The effect of external debt on economic growth in Kenya (1980-2020)

Abstract

The effects of foreign borrowing on economic growth have been a subject of debate in the academic and policy circles. This study examined the effect of external debt on economic growth in Kenya over the period 1980–2020. A theoretical framework was built based on a neoclassical growth model. The study investigated the effect of external debt and its debt servicing on economic growth. Using autoregressive distributed lag (ARDL), cointegration test was applied to examine the long-run relationship between external debt and economic growth. The main data source used is the World Development Indicators 2023, published by the World Bank. ADF's unit root test procedure was applied to examine the stationarity properties of the time series. The results of the unit root test suggested that only inflation and labor force were stationary at the level, while all other variables in the model were stationary at the first difference. The findings of the study show that external debt stock had a statistically significant positive effect on economic growth, meaning that a higher level of external debt leads to considerable increase in economic growth, whereas external debt service had a significant negative long-term effect on economic growth. Even though the findings from the study show that external debt has positive relationship with economic growth, still there is a need to control the volume of external debt before a threshold beyond which external debt turns to be negative since Kenya as being highly indebted is not attractive to foreign investors. This is due to the fact that the higher the flow of external debt, the more the burden to service of the debt. It is recommended that external financing should be made as a supplement and not as a replacement of internal savings in the long-term.