Effect of public debt and budget deficit on Kenya's economic growth

Table of content

List of Tables

Abstract

Chapter One
INTRODUCTION
1.0 Introduction
1.1 Background
1.2 Problem statement
1.3 Purpose of the study
1.4 Objectives of the study
1.5 Research question
1.6 Significance of the study
1.7 Limitation of the study
1.8 Assumptions of the study
1.9 Scope of the Study

Chapter Two
Literature Review
2.1 Introduction
2.2 Theoretical literature review.
2.3 Framework for the review
2.3.1 Keynesian theory
2.3.2 Ricardian Equivalence theory
2.3.3 Functional finance theory
2.3.4 The crowding-out theory
2.3.5 Tax smoothening theory
2.4 Insight from previous similar studies
2.4.1 Public debt and deficit facing definition
2.4.2 Public debts sustainability -definition and measurement
2.5 Definition of Terms
2.6 Empirical literature review
2.7 Summary of the literature

Chapter Three
Research Methodology
3.1 Introduction
3.2 Research Design
3.3 Location of the Study
3.4 Population of the Study
3.5 Sampling Procedure and Sample Size
3.6 Research Instrument
3.7 Data Collection
3.8 Ethical consideration
3.9 Data Analysis
3.10 Analytical Model
3.11 Estimation Techniques
3.11.1 Stationarity and Unit Root Test
3.11.2 Lag Order Selection
3.11.3 Co-integration Test
3.12 Diagnostic Tests
3.12.1 Multicollinearity Test
3.12.2 Autocorrelation Test
3.12.3 Heteroscedasticity Test

Chapter Four
Results and Discussion
4.1 Introduction
4.2 Descriptive statistics and test
4.2.1 Multicollinearity Test
4.3 INTERPRETATION

Chapter Five
Conclusion and Recommedation
5.1 Introduction

References

LIST OF FIGURES

Figure 1: Literature review plan

Figure 2: Histogram

Figure 3: scattered gram

Figure 4: Heteroscedasticity

LIST OF TABLES

Table 1: Data Analysis Matrix

Table 2: Descriptive Statistics

Table 3: Descriptive Statistics

Table 4: Correlation

Table 5: Multicollinearity Test

LIST OF ACCRONYMS

Abbildung in dieser Leseprobe nicht enthalten

ABSTRACT

Kenya's public debt has proliferated, precipitating debate on its impact on economic performance and causing public anxiety. The purpose of this quantitative ex post facto study was to investigate the long run and causal relationship between Kenya's public debt and economic growth. Keynesian theory, Ricardian equivalence theory, and neoclassical theory provided the framework for the study. Research Questions 1 and 2 addressed the causal relationship between public debt and select covariates as independent variables and actual gross domestic product (GDP) growth rate as the dependent variable. Research Question 3 addressed the relationship between primary budget balance and public debt. Archival data were analyzed using the vector error correction model and autoregressive distributed lag methods. Findings showed a positive long-run causality between public debt and real GDP growth. The relationship between primary budget balance and public debt was positive and statistically significant, demonstrating that Kenya's debt is sustainable. Findings may be used to promote the adoption of fiscal policies that increase economic growth, savings, investments, job creation, and living standards of Kenyans.

CHAPTER ONE

INTRODUCTION

1.0 Introduction

This chapter discusses the background of the problem, statement of the problem, the purpose of study, objectives of the study, research questions, significance of the study, limitations of the study and assumptions of the study.

1.1 Background

For a good economy to thrive in any given country, there should be plenty of productive resources to its needs at that particular time. In most countries, especially Kenya, needs are growing while the resources to meet them are insufficient or even depleted completely (Njoroge 2020). The growing budget has become a problem for the Kenyan government since our economies are expanding. However, the rate is not able to meet the rising demand for the ever-increasing population. At this level country is forced to procure internal and external debts to finance its budget deficit. However, in the long run, this does not solve the problem because the investments programmes do not give good returns, hence losing.

For this reason, the country is forced to have a series of public debts, therefore creating a vicious cycle of borrowing to problems it never solves (Osoro & Stella 2016). Procuring more public debts has caused the Kenya government to use more of its tax to finance the ever-increasing loans and leave minimal economic growth. Overall, most countries rely on foreign financing to meet their development expenditure occasioned by the budget deficits. Scholars and policymakers have argued that external debts have neutral effects on macroeconomic growth. Perhaps it depends on how a country spends its debts to boost economic growth through investments plans (Mbalu & Matanda 2021). Accordingly, this study delves into the impact of external and internal debts on Kenya's economic growth since it has been a borrowing spree to finance to smoothen its expenditure. Public finance decisions are vital to the economic growth rate, incentive and production level in any country.

