Effect Of Sectoral Allocation Of Commercial Banks’ Credit On Economic Growth In Kenya

Abstract

The Kenyan economic growth trend has been erratic over the past decades and has mostly been under 6% with negative growth rate of 0.8% recorded in 1992. On the other hand, private sector credit has been on a rising trend over the same period accounting for over 80% of total credit. The association between bank lending and economic growth remains unresolved due to conflicting study results; demand following, supply leading or neutrality hypotheses. There is also paucity of existing literature analyzing the impact on growth of a nation’s economy by commercial banks’ lending to private sector at sectoral level. The study explored the impact of sectoral credit to the building and construction, agriculture, manufacturing, trade and transport, storage and communication sectors on growth of the economy by employing the ARDL bound approach to identify and establish the relationship. Inflation, trade openness and skilled labor variables were adopted as the control variables in the study. The study utilized data that is time series ranging between 1970 and 2017 and analyzed the same using Stata 14. Diagnostic tests were conducted through Philips-Perron test, ARDL Bound test for cointegration, Jarque Bera test, Multicollinearity VIF test, Breusch-Godfrey test, Breusch- Pagan/Cook-Weisberg test and RESET test to ascertain that the CLRM conditions were not breached. This study established that lending to the agricultural sector had a positive and significant impact on economic growth while credit to the manufacturing sector had a negative and significant long run impact on economic growth. However, lending to the trade and building and construction sectors was observed to have a positive and negative insignificant impact on economic growth respectively. Among all sectors, only commercial banks’ lending to the building construction sector was found to have a significant positive impact on economic growth in the short run. The study made recommendations centered on the findings; regulation and maintenance of the interest rates at affordable levels so as to enhance lending to the private sector. Inflation should also be monitored and controlled as it impacts negatively on economic growth. The government should protect domestic industries from illicit markets and production of counterfeit, provide infrastructure, create a conducive operating environment as well as provide funding to agriculture sector. The government should promote policies to increase exports of local products and minimize imports so as to enhance trade openness and maintain a favourable balance of payments. Policies to promote local trade should also be implemented.