Kenya: Fitch Downgrades Kenya to ‘B-‘ with Stable Outlook

Fitch Ratings has downgraded Kenya’s Long-Term Foreign-Currency Issuer Default Rating (IDR) from ‘B’ to ‘B-‘, maintaining a stable outlook. This decision reflects growing concerns about Kenya’s public finances, political stability, and rising domestic debt costs.

The downgrade follows the Kenyan government’s reversal on revenue measures outlined in the Finance Bill 2024, triggered by violent protests. Fitch cites the increased risk to political stability and the elevated costs of domestic debt as key factors in the downgrade.

Despite Kenya’s efforts to reduce expenditures, Fitch notes that the country faces a moderately higher risk regarding external financing. This includes elevated external commercial borrowing costs and foreign-exchange reserves that fall below the ‘B’ category median.

The stable outlook indicates Fitch’s expectation that strong support from official creditors will help manage short-term external liquidity pressures. However, the sovereign’s funding needs are expected to remain significant and increase.

Tightening monetary policy is expected to anchor inflation and support the currency. Nonetheless, Fitch acknowledges that achieving fiscal targets has become increasingly challenging due to the socio-political climate.

The recent withdrawal of the Finance Bill 2024 by President William Ruto, following public protests, and the formation of a new government to replace the dismissed cabinet have not fully resolved the underlying issues. Analysts warn that the risk of prolonged social unrest continues to complicate fiscal consolidation efforts and could negatively impact economic activity.

Fitch projects that Kenya’s fiscal deficit will widen to 4.7% of GDP by the financial year ending June 2025, surpassing the government’s revised target by 0.5 percentage points. This adjustment reflects the withdrawal of planned revenue measures, increased debt servicing, and social spending costs amidst civil pressures.

For the fiscal year 2024, preliminary results indicate a budget deficit of 5.6% of GDP, driven by higher spending and shortfalls in tax revenue. Ordinary tax revenue collections fell short of targets, leading to greater reliance on expensive external and domestic borrowing. Short-term government securities’ yields have increased due to higher central bank policy rates and domestic liquidity constraints.

Fitch anticipates that government interest payments as a percentage of revenue will rise to 31.7% in 2025, compared to 31.5% in 2024 and 32.8% in 2026, significantly above the 12% median forecast for ‘B’ category peers.

Government debt to GDP increased to nearly 72% in FY23 from 67% in FY22, partly due to currency depreciation. Fitch projects a slight decline to 65.6% by the end of FY26, driven by strong nominal GDP growth, though this remains above the projected 51.5% median for the ‘B’ category.

External debt service is expected to decrease to USD 4.4 billion in FY25 from USD 5.4 billion in FY24 but will exceed USD 5 billion annually through FY28 due to large financing needs. The government aims to secure approximately USD 5 billion in foreign financing for FY25, including USD 2 billion from official creditors and USD 1.7 billion in project loans. However, analysts consider the target for raising USD 1.3 billion from commercial creditors ambitious and anticipate a shortfall of USD 0.5 billion.

The expiration of the IMF arrangement in April 2025 introduces uncertainty regarding future financing flows. Fitch notes that the adjustment to the FY25 budget complicates the achievement of IMF program targets, although these are expected to be renegotiated.

Fitch projects that Kenya’s current account deficit will widen to 4.2% of GDP in 2024, up from 3.9% in 2023, due to a recovery in imports and high external debt obligations. Gross reserves are expected to decline to USD 7.0 billion by the end of 2024, covering 3.2 months of current external payments or 4.6 months of imports.

Outstanding public sector arrears, totaling KES 487 billion at the end of March 2024, highlight ongoing issues in public financial management. Despite the establishment of a committee to address pending bills, high arrears are expected to persist due to revenue constraints and limited controls on leakages.