With domestic interest rates soaring to 17% and external loans shrinking, Kenya faces a tough challenge in securing affordable funding for its upcoming budget as investors demand higher returns and borrowing costs rise.
Kenya faces increasing challenges in securing domestic loans in the upcoming financial year, as a prolonged standoff with local investors over interest rates persists and external borrowing options remain limited.
The National Treasury plans to raise its domestic borrowing target by 27% to Ksh.522.7 billion ($4.05bn) and slash external borrowing by over 50% to Ksh.166.7 billion ($1.29bn) for the 2025/26 financial year (FY), aiming to shift from short- to long-term debt securities.
In the current financial year 2024/25, domestic and external borrowing stand at Ksh.413.1 billion ($3.2bn) and Ksh.355.5 billion ($2.76bn), respectively.
However, local investors — primarily commercial banks, pension funds, and insurers — are already demanding higher returns, with average interest rates at 17%. This could complicate the government’s efforts to secure cheaper loans and slow the rapid accumulation of debt.
“The Central Bank of Kenya (CBK) faces a huge test,” says analysts at AIB AXYS Africa.
“We expect heightened yield tensions between the CBK on the one hand, and investors on the other keen to maximise real yields.”
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With inflation at 4.4% as of August, well within the government’s preferred range, Cytonn Kenya estimates the real return on 10- and 20-year debt papers to be 12.9%.
“The government will continue to optimise concessional funding, extend the maturity profile of public debt, and deepen the domestic debt market to reduce the cost of borrowing,” said Trreasury CS John Mbadi in the 2024 budget review and outlook paper (BROP).
Recent long-term government bond sales, a key part of the fiscal consolidation strategy, have remained undersubscribed, reflecting investor caution.
Last week, bond buyers offered Ksh.22.64 billion against the Ksh.30 billion target for reopened 10- and 20-year papers. The (CBK) accepted Ksh.19.28 billion worth of bids, rejecting those deemed too costly.
These same bonds fell short by 50% during July sales. Analysts suggest that investors are hesitant to commit long-term, anticipating that central banks worldwide will cut rates in the coming months.
Failed tax targets
Public discontent over tax hikes, which aim to boost government revenue and reduce reliance on borrowing, further complicates Kenya’s fiscal challenges, especially given the country’s heavy debt repayment obligations and funding gaps.
The country’s fiscal deficit, which determines borrowing needs, is expected to drop to Ksh.689.4 billion ($5.3bn) in the next budget cycle. In the medium term, the government plans to borrow only for development purposes, rather than for recurrent spending.
However, the government’s increased demand for domestic credit could undermine CBK’s efforts to lower interest rates.
Government bonds, seen as risk-free, are more attractive than private-sector lending; a flood of local government bonds in the market will crowd out the private sector, pushing up interest rates for them.
In its last monetary policy committee (MPC) meeting, CBK trimmed the base lending rate by 25 basis points to 12.75% in response to “easing inflationary pressures”, with indications that other central banks will soon embark on a similar trajectory.
The cut, the first in four years, could help the private sector to access cheaper credit and spur economic growth. A lower interest rate will also help the central bank to tame inflation and foreign currency exchange rates, which had peaked at historic levels and made debt repayment costly.
