Kenya's overall external debt dropped by Sh37 billion in the six months to December following the strengthening of the shilling despite increased borrowing by the Treasury.
External debt dropped from Sh722 billion in June to Sh685 billion helping to ease pressure on the Treasury whose burden has increased as the cost of servicing external debt rises.
"The overall decrease is explained by Sh37.3 billion net decrease in external debt largely on account of exchange rate movement," said Finance ministry in its half-year economic and Budget review for the financial year 2011/2012.
Analysts said the value of foreign currency spent on debt servicing must be monitored and kept at lower proportion than the total foreign exchange earnings.
"Excessive foreign currency outflows in debt repayments can create a shortage of hard currency in the domestic market, which is essential for procurement of imports," said Gerishon Ikiara, a senior lecturer of International Economics at the University of Nairobi.
The government spent Sh15.5 billion to service debts from various donors up from Sh12.2 billion in the same period the previous year showing an increase in funds diverted to pay debt instead of domestic needs.
Of the total Sh15.5 billion, Sh3.2 billion was paid to Japan alone signalling increased interest of the Asian economic giant in Kenya.
The treasury normally gives money in shilling denominations to the Central Bank which enters the markets to buy foreign currency in order to pay the debts to donors abroad.
A rise in external debt increases demand for foreign exchange by the Central Bank piling pressure on the local currency while affecting stability in the financial markets.
"The external debt that is due this month depending on the agreement with lender will be determined by the average exchange rates of the previous month," said Mr Henry Rotich, the deputy secretary of economic affairs at the Treasury.
He said that the real value of the debt, therefore, is fully realised on the day the debt is settled.
The value of external debt depends on the exchange rate and sustained borrowing activities by the Treasury.
The shilling gained from a monthly average of 89.86 against the dollar in June to an average of 85.06 in December. This means that the government will spend less on debt this year going forward if the exchange rates remain stable.
Spending on external debt service rose by 27 per cent in the six months to December last year reflecting the impact of increased borrowing on Treasury.
However, in dollar terms, external public debt increased by $15.21 million from $8,044.3 million in June to $ 8,059.3 million by end of last December.
This comprised the debt owed to bilateral 34.5per cent multilateral 62.2 per cent and suppliers credit 3.2 per cent.
This increase is attributed to disbursements during the quarter under review.
The appreciation of the local currency therefore led to a general drop in the total gross public debt in shilling terms by Sh826.1 million from Sh1,487.1 billion at the end of June 2011 to Sh1,486.3 billion which is 45.1 per cent of GDP at December 2011.
The shilling had depreciated to 107 against the dollar in mid October sharply raising the amount of foreign debt that was due at that period.