Effect of External Debt on Exchange Rates in Kenya

Abstract

The external debt in Kenya has been on the rise for more than a decade now. Between 2013 and 2021, the average Kenyan external debt for example increased by half, that is, from 18.8 to 35.3 percent of the total GDP, positioning Kenya as one of the global rapidly-growing debt-accumulation states. At the same time, the value of the Kenyan shilling decreased by 45.6 percent. These demonstrate that, against expectations, macroeconomic stability has not been attained despite the role that external debt is supposed to play. The objective of this research was to determine the effect of external debt on Kenya’s exchange rates. The study was anchored on debt overhang theory and supported by Keynesian theory and Ricardian equivalence theory. The independent variable was external debt operationalized using the natural logarithm of quarterly external debt while the control variables were; interest rate, inflation and trade openness. The dependent variable that the research attempted to explain was the exchange rates in Kenya. The data was collected on a quarterly basis over a period of twenty years (from January 2002 to December 2021). A descriptive research approach was employed in the research, with a multivariate regression model used to examine the connection between the study variables. The study's findings yielded an R-square value of 0.906, indicating that the chosen independent variables could explain 90.6 percent of the variance in Kenya’s exchange rates, while the other 9.4 percent was due to other factors not investigated in this study. The F statistic was significant at a 5% level with a p=0.000. This suggests that the model was adequate for explaining exchange rates in Kenya. Further, the findings demonstrated that external debt and interest rate had a positive and significant influence on Kenya’s exchange rates while inflation and trade openness did not have a significant effect. The study recommends the need for practitioners and policy makers to ensure to monitor the prevailing levels of external debt as this has a significant effect on exchange rates. The policy makers should also develop policies aimed at stabilizing interest rates as they have a direct effect on the prevailing levels of exchange rates. Future studies can focus on other determinants of exchange rates in Kenya such as money supply, foreign direct investments among others. Future studies can also focus on a longer study period to confirm the findings.