How much State debt strains the Private sector

The World Bank has cautioned Kenya’s government about the private sector’s continued exclusion from the local debt market as a result of excessive borrowing.

The multilateral lender observes that commercial banks have not reached their optimal level of investment support, as the Treasury continues to compete for credit from banks with households and businesses.

Despite a rebound in private sector credit growth over the last year, the warning comes despite the end of interest controls and banks’ renewed appetite for higher risk-adjusted returns.

“Credit is growing more slowly than GDP, highlighting that the banks’ role in facilitating investments and economic activity remains challenged. Banking sector credit to the private sector peaked in 2015,” the World Bank noted in a recent report.

“This shift in the dynamic took place against a background of elevated demand by the government for domestic financing of the budget deficit, coupled with the cap on interest rates that was in place between 2016 and 2018.”

Due to restrictions on accessing the global capital markets, the National Treasury has been forced to rely on the domestic credit market to finance the budget deficit.

For instance, the Treasury increased the target for net domestic financing by Sh50 billion to Sh475 billion in order to close the funding gap in the recently completed 2023–24 financing year.

The Treasury anticipates that the Sh718 billion fiscal deficit in the new fiscal year beginning on July 1 will be paid for by the next external financing of Sh131.5 billion and the net domestic financing of Sh586.5 billion.

Credit flows to the private sector have shown some resilience despite the fiscal dominance in the domestic credit market. In March of last year, for the first time since interest rate curbs were implemented, they jumped back into a double-digit growth rate and have remained at similar levels ever since.

The Central Bank of Kenya (CBK) reported that the growth in credit to the private sector was 13.2 percent in both April and May.

Manufacturing, transportation and communication, trade, and consumer durables all experienced significant credit growth, with rates of 19.3, 22, 15, and 11.9 percent, respectively.

“The number of loan applications and approvals remained strong, reflecting increased demand and resilient economic activities,” the CBK noted.

In addition, with the government’s competition for credit, the second half of the year will see notable challenges for the private sector credit market, such as rising interest rates and deteriorating bank asset quality due to a rise in loan defaults.

The increased CBK benchmark lending rate, which increased to 10.5 percent at the end of June from 9.5 percent previously, is the basis for the rising interest rates for commercial bank loans.

Furthermore, it is anticipated that banks’ implementation of risk-based credit pricing will lead to the costlier loans for borrowers with a higher risk profile.

Meanwhile, the government’s growing backlog of unpaid bills, the majority of which are owed to suppliers, has been linked to the resurgence of non-performing loans, which at the end of May represented 14.9% of all gross loans.

Non-performing loans have become more prevalent in the manufacturing, trade, real estate, transportation, and communication sectors.