that while domestic debt is seen as less risky than foreign loans, the overall public debt burden remains high, with huge amounts of taxpayers’ money regularly applied to repay Kenya’s offshore debt obligations.

Read: Sh253 billion missed revenue target signals deeper borrowing pain

This constant outflow of revenue to foreign creditors undermines the government’s capacity to underwrite the cost of governance without further borrowing, creating a vicious circle of indebtedness. To reduce over-reliance on foreign borrowing, the government must make painful decisions, which include strict adherence to ongoing austerity measures and a commitment to punish malfeasance.

In conclusion, Kenya aims to build fiscal resilience by tapping into local savings for borrowing and reducing currency-related risks, while navigating the challenge of balancing public financing needs with private-sector credit access and private capital formation. To contain public debt within manageable limits, the government must fiercely resist the temptation to fall for China’s aggressive debt diplomacy, which includes “rescue loans” to defray imminent default.

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Professor Ongore is a Public Finance and Corporate Governance Scholar based at the Technical University of Kenya. [email protected]