Kenya's debt spirals as revenue crisis threatens economic stability

President William Ruto's ambitious economic model (Rutonomics) is confronting its most significant test, even as new data reviewed by the Financial Standard reveals a surging national debt burden coinciding with persistent shortfalls in government revenue.

Kenya's public debt has climbed sharply by 32.9 per cent to Sh11.51 trillion by May 2025 since President Ruto's administration assumed office in September 2022.

This Sh2.85 trillion increase underscores the rapid pace of borrowing, equating to an average accumulation of about Sh2.84 billion per day over the past 1,004 days.

The gravity of the situation is underscored by Moody's latest sovereign risk assessment, which places Kenya's government debt-to-GDP (Gross Domestic Product) ratio at a precarious 66.5 per cent for fiscal year 2025.

While this marks an improvement from a peak of 72 per cent in fiscal year 2023, analysts caution that the decline largely stems from GDP rebasing rather than fundamental fiscal consolidation.

The ratings agency notes with significant concern that interest payments now consume a substantial 33 per cent of government revenue, ranking it as the sixth highest burden among sovereigns globally.

"Kenya’s path to fiscal consolidation remains constrained by weak revenue performance, rigid spending structures, and public resistance to tax increases," Moody's stated.

"While the debt-to-GDP ratio declined to around 66.5 per cent in financial year 2025, the fiscal deficit exceeded the target at 5.7 per cent of GDP, highlighting continued fiscal pressures."

Moody's elaborated on the structural weaknesses in revenue generation, pointing out that "tax revenue has declined to 14 per cent of GDP over the past decade."

The agency highlighted the intense social backlash against proposed measures in the Finance Bill 2024, noting that such protests "limit scope for further revenue-raising tax measures before the 2027 elections."

On the expenditure side, the report detailed a rigid budget structure where "over 50 per cent of the budget is absorbed by wages, pensions, interest, and transfers to counties, while development spending has already been cut to 3.5 per cent of GDP," limiting the government's flexibility.

This escalating debt service challenge unfolds against a backdrop of continued revenue underperformance.

The Kenya Revenue Authority (KRA) missed its revised fiscal year 2025 target by Sh47.3 billion, despite the implementation of stringent collection measures.

Analysts suggest that a fundamental contradiction lies at the heart of the Ruto administration's economic strategy.

While aggressively pursuing new taxes through controversial legislation, the government appears to be encountering the very phenomenon warned of by former Treasury CS Njuguna Ndung'u: that beyond a certain optimal point, higher tax rates can paradoxically depress overall revenues by incentivising informal economic activity and tax evasion.

This "Laffer Curve" effect, a concept associated with American economist Arthur Laffer, posits that excessively high tax rates can discourage economic activity, stifle investment, and drive transactions underground, ultimately leading to a decrease in total tax revenue.

Prof Ndung'u, a former Central Bank of Kenya governor who was later removed from his post in the Ruto administration, openly questioned the efficacy of higher tax rates during an International Monetary Fund (IMF) virtual forum last year.

He articulated this concern, stating, "High tax rates create incentives for evasion," adding, "We're seeing this with our shrinking tax base."

He further emphasised that a vibrant economy is essential for higher tax generation, asserting that "the current economic structure and the vibrancy of the economy are so low to support added tax."

These comments by Prof Ndung'u at the time appeared to diverge from the government's public stance on aggressive taxation and echoed similar warnings from KRA Commissioner General Humphrey Wattanga.

Mr Wattanga had previously conceded difficulties in expanding the tax net to include Kenya's vast informal economy, which accounts for an estimated 84 per cent of employment, while also noting a decline in specific taxes from other sectors.

In response to these fiscal pressures, the Treasury has resorted to a combination of financial engineering and appeals for external support.

One of the most controversial moves has been CS John Mbadi's proposed Sh175 billion fuel levy securitisation plan—a hallmark of what some analysts have termed "Mbadinomics."

This innovative but contested approach aims to unlock infrastructure funding by packaging future fuel tax revenues into tradable securities.

However, the plan faces significant legal challenges, with critics arguing it potentially bypasses constitutional safeguards on parliamentary oversight of public debt.

Some economists have warned that the Special Purpose Vehicle (SPV) structure essentially mortgages future revenues while retaining repayment liabilities on the government's books.

Beneath these immediate measures lies a deeper structural crisis, as cautioned by Moody's. The rating agency points to Kenya's Sh3.2 trillion in tax exemptions, equivalent to 3.2 per cent of GDP, as a significant untapped potential for revenue enhancement.

Furthermore, overlapping levies, such as the housing fund and social health insurance deductions, are creating administrative complexities and contributing to taxpayer fatigue.

Moody's reiterated that Kenya's heavy reliance on domestic financing, which covers about two-thirds of its funding needs, remains a key vulnerability.

"While borrowing costs have declined, domestic debt still carries significantly higher interest (11.8 per cent) than external debt (four per cent), and Kenya’s interest-to-revenue ratio remains elevated at 33 per cent, among the highest globally," the agency stated.

Despite the fiscal challenges, Kenya's external position has shown some improvement. The current account deficit narrowed to 1.3 per cent of GDP in 2024, bolstered by robust export growth, a rebound in tourism, and rising diaspora remittances. International reserves have strengthened, now covering nearly five months of imports, providing a critical buffer.

However, "external debt service needs remain large—averaging $3.5 billion annually—and sustained access to concessional and commercial financing is essential to avoid pressure on reserves," Moody's stressed.

The government finds itself in a precarious position, balancing the IMF's demands for structural reforms with a restive population that publicly demonstrated in 2024 against additional tax burdens.

With debt servicing now consuming one in every Sh3 of government revenue, and substantial external repayments of $3.5 billion (Sh455 billion) annually coming due through 2028, Treasury officials face increasingly limited options.

The "Rutonomics" model—which promised to deliver economic transformation through fiscal discipline and innovative financing—now faces its pivotal moment.

Moody's assessment concludes that Kenya's path to fiscal sustainability remains fraught with risks, and the window for effective course correction is narrowing.

"Disbursement of World Bank and IMF support is contingent on progress with reforms, including e-procurement and conflict-of-interest legislation," Moody's observed, adding that "a successful IMF programme could anchor investor confidence and reduce external borrowing costs."