Effects of Capital Flight on Economic Growth in Kenya

Abstract

Financial globalization spurs economic growth by availing additional capital to the economy, leverages the effects of capital flight in the economy and generates foreign exchange rate for a country. However, in Kenya this seems not to happen. Kenya continues to receive foreign capital inflows and lose billions of dollars to capital flights at the same time. The annual economic growth rate averaged 5.43 percent from the year 2004 until 2016, which lags behind the Vision 2030's main economic pillar that aims at an economic growth of 10% p.a. The main challenge Kenya is facing today is to regulate capital flight, enhance economic growth and control the foreign exchange rate volatilities. Since foreign exchange rate is a strong determinant of gross domestic product, the effects of capital flights are thus a great economic concern. The dependent variable for this study was economic growth while the independent variables included external debt repayments, foreign portfolio investment outflows, outward foreign direct investments and profit repatriations. The general objective of this study was to determine and evaluate the effect of capital flight on the economic growth in Kenya. The specific objectives were to evaluate the effect of external debt repayments, foreign portfolio investment outflows, outward foreign direct investments and profit repatriations on the economic growth in Kenya. Lastly, the final specific objective was to evaluate the mediating role of foreign exchange rate on the relationship between capital flight and economic growth. The indicator of economic growth was the percentage change in gross domestic product. This study adopted an ex-post facto research design with a sample size of 30 years from 1986 to 2016 and relied on secondary data from Kenya National Bureau of Statistics, International Financial Statistics, Central Bank of Kenya, International Monetary Fund, World Development Index, United Nations Commodity Trade and African Development Indicators. This study adopted a panel data regression model using the ordinary least squares method. Hausman test was performed to determine the appropriate model for this study. Baron and Kenny model was used to detect the mediating effect on the relationship between capital flight and economic growth. Descriptive statistics were carried out to determine the spread of data over time. A correlation analysis was conducted to check for highly correlated variables. The study applied four panel unit root tests: Levin, Lin and Chu, Im, Pesaran and Shin W-stat, Augmented Dickey-Fuller test and PP - Fisher Chi-square. Granger causality tests were conducted to establish the existence of a unidirectional, bidirectional or no causal relationship between the proxies of capital flight and economic growth. The probability value of the F-test was employed to examine the null hypothesis. The test results showed that there was a negative relationship between external debt repayments, outward foreign direct investments and foreign exchange rate on the economic growth in Kenya but the effects were insignificant. Foreign portfolio investments outflows were found to have a positive relationship with economic growth in Kenya, but the effect was also insignificant. Further, profit repatriations significantly impacted economic growth negatively, during the study period, the magnitude of which a slight repatriation of 0.48% each year resulted to a 1% reduction in economic growth. The study found that FER did not mediate on the relationship between capital flight and economic growth. The findings of this study will benefit policy makers to make appropriate policies that discourage capital flight, improve FER management, cushion investors and traders from FER fluctuation risks, and boost the country's economic growth. This study will also benefit academicians interested in capital flight studies and the growth of a country's economy as it aims at shedding light on the conclusions earlier drawn on the pertinent problems of capital flight in Kenya.