The Effect Of Real Interest Rate, Inflation, Exchange Rate And Competitiveness On Foreign Direct Investment In Kenya

ABSTRACT

FDI has grown significantly over time. According to the World Bank Economic report 2014, foreign direct investment in Kenya has increased from as low as 2 million US Dollars in the early 1990’s to 944.3 million US Dollars in 2014. A review of literature reveals that, the relationship between FDI and macroeconomic variables is contradictory. Mixed results have been evident with some results indicating that macro-economic variables like interest rate have a positive impact on foreign direct investment. Further, there is scanty literature on the influence of competitiveness/ease of doing business on FDI inflows, particularly, in Kenya. The main objective of this study was to establish the effect of real interest rates, exchange rate, inflation and competitiveness on FDI in the Kenyan economy. Specifically, the study sought to establish the effect of interest rates on FDI inflows to Kenya; establish the effect of exchange rates on FDI inflows to Kenya; establish the effect of inflation on FDI flows into Kenya; and establish the effect of competitiveness on FDI flows to Kenya. The study was guided by the flexible accelerator model. The study used time series data to establish the effect of macroeconomic variables on FDI inflows in Kenya. The study collected annual data on FDI inflows, real interest rates, exchange rate, inflation rate and competitiveness for the period 1970-2016. The secondary data was obtained from the World Bank, World Development Indicators (WDI) report available as at 31st December 2016. Regression analysis was conducted to determine the significance of the regression coefficients. From the findings, the study concluded that real interest rates and exchange rates have negative and significant influence on foreign direct investment inflows to Kenya. Further, the study concluded that competitiveness has a positive and significant influence on foreign direct investment inflows to Kenya. However, inflation was found to have insignificant influence on FDI. Based on the results the most significant factor affecting FDI inflows was competitiveness, followed by interest rates and then exchange rate. From the study findings, the following policy implications arose; need for favorable interest rates, desirable exchange rates and liberalization of the economy by undertaking a comprehensive programme to reforms, that is intended to open the economy and increase its competiveness. The government should also encourage freedom of capital transactions with foreigners and competition in the domestic market.