Moody’s Affirms Kenya’s B2 Ratings; Outlook Remains Negative
Moody’s affirms Kenya’s B2 ratings, saying the country outlook remains negative following the outbreak of coronavirus pandemic in 2020.
Kenya plans a gradual fiscal consolidation that will limit the deterioration in the sovereign’s debt and interest burdens. In the near term, fiscal consolidation will rest primarily on the efficacy of tax measures already taken by the government and the withdrawal of pandemic-related spending.
The reversal of pandemic-related tax cuts already supported improved revenue collection in the second half of the fiscal year ending 30 June 2021 (fiscal 2021).
Moreover, the removal of several value-added tax (VAT) exemptions and the introduction of a minimum alternative tax will boost corporate income tax collection, further broadening the tax base.
Over time, the government intends to reduce the fiscal deficit further by reducing recurrent spending while aiming to prioritize key infrastructure projects, before undertaking further measures to broaden the tax base in later years of the IMF program.
However, Kenya’s mixed track record in terms of fiscal consolidation suggests achieving the government’s ambitious fiscal consolidation targets over a multi-year timeframe will prove difficult.
These institutional challenges are reflected in the government’s lackluster track record in terms of fiscal policy effectiveness, which resulted in a narrowing revenue base and larger-than-budgeted fiscal deficits in three of the past four years.
Taking into account these challenges, Moody’s expects the fiscal deficit to narrow gradually, from 8.7% of GDP in fiscal 2021 to 6.8% of GDP by fiscal 2023.
Moody’s also expects the debt and interest burdens to peak by 2023, at 72.6% of GDP and around 28% of revenue, respectively, before declining very gradually, while remaining above the median for B-rated sovereigns.
Meanwhile, uncertainty over the economic recovery from the coronavirus pandemic poses significant downside risk to fiscal consolidation through lower-than-expected tax collection and the potential crystallization of contingent fiscal risks.
The deteriorating financial performance of several large state-owned enterprises (SOEs) increases fiscal risks, either because of increased budgetary support being potentially needed or the crystallization of contingent liabilities related to outstanding guaranteed and non-guaranteed SOE debt.
Moreover, Kenya’s political cycle, with a potential constitutional referendum in 2021 and elections in 2022, will likely challenge the reform agenda. A prolonged period of political uncertainty may damage business confidence and undermine growth.
IMMEDIATE LIQUIDITY RISK HAS MODERATED, BUT REMAINS PRESENT
With the agreement on an IMF program providing a tangible backstop, Kenya’s immediate financing risks have eased due to slightly lower gross financing needs and expanded access to a diverse funding mix.
However, a slower pace of fiscal consolidation than Moody’s currently expects would increase financing needs and leave Kenya vulnerable to tightening financial market conditions.
Moody’s expects Kenya’s gross financing needs to decline to around 18% of GDP in fiscal 2022. The decline in gross financing needs reflects smaller fiscal deficits, savings from participation in the G-20 Debt Service Suspension Initiative (DSSI), and a reduction in domestic Treasury bills.
Moody’s expects Kenya to meet its gross financing needs through a diverse funding mix, including external concessional and commercial borrowing and with greater reliance on the domestic debt market. If achieved, Kenya’s already weak debt affordability metrics would not deteriorate further.
However, failure to deliver on the government’s fiscal consolidation would increase liquidity risk, particularly if this were accompanied by an increase in external commercial borrowing or short-term domestic debt issuance. This would risk reversing some of the improvements in the government’s debt structure and financing over the past year and leave the sovereign more vulnerable to shifts in financing conditions.
RATIONALE FOR AFFIRMING THE B2 RATING
The affirmation of the B2 rating balances the debt level and debt affordability challenges against key credit strengths, including Kenya’s larger and more diversified economy relative to rated peers.
Kenya’s economic strength is supported by a relatively diversified economy with high growth potential at around 6%, which provides some capacity to absorb economic shocks.
The economy has grown robustly, averaging 5.8% real GDP growth between 2010 and 2019. In 2020, the coronavirus outbreak and related containment measures had a severe impact on activity in almost all sectors of Kenya’s economy, with the tourism industry among the hardest hit.
In 2021 and 2022, Moody’s expects Kenya’s growth rate to return to its long-term average of around 6%, resulting in limited permanent scarring. In turn, a relatively stable economy would limit the risk of a sudden decline in the government’s revenue base.
Kenya also benefits from a relatively deep domestic financial market which supports domestic, local currency debt issuance with longer tenors, alongside short-term debt issuance.
Over the past year, the Kenyan government has improved the structure of its domestic debt, reducing the share of short-term Treasury bills, which has extended the average maturity and reduced rollover needs.
The share of Treasury bills declined to 25% of total domestic debt in 2020, or 8.3% of GDP, down from 31% of total debt and 9.2% of GDP in 2019.
The average term to maturity on the domestic debt stock stood at 5.5 years as of 30 June 2020, an increase from 4.7 years compared with a year earlier.
Kenya’s creditworthiness remains constrained by institutional and governance challenges, as evidenced in weak fiscal policy effectiveness.
Fiscal policy effectiveness has proven weak, as exhibited by the deterioration in fiscal metrics and erosion of the revenue-to-GDP ratio, which has limited the government’s ability to narrow the fiscal deficit.
Moody’s Affirms Kenya’s B2 Ratings; Outlook Remains Negative