Relationship between Public Debt and Financial Development in Kenya
Kipyego, Aloket Samwel
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Financial development is critical for mobilization of saving, credit growth, investment decision, and access to financial service by the poor. Despite various revitalization programs, including regulatory changes, bond market development, and liberalization for spurring financial development, Kenya's financial development has been below the low and medium income countries On the contrary, Kenya's overall public debt increased to 60.15% of Gross Domestic Product in 2019, surpassing the 50% indicative threshold for developing countries set by International Monetary Fund. This study sought to analyse the relationship between public debt and financial development in Kenya. The specific objectives were to examine the relationship between public domestic debt and financial development, to analyse the relationship between public external debt and Kenya's financial development. In addition, the study determined the mediating effects of interest rate on the relationship between public debt and financial development and to investigate the moderating effects of inflation and exchange rate on the relationship between public debt and financial development in Kenya. The study was underpinned on Lazy Bank Hypothesis, Financial Liberalization, Demand Following Hypothesis, Keynesian Theories, and the MacKinnon theoretical model. Besides, the positivism philosophy and explanatory research design were applied. The study used country data hence no need for sampling. Annual time series data from 1964 to 2019 was collected from Kenya's Central Bank, Kenya National Bureau of Statistics and World Bank. Descriptive and inferential statistics were used in the study.Diagnostic tests suggest an absence of multi-collinearity, Auto-correlation, Normal distribution, and unit root test indicate that some of the variables were stationary at a level while others were stationary at first difference. The long run and short-run relationships were analysed using the Auto-Regressive Distributive lag (ARDL) bound test and Error Correction Model. The ARDL test suggested the presence of a stable long-run relationship between financial development, public domestic debt, public external debt, and interest rate. Specifically, the finding indicates that public domestic debt has a statistically significant negative relationship with Kenya's financial development both in the long and short run. Also, public external debt has a statistically significant positive long and short-run relationship with financial development. Further, the results suggest that the interest rate partially mediates the relationship between public domestic debt and Kenya's financial development from the mediation test. In addition, inflation moderates the relationship between public debt and financial development. Furthermore, the exchange rate moderates the relationship between public external debt and financial development in Kenya. This study recommends that the government reduce the amount of public domestic debt as it negatively impacts financial development. Furthermore, the government should continue fostering financial liberalization policies that encourage public external debt has its impacts positively on financial development. In addition, the Central Bank of Kenya should focus on instituting appropriate policies on interest rate liberalization as it mediate the relationsip.In addition Central Bank need to check on inflation and exchange rates to moderate the effects of public debt on financial development.