The effect of foreign direct investment and the balance of payment on the foreign exchange rate in Kenya

Abstract

The study sought to understand the effects of foreign direct investments and the current account on the foreign exchange rate in Kenya. Many factors affects the foreign exchange rate in Kenya and elsewhere globally but this study was keenly interested in understanding the relationship between foreign direct investment and the current account on the foreign exchange in Kenya. The development of literature was guided by several theories and models; Elasticity approach to balance of payment, the balance of payments theory, Mundel-flaming model and the Balance of payment constraint model . The descriptive research design was used in this study. Data was sourced from Kenya Bureau of Statistics (KBS) and the Central Bank of Kenya and the World Bank database. The study used annual averages of foreign direct investment net inflows (% of GDP), annual averages on foreign exchange rates (LCU per USD) and annual current annual averages (% of GDP) from 1980-2014. The data was analyzed using descriptive analysis to model the relationship between two explanatory variables and a response variable by fitting a linear equation to estimate the relationships between the study variables as well as OLS regression analysis after testing for non-stationarity of data using Breusch-Pagan test. The findings established that the co-efficient of multiple determinations R-square value was 0.214; this imply that the chosen variables specifically foreign direct investment and the current account in Kenya during years 1980-2014 affect the foreign exchange rate by 21.4% and therefore 78.6% effects of the foreign exchange rate was associated with other unexplained factors. The regression results also indicate that the model used was significant at 5% level of significance with an F-statistic of 0.0023. The study recommends that the government should consider undertaking rigorous reforms towards improving the inflow of foreign direct investment. It was further recommended that Kenya being a developing nation key sector like infrastructure should be the center of focus and more funds should be channeled to this subsector so as to boost government consumption through establishing a debt fund as well as relaxing external commercial borrowing.