Effects of real interest rate on the financial deepening in Kenya

Abstract

Kenya has been implementing policies relating to financial deepening or financial development for many years from 1990s, this has seen the financial asset base of Kenyan economy increased significantly over the years. The objective of this study was to determine the effects of real interest rate on financial deepening in Kenya; the study used the quarterly time series data for the 40 periods of 2004-2013. The study used money velocity M3 to Real GDP as a proxy for financial deepening (FD), regressed against real interest (INT) adjusted for Fisher‟s effect, fiscal and monetary policies (GP) measured on domestic borrowing proxied by real GDP and financial intermediation (FI) proxied by domestic credit to private sector against real GDP. To answer the question that does real interest rate affects financial deepening in Kenya; the study found a strong positive relationship of 0.997211 exists between real interest rate, monetary and fiscal policy and financial intermediation. The Ordinary Least Square Method (OLS) was used in the study to capture the effects of real interest rate (INT), government policy (GP) and financial intermediation (FI) effect on financial deepening. The results indicates that real interest rate and government policies have impact on financial deepening, while financial intermediation (FI) has little effect on financial deepening. The independent variables are able to explain 99.4% of the changes in the dependent variables as indicted by adjusted R-squared. The analysis of variable (ANOVA) statistics gave a p-value of 0.021which is below the recommended p=0.05, this indicate that the variables are significant. This implies that government policies and interest rate affects the financial deepening, therefore more attention should be given to policies government takes from time as they influence the financial development. Interest rate also has a positive impact on financial deepening; this outcome confirms other studies that real interest rate has effect on saving and investment.