Effects Of Capital Flows On Economic Growth In Kenya

Abstract

There has been a phenomenon of increased capital flows into African countries including Kenya over the last few years. The role of capital inflows on economic growth has been controversial. There has been considerable debate in the academic literature as to whether capital flows promote economic Growth (World Bank report – 2001). This study investigated the immediate and lagged effects of the various forms of capital flows - FDI flows, portfolio flows and “Other investments capital flows” (which mainly represents corporate, financial institutions and general government borrowings as well as remittances from the diaspora) - on economic growth in Kenya over a 30-year period from 1984 to 2014 using Auto Regressive Distributed Lag Model (ARDLM). The findings indicated that FDI and portfolio investments flows have a negative impact on the GDP growth rate and that their impact is not statistically significant. However, other investments flows, which mainly represents corporate, financial institutions and general government borrowings as well as remittances from the diaspora, have a positive impact on GDP growth rate and the impact is statistically significant. Based on the study findings, it can be inferred that a significant slowdown or a reversal in capital flows in form of “Other investments capital flows” into Kenya could result in significant slowdown in economic growth in the country. Policy makers may therefore lay much emphasis on attracting portfolio investment flows and “Other investments capital flows”, while investors and firms should consider the upside opportunities that may be created by increase in other investments capital flows and the downside risks that could results from a significant slowdown or a reversal in these forms of capital flows into the country. Further study may need to be done in order to establish whether it is the various forms of capital inflows that promote economic growth or it is economic growth that attracts these forms of capital inflows in Kenya. Even when growth and capital flows are positively correlated, possibility exists that economic growth attract capital flows and the resulting capital flows enhances growth further meaning these variables have mutually reinforcing relationship.