Fitch downgrades Kenya to ‘B-‘ with stable outlook

Fitch Ratings has downgraded Kenya’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B-‘ from ‘B’ with outlook accorded as stable.

In its rating note, Fitch stated that the downgrade reflects heightened risks to Kenya’s public finances after the government backtracked on revenue measures in the Finance Bill 2024 in response to violent social protests, the increased risk to political stability, and rising domestic debt costs.

The country’s ratings was lower despite the authority’s decision to embark on expenditure cuts. Fitch also see a moderately greater risk to external financing, partly reflecting elevated external commercial borrowing costs in the context of foreign-exchange reserves that are below the ‘B’ median.

The stable outlook reflects Fitch’s expectation that continued strong official creditor support will help alleviate near-term external liquidity pressures, although the sovereign’s funding needs will remain large and are expected to rise.

The tightening of monetary policy will help to keep inflation anchored, providing support for the currency, according to the rating note.

Fitch Ratings said the authorities plan to continue with their fiscal consolidation agenda, although the path to achieving fiscal targets has become increasingly challenging, in analysts view.

Violent social protests related to tax hikes in the Finance Bill 2024 and calls for governance reforms have increased socio-political risk, Fitch Ratings said.

President William Ruto has responded by withdrawing the bill, and initiating efforts to form a broad-based government to replace the previous cabinet that was dismissed in July 2024.

However, analysts consider the risk of prolonged social unrest remains, significantly complicating the environment for fiscal consolidation and presenting downside risks to economic activity.

Fitch anticipates a widening of the fiscal deficit to 4.7% of GDP in the financial year ending June 2025, 0.5 percentage points higher than the government’s new deficit plan which was revised up by 0.9 percentage points in the July draft supplementary budget.

This reflects the withdrawal of planned revenue measures, and higher debt servicing and social spending costs, amid civil pressures, notwithstanding efforts to cut spending. “We expect revenue to continue to underperform its target in FY26, at 17.4% of GDP, with only a modest narrowing of the deficit, to 4.3% of GDP”.

The country’s current fiscal pressures follow slippage in FY24, when based on preliminary results, the budget deficit was 5.6% of GDP, 1.2 percentage points higher than budgeted due to higher spending and shortfalls in tax revenue.

Fitch in FY24, ordinary tax revenue collections fell short of the revised and original targets by 1.1% and 1.8% of forecast FY24 GDP, respectively.

Revenue shortfalls have led to greater recourse to more expensive borrowing from external commercial creditors and the domestic market.

Average yields on short-term government securities have risen, reflecting higher central bank policy rates and domestic liquidity constraints.

“We project government interest payments/revenue to reach 31.7% in 2025 from 31.5% in 2024 and 32.8% in 2026, well above the 2026 median forecast for ‘B’ category peers of 12%”.

Government debt to GDP rose to nearly 72% in FY23, from 67% in FY22, partly due to currency depreciation. Analysts estimated that the debt/GDP would decline to 66.4% in FY24, mainly linked to a stronger shilling in the second half of the year. Fitch said nearly half of Kenya’s government debt is foreign-currency denominate.

“We expect the ratio to decline marginally to 65.6% by FYE26, due partly to strong nominal GDP growth, but remain above the projected 2025 ‘B’ median of 51.5%.

The government’s external debt service will moderate in FY25 to USD4.4 billion, from USD5.4 billion in FY24, but will exceed USD5 billion in FY26 through FY28, due to continuing large financing needs.

The government aims to secure about USD5 billion in foreign financing in FY25, including USD2 billion from official creditors and USD1.7 billion in project loans.

Kenya also plans to raise USD1.3 billion from commercial creditors, but analysts view this target as ambitious, and anticipate it will fall short by USD0.5 billion.

Fitch said the country’s adjustment to the FY25 budget greatly complicates hitting targets agreed in the IMF programme, but the rating agency said it anticipates that these will be renegotiated.

The expiration of the IMF arrangement in April 2025 is a source of uncertainty over subsequent financing flows, the rating note added.

“We expect the current account deficit/GDP to widen to 4.2% in 2024, from 3.9% in 2023, due to a recovery in imports and high external debt obligations. We project gross reserves will decline to USD7.0 billion by end-2024, providing coverage of 3.2 months of current external payments or 4.6 months of imports”

Analysts said pending bills have accumulated in recent years, highlighting shortfalls in public financial management. Outstanding public sector arrears were KES487 billion at the end of March 2024, with the majority attributed to state corporations.

The government has established a pending bills committee mandated to verify and clear existing arrears, but we expect pending bills to remain high in the near term, due to revenue constraints and limited controls to reduce leakages.