Effect of Interest Rates on Foreign Direct Investment Inflows in Kenya

Abstract

Interest rates are critical determinants of foreign direct investment. Traditionally, an investor will go for credit sources of low cost or lower interest rates and invest it in an economy which promises higher returns. The economic theory which expounds on how capital moves a worldwide economy insist on the fact that capital tends to flow to states which have a return on investment that is higher as compared to countries with low interest rates. Consequently, there is high investment in states which offer better investment returns and security in the form of lower interest rates as well as a better business environment. The study aims at determining the impact of interest rates on foreign direct investments inflows in Kenya. The independent variable was interest rates as measured by quarterly CBK lending rate. The control variables were economic growth as measured by quarterly GDP, external debts as measured by quarterly external debt in natural logarithm form and balance of payment as measured by quarterly difference between exports and imports in natural logarithm form. FDI inflows in Kenya were the dependent variable which the study sought to explain and it was measured by FDI inflows in the country on a quarterly basis. Collection of secondary data was done for a period of 10 years (January 2008 to December 2017) on a quarterly basis. This study used a descriptive research design. A multiple linear regression model was employed for analyzing the association between the variables. SPSS version 21 was employed for data analysis purposes. The results of the study produced R-square value of 0.700 whose implication is that about 70 percent of the variation in FDI inflows in Kenya can be explained by the four selected independent variables while 30 percent in the variation was associated with other factors not covered in this research. The study also found that the independent variables were strongly correlated with FDI inflows (R=0.837). ANOVA results show that the F statistic was significant at 5% level with a p-value less than 0.005. Therefore the model was fit to explain FDI inflows in Kenya. The results further revealed that individually, interest rates have a significant negative effect on foreign direct investment inflows while external debt as well as balance of payment have a significant positive impact on foreign direct investment inflows in Kenya. Economic growth was found to be an insignificant determiner of FDI inflows. This study recommends that there is need for policy makers to regulate the interest rates prevailing in the country bearing in mind that they influence FDI inflows in the country.