Effect of external debt and government expenditure on economic growth in Kenya

Abstract

Kenya is among the Sub-Saharan African countries, which are highly dependent on external debt to finance its developmental activities. Because of insufficiency in domestic revenue sources such as taxes, fines and fees to finance the budget deficit, the successive governments have to borrow not only domestically, but also externally to reduce the budget deficit gap or finance the productive capital projects such as roads, railways, ports, provision of water and production of energy. Scholars and experts have raised concern over the possibility of Kenya’s external debt exceeding its sustainable threshold. This could easily stretch the country’s repayment ability in future and may spill over to a negative impact on economic growth. The main objective of the study was to establish the effect of external debt and government expenditure on economic growth in Kenya. Specifically to investigate the effect of external debt stock on economic growth in Kenya, determine the effect of external debt service on economic growth in Kenya, determine the effect of government expenditure on economic growth in Kenya and finally determine both short-run and long-run relationship between external debt stock, external debt service and government spending on economic growth in Kenya. The study was guided by the Solow growth theory. Central Bank of Kenya, Kenya National Bureau of Statistics, International Monetary Fund and World Bank were the main sources of time-series data set. The study period was thirty-eight (38) years from 1980 to 2017, data stationarity was tested using Augmented Dickey-Fuller and Phillips Perron and the Autoregressive Distributed Lag approach was used to test for the null hypotheses. The study established that external stock (β = -7.53, P=.0196) and debt service (β = -13.59, P = .047) had negative significant effect on economic growth while government expenditure had a positive (β = 26.97) and significant (P = .0385) effect on economic growth. In addition, the study found a long-run significant (F = 6.56 > 1(0) = 4.136, 1(1) = 5.304) relationship between the independent and dependent variables. The Error Correction Model test reveals a high speed of 112 percent (-1.115) of adjustment to equilibrium with significance (P = .000). The paired statistics reveal bidirectional causality in external debt stock and debt service, unidirectional causality between debt service and GDP, external debt stock and government expenditure, and debt service and government expenditure and between government expenditure and GDP, there was no causality. The study recommends a policy review and guideline on the use of externally borrowed funds to ensure that these funds are put into development projects. Further, policies on government expenditure to be directed to the productive sectors of the economy to appreciate the proper utilization of the external debts to boost the economic growth of the country. Finally, the study findings fill the knowledge gap existing in both empirical and theoretical literature related to external borrowing, debt repayments, government expenditure and economic growth.