Effects of foreign aid predictability on investment and economic growth in Kenya

Abstract

Foreign aid forms one of the largest components of foreign capital flows to low-income countries. Since attaining political independence in 1963, Kenya has been dependent on foreign aid for capital and social investments. The Paris declaration of 2005 commits donors to provide reliable, indicative commitments of aid over a multi-year framework and also disburse aid in a timely and predictive manner in line with the agreed schedules. Studies have also argued that stable macroeconomic policy environment is a requisite for aid effectiveness. However, foreign aid flows in Kenya have been unpredictable and the macroeconomic policy environment unstable. The general objective of this study, therefore, was to examine the effects of foreign aid predictability on investment and economic growth in Kenya. Specifically, the study sought to examine the effect of foreign aid on investment and economic growth; examine the effect of macroeconomic policy environment on foreign aid, investment and economic growth; analyse the effect of aid unpredictability on investment and economic growth; and suggest policy implications. The study drew from the Samuelson model and used time series data for the period 1966-2010. The data was collected from published sources. It employed the autoregressive distributed lag estimation technique. Results of the bound tests indicated that there was a long-run relationship between the variables. The study found that foreign aid had a positive effect on Kenya’s economic growth and public investment. The lagged effects of foreign debt positively affected economic growth and public investment after one year and negatively thereafter. The empirical findings show that private investment positively affected economic growth and public investment. It was found that there was a complementary relationship between private investment and public investment. Kenya’s macroeconomic policy environment was found to be unstable over the study period thus negatively affected economic growth and public investment. This was despite the macroeconomic policy reforms that the Government of Kenya had undertaken and the push for such reforms by the development partners. Foreign aid flows to Kenya were found to be unpredictable and negatively affecting economic growth and public investment despite Kenya and her development partners having committed to work towards predictable foreign aid. In light of the foregoing, this study recommended among other things, the need to review Kenya's Joint Assistance Strategy, ensuring sustained economic growth of over 10 per cent while keeping inflation low. Additionally, there is need to encourage private investment in the country and that development partners have a role to play in this respect as part of their commitments in Busan in 2011.

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