The Effect of Debt Service Ratio and Exchange Rate on Public Debt Sustainability in Kenya

Abstract

This study investigated the impact of the debt service ratio and exchange rate on the sustainability of Kenya’s debt. Since the 1970s, governments worldwide have struggled with unsustainable fiscal conduct. Kenya’s overall governmental debt rose close to 69 percent of GDP by the end of 2022 from 48.6 percent in 2015. For a nation’s macroeconomic and financial health, debt sustainability means the government can satisfy its financial obligations without special help or defaults and provides citizens with trust in the government’s financial management. Conversely, unsustainable debt diverts tax income from vital social and development projects, compromising government spending. The choice of debt service ratio and exchange rate lies in their role as crucial indicators that reflect a nation’s fiscal well-being and its ability to successfully handle its debt. The study applied time series data (1990-2021) and the Vector Error Correction Model to establish the relationship between the study variables. The study established a statistically significant negative association between Kenya’s debt sustainability and debt service ratio. At greater levels, the debt service ratio hurts public debt sustainability. The study further established that exchange rate depreciation negatively affects public debt sustainability. Considering the findings, the government may consider monitoring and manage the debt-service ratio to sustain the public debt level. Negotiating better borrowing conditions or debt repayment plans can lower this ratio and assist maintain a sustainable debt level. Public debt sustainability requires exchange rate stability. To lessen the negative impact on public debt sustainability, policymakers may employ foreign exchange reserves or hedging options. Finally, economic diversification and debt management that supports sustainable development may improve long-term resilience and public debt repayment while boosting economic growth.