The Effect of Public Debt on Economic Growth in Kenya

Abstract

Using annual data from 1980 to 2019, this study examined the impact of public debt on Kenya's economic growth. Financing Gap theory served as a guide for the investigation. An explanatory research design was adopted in this study. The analysis of the long-run and short-run effects used a customized version of the Vector Error Correction Model (VECM) Model. The R-square value from the VECM model was 58.62, and the Chi-square was 26.913 (p > Chi2 = 0.0494), indicating that the VECM was suitable for parameter estimation. While external debt revealed a coefficient of 0.0003 with a p-value of 0.001 had a significant positive impact on economic growth, domestic debt reported a coefficient of -0.266 with a p-value of 0.019, supporting the debt overhang effect. If the marginal output of an available external debt is greater than or equal to the principal and interest payment, the study found that external debt had a positive impact on the economy of the borrowing country. On the other hand, domestic debt has a significant negative impact on economic growth. The government will be able to develop sound fiscal and monetary policies with the aid of the study's findings. The study demonstrates that increasing domestic debt levels in Kenya during the study period negatively and significantly impacted economic growth. As a result, this study suggests that the Kenyan government reduce domestic borrowing to avoid the crowding out effect, which has a detrimental long-term impact on economic growth. The government should use the borrowed domestic money to diversify the economy's productive base. This will boost long-term economic growth, widen the base of taxation, and increase the country's ability to pay off its obligations when they are due.