1.2 Problem statement

Preferably, the Kenyan economy should have the highest employment rate, industrialized with managing and processing industries using its resources optimally. However, Kenyan's debt has overgrown, raising questions on sustainability and economic growth. Statistically, public debts have increased from sh. 1.89 trillion in 2013to sh 5.04 trillion. It is believed central bank of Kenya (CBK) recorded the highest GDP of 57.1% in 2017. Since the GDP is higher than the IMF recommended threshold of 40% for countries such as Kenyan (Murungi & Okiro 2018). Debt increment has resulted in heated and continuous debate among the citizens for and against the accumulation of debts. Economists and policy makers argue that public debts have grown faster than the macroeconomic growth of the country. Moreover, research has reviewed that at this level Kenyan economy is unsustainable (Maingi 2010).

The government has informed the citizen that continuous accumulation of public will aid the growth of the economy. President also argued that the government needed to procure public debts to finance budget deficits, triggering the developments. The treasury has also argued that the Kenyan economy needs to procure more debts to finance its Big Four Policy Agenda. The government Big Four Policy Agenda involves the provision of affordable housing, expansion of the manufacturing sector, food security and health care (Mukui 2013).

The major problem with the Kenyan government is that they procure more debts to finance capital development instead of current expenditure. Development economist argues that the revenue collected should pay recurrent expenditure, but that is not the case for the Kenyan government. The government is borrowing to finance recurrent expenditure, which is dangerous for devaluing the local currency, a decline in terms of trade for Kenyan which may lead to demand-side shock, which reduces GDP and consequently discourage foreign and private investment (Lidiema 2018). Therefore, this study aims to address how the Kenyan government can correct the total tax burden.

1.3 Purpose of the study

The purpose of this study is to investigate the causal relationship between Kenyan public debts and budget deficits on economic growth and to understand the impact of borrowing on economic performance (King'wara 2014). My research was successful because of archival data and time-series data for the period 2001 to 2020. The primary source for archival was the IMF, CBK and KNBS and the internet-based sources. To investigate the long run and relationship of the variables. My variables include economic growth rate (dependent variable) and public debts (independent variable).

1.4 Objectives of the study

This study seeks to evaluate the relationship between BUDGET DEFICIT and ECONOMIC GROWTH.

Specially:

1. To examine whether low debts triggers growth.
2. To establish the relationship between public debts and macro-economic growth.
3. To establish the level of the budget deficit that is sustainable for economic performance.

1.5 Research question

1. How does the budget deficit affect economic growth?
2. What are the primary policies the Kenyan government can contrivance to control public debts?
3. What is the budget deficit magnitude level that is sustainable?
4. How to mitigate public borrowings?

1.6 Significance of the study

The research provided is to help the Kenyan government understand the impact of budget deficits on economic performance. The Kenyan government should deploy public financing decisions and influence economic performance through massive investments. To provide evidence, I decided to research the effects of public debt and budget deficits on Kenya's economy. My study aims to inform the Kenyan government and citizens how budget deficits affect macroeconomic performance. My study will provide better ways the Kenyan government can employ to defer from external borrowings.

Notably, when the government spends more than the revenue its collects from the public, there is a huge budget deficit and, therefore, the need to acquire foreign debts. Modern Economist argues that debt has more implications on savings, investments, employment, economic growth and standards of living. However, Erickson 2017 argued that procuring more debts can increase the incentive, resources and production possibilities (Murungi & Okiro2018). It sounds positive because an increased money supply in the economy will trigger off investments, job creations and living standards of citizens.

My research also provides the positive socio-economic change in Kenya in different ways. My findings may contribute to improvement in public debt evaluation in Kenya. Hyman (2014) articulates that if a nation uses its debt to finance capital expenditure will create streams of benefits to the taxpayers since the debts do not burden them. However, debt burden occurs where the well-being of the citizens decreases because of huge payoff interest and debts principals. Overall, my findings indicate the potential to increase the allocation of public funds and mitigate misuse of public funds. Moreover, similar countries like Kenya can use the evidence provided to improve their public financing policies.

1.7 Limitation of the study

I used archival data from the World Bank, CBK and IMF, reliable and valid. Perhaps I relied on my capability of the integrity of cleaning and data collection of archival data.

My study primarily focused on the relationships between public debts and economic growth. However, globalization indicated that events happening beyond our countries also affect economic growth. Bryson 2011 argued that the world is becoming flatter because of globalization effects. (Musyoka 2013). A good example of globalization financial crisis happened in 2008, affecting all developing countries, including the United States of America. Though my study has only one variable touching Kenyan's economy trading with the rest of the world, I did not capture the potential effects of globalization on the Kenyan government.

Finally, my study faced limitations on data analysis and statistical conclusion validity. Green (2012) argues that analysis of time series data possesses many problems because of high autocorrelation in the residuals. It possible to conclude that the relationships of these two variables even if it does not exist.

1.8 Assumptions of the study

Assumptions are the circumstances that researchers expect readers to accept as plausible. Simon and Goes 2013 argued that assumptions are beliefs proposed by the researcher that is necessary to conduct research, but they cannot be proven.

