IMPACT OF PUBLIC DEBT BURDEN ON ECONOMIC GROWTH

A case study of Kenya

DECLARATION

This research paper is our original work and has not been presented for any degree or any diploma in any university.

Signature………………………………………               Date ……………………

Student: Jane Wambui Maina

Signature………………………………………              Date ……………………

Student: Charles Kabatha

Signature………………………………………              Date ……………………

Student: Mercy Nzilani Mutinda

Signature………………………………………              Date ……………………

Student: Joy Ann W. Mbuthia

Signature………………………………………              Date ……………………

Student: Wilson Kiraithe

This work has been carried out under my supervision and approval as a university supervisor.

Signature………………………………………              Date ……………………

Supervisor: Ruth Muinga

LIST OF ACRONYMS

CBK                     Central Bank of Kenya

CLRM                  Classical Linear Regression Model

FDI                      Foreign Direct Investment

GDP                     Gross Domestic Product

HAC                     Heteroscedasticity Autocorrelation Consistent standard errors

HIPC                              Highly indebted poor countries

IMF                      International Monetary Fund

KNBS                  Kenya National Bureau of Statistics

OLS                      Ordinary Least Square

WB                      World Bank

ACKNOWLEDGMENT

First, we thank God for His grace which has been sufficient to see us through our academic journey. Our heartfelt gratitude goes to our supervisor, Madam Ruth Muinga who dedicated her time in guiding us through this project.

We would also like to thank our other lecturers, course mates, friends and family for their support and help during the research.

ABSTRACT

The aim of this study is to examine the impact of public debt burden on economic growth in Kenya. It implements data from 1999-2018 from World Bank and International Monetary Fund. Real GDP is acts as a representation of economic growth and is our dependent variable. The independent variables in this study are: Real interest rate, inflation rate, external debt, domestic debt, FDI and wages. The data is in time series and we employ the OLS in the data analysis.

The results from this study show that external debt, inflation rate and real interest rate impact the economic growth in Kenya negatively while domestic debt, FDI and wages positively impact economic growth in Kenya. Further analysis of the data show that ceteris paribus, an increase in external debt would lead to a decline in the economic growth. This study recommends that the Kenyan government should take into account policies on management of debt and proper utilization of debt as well as restructure the debt in a way that does not compromise service delivery.

