Fiscal Policy Regimes Impact on Public Debt in Kenya
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Date
2025-11
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Kenyatta University
Abstract
The fiscal policy regime in Kenya is thought to be unsustainable as the rise in debt levels is linked to a worsening fiscal balance. The unprecedented accumulation of debt shows that debt stabilization is not a major concern for the government. Thus, the study tried to relate the ways in which fiscal policy regimes impact public debt in Kenya. The particular objectives were to establish the fiscal regimes that favor sustainable debt in Kenya and how long fiscal policy regimes last. The study was conducted using the yearly time series data from 1990 to 2023. Data that was utilized for the research was obtained from Kenya's Economic Surveys and the World Bank. The economic surveys were the data source for domestic debt and fiscal deficit, while World Bank data provided information on the interest rate and inflation. The primary objective of the study was accomplished by using transition probabilities and intercepts to identify fiscal policy regimes. The study used structural breaks to account for regime changes. The Markov switching model was used as a way to set up the fiscal regimes endogenously. The debt coefficient in the Markov Switching model was used to determine whether the fiscal regime was active or passive, i.e., a significant and negative debt coefficient, the regime was termed passive, and vice versa. The study confirmed the presence of two fiscal policy regimes between 1990 and 2003. The passive regime labeled “state 1” was confirmed by a constant of -0.20702(p-value = 0.009), which showed a significant negative intercept, suggesting that public debt was low in this state, while in state 2, the active regime, the constant of -0.05517 (p-value = 0.479) showed an insignificant negative intercept, suggesting high debt levels. The presence of two regimes (passive and active) confirmed that Kenya’s fiscal policy has been changing over time and that passive fiscal regimes favored debt stabilization compared to active regimes. The study established the duration of fiscal policy regimes through the transition probabilities and computation of expected duration, which revealed that the active regime was more persistent and lasted for approximately 6 years, while the passive regime lasted for approximately 4 years. Structural breaks were also identified in 1993,1995, 2002, and 2010, indicating efforts of debt stabilization and transition to a passive regime. The absence of structural breaks from around 2012 indicated a strong shift away from the passive regime to the active fiscal regime. The regression findings revealed that real interest, exchange rate, and fiscal balance were statistically significant and had affected debt levels in both regimes. The study confirmed that Kenya’s debt is highly sensitive to policy choices rather than historical debt levels, since lagged debt was statistically insignificant, emphasizing the need for proactive fiscal management in stabilization. Therefore, for sustainable debt management, policymakers should strengthen the institutional rules, such as fiscal deficit caps, debt brakes/ debt ceilings, and policy frameworks that support the conditions observed in a passive regime. Policy makers should also avoid prolonged active regimes, as they lead to debt accumulation and unsustainability
Description
A Research Project Submitted to the Department of Economic Theory in the School of Business, Economics, and Tourism in Partial Fulfillment of the Requirements for the Award of the Degree of Master of Economics (Policy and Management) of Kenyatta University, November, 2025
Supervisors;
1.Martin Etyang