- The shilling’s 24% depreciation in 2023 has exacerbated stagflationary pressures by simultaneously increasing import costs and dollar-denominated debt obligations for both businesses and households.
- For households, expanded social safety nets and targeted wage subsidies could free up income for debt servicing, reducing default risks without requiring extensive debt forgiveness programs.
- Evidence suggests that countries that successfully navigate stagflationary episodes typically combine prudent macroeconomic management with targeted sectoral interventions, suggesting Kenya would benefit from a similarly balanced approach rather than exclusively prioritizing fiscal consolidation or expansion.
Kenya’s economy exemplifies the complex interplay between stagflation, loan defaults, and economic stability that challenges many developing economies today. While experiencing moderate GDP growth projections of 5.4% in 2024 and 5.6% in 2025, Kenya simultaneously grapples with persistent inflation at 6.2% and an alarming 17-year high in non-performing loans (NPLs), which have reached 14.8% of all loans, totaling Sh621.3 billion.
This paradoxical combination of growth alongside high inflation and financial sector stress creates classic stagflationary conditions, where policymakers must navigate competing priorities of controlling inflation, stimulating growth, and maintaining financial stability. The banking sector faces particular strain in personal and household loans, where default rates have climbed to 16.4% by December 2024, reflecting diminished household capacity to service debt amid rising living costs and increased payroll deductions.
The surge in loan defaults represents not merely a banking sector challenge but a systemic economic risk with far-reaching implications. Banks have responded defensively by nearly doubling loan loss provisions to Sh109.5 billion in 2023, a necessary but consequential move that diverts capital away from productive lending. Smaller financial institutions bear a disproportionate burden of this credit contraction, limiting their ability to finance small and medium enterprises traditionally the engines of job creation and economic dynamism.
This credit crunch threatens to undermine Kenya’s broader economic trajectory, particularly in manufacturing and agriculture sectors, which already account for 14.5% of NPLs despite their strategic importance to the economy. The resulting feedback loop where reduced lending leads to slower business expansion, lower employment, and further defaults illustrates how banking sector health and broader economic performance are inextricably linked in a stagflationary environment.
The shilling’s 24% depreciation in 2023 has exacerbated stagflationary pressures by simultaneously increasing import costs and dollar-denominated debt obligations for both businesses and households.
Agriculture, which contributes 23% to Kenya’s GDP growth, remains vulnerable to climate shocks that perpetuate food price volatility, further fueling inflation. These external and structural factors create a dual threat to economic stability: high inflation erodes purchasing power and increases default risk, while slowing growth reduces income generation capacity and loan servicing ability.
Without targeted interventions, these conditions threaten to reverse recent poverty reduction gains, with poverty rates having only marginally declined to 35.1% in 2023. The Central Bank’s accommodative monetary policy offers limited relief as transmission mechanisms operate inefficiently in Kenya’s high-interest environment, demonstrating the constraints of conventional policy tools in addressing stagflationary conditions.
Banks face a delicate balancing act between prudent risk management and their role as economic stewards during stagflation. Tightening credit standards reduces NPL exposure but potentially starves critical sectors of capital needed for expansion and job creation. Alternatively, extending forbearance and restructuring loans for distressed borrowers preserves economic activity but delays necessary balance sheet repair.
The human dimension of this trade-off is stark: 63% of Kenyans already lack financial security, with many resorting to reduced housing quality and educational expenditure to survive. Personal and household NPLs reached Sh94.6 billion by mid-2024, reflecting deepening inequality as measured by Kenya’s Gini coefficient of 0.39. Banks’ continued reliance on collateral-based lending models further excludes informal workers, who constitute a significant portion of the economy, from accessing formal financial services during economic hardship.
Kenya’s public debt dynamics further complicate recovery efforts, with debt service consuming 68.3% of government revenue in 2023/2024. While the debt-to-GDP ratio moderated to 65.7% in 2024, servicing costs remain elevated due to currency depreciation and high global interest rates.
The 2024 Eurobond maturity placed additional strain on foreign exchange reserves, compelling the government to prioritize external obligations over domestic stimulus measures. This fiscal tightrope limits the government’s ability to implement countercyclical policies that might otherwise alleviate stagflationary pressures. For financial institutions, the government’s fiscal constraints mean that private sector-led recovery strategies must be developed with limited expectation of public sector support, particularly as fiscal consolidation aims to reduce the deficit to 5% of GDP by 2025.
A sustainable approach to navigating stagflation and loan defaults requires structural reforms that address underlying economic vulnerabilities. Export diversification could help narrow Kenya’s trade deficit, which stood at 4.6% of GDP in 2024, while reducing dependence on dollar-denominated imports that fuel inflation during currency depreciation. Strengthening foreign exchange reserves and creating a stable policy environment to attract foreign direct investment would provide additional buffers against external shocks.
For households, expanded social safety nets and targeted wage subsidies could free up income for debt servicing, reducing default risks without requiring extensive debt forgiveness programs. The banking sector could complement these macroeconomic measures by transitioning toward cash-flow-based lending assessments rather than purely collateral-based approaches, potentially broadening financial inclusion while maintaining risk management standards.
Financial institutions can leverage technology to balance stakeholder interests in addressing the default crisis. Fintech solutions enable more sophisticated risk assessment and efficient recovery processes that reduce NPLs without necessarily restricting credit access. Microinsurance products could help protect vulnerable borrowers against income shocks that trigger defaults, benefiting both lenders and borrowers.
Banks might also consider sector-specific approaches to restructuring, recognizing that different economic segments face distinct challenges under stagflationary conditions.
Manufacturing firms, for example, might benefit from extended repayment periods that align with their longer investment horizons, while agricultural borrowers might need seasonal payment schedules that accommodate harvest cycles. Such tailored approaches acknowledge the diverse needs of Kenya’s economic stakeholders while preserving the banking system’s overall stability.
Kenya’s pathway through stagflation and loan defaults will determine its economic trajectory for years to come. The World Bank projects 5.2% average growth through 2026, but realizing this potential requires effectively harmonizing debt sustainability with inclusive growth policies.
Prioritizing investments in agro-processing and digital infrastructure could enhance export competitiveness while creating high-value employment opportunities that improve households’ debt servicing capacity.
The banking sector’s approach to managing defaults during this period will significantly influence Kenya’s ability to maintain financial stability while supporting economic transformation. As noted by the African Development Bank and Kenya Bankers Association, progress hinges on collaborative solutions that distribute adjustment costs equitably among borrowers, lenders, and public institutions.
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Evidence suggests that countries that successfully navigate stagflationary episodes typically combine prudent macroeconomic management with targeted sectoral interventions, suggesting Kenya would benefit from a similarly balanced approach rather than exclusively prioritizing fiscal consolidation or expansion.
The writer is a legal scrivener