Table of Contents

DECLARATION.. i

LIST OF ACRONYMS. ii

ACKNOWLEDGMENT. iii

ABSTRACT. iv

CHAPTER ONE. 1

INTRODUCTION.. 1

1.1         Background of the study. 1

1.1.1 Public Debt and Economic Growth. 2

1.2 Statement of the Problem. 5

1.3 Objectives of the Study. 6

1.4 Research Questions. 6

1.5 Significance of the Study. 6

1.6 Scope of the Study. 7

CHAPTER TWO.. 8

LITERATURE REVIEW… 8

2.1 Introduction. 8

2.2 Theoretical Framework. 8

2.2.1 Classical view.. 8

2.2.2 Keynesian view.. 9

2.2.3 Barrow –Ricardo equivalent proposition. 9

2.2.4 Debt overhang theory. 10

2.2.5 Dual gap analysis theory. 10

2.3 Conceptual Framework. 11

2.4 Empirical Literature Review.. 12

2.5 Summary of Literature Reviewed. 15

CHAPTER THREE. 16

RESEARCH METHODOLOGY. 16

3.1 Introduction. 16

3.2 Research Design. 16

3.3 Theoretical Framework. 16

3.4 EMPIRICAL MODEL. 17

3.5 Data Collection and Analysis. 18

3.6 Diagnostic Tests. 19

CHAPTER FOUR. 21

DATA ANALYSIS AND INTERPRETATION.. 21

4.1 Introduction. 21

4.2 Descriptive Statistics. 21

4.3 Diagnostic Tests. 22

4.3.1 Correlation Analysis. 22

4.3.2 Heteroscedasticity Test. 23

4.3.3 Autocorrelation. 23

4.3.4 Stationarity Test. 24

4.4 Regression Results. 25

CHAPTER FIVE. 27

SUMMARY AND CONCLUSIONS. 27

5.1 Introduction. 27

5.2 Summary of Findings. 27

5.3 Conclusions. 27

5.4 Policy Recommendation. 28

REFERENCES. 29

Appendix 1. 30

CHAPTER ONE

INTRODUCTION

1.1  Background of the study

Since independence, current account deficits were considered normal as countries were urged to borrow abroad thereby creating an environment conducive for foreign investment which would boost economic growth. Economic growth is the increase in the inflation adjusted market value of goods and services produced by an economy over time. Kenya as a country has unfortunately not been able to keep it at a consistent level for a long period of time. The growth rate of the Kenyan economy has been fluctuating form the 1960s with more growth being witnessed in the 1960s and 1970s before the performance of the economy began receding in the mid1970s (Were, 2001).

In the period between the mid1960s and early 1970s, there was a reduction in real GDP since aids and grants began diminishing as a result of mismanaged resources and other factors. Due to bad weather conditions and reduced economic activities in the period before elections the GDP entered into a period of slow or stagnant growth in the late 1990s.

Moreover, Kenya being a developing country has accumulated huge debts over the years due to reasons such as: enabling higher spending without having to increase taxes, meeting national emergencies, for example, during wars and natural calamities, low interest rates which consequently make borrowing costs low and servicing other already existing debts as well as financing budget deficits. These reasons have resulted to debt burden and as a result redundant economic growth has been felt.

A study by Were (2001) portrays Kenya as being among a group of low-income countries categorized as highly indebted poor countries (HIPCs) which have continued to experience various obstacles in managing and servicing their huge amounts of public debt. This relatively high indebtedness level and rising debt burden has majorly impacted the country’s development and debt sustainability initiatives. Since the early 1990s, debt burden indicators have been rising steadily due to accumulation of external debt over the years. Despite the significant outflow of resources to meet the debt obligations in the 1990s, the performance of the Kenyan economy keeps deteriorating.

1.1.1 Public Debt and Economic Growth

Public debt is defined as how much a country owes to lenders outside of itself. It is also known as national debt and comprises of domestic and external debt. Economic growth is defined as the increase in the production of goods and services over a specific period conventionally measured as a percentage.

According to Aybarc (2019) who studied the theory of public debt and current reflection; public debt, also referred to as government debt, represents the total outstanding debt (bonds and other securities) of a country or central government. Public debt is often expressed as a ratio of Gross Domestic Product (GDP). It can be raised both internally and externally; whereby external debt is owed to lenders outside the country (foreign debt) and internal debt represents the government’s obligation to the domestic lenders (domestic debt).

Public debt is an important source of resources for a government to finance public spending and fill budget deficits. Public debt can be further classified according to maturities; short-term, medium term and long-term public debt. Public debt burden occurs when the government borrowings become unmanageable and the total cost of the borrowings and debt servicing comes close to the GDP per capita of the country.

In order to improve the welfare of Kenyan citizens and promote economic growth the Kenyan government has undertaken public development projects. Consequently, the country has had to acquire public debt to supplement domestic savings due to scarcity of capital – budget deficit. The process if social development necessitates public borrowing. The state is faced with budget deficits due to reasons such as large infrastructural investments, wars and development financing.

According to Kibui (2009), over-reliance on public debts and foreign aid results in a notable increase in the level of public debt in Kenya leading to an increase in the inflation rate and a high exchange rate. Consequently, this increases the interest on loans and the government faces difficulties in total debt servicing and payment. As a result, funds are diverted to debt servicing at the expense of social welfare, economic development and domestic consumption.

Source: Central Bank of Kenya, Institute of Economic Affairs.

Source: Institute of Economic Affairs, Central Bank of Kenya.

According to Rok (2009) the Kenyan economy has been distorted and macroeconomic management has been complicated and made complex by public debt leading to Crowding out of some development and social programs as huge portions of government revenue are taken away from essential services and used instead to service existing debts. It has also led to the depletion of country’s foreign exchange reserves devaluing the domestic currency since the principle and interest rates are paid in foreign currency.

