The Impact Of External Debt Service On Foreign Direct Investment Inflows In Kenya (1980-2014)

Abstract

Foreign direct investment has significant contribution to a host country’s fixed capital formation. The outcomes of FDI inflows are very important to developing countries than the developed countries due to the fact that the former are characterized by inadequate capital. In addition these countries have limited access to modern technology among other deprivations. FDI inflows are therefore important in bridging these shortfalls and also benefit foreign investors. In Kenya, fixed capital formation stands at 21 % of GDP of which 7% is contributed by FDI. According to economic theory, external debt service is a key determinant of FDI inflows. The theory stipulates that an increase external debt service leads to increased taxes that discourage foreign direct investors since they are not guaranteed of good returns to their investments. Kenya’s public debt stands at 53 percent of GDP of which about 26 percent is external debt. The country’s budget deficit to GDP has also increased from 8 percent during the 2015/2016 financial year to about 9 percent in 2016/2017 financial year an indication that debt service is likely to increase. In Kenya, a few studies have explored external debt service but in different approaches. This study therefore sought to bridge the gap by investigating the effect of external debt service on foreign direct investment inflows for the period between 1980 and 2014. The study used OLS method in estimating long-run cointegrating equation. The study carried out pre-estimation tests so as to validate the results. Among the pre-estimation tests carried out are autocorrelation, heteroscedasticity, multicollinearity and normality test. Stationarity of the variables was further investigated using Augmented Dickey Fuller test. The estimated results revealed overall significance of the explanatory variables in explaining FDI inflows with a coefficient of determination showed that 90.71 percent. The findings further revealed that lag one of exchange rate to be positive and individually significant at 10 percent level of significance in influencing FDI inflows in the short run. Lag one of GDP was also revealed to be positive and individually significant at 10 percent level of significance in influencing FDI inflows in the short run. Further, Lag two of GDP was also revealed to be positive and individually significant at 5 percent level of significance in influencing FDI inflows in the short run. The study findings suggested that external debt service is insignificant in determining foreign direct inflows in Kenya. Based on the study findings, the study recommends an improvement in country’s GDP due to its positive effect on FDI inflows. To achieve higher GDP levels, the study recommends investment in more growth enhancing activities for instance, infrastructure, education, healthcare, technology and also ensures political stability. The findings do not reveal significant relationship between external debt service and FDI inflows therefore the study recommends identification of other factors that may influence FDI inflows for instance the ease of doing business and strong property rights in Kenya.