The Effect of Inflation Rate on Liquidity of Manufacturing Firms Listed in Nairobi Securities Exchange

Abstract

The paper was commissioned to find out the effect of inflation rate on the CCC of listed Manufacturing firms at the NSE for a period of five years between 2010 -2014.A two tail non-directional hypothesis test of statistical significance at 95% confidence interval shows that the model is statistically significant and persistent in explaining the variation of CCC. The Pearson correlation shows a negative relationship among the variables with the size of the company, inflation rate and interest rate accounting for 7.34%, 0.22% and 0.068% of the variation in the CCC respectively. The log-log random effects regression model established a negative statistically significant relationship between size and CCC,a negative statistically insignificant relationship between CCC and inflation, a positive statistically significant relationship with CCC and a positive constant which is statistically different from zero. The significance of the constant is consistent with prudent working capital management practices which require that manufacturing firms maintain an optimal level of liquidity that is necessary for honoring maturing obligations. The explanatory variables were tested for statistical significance using the P-test, at 95% confidence level. The results demonstrated that a 1% increase in the size of the firm leads to a decrease of CCC by 21.5%, 1% increase in inflation decreases the CCC by 24.5% indicating that inflation and CCC has a negative relationship, however an increase in interest rate leads to an increase in CCC by 8%, as interest rates increase the opportunity cost of money increases and traders get motivated to shift to credit transactions. The results also shows that every company need to finance 8 days of the CCC, this is the autonomous CCC that is independent of any event.