My first assumption was that the relationship between public debts and economic growth would be linear across all ranges of variables. However, most studies argue that public debts and budget have a linear relationship. However, few researchers like Coupet 2017 and Ogundipe 2016contends that the non-linear model was most appropriate for their study. Coupet assumed an open relationship with public debts indicating a positive growth rate at lower levels and negative economic growth at a higher level.

My second model is about data. I used time-series data to determine autocorrelation, nonstationary and stochastic patterns that render standard statistical methods like ordinary least squares (OLS).

My third assumption was also about data. I analyzed archival data from the World Bank, CBK and IMF. I assumed that the data was accurate, unbiased and suitable to analyze the relationship between public debts and the budget deficit for the Kenyan government.

1.9 Scope of the Study

The study used time-series data to examine public debts trends in Kenya compared to the GDP growth rate from 2001 to 2019. Statistically, Kenya's overall public debt increased from 48.6% of GDP at the end of 2015 to an estimated 69% GDP in 2020. As of September 2020, Kenyan external debt was 51.4% of its total debt stock of 7.1 trillion Kenya shillings (Makau, Njuru & Ocharo 2018). Furthermore, the study will be necessary to the government of Kenya, especially the ministry of finance, in making a policy decision. However, there are several methods government can use to repay public debts; refunding, surplus budget, additional taxation, capital levy and surplus balance of payment. To understand the right path to pay the debt, the debt management should understand the following; amount owed, interest rates and due dates.

The main reason why a government borrow includes;

1. To finance deficit budget
2. To finance a huge capital project
3. To procure war materials
4. Servicing loans
5. To provide employment opportunities
6. Balance of payment disequilibrium

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter has two sections, section one explores theories behind budget deficit, and the other sections discuss empirical theories that have previously been carried out on the subject.

2.2 Theoretical literature review.

The theoretical framework represents the ideas, concepts, and variables addressed in a study and is provided based on what the researcher should explore and measure or examine. Thus, I examined how public debts has affected the growth of the macro-economic performance of Kenya. An increase in public debts has caused numerous public debates on the impact of the public debts. Economist Ndii (2017) argued that an increase in public debts leads to a high interest rate in future, thus burdening taxpayers (Mwaniki 2016). Statistically, principal external debt is currently at Sh4.015 trillion. In contrast, Kenyan's interest on external debts stands at Sh2 trillion in June 2021 compared to the ordinary revenue of Ksh 1.59 trillion projected for 2020/2021. Kenya government is spending 40% of its total revenue to finance the debt burden. The Institute of Certified Public Accountants has warned the Kenyan government on the accumulation of external debts to grow its economy (Meme & Muturi 2016). To alleviate such economic recession, Kenya Revenue Authority should increase its tax base. For example, KRA has mobilized Ksh 93.7 billion in FY 2020/2021 compared to Ksh 84.7 billion collected in FY 2019/2020. In addition, KRA has intensified its fight against tax evasion to ensure no revenue is lost. Despite the problematic year operating economy brought about by COVID 19 pandemic, the revenue collection in FY 2019/20(JULY 2019- JUNE 2020) stands at Ksh 1.607 trillion compared to the previous FY Ksh 1.580 trillion. This represents an economic performance rate of 97.9% and revenue growth of 1.7% compared to last Financial Year. Thus, the Authority is determined to make the taxpaying experience better for all its customers (Okech & Mweni, Njuguna 2016). Overall, KRA is optimistic that we will perform better economically in this new financial year 2021/22. (TULIPE USHURU, TUJITEGEMEE!). Thus, the purpose of this quantitative study was to investigate the long run and causal relationship between Kenya's public debt and economic growth to understand the impact of borrowing on economic growth.

2.3 Framework for the review

I developed my literature review using the plan depicted below in figure 2. The goal of the literature review was to obtain good understanding work of other researchers had done, the method had been used, and concepts had been measured and defined.

Theoretical background

a. Keynesian theory
b. Ricardian equivalence theory
c. Functional finance theory
d. The crowding-out theory
e. The tax smoothening theory

Insight from previous studies

a. Public debt and deficit facing definition
b. Public debts sustainability -definition and measurement

Figure 1: Literature review plan

Researchers have used the main theoretical frameworks to discuss the relationship between budget deficit and economic growths. These theories include; Keynesian theory, Ricardian equivalence theory, neo-classical theory, classical theory and crowding out the theory. Theories represent different prepositions of the impact of public debt on economic growth.

2.3.1 Keynesian theory

The Keynesian theory argues that the accumulation of public debts and a huge budget deficit leads to high government spending, resulting in high demand, leading to redundant resources and increased national output (Onyango 2013). He argued that a continuous increase of public debts in any economy would boost the economy's growth since procurement of debt drives the growth of output hence a multiplier process.

Keynesian argues that borrowing from private sectors and returning the funds to the private sector through spending can help the government reverse economic downturns. Thus, total spending in the economy stimulates economic growth and stability and therefore using public debts to finance no harm to the economy. According to Keynes theory of fiscal stimulus, an injection in government spending can lead to business activity and even more spending. Thus, the theory proposes that more spending boosts aggregate output and generates more income for the economy.

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