Effect of Exchange Rate Movements on Foreign Direct Investment in Kenya

Abstract

Foreign direct investment plays a critical role towards economic growth and development especially in capital deficient countries like Kenya. It necessitates capital inflows which comes with spillover effects such as technology transfer, human capital specialization, expansion of international trade, job creation for the locals and an enhanced business environment. Despite all these benefits, it has remained unclear on how movements in the exchange rate affects foreign direct investment due to conflicting findings in the earlier studies and limited literature for the Kenyan case. It was based on these glaring gaps that this study sought to determine the effect of Kenya’s exchange rate movements on the foreign direct investment. The study used secondary time series data for 47 years (1970-2016). This data was collected from World Development Indicators, Kenya National Bureau of Statistics, Economic Surveys, Statistical Abstracts, United Nations Conference on Trade and Development and Central bank of Kenya database. The study employed Ordinary Least squares regression with robust standard errors to address the challenge of heteroscedasticity. In addition, multicollinearity test was conducted on the estimates to ensure that the results did not suffer from endogeneity problem. The study generated both descriptive and correlation statistics. Regression statistics revealed that real effective exchange rate was negatively related to foreign direct investment. However, this was not significant. Additionally, gross domestic product was significant and positively associated with the foreign direct investment. Even though inflation was negatively related to foreign direct investment, its coefficient was not significant. The study recommended that appropriate mechanisms should be put in place by the Kenyan government to ensure stability in the exchange rate. It was also recommended that the country should effectively manage its fiscal and monetary policies to ensure a steady economic growth. A further study on the effect of real exchange rate on foreign direct investment was suggested to find out why this relationship was not significant.