Domestic savings and foreign capital inflows:a case for kenya.

Abstract

The main objective of this research paper is to analyze empirically the impact of foreign capital inflow on domestic savings. This is necessitated by lack of detailed study on the effect of foreign capital inflow on domestic savings. Past studies have treated foreign capital inflows as one homogeneous element, but in this study, foreign capital inflow is disaggregated into net long run private and public foreign capital inflows. The methodology used by past studies has only enabled them to capture direct effects of foreign capital inflows on domestic savings.This is because they used ordinary least squares as the estimation method. The present study uses two stage least squares which captures both the direct and indirect effects at the same time. Kenyan data on the relevant variables for the period 1970-1990 is used. The independent variable used is domestic savings rate and the regressors are real growth rate of gross national product, real per capita gross national product, ratio of net long run public foreign capital inflow to grossational product, ratio of net long run private foreign capital inflow to national product, and ratio of exports of goods and services to gross national product. Regression results show real per capital gross national product to have a negative impact on domestic savings rate. This is a surprising result because it was not expected and does not also agree with economic theory. Real growth rate of gross national product is found to have positive relationship with domestic savings rate. This concurs with results of past studies done using Kenyan data. Ratio of net long run private foreign capital inflow to gross national product is found to have a negative impact on domestic savings rate. This is a surprising finding because the opposite was expected. strong policy recommendations could therefore not be suggested. Ratio of public foreign capital inflow to gross national product is found to have a negative impact on domestic savings rate. Although the sign of the coefficient is as expected, the coefficient is statistically insignificant when current values of public foreign capital inflows are considered. Lagging public foreign capital inflows makes the coefficient statistically significant but the effect is still negative. This verifies that, the time lag between when the inflows are received and when their returns are realized. The set null hypothesis could therefore be rejected when lagged values are considered. From this finding, we could conclude that, the psychological hypothesis is applicable in Kenya. The Government therefore relaxes domestic savings as foreign capital inflation are available. In other words, public foreign capital inflows substitute domestic savings.