State's appetite for domestic debt to grow with fuel VAT cut

The government is expected to borrow heavily from the local market to cover the revenue gap created by fuel value added tax (VAT) cuts, a move that is expected to squeeze out households and businesses in the credit market. 

Just as private sector lending is showing signs of recovery from a prolonged period of double-digit interest to tame runaway inflation, businesses may end up being starved of credit since the government would be raiding banks for cheaper domestic loans. 

In the upcoming budget, the government is expected to borrow close to Sh900 billion from the domestic market since its options in the global space have shrunk due to tighter conditions set by multilateral lenders, and the country’s economic ranking which no longer classifies Kenya as low income. 

Experts have detailed how the cut on VAT applied on fuel will shrink the Kenya Revenue Authority (KRA) collections for the last quarter of the 2025/26 financial year extending into the first quarter of the 2026/27 fiscal period.

VAT on fuel has been slashed from 16 to eight per cent as a relief measure by the government due to the ongoing US-Iran war that has disrupted global logistics of fuel shipping. 

“The moment this country moved from low income to low middle income, we rarely get grants, so we finance most of our deficits from borrowing, and that is from both local and foreign markets,” explains Robert Maina, tax associate director at EY, a tax consultancy firm. 

The National Treasury already has an ambitious budget of Sh4.7 trillion for 2026/27 with total revenue projections of Sh3.5 trillion in the period. 

According to the Budget Policy Statement 2026 prepared by National Treasury Cabinet Secretary John Mbadi, the upcoming financial year's budget has a deficit of Sh1.1 trillion. This is 5.3 per cent of the country’s gross domestic product (GDP). 

“The FY 2026/27 fiscal deficit will be financed through net external borrowing amounting to Sh225.5 billion (1.1 per cent of GDP) and net domestic financing of Sh890.4 billion (4.2 per cent of GDP),” the policy statement reads. 

This figure may be higher in actual sense owing to the foregone revenue from the VAT cuts. 

Data from the CBK shows as at April 2, 2026, gross domestic debt stood at Sh7.2 trillion. In December 2025, this figure was Sh6.8 trillion. 

This means in just three months, the government borrowed in excess of Sh300 billion from the domestic market. Returns on bonds issued by the government average 13 per cent while bills are attracting eight per cent. 

In the latest Monetary Policy Committee communication from the Central Bank of Kenya (CBK), it is documented that growth in commercial banks’ lending to the private sector continued to improve and stood at 8.1 per cent in March compared to 7.4 per cent in February. 2026. 

In January 2025, the growth was negative 2.9 per cent. 

“Growth in credit to key sectors of the economy, particularly building and construction, trade, agriculture and consumer durables remained strong, reflecting improved demand for credit in line with the declining lending interest rates,” it says.

“Average commercial banks’ lending rates stood at 14.7 per cent in March 2026, down from 14.8 per cent in February 2026 and 17.2 per cent in November 2024.” 

Aditi Nayar, strategy and transaction partner at EY, pointed out that analysed data of banking business still shows that they are holding back on lending. A breakdown she presented shows that while assets in the sector grew by 10.7 per cent to Sh8.4 trillion in 2025, gross loans improved by 7.4 per cent in the period to Sh4.4 trillion. 

"The question that comes to mind is: Why is loan growth less than asset? This is a reflection of banks being a little bit conservative in their risk profile as well as the increased borrowing rate,” she said. 

Nayar added that due to the fuel challenges, there is a likelihood of inflationary pressure which will also dictate how CBK will react in its next MPC cycle. This might have a negative impact on credit flow to consumers. 

“Based on these measures, CBK does have interactions to play with the interest rate. Obviously, if we do see inflationary pressures increase, which will reduce the disposable income and liquidity in the market, that in turn will dictate the policy that will come to interest rate,” she said.