Determinants of Inward Foreign Direct Investment Stock in Kenya

Abstract

Kenya’s foreign direct investment overtime has been waning despite investment policies and frameworks to attract it. This study analyses the FDI dynamics in Kenya for 1970- 2018 period using annual data. Unlike existing studies in the Kenyan context, this study adopts the Markov switching regression. The use of this approach unlike other approaches allows the constants and the conditioning variables to shift. Several findings emerge. First, inward FDI stock over 1970-2018 period exhibited two regimes; high and low state FDI episodes with the low FDI episodes being dominant and more persistent. Second, the estimation show that FDI is positively correlated with lagged FDI, fiscal imbalances, education, natural resource rents in regime 1, a regime of low FDI flows and negatively correlated with institutional quality, market size, fixed capital formation, infrastructure, inflation, financial development and higher interest rate differentials and exchange rates in the same regime. In regime 2, a regime of high FDI flows, lagged FDI, fiscal imbalances, market size, education, natural resources rent, domestic investment and exchange rates positively relate to inward FDI flows while being negatively affected by financial development and higher interest rate differentials. These findings provide several policy implications. First, there is need to ensure a stable political and economic environment while also ensuring that the overall legal framework is supportive of a conducive environment for attracting FDI flows. Second, is the need for the government to strike a balance between the benefits that accrue from a weaker shilling that attracts FDI and the costs that it widens the country’s debt obligations. Third, and more importantly is the need to ensure a well-established legal framework that would enhance the enforce ability of contracts and improving the observance of law and order as the results show that the current levels of institutional quality remains low and thus acting against attracting more FDI inflow. Lastly, there is need to be keen in improving the labor force quality while keeping the economy’s comparative advantage in quality labor as neighboring countries also compete with Kenya to attract foreign investors