Global credit ratings agency Standard & Poor's (S&P) has downgraded Kenya's sovereign credit rating from "B" to "B-" due to concerns over the country's fiscal consolidation and rising debt levels.

This downgrade reflects the agency's view that Kenya's financial outlook has deteriorated following the late June repeal of the 2024/2025 Finance Bill, which was intended to raise tax revenues and help stabilize the economy.

President William Ruto's decision to rescind the Finance Bill for the FY2024/2025 has raised several concerns about the country's fiscal health. The bill, which contained tax hikes worth Kes346 billion, was dropped following widespread protests that led to the deaths of more than 50 people.

According to the government, the bill was structured as a crucial component of Kenya's fiscal strategy, supported by the International Monetary Fund (IMF), and aimed at narrowing the fiscal deficit and stabilizing the nation's debt trajectory.

According to S&P, the repeal of the Finance Bill is expected to slow Kenya's fiscal consolidation efforts. Fiscal consolidation refers to policies aimed at reducing government deficits and debt accumulation.

Without the additional tax revenues that the Finance Bill would have generated, Kenya's ability to rein in its rising debt becomes increasingly challenging, noted S&P in an update last week.

Rising debt and fiscal challenges

S&P's downgrade of Kenya's rating to "B-" highlights the growing concerns over the country's debt levels and fiscal challenges. The agency projects that Kenya's debt-servicing costs will continue to exceed 30 percent of government revenue over the 2024-2027 period.

This figure is among the highest of all sovereigns rated by S&P, indicating a significant burden on the country's finances.

Debt-servicing costs represent the portion of government revenue allocated to paying interest and principal on existing debt. High debt-servicing costs limit the government's ability to invest in essential services, infrastructure, and social programs, which can, in turn, hinder economic growth.

The downgrade also reflects concerns about the government's revised budget for the 2024/25 financial year. In response to the repeal of the Finance Bill, the government has opted to cut some spending and increase its local borrowing target to cover the wider fiscal deficit.

However, this approach raises the risk of further debt accumulation, particularly if the government's revenue generation efforts fall short of expectations.

Read also: Why Fitch has downgraded Kenya to ‘B’; Outlook stable

Economic outlook

Despite the downgrade, S&P maintained a stable outlook for Kenya, citing the country's strong economic growth and continued access to concessional external financing as factors that could offset some of the challenges posed by high-interest costs, slow fiscal consolidation, and structural imbalances.

Concessional external financing refers to loans provided by foreign governments, international organizations, or development banks on favorable terms, such as low-interest rates and extended repayment periods.

Access to such financing is crucial for Kenya as it seeks to manage its debt burden while continuing to invest in critical sectors of the economy.

However, the downgrade could have negative implications for Kenya's borrowing costs in the global markets. A lower credit rating typically leads to higher interest rates on sovereign bonds, as investors demand greater compensation for the perceived increase in risk. This could exacerbate the country's debt-servicing challenges and further strain its fiscal position.

Kenya's fiscal outlook is closely tied to its relationship with the IMF, which has been providing financial support under a $3.6 billion lending program that is set to expire next year.

The IMF board is expected to convene in September 2024 to approve a $600 million disbursement under this program. This disbursement is crucial for Kenya as it seeks to shore up its external reserves and manage its fiscal deficit.

S&P noted that while immediate external liquidity pressures have slightly receded, Kenya's structurally large external imbalances remain a key vulnerability. External imbalances refer to the difference between a country's total foreign liabilities and assets, which can create risks if they become too large.

The IMF's continued support is vital for Kenya, but it also comes with conditions, including the implementation of fiscal reforms and measures to reduce the budget deficit. The repeal of the Finance Bill has raised questions about the government's commitment to these reforms, which could affect future disbursements and the overall success of the IMF program.

S&P's downgrade of Kenya follows similar actions by other major credit rating agencies. In July, Moody's downgraded Kenya's credit rating further into junk status, signaling increased concerns about the country's fiscal health and debt levels.

Earlier this month, Fitch also downgraded Kenya's sovereign rating to "B-" from "B," causing the country's dollar bonds to fall in value.

These downgrades collectively paint a concerning picture of Kenya's financial outlook. While the country's economy continues to grow, the rising debt levels, high-interest costs, and fiscal challenges pose significant risks that could undermine long-term stability.

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