In most developing countries, public debt and economic growth have an inverse relationship. According to the Ricardian Equivalence Theorem, an increase in public debt today must be accompanied by an equivalent rise in taxes in the future.

Source: Institute of Economic Affairs

According to Drozen (2000), Imbeaur and Petry (2004) and Swaray (2005) who studied the microeconomic determinants of public growth ,they identified credibility of monetary policy, interest rates, debt stock, economic growth, budget deficit, inflation, public spending and openness to be the determinants of public debt burden.

1.2 Statement of the Problem.

M’Amanja and Morrissey (2003) who studied the effect of fiscal policy on economic growth found that external loans had a negative impact on long run growth and domestic debt. Various studies on economic theories suggest that rational borrowing levels by a developing country could potentially improve its economic growth. As emerging countries begin to develop, they tend to have a limited amount of capital and are likely to have investment opportunities with higher rates of return compared to countries with advanced economies.

Most developing countries are concerned by the increasing levels of public debt (Thugge et al, 2008). The debt burden is rising to dangerous levels due to continuous accumulation of the debts since the country has been borrowing to repay the existing debt. Hence the debt crisis is at par, i.e. both domestic and external debt. The burden has risen to high levels since loan agreements are not transparent, projects are not well prioritized, accounting procedures are weak and it is not clear what projects are costing.

Empirical studies such as M’Amanja and Morrissey (2013), Sheikh et al (2010) Kibui (2009), Checherita and Rother (2010) show mixed inferences on the effects of the public debt burden on economic growth. For instance, Barrow and Salai–Martin (1995) empirically showed that the ratio of government consumption to GDP has a negative on per capita GDP. Therefore the results were inconclusive.

1.3 Objectives of the Study.

The general objective of this study is to evaluate the impact of public debt burden on economic growth in Kenya.

The specific objectives are;

1. To examine effect of domestic debt on economic growth in Kenya.
2. To examine effect of external debt on economic growth in Kenya.

• To draw policy recommendations on public debt and economic growth.

1.4 Research Questions.

This study seeks to answer the following questions:

1. What is the effect of domestic and external debt on economic growth in Kenya?
2. What is the relationship between economic growth and other macroeconomic variables that potentially affect economic growth?

• What is the policy implication of public debt and economic growth in Kenya?

1.5 Significance of the Study.

The aim of this study is to provide a fundamental foundation for policy development geared towards an efficient debt management strategy which contributes to the country’s sustainable economic growth. As well as to provide a basis for further research and be a source of reference material for future researchers on related topics thereby contributing to pre-existing literature and policy.

1.6 Scope of the Study.

The report is divided into five key sections: chapter one gives a background on public debt and its effect on economic growth in Kenya highlighting the trend of borrowing by the government over the years as well as the various causes and impacts of public debt. It further states the problem statement, research objectives and research questions formulated to guide the study and the significance of the study.

Chapter two gives the chain of reasoning of the various schools of thought brought forward with regard to the relationship between public debt and economic growth. Chapter three describes in detail, the research design and methodology to be used for the purposes of conducting this study.

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter discusses the relevant literature on the impact of public debt on economic growth in Kenya. It draws literature on this topic from different scholars across the world. This chapter is organized into the following sections: review of theories, conceptual framework, and review of empirical studies. The aim of this chapter is to give existing knowledge gaps in the literature review and a summary of the chapter.

2.2 Theoretical Framework

Over the years, the theory of economic growth has evolved from simplest model to complex economic modeling techniques. Regardless of their social and political systems, many countries have pursued economic growth through the adoption of different strategies based on theories that are compatible to their economic conditions.

2.2.1 Classical view

Adam Smith, famously known as the father of economics, opposed public borrowing. In his view, borrowings can be unwisely spent since they are such an easy way to acquire additional income and this tends to lead to a degenerating economy. He argued that capital is squandered and the debt burden inherited by the succeeding generations due to disorganization of public expenditures. However, he also defended that borrowing in some cases would be of good use. For instance, in catastrophic events such as wars, but it should be limited and spent wisely.

