Effect of Financing Options on Economic Development in Kenya

Abstract

Financing options play a crucial role in a country's economic development by providing essential capital for public and private investments. While previous research has examined individual financial instruments such as taxation, internal borrowing, and external debt, the combined effects of these financing options on economic development remain underexplored. This study investigated the effect of various financing options on economic development in Kenya, specifically focusing on donor funding, concessional loans, commercial lending, taxation, and the control variable of foreign exchange rates. The analysis was underpinned by Modernization Theory, Power Relations Theory, Institutional Theory, and Wagner’s Theory to explain the variables involved. A descriptive correlation design was adopted, targeting the Kenyan economy, with financial data collected from December 1978 to December 2023. Various diagnostic tests were conducted, including those for model specification, autocorrelation, stationarity, variability, convergence, and normality. Linear regression analysis was utilized to interpret the data, referencing the foundational works of Granger (1987) and Johansen (1988). The vector autoregression (VAR) econometric model was employed to capture the relationships and dependencies among multiple time series, effectively extending univariate autoregressive (AR) models into a multivariate context. EViews 12 Version Lite was selected as the data analysis tool due to its robust capabilities. The model demonstrated a high R-squared value of 0.9919, with an adjusted R-squared of 0.9909, indicating that 99% of the variations in gross national product (GNP) were explained by the examined variables, thereby showcasing the model's explanatory power. The F-statistic (956.90, p = 0.0000) further confirmed the model's fit, suggesting it effectively captured the impact of financing options on economic development. The study revealed a strong positive correlation between donor resources and economic development in Kenya, indicating that these resources significantly contributed to growth by facilitating essential development projects and infrastructural improvements. Among the financing options, commercial lending exhibited an even stronger positive correlation with GNP than concessional loans, highlighting its critical role in driving economic development through infrastructure financing and business expansion. Taxation emerged as the most significant financing option, demonstrating the strongest positive correlation with GNP and underscoring its fundamental importance to Kenya’s economic health. The study recommended measures to enhance access to donor funding to stimulate economic development, including evaluating credit terms and conditions to achieve desired goals. The government should facilitate easier access to commercial credit services through the development of technology-based platforms, such as mobile apps for credit borrowing, and by digitizing government securities to enhance liquidity. Additionally, creating a securitization platform would benefit small investors who may struggle to meet the minimum investment requirements for government securities.