Effects of Government Domestic Borrowing to Private Sector Investment in Kenya

December 3, 2021 - Reading Time: 3 minutes - By Amrit Labhuram

By: John Mburu

The EGCL Institute recently conducted a study on the impact that Government domestic borrowing has on private sector investment in Kenya.

In summary, the study established that Government domestic borrowing can affect private investment negatively by reducing the amount of credit available to the private sector, increasing interest rates, or increasing the moral hazard in the banking sector. On the other hand, government domestic borrowing can affect private sector investment positively through financial sector development, helping banks to diversify risk, or investing in public projects that are complementary to private sector investment.

In essence, the study concluded that government domestic borrowing crowds in private sector investment at lower levels, but crowds out private investment at higher levels. Moreover, the study found that domestic credit to the private sector, annual GDP growth and trade as percent of GDP has a positive and significant effect on private sector investment.

Second, growth in credit to the private sector is vital for private sector investment. Third, the study concludes that economic growth is important for private sector investment as it increases the demand for goods and services. Fourth, trade openness is important for access to the international market as trade openness has a positive effect on private sector investment. The policy implication of the study is that the government should monitor the annual government domestic borrowing and ensure that it does not over borrow in the domestic market. This will help the banking sector to diversify their portfolio and spur private sector investment. Furthermore, the government should focus on developing the financial sector.

The study findings also showed that the effect of domestic credit to the private sector on private sector investment is economically and statistically significant. Hence, financial development which helps increase the amount of loanable funds and efficiency of the banking sector can help spur private sector investment. Lastly, and as a recommendation, the government should focus on increasing access to international marketing and reducing trade barriers. As the study suggests, trade as a percentage of GDP has a positive effect on private investment.

With regards to the optimal level of borrowing, the study estimated that the optimal level of annual government domestic borrowing as a percentage of GDP in Kenya was 3.96 percent. Therefore, the study concludes that first, annual government domestic borrowing as a percentage of GDP below 3.96 percent crowds in private sector investment but beyond this optimal point further borrowing crowds out private sector investment.

On 30th November, 2021, the Public Finance Sector Board leadership at KEPSA in collaboration with the Vellum team at Oxygène and EGCL Institute Fellow Mr. John Mburu hosted a panel discussion to deliberate on these findings where several issues were raised in the plenary notably, concerns over Kenya’s debt structure and how Kenya can leverage on proper fiscal management to attract foreign investors and become a hub of value addition and manufacturing.

Needless to say that Kenya’s debt levels have been news fodder for some time now with focus being on (un)sustainability in comparison to repayment capacity. Moreover, this is not the first research undertaken to establish the impact that domestic borrowing has on the private sector. In 2017, the Kenya Bankers Association (KBA) conducted a similar study which sought to investigate the role of domestic borrowing on private investment growth and development in Kenya over the years. The most robust finding of this paper was that, in the short run, government domestic borrowing negatively and significantly affects gross fixed capital formation and hence investment, this however diminishes as in the long run.

Similar findings were found in the current study following a closer investigation of the relationship between private sector investment and government domestic borrowing.

That said, it is crucial that an appropriate monetary-fiscal policy mix would encourage better utilisation of domestic debt for the Government and private sector.

Source: John Mburu Research Fellow at EGCL Institute and PhD student at Kenyatta University, School of Economics. Email: john@egclinstitute.org/mburngugijn@gmail.com 

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