2.2.2 Keynesian view

The Keynesian theory (1935) states that the microeconomic-level actions if taken collectively by a large proposition of individuals and firms can lead to inefficient aggregate macroeconomic outcomes, where the economy operates below its potential output and growth rate. Keynes model was inspired by the great depression (1929). Economist John Maynard in his book “The general theory of unemployment, interest rates and money” observed that the economy is not always at full employment (it can either be can be below or above its potential).

He further argued that during the Great Depression unemployment was wide spread, many businesses failed and the business was operating at much less than its potential. The solution to the Great Depression was to stimulate the economy (“inducement to investment”) through combination of two approaches: a reduction in interest rate and government investment on infrastructure. In conclusion Keynes model postulates that there is no real burden associated with the public debt and it has no effect on economic growth (Metwally and Tamschke1994).

2.2.3 Barrow –Ricardo equivalent proposition

According to Ricardian equivalent hypothesis was developed by David Ricardo in the early 19^th Century and was elaborated by Professor Robert Barrow. This theory argues that the attempt to stimulate an economy by increasing debt-financed government, spending are doomed to fail because demand remains constant. It further argues that anticipation of future taxes increases, consumers will save money they received in order to pay off the debt. The Ricardian equivalence theorem maintains that government spending to stimulate the economy is effective.

2.2.4 Debt overhang theory

The debt overhang theory clearly shows the magnitude of debt in the economy of a country. Concluding that the situation is large such that the economy cannot hold more debt to finance future projects. According to Reinhart, Reinhart and Rogoff (2012) the existence of a poor economy is due to the accumulated debt burden (debt burden overhang). It was not known that the balance of public debt affects economic growth example Barrow and Salai-Martin (1995) empirically showed that the ratio of government consumption to GDP has a negative impact on per capita GDP.

Krugman (1988) coins the term of “debt overhang” as a situation in which a country’s expected repayment ability on external debt falls below the contractual value of debt. Debt overhang is such that up to a certain threshold foreign debt accumulation can promote investment, while beyond this point the debt overhang will generate negative pressure on investors’ willingness to provide capital. Assuming that a part of government debt is used to finance productive public debt, an increase in debt would have positive effect up to a certain threshold and negative effect beyond the threshold on the country’s economy.

2.2.5 Dual gap analysis theory

The theory was developed by Chenery and Strout (1966) and states that for an undeveloped economy, there are two types of obstacles that is savings and foreign exchange gap. According to these economists, in the light of national income accounting these gaps remain equal in the export sense. The theory explained that development is a function of investment and that such investment which requires domestic savings. If the domestic savings available is less than the level needed to realize the target rate of growth then a savings – investment gap is said to be in existence hence the debt overhang.

The theory further explained that the tendency of the developing countries of borrowing foreign capital to finance the economy in development. Since the debt overhang does not show fine details on the effects of debt growth, the dual gap analysis theory explains the effects in detail, making it better than the debt overhang model.

2.3 Conceptual Framework.

A Conceptual Framework is the researcher’s “map” in pursuing the investigation, Mcgaghie et at (2001) and represents the researcher’s synthesis on how to explain a phenomenon. It maps out the actions required in the course of the study given previous knowledge of other researcher’s points of view and observations on the subject of research.

Thus, the Conceptual Framework identifies the variables required in the research investigation. The variables discussed in this study are with reference to studies conducted by other researchers including publications on the same. In the context of this investigation, there will be one dependent variable and three independent variables as illustrated below.

Independent Variable

Dependent Variable

Control Variables

Figure 2.1: Conceptual Framework

Source: (Authors, 2019)

2.4 Empirical Literature Review

A study by Njoroge (2015) on the effects of domestic public debt on economic growth in Kenya proved that there is a negative relationship between the inflation and unemployment and a negative correlation between debt and growth but debt does not have a causal effect on the economic growth. The domestic borrowing should be discouraged in favor of external debt, Nyachae (2015). Ochieng (2013) assessed the relationship between public debt and economic growth in Kenya using the Harrod Domar growth model. The study indicated that domestic debt in Kenya was reasonably sustainable.

