Fitch Affirms Kenya at 'B' with Negative Outlook

Fitch Ratings has Kenya’s credit ratings at ‘B’ with an outlook accorded as negative, reflecting the sovereign’s large funding needs, ongoing risks to external finances, high domestic financing costs, expensive external commercial borrowing and challenges to fiscal consolidation.

In its latest update, the global rating form however noted the government’s stronger commitment to narrowing the budget deficit.

Fitch said Kenya’s rating is supported by the authorities’ fiscal consolidation plans and monetary policy tightening anchored by an IMF programme, recent recovery in the macroeconomic environment and strong medium-term growth prospects.

However, the sovereign rating is constrained by weak governance, high interest payments, a narrow revenue base and high external indebtedness.

Kenya’s sovereign external financing requirement has increased sharply in the current fiscal year ending June 2024 to about USD5.5 billion, up from USD2.6 billion in 2023, mainly due to higher principal repayment including the USD2 billion

Eurobond repayment is due in June 2024. A weaker exchange rate also adds to Kenya’s debt servicing challenges, as half of its government debt is foreign-currency denominated.

The government’s external debt service will moderate in 2025, but remain significant at just over USD3 billion and is projected to remain above USD3 billion in 2026-27.

“We assume that the government will meet its financing obligations in FY24 through a combination of official lending and commercial borrowing”.

The government has secured about USD0.8 billion from the IMF and USD0.4 billion in syndicated loan and expects to receive over USD1 billion from the World Bank in April and a further USD1.1 billion from the IMF before the end of 2024.

It is also in talks with other external partners including China. The government has issued a USD1.5 billion Eurobond to buy back the majority of its upcoming Eurobond maturity. Fitch does not consider this constitute a distressed debt exchange.

Kenya is targeting nearly USD4 billion in external borrowing in FY25, of which nearly USD2 billion would be from official creditors.

Fitch forecasts the current account deficit/GDP ratio to widen to 4.3% in 2024 and remain unchanged in 2025, reflecting higher import needs and a relatively narrow export base.

The trend of current account deficits largely financed by borrowing has led to a build-up in net external debt, which we forecast above 60% of GDP in 2024-2025, more than double the ‘B’ median.

The combination of the current account deficit, higher external debt obligations and external financing constraints have resulted in currency depreciation and downward pressure on reserves.

External official and commercial disbursements should moderate pressure on reserves over the short term. Analysts project gross reserves will rise above USD 8.0 billion by end-2024, providing coverage of just over our ‘B’ median of 3.7 months of current external payments.

External funding constraints have increased the government’s reliance on domestic financing, putting upward pressure on interest costs.

Average yields on short-term government securities have repriced upwards, reflecting the increase in central bank policy rates, stronger demand for shorter-term government securities and domestic liquidity constraints.

“We project the government interest payments/ revenue ratio to reach 30.2% in 2024 and 31.2% in FY25, well above 2025 ‘B’ median forecast of 13.7%”.

Kenya’s central bank has raised the policy rate twice by a total of 250bp to 13% since November 2023 to curb inflation and support the currency.

Although external funding constraints will moderate and real rates will remain in positive territory, Fitch expects the Central Bank of Kenya to be cautious on rate cuts, especially while pressure on the currency persists.

The government’s budget deficit narrowed to 5.6% of GDP in 2023, from 6.2% of GDP in 2022. The government plans to continue on its fiscal consolidation path in FY24.

Fitch forecasts the FY24 budget deficit at 5.2% of GDP amid still high spending pressure and legal challenges to revenue reform efforts.

Revenue collection in 1HFY24 was short of target on a pro-rata basis. Fitch forecasts the deficit to narrow to 4.4% of GDP in FY25 as revenue reforms gain momentum through a combination of tax reforms and non-tax measures, while spending will edge down marginally as a percentage of GDP.

High Debt Level, Currency Risk: A record of underperformance in revenue collection and high spending pressures has increased government debt in recent years. Fitch estimates that government debt/GDP rose to 71.8% in FY23 from 67.6% in FY22, above the ‘B’ median of 60.3%. As at end-FY23, nearly half of public debt was foreign-currency denominated, exposing it to currency risk. Fitch expects government debt to rise in FY24 to 73.8% of GDP, partly linked to currency depreciation, but to decline slightly in FY25 as revenue reforms materialise and GDP growth remains strong.

Public Finance Management Shortfalls: Pending bills have accumulated in recent years, highlighting shortfalls in public financial management. Outstanding public sector arrears amounted to KES568 billion (4.0% of GDP) in FY23, falling slightly to KES539 billion (3.3% of GDP) at end-2023. However, pending bills of county governments rose 7.7% to KES164.8 billion (1.2% of GDP) in FY23. The government has established a pending bills committee mandated to verify and clear existing arrears, but Fitch expects pending bills to remain high in the near term. #Fitch Affirms Kenya at ‘B’ with Negative Outlook

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