Private Capital Inflows, Remittances and Economic Growth in Kenya

Abstract

Most studies on private capital inflows and economic growth are cross-country and give more weight to foreign direct investment than the other components of private capital inflows. Moreover, these studies have not included remittances as an explanatory variable in their estimation procedures. In addition, the question as to whether it is private capital inflows that promote economic growth or it is economic growth that attracts private capital inflows has not been investigated in Kenya. This study investigated the causality between foreign direct investment, portfolio investment and cross-border interbank borrowing and economic growth; analyzed the effect of foreign direct investment, portfolio investment and cross-border interbank borrowing on economic growth; and examined the effect of remittances on economic growth in Kenya. The data used was sourced from World Bank‟s African Development Indicators and various Economic Surveys and Statistical Abstracts for the period 1970 to 2010. The study used Granger Causality to investigate the causality between foreign direct investment, portfolio investment and cross-border interbank borrowing and economic growth. The ordinary least squares estimation was used to determine the effect of foreign direct investment, portfolio investment and cross-border interbank borrowing; and remittances on economic growth. The study found that there was a unidirectional causality from foreign direct investment to economic growth and from economic growth to cross-border interbank borrowing. Regression results showed that the coefficient of foreign direct investment as a ratio of gross domestic product was positive and statistically significant, and the coefficients of portfolio investment as a ratio of gross domestic product and cross-border interbank borrowing as a ratio of domestic product were positive and statistically insignificant. Similarly, the coefficient of remittances as a ratio of gross domestic product was positive and significant. Following these results, the Government of Kenya should work towards an environment that attracts foreign direct investment, pursue a high and sustainable economic growth rate so as to attract cross-border interbank borrowing and put in place policies that encourage remittances.