Harmon (2012) highlighted the impact of public debt on inflation, GDP growth and interest rates in Kenya by looking at the impact of public debt on the major economic indicators like inflation, GDP growth and interest rates) in Kenya. The study drew upon secondary data on the mentioned variables by the government of Kenya covering the period 1996-2011. Findings from these studies vary across variables. Some studies show positive relationships, others negative relationships while others show relationships at all.

Using three simple linear regression models, the study finds out that there is a weak positive relationship on the public debt inflation GDP growth link with the public debt GDP growth link being the highest. A negative strong relationship is observed alone the public debt-interest rates link. On a general note, the study concludes that the Public Debt Inflation GDP growth Interest rates link cannot be found in a single analysis. The relationship varies across variables. While other variables show a weak relationship, others portray a strong one. For instance, of the variables compared in this study public debt and interest rates show the strongest relationship.

Njuru (2012) highlighted the effect of fiscal policy on private investment in Kenya using the VAR model and the results showed that fiscal policy design and implementation matters to private investment levels. The research focused on fiscal policy on private investment.

Abbas & Christensen (2010) analyzed optimal domestic debt levels in emerging markets and low income countries (including 40 sub-Saharan Africa countries) between 1975 and 2004 and found that moderate levels of marketable domestic debt as a percentage of GDP have significant positive effects on economic growth. The study provided evidence that debt levels exceeding 35% of total bank deposits have negative impact on economic growth.

Sheikh et al (2010) assessed the impact of domestic debt on the Growth model using OLS technique found that there was an impact on the domestic debt since the debts servicing costs on domestic debt was negative compared to domestic debt on the growth model. Checherita and Rother (2010) looked at the average impact of public debt on per capita GDP established that the government debt on economic growth curve was negative and non-linear.

Kumar and Woo (2010) who studied the impact of high public debt on the long-run economic growth of advanced and emerging economies and adapted the Vector Autoregressive (VAR) Model established that there was an inverse relationship between subsequent growth and initial debt. This means that there was a slow-down in annual real per capita GDP. The impact is however smaller in advanced economies. The variables used in the study were Government size, investment and population size.

Achieng (2010) analyzed the effect on private investment using the Johansen Co integration approach and found that the variables are significant at 5%. The research focused on domestic debt variable on private investment.

Kibui (2009) studied the impact of external debt on public investment and economic growth in Kenya Augmented growth model. This study empirically showed that the key debt indicators surpassed the critical level since the year 1982. Results indicated that the debt service ratio is significant in explaining the GDP growth in Kenya from 1970 to 2007.

Makau (2008) did an empirical analysis on the external debt servicing and economic growth in Kenya. The study used a single growth equation model estimated using OLS method with annual time series data covering the period 1970-2003. The study showed that Kenya’s external debt accumulation has been rising over the years with debt burden indicators increasing steadily in the early 1990s. The model estimated that in the long-run, the coefficients of debt to GDP, debt service to GDP and savings to GDP were significant while growth in labour force and interest to GDP coefficients were insignificant.

Maana et al (2008) investigated the impact of domestic debt on Kenya’s economy using the OLS method and modified Barrow Growth regression model. This study showed that although the relationship between domestic debt and economic growth is positive, it is insignificant. The study failed to incorporate the foreign debt variable.

M’Amanja and Morrisey (2003) determined the consequences of fiscal policy on economic growth in Kenya. This study was centered on the impact of government national expenditure on economic growth in Kenya. The findings confirmed that borrowings have a negative impact on the long-run growth of the economy.

Were M. (2001) used regression and granger causality models to identify the relationship between Kenya’s external debt, debt service, economic growth and investment and external debt accumulation. She found that those variables have a negative effect on economic growth and private investment in Kenya thereby confirming the existence of debt overhang during that period.

2.5 Summary of Literature Reviewed

From the Empirical studies discussed above, Maana et al (2008) failed to incorporate the foreign debt variable. Ochieng (2013) used different variables from this study; external debt, treasury bills and bonds, government stock, advances from commercial banks and overdrafts by CBK. He failed to include inflation and real interest rates.

