Global rating agency Moody’s has downgraded Kenya’s local and foreign currency long-term issuer ratings and foreign-currency senior unsecured debt ratings to Caa1 from B3, with the outlook remaining negative.
This downgrade reflects a significantly diminished capacity for the East African nation to implement revenue-based fiscal consolidation, which would improve debt affordability and place debt on a downward trend.
Moody’s highlighted that the Kenyan government’s decision to forego planned tax increases and instead rely on expenditure cuts to reduce the fiscal deficit represents a significant policy shift. This change has material implications for Kenya’s fiscal trajectory and financing needs.
“The government’s decision not to pursue planned tax increases and instead rely on expenditure cuts to reduce the fiscal deficit represents a significant policy shift with material implications for Kenya’s fiscal trajectory and financing needs,” Moody’s stated.
The negative outlook reflects downside risks related to government liquidity. Moody’s updated forecasts assume a narrowing of the fiscal deficit through spending cuts, but at a more gradual pace than previously assumed. The agency does not expect the government to introduce significant revenue-raising measures in the foreseeable future, leading to a slower narrowing of the fiscal deficit and weaker debt affordability for a longer period. This situation increases liquidity risk against more uncertain external funding options.
Moody’s noted that larger financing needs or an increase in borrowing costs would amplify liquidity risks.
“In particular, slower fiscal consolidation would risk constraining external funding options even more, including diminishing support from multilateral creditors which have been the largest source of external financing since 2020. Larger financing needs would risk reducing domestic appetite for government securities, which would challenge the government’s ability to continue servicing domestic debt,” the agency explained in a statement.
Kenya’s local currency ceiling was lowered to B1 from Ba3, maintaining a three-notch difference with the sovereign rating. This reflects relatively weak institutions, policy predictability, and moderate political risk, set against a relatively small government footprint in the economy and limited external imbalances.
The foreign currency ceiling was lowered to B2 from B1, one notch below the local currency ceiling, reflecting relatively low external debt and a moderately open capital account, which reduce, although do not entirely remove, the incentives or need to impose transfer and convertibility restrictions in scenarios of intensifying financial stress.
Kenya’s previous B3 rating was based on the government’s continuation of a fiscal consolidation strategy that included significant revenue-raising measures aimed at narrowing the fiscal deficit, containing the debt burden, and at least stabilizing debt affordability.
These efforts would ensure multilateral support from the IMF and others, alleviating financing pressure from Kenya’s large external amortizations. However, the negative outlook now captures downside risks primarily related to liquidity risk and elevated refinancing needs against limited external financing options and reliance on expensive domestic financing of the fiscal deficit.
In response to recent protests, President William Ruto’s government canceled planned tax increases included in the 2024 Finance Bill, which initially aimed at raising KES 346 billion (1.9% of GDP).
Given the current social context and foreseeable future, Moody’s no longer finds the government’s capacity to implement revenue-raising measures plausible. Consequently, the government plans to reduce spending by KES 177 billion, increase borrowing, and raise the fiscal deficit to 4.6% of GDP, 1.3% higher than the original 3.3% of GDP budget for fiscal 2025.
Moody’s expects Kenya’s fiscal deficit to average 4.4% of GDP in fiscal 2025 and fiscal 2026. Although this represents a smaller deficit compared to 5.9% of GDP in fiscal 2024, it implies a slower pace of fiscal consolidation compared with previous forecasts, with government debt now stabilizing rather than gradually declining as previously anticipated.
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