State ups domestic borrowing to avert global lenders' scrutiny

Kenya’s growing reliance on domestic borrowing to plug budget holes is now being seen as a way of skirting the tough conditions pegged on accessing external loans, especially from multilateral lenders.

The shift is now seen as having the potential to edge out the private sector from the credit market while at the same time raising the long-term cost of loans.

Concessional lenders such as the International Monetary Fund (IMF) and the World Bank offer loans at friendlier terms, including cheap rates, longer repayment period and even a grace period before a country is required to start paying the principal.

However, the facilities also come with conditions, including transparency and governance requirements. 

The government has, over the years, struggled to meet many of these conditions. External commercial loans - such as Eurobonds – are also becoming difficult to access, with the costs being prohibitively high, forcing the government to look inwards to finance the budget deficit.

Over the current financial year, Treasury plans to borrow Sh885.9 billion from local markets to finance the Sh1.140 trillion budget deficit.

This translates into 77.66 per cent, leaving external loans to fill the balance of 22.34 per cent (Sh254.8 billion) of the fiscal deficit. 

The trend will continue next financial year, when the government plans to borrow Sh1.115 trillion, of which 80 per cent or Sh890.4 billion will come from the domestic market while Sh225.5 billion will come from external lenders.

There are, however, concerns that the government could borrow beyond what it had planned in the current financial year as it revises expenditure upwards in the coming months through supplementary budgets, with the borrowing rather than revenues expected to cater for the higher spending. 

Treasury, as of January this year, borrowed Sh732.56 billion from the domestic market, inching closer to the Sh885.9 billion it plans to borrow locally in the course of the 2025-26 financial year.

Different analyses show Kenya is finding it difficult to meet conditions by the concessional lenders, some of them requiring what could be seen as politically sensitive structural changes, as well as high-speed fiscal adjustments that the local economy might not absorb.

Ken Gichinga, chief economist at Mentoria Economics, also notes that Kenya faces difficulties in accessing loans from lenders such as the IMF and World Bank.

“The heavy focus on domestic borrowing points to emerging challenges in accessing concessional loans from development partners,” said Gichinga, adding that this would have an effect of locking out businesses and households from the credit market as local lenders lend more to the government. 

“This will undoubtedly lead to the crowding out of the private sector.”

Raphael Muya, programme officer for Public Finance Management at the Institute of Economic Affairs (IEA), said among the factors that have seen the government resort to borrowing locally in the recent past include the tough conditions by multilateral lenders. 

Other factors, he said, include the foreign exchange fluctuation risk, whereby weakening of the shilling against major world currencies usually has the effect of increasing the stock of public debt but also the cost of debt service.

“One of the things that the government will say is that external borrowing comes with conditionalities,” he said, explaining the government’s growing preference for local debt.

“When you are paying external loans, you pay using foreign currencies, especially the US dollars, which carries a foreign exchange fluctuation risk.”

Treasury CS John Mbadi has in the past said there is enough liquidity in the local market for both the government and the private sector.

He has also explained that despite the government’s heavy presence in the local credit market, interest rates have been on the decline.

The average interest rate on Treasury Bills has reduced to between eight and nine per cent, down from a high of 16.5 per cent in June 2024.

Reliance on domestic debt in the recent past has seen domestic debt account for 55.59 per cent (Sh6.837 trillion) of total debt as at December 2025, which stood at Sh12.299 trillion, according to data by the Central Bank of Kenya (CBK).

This is a departure from a scenario where external debt has always accounted for more than 50 per cent of total debt.

In September 2023, for instance, domestic debt accounted for 46.4 per cent of total debt while external debt was at 53.6 per cent.

As the government increased borrowing locally, this started to change, and domestic debt stood at 51.9 per cent of total debt as of September 2024, while external debt was at 49.8 per cent. In its Medium Term Debt Strategy, Treasury said it plans to increase borrowing from domestic sources to 75 per cent and reduce borrowing from foreign lenders to 25 per cent. 

The Parliamentary Budget Office (PBO), which advises MPs on budget matters, also noted that the shift to the local debt market has been on account of the Treasury’s failure to meet the conditions of concessional lenders. 

“The current external financing landscape is heavily skewed toward Programme-Based Operations (PBOs), which are strictly contingent upon the timely implementation of specific, often contentious, structural reforms. The government’s inability to meet these prior actions within the stipulated timelines has led to significant delays in the disbursement of projected external funding, exacerbating the domestic liquidity crisis,” said PBO.

It noted that while concessional financing offers lower interest rates, it comes with stringent conditionalities related to fiscal consolidation, tax policy changes, and governance reforms.

These have proven difficult for the government to effect, which PBO noted could be on account of the country’s immediate socio-economic priorities and the protection of the most vulnerable.

PBO added that the international capital markets effectively remain closed or prohibitively expensive for frontier economies like Kenya due to high risk premiums.

This has left the country dependent on multilateral lenders whose conditionalities necessitate rapid fiscal contraction, which in turn threatens to stifle domestic growth and human capital development.

Kenya has been having a back-and-forth with the IMF over reforms that the country needed to undertake to access a new facility.

A $2.3 billion (Sh296.09 billion) IMF programme was terminated in 2025 after Kenya failed to meet targets, cutting off a crucial funding line. Since then, Nairobi has relied on expensive commercial debt, including high-yield Eurobonds.