The study by Achieng (2010) focused on the domestic debt variable on private investment rather than focusing on public debt as a whole on economic growth in Kenya. On the other hand, the study by Kibui (2009) focused on external debt variable on public investment, thereby ignoring domestic debt.

Empirical studies such as M’Amanja and Morrissey (2013), Sheikh et al (2010) Kibui (2009), Checherita and Rother (2010) show mixed inferences on the effects of the public debt burden on economic government consumption to GDP has a negative on per capita GDP. Therefore the results were inconclusive. Our study will focus on domestic debt and external debt as well as incorporate real interest rates and inflation.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

In this chapter, the methodology adapted in this study is set out. The chapter is organized as follows: theoretical framework, empirical model, data collection and analysis and diagnostic tests.

3.2 Research Design.

A research design can be defined as the framework for answering research questions; the framework of methods and techniques chosen by a researcher in a logical manner to enable efficient handling of the research problem.  It is also the set of methods and procedures used in collecting and analyzing measures of the variables specified in the problem research.

3.3 Theoretical Framework

This study majors on the Endogenous Growth Model which is an economic theory that emerged in the 1980s as an alternative to the Neoclassical Growth theory. It argues that economic growth is primarily the result of internal processes rather than external ones challenging the views if neoclassical economists. It postulated that a persistent rate of prosperity is significantly influenced by labour and capital rather than external uncontrollable forces (Liberto, 2019).

This study borrowed the initial model from Akram (2010), therefore a Cobb-Douglas function was assumed:

Y=AK^αL^1-α

Where, Y: Real GDP                                                  A: Constant

K: Capital                                                       L: Labour

This production function shows that economic growth (real GDP) is a function of capital and labour. Cunninghum (1993) incorporated debt into the production function as per Akram’s (2010) model. This is because debt acts as a complement to capital in that it leads to an increase in capital. It can be incorporated in various development projects that can lead to capital increase in the long run. For instance, improvement of infrastructure e.g. trains like SGR and roads.

Therefore, this means that since debt complements capital, it consequently affects GDP. Hence GDP becomes a function of debt. This means that:

Y=AK^αL^1-α + Debt

Since debt and capital are correlated and capital directly affects labour, we assume them to have a similar effect. Therefore, in this study we will assume GDP to be a function of external debt and domestic debt. Various authors; Ochieng (2013), Ngugi (2016), based their studies on the Harrod-Domar model. They considered economic growth to be a function of various variables. Ochieng considered treasury bonds and bills, government stock to mention a few. However, in this study we will consider economic growth as a function of real interest rate, inflation rate, domestic debt and external debt. We will use a stochastic model that incorporates the error term (Ս) to take care of the variables that could be affecting economic growth but are not included in the model.

3.4 EMPIRICAL MODEL

Following Hassan and Mamman (2013), a linear relationship is assumed. A multiple regression model was used in this study.

The model is specified as follows:

Y=₀+₁X ₁+₂X ₂+₃X ₃+₄X₄+₅X₅+₆ X₆+µ

Where:

Y – Represents the economic growth of Kenya measured using real GDP.

X₁ – Represents domestic debt measured using treasury bills and bonds

X₂ – Represents external debt.

The control variables used in this study are:

X₃– Represents interest rates.

X₄ – Represents inflation rate.

X₅ – Represents Foreign Debt Investment.

X₆ – Represents wages and salaried workers.

µ – Represents the error term.

3.5 Data Collection and Analysis.

Secondary data was used in this study. This data was obtained from the following credible sources: Data on economic growth – KNBS; Data on domestic debt – National Treasury publications; Data on external debt – IMF and Institute of Economic Affairs Kenya and WB. The study period is from 1999-2018. This period is convenient because it covers the effect of the political climate through the years and also provides a wide range of comparable data.

Data analysis involves examining what has been collected in the research and drawing deductions. Data analysis was guided by the study objectives. The data collected was analysed by use of STATA. Time series regression model was used in this study to assess the effects of the explanatory variables or the explained variable.

