EXTERNAL DEBT SUSTAINABILITY AND DEBT DYNAMICS: THE CASE OF KENYA
Abstract
Purpose of Study: This study examines the sustainability and dynamics of Kenya's external debt, utilizing the International Monetary Fund (IMF)-World Bank Debt Sustainability Framework (DSF) alongside empirical estimations of a fiscal reaction function. The analysis explores the evolution and structure of Kenya’s external debt and evaluates its sustainability based on recent debt sustainability analyses (DSA) conducted by the Kenyan government. Data were collected from sources such as the World Bank, IMF, Central Bank of Kenya, and the Kenyan National Treasury.
Problem Statement: Public debt, particularly in sub-Saharan Africa, has become an increasing concern, with Kenya facing a rising external debt burden driven by large infrastructure projects and the need to finance budget deficits. The DSA reveals that while the present value of Kenya's debt-to-GDP ratio remains within the threshold, the debt service-to-exports ratio exceeds recommended limits, indicating pressure on export earnings. However, projections suggest gradual improvements in debt sustainability, with the debt-to-GDP ratio expected to significantly decrease by 2042.
Results: Empirical results from Kenya’s fiscal reaction function underscore the critical role of past fiscal balances. For public debt, lagged fiscal balances significantly and positively influence current fiscal balances, with stronger effects observed in models accounting for policy changes. The results also suggest that while public debt ratios are generally positive, their impact is statistically weak. For external debt, lagged fiscal balances similarly demonstrate a robust positive influence, whereas the external debt-to-GDP ratio has a limited and insignificant impact. The output gap's effect varies, highlighting mixed sensitivity to economic performance across models. The Ordinary Least Squares (OLS) models generally show better explanatory power than the Generalized Method of Moments (GMM) models, emphasizing broader economic factors' role in fiscal dynamics.
Conclusion: These findings suggest that Kenya’s fiscal policy is responsive to past performance, underlining the importance of fiscal discipline for debt sustainability. Despite current high debt levels, long-term projections point to improved debt sustainability, contingent upon fiscal consolidation and the rationalization of capital spending. The study recommends that the government prioritize prudent debt management, favor concessional financing with favorable terms, and adopt a balanced borrowing strategy to mitigate the risks associated with debt accumulation.
Keywords: External Debt, Public Debt, Debt Sustainability Analyses, Fiscal Reaction Function, Fiscal Balances, Debt Sustainability Framework, Debt Accumulation
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