Moody’s has downgraded Kenya’s long-term issuer rating in both local and foreign currencies from B3 to Caa1, with a negative outlook. This downgrade signals a reduced capacity for the country to implement revenue-based fiscal consolidation, posing broader risks to Kenya’s short-term economic stability.

Negative economic outlook for the Kenyan economy

East Africa’s largest economy faces a pivotal moment after Moody’s decision to downgrade its long-term issuer ratings in local and foreign currencies from B3 to Caa1, with a negative outlook.

The downgrade follows three weeks of nationwide protests, compelling the government to scrap the 2024 Finance Bill. This setback indicates a diminished ability for the economy to pursue revenue-driven fiscal consolidation, contributing to a negative outlook and posing broader implications for Kenya’s short-term economic stability, as highlighted by Moody’s.

Kenya’s fiscal challenges amid negative outlook

Moody’s downgrade reflects a significant shift in Kenya’s fiscal policy, which previously emphasized spending cuts to reduce the current budget deficit. This change, driven by heightened social tensions, diverges sharply from past strategies that relied on increasing revenues.

The Finance Bill 2024, intended to boost revenues by 2.69 billion USD (1.9 % of GDP), was abandoned. Instead, the government opted for a 1.38 billion USD reduction in spending and increased borrowing. Consequently, Kenya’s budget deficit is expected to narrow more slowly than initially projected. Forecasts suggest an average deficit of 4.4 % of GDP for fiscal years 2025 and 2026.

While the anticipated deficit of 4.4 % in 2025 marks an improvement from the 5.9 % deficit in fiscal 2024, it signifies a slower pace of expenditure reduction rather than revenue growth. This trend limits Kenya’s ability to bolster its debt repayment capacity, posing a critical challenge for the country.

Impact on Kenya’s debt capacity

Kenya’s debt capacity is poised to worsen as a consequence of higher interest payments stemming from recent government budget decisions. The interest-to-revenue ratio is expected to climb from 30 % in 2024 to 33 % in 2025, signaling imminent fiscal constraints for the economy.

Despite efforts by the Central Bank to ease monetary policy and the Kenyan shilling’s appreciation, domestic borrowing costs remain elevated in the country. Moody’s highlights significant implementation risks for President William Ruto’s government’s spending reduction plan.

In fiscal 2025, over half of Kenya’s public spending is categorized under consolidated fund services, comprising statutory obligations and allocations that are typically non-discretionary.

Efforts to reduce spending involve:

• dissolving 47 public enterprises
• Suspension of new hiring in the civil service
• accelerating the retirement of workers over the retirement age of 60

External shocks and increased risk of liquidity shortages

Kenya faces vulnerabilities to external shocks that are likely to escalate spending demands throughout the year. Challenges such as poor harvests in 2021 and 2022, declining agricultural productivity, and extreme weather events necessitate emergency relief measures, placing additional strain on the government’s fiscal capacity.

The resulting larger budget deficits will heighten the government’s borrowing needs, exacerbating pressure on domestic borrowing costs. Moody’s underscores uncertainties surrounding the government’s ability to secure external financing. While the International Monetary Fund (IMF) and the World Bank have traditionally been significant sources of external funding, shifts in Kenya’s revised budget and fiscal policies could impact these relationships.

IMF programs were anticipated to provide USD 976 million in external financing for fiscal 2025. However, delays or complications may necessitate increased reliance on the domestic market, further driving up borrowing costs.

Consequences for investor trust

The uncertainty surrounding Kenya’s fiscal path and the government’s commitment to fiscal consolidation are likely to dampen investor confidence. The government’s access to alternative external financing sources, such as sustainable development bonds or Samurai bonds, hinges on its fiscal policies and credibility.

With increasing domestic borrowing requirements and costs, there’s a risk of diminishing investor interest in government securities. This situation strains the government’s capacity to manage its domestic debt obligations.

President Ruto’s approach of funding larger budget deficits through heightened domestic borrowing has already led to an escalation in domestic borrowing costs. In fiscal 2024, Moody’s notes that the average interest rate on newly issued Treasury bonds rose to 17.8 %, up from 14.4 % in fiscal 2023. The necessity to refinance maturing Treasury bonds further compounds the government’s fiscal challenges.

Long-term economic consequences

Moody’s negative outlook underscores the looming challenges to Kenya’s government liquidity in the coming years. Increased financing requirements and elevated borrowing costs heighten risks, complicating the government’s fiscal strategies.

Kenya’s vulnerability to environmental, social, and governance (ESG) risks adds further complexity to its economic outlook. Persistent issues such as high poverty rates, unemployment, inadequate access to essential services, and environmental threats like climate change and natural disasters constrain fiscal resilience.

Moody’s also cautions about the country’s ineffective fiscal policies, widespread corruption, and weak rule of law, all of which erode investor confidence and economic stability. These factors collectively pose significant hurdles for Kenya’s economic prospects.