Impact of foreign aid on domestic savings in Kenya

Abstract

Earlier papers written on the subject of the effect of foreign aid on domestic savings disagreed on whether this effect is positive or negative. However they were empirically consistent in finding this correlation to be negative. Theoretically, foreign aid is assumed to be additive to domestic savings, therefore causing an increase in economic growth and hence domestic savings (Chenery & Strout, 1966).This study sought to establish the impact of foreign aid on domestic savings in Kenya. The empirical results established an inverse relationship. There is a negative and significant relationship between foreign aid and domestic savings. Under Vision 2030, oversees development assistance (ODA) has been identified as one of the ways of alleviating the low savings to GDP ratio constraint .For foreign assistance to be more effective in playing this role, there are areas particularly the frequency and the continuity of the inflow of aid, project and programme combination and the terms on which aid is granted, which could be improved upon so as to make the aid flow more effective. Issues of fungibility and the impact of foreign aid on private sector investment warrant further investigation in Kenya. The period under study are periods of decadence when foreign aid become the main source of development finance, in which case its effectiveness could have been drowned by the many demands. This period also witnessed two major donor-aid freezes. This aid uncertainty may have had adverse effect on government expenditure causing a reduction in public investment which may have led to lower private investment and ultimately lower economic growth and domestic savings. The study has also established that growth in GDP and inflation are significant factors. influencing domestic savings in Kenya: -Exports are not ambiguous in explaining . domestic savings in Kenya. This would simply add to the calls for diversification of exports to include manufactures.