The Effect of Macroeconomic Variables on External Debt in Kenya 1972-2012

Abstract

This study sought to investigate the relationship between some macroeconomic indicators and external debt. The specific objectives of this study were to investigate the relation between the GDP growth rate, balance of trade, inflation, exchange rates, total investment and external debt from 1972-2012, with political regime being the moderating variable. A mixed-method design, incorporating elements of a descriptive survey and econometrics was used. Primary data was collected using questionnaires and interviews. Secondary data was collected from IMF International Financial Statistics for the macroeconomic variables: GDP growth rate, balance of trade, inflation, exchange rates, total investment and external debt, covering the period 1972-2012. Primary data from questionnaires was analysed using IBM SPSS 21. Descriptive statistics was used to summarize responses into frequencies, percentages, means and standard deviations for all the individual variables. Descriptive statistics enabled the researcher to obtain pertinent and precise information about the opinions of respondents on the nature of the relationship between macroeconomic indicators and external debt. Secondary time series data was analysed using STATA. The study tested for violation of assumptions of Classical Linear Regression Model (CLRM) using the diagnostic tests: multicollinearity, logarithmic transformation, stationarity, heteroskedasticity, autoregressive conditional heteroskedasticity, autocorrelation and normality. A multiple regression method based on the Ordinary Least Square (OLS) technique was used to estimate the relationship between macroeconomic variables (GDP growth, balance of trade, inflation, official exchange rates, total investment/GDP ratio, foreign exchange reserves) and external debt in Kenya. Data was presented in tables and graphs. Spearman‘s correlation coefficient showed that the GDP growth rate and external debt are negatively related, with regression results indicating that the relationship was not significant. Balance of trade and external debt were also negatively correlated. Regression results show that there is a significant relationship between balance of trade and external debt. Inflation and external debt were also negatively correlated according to Spearman‘s correlation coefficient. Regression findings also indicated no significant relationship between inflation and external debt. Spearman‘s correlation coefficient was positive for the link between exchange rate and external debt, and regression analysis also confirmed a positive and significant relationship between exchange rate and external debt. On public investment/GDP ratio, Spearman‘s correlation coefficient was negative. Regression results for the same variables reported no significant relationship between public investment as a percentage of GDP ratio and external debt. Foreign exchange reserves and external debt were positively correlated, with regressions showing that individually foreign exchange reserves do not have a significant influence on external debt. The study also reported a negative and significant relationship between political regime and external debt. This study recommends that the government should focus on policies that spur economic growth as this will make the country more self-sufficient and reduce overreliance on external debt to fund development. The government should focus on reducing the imports which are paid for using foreign currency and instead expand the domestic production and consumption of local goods and services in order to reduce the import demand. The government should also stabilize inflation in order to avoid major fluctuations in external debt. Further, to ensure sustainable debt service, it is important that the fluctuations in exchange rate are kept as minimal as possible. Lastly, this study recommends that the government should focus on encouraging investment in the country and ensuring the country is conducive for investment.