The Effect of Public Debt on Economic Growth in Kenya

Abstract

Using annual data from 1980 to 2019, this study examined the impact of public debt on Kenya's economic growth. Financing Gap theory served as a guide for the investigation. An explanatory research design was adopted in this study. The analysis of the long-run and short-run effects used a customized version of the Vector Error Correction Model (VECM) Model. The R-square value from the VECM model was 58.62, and the Chi-square was 26.913 (p > Chi2 = 0.0494), indicating that the VECM was suitable for parameter estimation. While external debt revealed a coefficient of 0.0003 with a p-value of 0.001 had a significant positive impact on economic growth, domestic debt reported a coefficient of -0.266 with a p-value of 0.019, supporting the debt overhang effect. If the marginal output of an available external debt is greater than or equal to the principal and interest payment, the study found that external debt had a positive impact on the economy of the borrowing country. On the other hand, domestic debt has a significant negative impact on economic growth. The government will be able to develop sound fiscal and monetary policies with the aid of the study's findings. The study demonstrates that increasing domestic debt levels in Kenya during the study period negatively and significantly impacted economic growth. As a result, this study suggests that the Kenyan government reduce domestic borrowing to avoid the crowding out effect, which has a detrimental long-term impact on economic growth. The government should use the borrowed domestic money to diversify the economy's productive base. This will boost long-term economic growth, widen the base of taxation, and increase the country's ability to pay off its obligations when they are due.

The Effect of National Public Debt on Economic Growth in Kenya

“…These results agree with that of Maghyereh et al (2005) whose findings indicate externally sourced funds in Jordan has a positive effect on its economy. Also, a research work carried out in Kenyan context by Gicheru and Nasieku (2016) and Wanjuki (2016) indicate that externally borrowed finances exert a significant positive effect on its economic expansion. However, these results contradict findings of various researchers who found borrowing from other nations had adverse effects on the economic growth in nations where research was conducted.…”

“…Kenya's growth1economically would slow down because the country's economy could lose its attractiveness among potential investors. There's also the risk that the loans repayments could exhaust a significant part of Kenya's public financial resources making it harder for the country to get back to growth (Gicheru & Nasieku, 2016;Wanjuki, 2016). As suggested by Lee and Ng (2015) as well as by Saifuddin (2016), even with governments' institution of structural adjustment programs high public debts' adverse effects would still be experienced by many via a country's deteriorating economic1 outlook.…”

“…This aligned with suggestions made in the 2010 Medium-Term Debt Management Strategy (MTMDS) which advocated for increasing the component of funds borrowed internally in the country's debt portfolio. The logic behind being minimization of being exposed to foreign exchange rate risks that come with borrowings made externally through increasing the maturing duration/term of funds borrowed locally while supporting greater growth of the local financial sector and markets (Wanjuki, 2016).…”

“…Its main aim being to make sure that the country meets its financing requirements and repayment conditions cost-effectively in the intermediate and long-run intervals while maintaining reasonable levels of risks. The debt policy's subsidiary aims being to further develop the local financial sector and markets while ensuring that the burden and gain of the country's debts is equitably shared by generations of today and later (Wanjuki, 2016).…”

“…Whereas the acquired debt funds are hoped to help improve Kenya's economic growth through infrastructure development, there is growing concern that the high level of public debt in Kenya may occasion a debt crisis injuring Kenya's prosperity prospects economically and financially (Ngugi, 2019). There is growing concern that the national public debt has reached critical levels and questions over Kenya's ability to meet its repayment obligations are beginning to gather momentum (Wanjuki, 2016). In addition, there are concerns that high public debt risks lowering the country's spending on capital projects and social programs1as larger parts of government's revenues go to debt1repayment (Ombuya, 2017).…”