3.6 Diagnostic Tests.

To test the distribution of the variables, normality tests will be applied in order to minimize data bias. Our study will employ Ordinary Least Square Model (OLS) to estimate the empirical model above. A classical linear regression model (CLRM) will be used based on the existing theories where GDP was functionally explained by the explanatory variables. In order to prove the cause-effect relationship autocorrelation tests are then applied to test for errors in the data collection.

Heteroscedasticity

OLS assumes that variance is constant and the error term does not vary with changes in magnitude of the explanatory variable. The variation of this assumption is heteroscedasticity. To test for this, we will apply the Breusch-Pagan Test which was developed in 1979 by Trevor Breusch and Adrian Pagan. It tests for the relationship between explanatory variables and the error term in a linear manner.

Multicolinearity

OLS assumes that there is no correlation between explanatory variables and a violation of this assumption is multicolinearity. To test for this, we will employ Variance Inflating Factor (VIF).

Autocorrelation

Autocorrelation refers to a situation where the current error term is related to the preceding error term, a common problem in time series. To test for this, we apply the Breusch-Godfrey Test named after Trevor Breusch and Leslie Godfrey.

Stationarity Test

Stationarity time series is a stochastic process where mean is zero and variance is δ² implying that the error term is white noise. However, a time series where any of the above is violated is known as non-stationarity time-series. Tests for stationarity are known as unit root tests since we are interested in checking whether ϱ=1. These tests include Dickey Fuller and Augmented Dickey Fuller.

CHAPTER FOUR

DATA ANALYSIS AND INTERPRETATION

4.1 Introduction

The aim of this chapter is to discuss the major findings analyzed using secondary data obtained from the World Bank Database. The study covered a period of 20 years (from 1999-2018).  This chapter includes descriptive statistics, diagnostic tests, regression analysis and discussion and findings. This was done in order to achieve the study objective which is to assess the impact of public debt burden on economic growth in Kenya.

4.2 Descriptive Statistics

Table 4.2 Source: Own Computation

From the table above, the GDP (%) in Kenya has a mean of 4.240617 with a standard deviation of 2.437785, a minimum value of 0 and a maximum value of 8.405699 over a period of 20 years. The real interest rate (% of GDP) in Kenya has a mean of 7.58273 with a standard deviation of 6.645905, a minimum value of -8.009867 and a maximum value of 17.8125 over a period of 20 years. The inflation rate (%) in Kenya has a mean of 8.785167 with a standard deviation of 5.471765, a minimum value of 0 and a maximum value of 26.23982 over a period of 20 years. The external debt (% of GDP) in Kenya has a mean of 45.62045 with a standard deviation of 7.000895, a minimum value of 0 and a maximum value of 34.423 over a period of 20 years. The domestic debt (% of GDP) in Kenya has a mean of 36.93289 with a standard deviation of 9.562123, a minimum value of 0 and a maximum value of 45.21236 over a period of 20 years. The FDI (%) in Kenya has a mean of 0.8954755 with a standard deviation of 0.9802873, a minimum value of 0 and a maximum value of 3.457345 over a period of 20 years. The wages (%) for Kenya has a mean of 35.66835 with a standard deviation of 1.626755, a minimum value of 33.234 and a maximum value of 38.163 over a period of 20 years.

The results show that for the period between 1999 and 2018 Kenya’s average borrowing rate has been very high while at the same time average growth rate has been very minimal. The data shows that domestic debt to GDP ratio has the largest spread as compared to the other variables.

4.3 Diagnostic Tests

4.3.1 Correlation Analysis

Table 4.3.1 Source: Own Computation

The Above table represents the correlation matrix. Our analysis focused on establishing the relationship between GDP, Real r, Inflation, External Debt, Domestic Debt, FDI and Wages. From the above results, we realized that our variables are weakly or fairly/moderately correlated. That is, GDP has a weak positive correlation with FDI, Wages and Domestic Debt and a weak negative correlation with inflation and interest rates and a moderate correlation with external debt. External debt and domestic debt also have weak or fair correlation with the other independent variables.

4.3.2 Heteroscedasticity Test

Table 4.3.2 Source: Own Computation

The results from the test above has a probability of 0.5238 which is more than 0.05 level of significance signifying presence of heteroscedacity. To remedy this problem we used HAC standard errors.

