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Kenya risks missing its economic growth targets in the medium term as the country grapples with high debt distress and a deteriorating macroeconomic operating environment, a new report warns.

The Institute of Public Finance (IPF) says in its latest Macro Fiscal Analytical Snapshot Report that the country finds itself in a tight spot following years of successive borrowing, coupled with the inability of the private sector to create sufficient jobs for millions of young people entering the job market annually.

Since 2014, the report notes, persistent high fiscal deficits have resulted in a swift escalation of public debt, now standing at 70 per cent of the gross domestic product (GDP).  “The recent depreciation of the shilling against the US dollar signifies a downgrade in the country’s economic outlook. Furthermore, the elevated risk of debt distress as highlighted by the International Monetary Fund poses challenges in effectively managing external debt servicing,” it adds.

Drought and floods

 Speaking during the official launch of the report, the IPF chief execcutive James Muraguri noted that for Kenya to maintain robust economic growth, it must put in place the necessary fiscal levers to promote faster private-sector-driven growth.

Other impediments, he added, include Kenya’s vulnerability to climate shocks such as drought and floods, which may derail growth over the long-term. “Revenue optimism has been a persistent problem in Kenya for several years which in the past has tended to result in higher-than-planned fiscal deficits financed by additional borrowing,” Muraguri said.

“More recently, rising global interest rates and a subsequent decline in inward foreign investments have caused the Kenyan shilling to depreciate steeply, significantly increasing the cost of external debt servicing and further putting pressure on Kenya’s foreign exchange reserves,” he noted. In addition, just like many African countries, growth in Kenya has been led by non-tradeable services and exports have halved as a share of GDP, whereas external debts have increased.

Kenya’s external debt service as a proportion of exports is significantly above the level that the IMF considers sustainable for a country of its size.

“Even if the IMF reclassified Kenya as a country with “high” debt-carrying capacity, it would still be in breach of the upper limit until at least 2027,” the report points out. While fiscal consolidation undertaken by the government over the past two years has relied on adjustments to expenditure, revenues are yet to fully recover to their pre-pandemic level.  Revenue mobilisation fell sharply in 2019/20 as a direct consequence of the measures implemented to reduce the tax burden on businesses during the pandemic.  According to Muraguri despite a variety of reform measures having been undertaken since then, revenues have been slow to return to pre-pandemic levels and have lagged previous projections and targets.

On the expenditure side, fiscal consolidation in the past two years has led to a decline in real per capita spending, impacting development and fiscal transfers to counties.  Counties heavily rely on national fiscal grants, constituting 91 per cent of expenditures, with limited own-source revenue (OSR) at 9 per cent.

Muraguri noted that until 2020/21, fiscal deficits were regularly higher than planned – the result of revenue optimism – and were financed by additional borrowing rather than corresponding cuts to expenditure.  However, from 2021/22 onwards, he said this changed as Kenya’s debt dynamics started to bite as revenue shortfalls were matched by a comparable reduction in expenditure to ensure the deficit remained similar as planned.

“Given the limited room for borrowing to address revenue shortfalls for the foreseeable future, it is likely that revenue and expenditure will be more closely linked over the intervening period,” Muraguri added.