The impact of external debt on private investment in Kenya: empirical investigation for the period 1970-2002

Abstract

A group of the low-income countries classified as Highly Indebted Poor Countries (HIPC) have continued to experience difficulties in managing and servicing their huge stocks of external debt and this has constrained private investment hence growth. Most of these countries including Kenya are in Sub-Saharan Africa (SSA). The relatively high level of Kenya's external indebtedness and rising debt burden has serious implications on the country's development and debt sustainability initiatives. This paper, using time-series data for the period 1970-2002, explores empirically the impact of external debt on private investment in Kenya. The empirical result/ndicate that external debt stimulates private investment while debt overhang effect works against private investment. However the debt overhang effects are not statistically significant, and this can be supported by the fact that Kenya is still considered as a moderately externally indebted hence does not qualify for HIPC debt relief Initiatives. Debt servicing appears to have a strong negative relationship with private investment as a ratio of GDP, implying that the debt service obligations crowd-out private investment in Kenya. Other policy and fundamental variables were also included in the model, among them; terms of trade, public investment, lagged private investment and percapita GDP growth rate were found to have an effect on private investment. Several policy implications emerged from the study and particularly the need to diversify the export base as well as discovering new markets and new products to help earn foreign exchange to reduce debt service ratio.