When lenders face a choice between government and private sector lending, the former typically prevails due to the lower risk associated with holding government securities.
In Kenya, the fiscal expansion of recent years has intensified this preference, with consequences for households and enterprises, namely, diminished disposable income and a declining propensity to save.
Together, these dynamics reinforce the crowding-out effect in domestic credit markets.
This distortion is further amplified in a high-yield environment. Elevated interest rates enhance the attractiveness of government debt, diverting capital from the private sector and resulting in unmet credit demand among businesses and households.
Recent oversubscription levels, reaching up to 200 percent for government bond issuances at Central Bank of Kenya (CBK) auctions, reflect this trend.
For enterprises, the implications are multifaceted: elevated borrowing costs, heightened credit risk, and reduced access to growth capital. Over time, these factors suppress private sector contribution to gross domestic product (GDP).
Private sector credit growth
Economic data confirms the crowding-out hypothesis. CBK statistics show that private sector credit growth declined by 1.4 percent in fourth quarter of 2024, extending a trend of softening credit expansion.
While currency valuation effects may partly explain the slowdown, the dominant driver has been the reallocation of commercial bank lending toward government securities.
Simultaneously, credit risk has escalated. Non-performing loans constituted 16.4 percent of gross loans in December 2024, rising to 17.2 percent by February 2025, according to Kenya National Bureau of Statistics (KNBS) data.
The public sector’s share of total credit increased from 30 percent in December 2020 to 34 percent in December 2024, while the private sector’s share declined from 70 percent to 66 percent. This shift has directly impacted employment, with Q4 2024 recording the lowest net job creation since the Covid-19 downturn.
Given the strong correlation between private sector growth and real economic expansion, it is unsurprising that Kenya’s nominal GDP growth in 2024 slowed to 4.7 percent, the weakest performance since the pandemic.
Cause for hope
Macroeconomic signals suggest a possible reversal. The government has acknowledged the unsustainable nature of private sector exclusion and, through the February 2025 Budget Policy Statement, committed to fiscal consolidation.
This includes containing expenditure and enhancing domestic revenue mobilisation while reducing reliance on debt.
Accordingly, the Finance Bill 2025 avoids introducing major new tax measures, and the FY 2025/26 budget targets a reduction in the fiscal deficit, from 4.9 percent of GDP in FY 2024/25 to 4.3 percent.
The fiscal strategy aims to achieve this through improved tax compliance and structural adjustments, including converting zero-rated VAT items to exempt status.
Should these measures succeed, more credit could be channelled toward the private sector. Still, fiscal financing will remain reliant on domestic borrowing: 78 percent of the FY 2025/26 deficit (equivalent to Sh648.2 billion) is expected to be financed domestically.
While this reflects a modest seven percent year-on-year increase, down from 10.3 percent in 2022. The government aims to reduce domestic debt growth to 4.2 percent by FY 2027/28.
Thus, although the debt burden remains considerable, the trajectory suggests reduced upward pressure on interest rates and a more stable credit environment.
Monetary policy support
CBK has aligned monetary policy to support this fiscal pivot. Yields on government bonds have declined from their peak levels, tempering banks’ enthusiasm for sovereign lending.
Furthermore, at its latest Monetary Policy Committee meeting, CBK lowered the Central Bank Rate from 10.75 percent to 10 percent and reduced the Cash Reserve Ratio to enhance bank liquidity for lending to the private sector.
These coordinated efforts appear to be yielding initial results. CBK data indicates private sector credit grew by 0.2 percent in February 2025,modest but indicative of an improving trend.
In conclusion, while past tax hikes and the borrowing appetite by the government have undoubtedly left the private sector reeling, recent economic fundamentals give cause for hope.
Going forward, policymakers need to understand and appreciate the role of a vibrant private sector in driving economic growth.
The writer is a Tax Accountant at Deloitte East Africa. The views presented are his own and not necessarily those of Deloitte. He can be reached at [email protected]