4.3.3 Autocorrelation

Table 4.3.3 Source: Own Computation

We used Breusch-Godfrey LM test and the test showed that there is no relationship between the current error term and the preceeding error terms.

4.3.4 Stationarity Test

Table 4.3.4 Source: Own Computation

After conducting the Dickey Fuller Unit Root test, we found that all our variables to be stationary at lag (0) without differencing.

4.4 Regression Results

Table 4.4 Source: Own Computation

The above table shows the OLS Regression results. The F-statistic is 0.0090 which is less than 0.05 level of significance; this implies that the independent variables are jointly significant.

The R² is 0.6868 or 68.68% which implies that 68.68% variation in GDP is explained by our independent variables. The regression results further showed that external debt, domestic debt and inflation are statistically significant in influencing economic growth in Kenya. This is shown by their coefficients: -0.16873, 0.1820138 and -0.3317225 respectively and this implies that a unit decrease in external debt and inflation rate would increase GDP by 16.873% and 33.17225% respectively while a unit increase in domestic debt would increase GDP by 18.20138%.

According to our results, domestic debt has a positive effect on economic growth in Kenya while external debt and inflation rate have a negative effect on economic growth in Kenya.

Summary

The results from Table 4.3 show that capital formation (FDI) has a positive relationship with GDP in Kenya and this conforms with various economic growth theories, for example, the Endogenous Growth Model that postulated that a persistent rate of prosperity is significantly influenced by labour and capital rather than external uncontrollable forces (Liberto, 2019). This is seen through increased infrastructural development due to increased FDIs.

On the contrary, external debt is seen to have a negative impact on economic growth as compared to domestic debt which seems to have positive impact on economic growth in Kenya. This implies that increased external debt would decrease economic growth because of factors such as debt servicing and interest payments. With domestic debt, an increase would lead to an increase in economic growth.

Contrary to our expectations, wages and inflation have a negative impact of economic growth in Kenya.

CHAPTER FIVE

SUMMARY AND CONCLUSIONS

5.1 Introduction

This chapter is a summary of findings, conclusions and policy recommendations.

5.2 Summary of Findings

The aim of this study was to determine the impact of public debt burden on economic growth in Kenya over a period of 20 years from 1999-2018 using annual time series data obtained from World Bank Database. Our study adapts the Cobb-Douglas growth model to capture the additional variables of capital formation and labour participation.

Empirical results demonstrate that the relationship between external debt and economic growth in Kenya as being negative. That is, as external debt increases economic growth declines. Our results further show that increased levels of public debt would lead to negative economic growth.

In addition, interest rates have an inverse relationship with economic growth.

However, our results established that domestic debt, capital formation (FDI) and labour participation (wages) have a positive relationship with economic growth in Kenya.

5.3 Conclusions

With a view to determine the impact of public debt burden on economic growth in Kenya, this study was conducted between 1999 and 2018. A time series regression model was employed and the results showed that capital formation and domestic debt have a positive impact on economic growth and Kenya should venture into good policies to accelerate capital formation and domestic debt. The results further showed that the coefficients of external debt and interest rates are negative and significant; an increase in any of these variables would deteriorate the economy further, therefore having a negative overall impact on economic growth in Kenya.

The negative effect of external debt felt in the Kenyan economy is as a result of fungibility of money. That is, funds borrowed by the government are not efficiently allocated. Therefore, there is need for the government to properly manage its funds in order to improve economic growth.

5.4 Policy Recommendation

Following the results of our data analysis we can suggest several policy recommendations; Policy makers ought to maximize more on projects that bring in more capital to boost economic growth in the country.  Our study further suggests that they should create policies that will help regulate budget deficits in Kenya thereby reducing the need to borrow. They should also be mindful of raising the public debt levels. Legislators should generate policies that will control the rate of public borrowing in order to further improve the economy.

Also, the government should undertake policies that are focused on reducing the external debt stock in order to reduce the negative impact on economic growth in Kenya. Moreover, it should focus on the efficient allocation of its funds and proper management of its expenditure.

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Appendix 1