Kenya’s long-running struggle with public debt, a weakening shilling, and persistent economic pressure has received fresh academic backing following the publication of a new study by economist Ndindi Nyoro, co-authored with Stephen Githae Njaramba. The paper, titled “Dynamic Relationship between Public Debt and Exchange Rate Misalignment in Kenya,” was published in the American Journal of Industrial and Business Management (Vol. 15, No. 11, November 2025) and delivers a sobering conclusion: persistent budget deficits are a major driver of exchange rate misalignment and Kenya’s mounting public debt burden.
At a time when Kenyans are grappling with rising prices, heavy taxation, and a volatile foreign exchange market, the findings could not be more timely. The study offers a data-driven explanation for why the Kenyan shilling has struggled for years and why government interventions have repeatedly failed to deliver lasting stability.
Kenya’s Growing Debt Problem: A Snapshot
Kenya’s sovereign debt has expanded rapidly over the past decades, crossing the KSh 10 trillion mark. By the end of June 2023, the country’s public debt stood at alarming levels:
- External debt: Approximately KSh 5.39 trillion
- Domestic debt: About KSh 4.90 trillion
This explosive growth in borrowing has pushed the country into what many analysts now openly describe as a debt crisis. Debt servicing costs have ballooned, consuming a significant portion of government revenues and leaving little fiscal space for development, social services, or economic stimulus.
According to the study, the situation is aggravated by persistent fiscal deficits, averaging around 5.2% of GDP in the 2023/2024 fiscal year. Instead of borrowing for growth-enhancing investments that could generate future revenue, Kenya has increasingly relied on new debt to refinance existing obligations, a dangerous cycle that compounds fiscal stress.
Exchange Rate Misalignment: What It Means for Kenya
Exchange rate misalignment occurs when a country’s currency deviates significantly from its “equilibrium” value—the level consistent with economic fundamentals such as productivity, trade balance, and capital flows. In Kenya’s case, the study notes that the real exchange rate has often been overvalued, creating distortions in trade and capital markets.
An overvalued currency has several negative consequences:
- Exports become less competitive, reducing foreign currency earnings
- Imports become cheaper, widening the trade deficit
- Pressure builds on foreign exchange reserves
- Volatility increases, undermining investor confidence
The authors observe that Kenya’s exports have continued to decline, while imports have steadily expanded, worsening the current account deficit. This imbalance means the country earns less foreign currency even as it needs more dollars to service external debt.
The Budget Deficit–Exchange Rate Link
The most critical finding of the paper is clear and direct:
“The Budget Deficit is a strong determinant of Exchange Rate Misalignments.”
In simple terms, the study concludes that persistent budget deficits fuel both public debt accumulation and external imbalances, which in turn distort the exchange rate.
When the government consistently spends more than it collects in revenue, it must borrow to fill the gap. In Kenya, this borrowing increasingly comes from external sources, denominated in foreign currency. As external debt rises, demand for foreign exchange increases, putting pressure on the shilling.
At the same time, deficit financing often stimulates domestic demand without a corresponding increase in export capacity. This leads to higher imports, a wider current account deficit, and further pressure on the exchange rate.
A 43-Year Data Analysis
One of the strengths of the study lies in its scope. The authors analyzed secondary time-series data spanning from 1980 to 2023, covering more than four decades of Kenya’s economic history.
The period begins in 1980, when Kenya adopted a floating exchange rate regime, making it particularly suitable for examining exchange rate dynamics. Using a Vector Autoregressive (VAR) Model, the researchers assessed:
- Direction of causality between public debt and exchange rate misalignment
- Impact responses over time
- Interactions between fiscal, monetary, and external sector variables
This robust methodology allows the study to go beyond simple correlations and identify dynamic relationships, strengthening the credibility of its conclusions.
Why Central Bank Interventions Haven’t Worked
For years, the Central Bank of Kenya (CBK) has actively intervened in the foreign exchange market to support the shilling and curb volatility. These interventions include selling foreign currency reserves and implementing monetary policy measures aimed at stabilizing the exchange rate.
However, the study suggests that such interventions address symptoms rather than causes.
If budget deficits remain high and public debt continues to grow, exchange rate pressures will persist regardless of short-term market interventions. In fact, repeated interventions can deplete foreign exchange reserves, leaving the country more vulnerable to external shocks.
The paper raises a fundamental question: Can monetary policy alone fix an exchange rate problem rooted in fiscal imbalance? The authors’ findings strongly suggest the answer is no.
External Debt and the Foreign Currency Trap
The study highlights that Kenya’s problem is more pronounced in external debt. Unlike domestic borrowing, external debt requires repayment in foreign currency—mainly US dollars.
This creates a dangerous feedback loop:
- Budget deficits increase borrowing
- External debt rises
- Demand for foreign currency grows
- The shilling weakens
- Debt servicing costs increase in local currency terms
- Fiscal pressure intensifies, leading to more borrowing
As the paper notes, Kenya needs to earn more foreign currency to service its debts. Yet exports continue to underperform, while imports expand—an imbalance that undermines long-term stability.
Exchange Rate Misalignment and Economic Growth
Exchange rate instability does more than weaken the currency; it affects the entire economy. According to the study, misalignment:
- Harms trade competitiveness
- Increases uncertainty for investors
- Raises the cost of imported inputs
- Fuels inflationary pressure
- Slows overall economic growth
For households, this translates into higher prices, especially for fuel, food, and manufactured goods. For businesses, it means higher operating costs and unpredictable planning conditions.
Fiscal Discipline as the Missing Link
One of the paper’s most important policy implications is the need for coordinated macroeconomic management. The authors argue that exchange rate stability cannot be achieved without fiscal discipline.
Key recommendations implied by the study include:
- Reducing persistent budget deficits
- Improving revenue collection without stifling growth
- Prioritizing productive public spending
- Limiting excessive reliance on external borrowing
- Aligning fiscal policy with monetary and external sector goals
Without these measures, attempts to stabilize the shilling will remain temporary and fragile.
Why This Study Matters Now
Kenya is currently at a crossroads. Rising taxes, public protests, IMF-backed fiscal reforms, and growing public dissatisfaction have placed economic policy under intense scrutiny. Ndindi Nyoro’s study provides empirical evidence that many critics of deficit-driven borrowing have long argued: fiscal indiscipline has real and painful consequences.
The paper also arrives at a time when Kenya is renegotiating debt terms, seeking foreign financing, and struggling to restore confidence in its currency. Policymakers can no longer afford to treat exchange rate instability as a purely monetary issue.
The Bigger Picture: Lessons for Policymakers
The central lesson from the study is straightforward but uncomfortable: you cannot borrow your way out of an exchange rate crisis caused by fiscal excess.
As long as budget deficits persist, they will:
- Expand public debt
- Worsen external imbalances
- Distort the exchange rate
- Undermine economic stability
The findings reinforce the idea that sustainable growth requires hard fiscal choices, not just technical monetary interventions.
Conclusion: A Warning Kenya Cannot Ignore
“Dynamic Relationship between Public Debt and Exchange Rate Misalignment in Kenya” is more than an academic exercise—it is a warning. By linking persistent budget deficits directly to exchange rate misalignment and public debt accumulation, the study exposes the structural roots of Kenya’s economic challenges.
For policymakers, the message is clear: without fiscal reform, currency stability will remain elusive. For citizens, the study helps explain why the cost of living keeps rising and why the shilling remains under pressure.
As Kenya debates its economic future, this research adds weight to calls for discipline, transparency, and long-term planning. Ignoring its findings may come at a cost the country can no longer afford.
