Impact of interest rate liberalization on sectoral growth in Kenya- A panel study

Abstract

This study empirically analyzes the impact of interest rate liberalization on economic growth in Kenya through its influence on sectoral performance and it also identifies policies that must accompany interest rate liberalization so to stimulate sectoral economic performance in Kenya. Its objective is to examine the impact of interest rate liberalization on GDP contribution per sector to the Kenyan economy. It is based on McKinnon-Shaw argument that financial deregulation (higher real interest rates) encourages savings and investment and predicts that under the presence of complementary policies, interest rate liberalization leads to growth. In an attempt to empirically examine the linkage between interest rate and growth, the study employed a panel data analysis over the major sectors of the Kenyan economy which gives it a unique approach from other studies that have generally employed time series in showing the positive role of interest rate liberalization on economic growth. In this study, the Fixed Effects Panel Data Model was adopted as there was an assumption that there are different intercepts for each cross-sectional group. The study analyzed a sample of 12 listed sectors using panel data for a period of 25 years (1982-2006). Policy variables associated to interest rate liberalization that stimulate sectoral growth were included as explanatory variables. The results show that among the complimentary policies to interest rate liberalization, investment in physical capital has a greater positive impact on sectoral growth. Generally, the findings support the fact that financial deregulation (higher real interest rates) encourages savings and investment and predicts that under the presence of complementary policies, interest rate liberalization leads to growth.