Relationship between foreign direct investment inflows and selected macroeconomic variables in Kenya

Abstract

Foreign direct investment (FDI) emerges as a critical strategy in the pursuit of long standing financial growth and advancement within the majority of evolving nations. This is primarily achieved by improving infrastructure, advancing information and communication technology, increasing productivity, creating employment openings, and enhancing export activities to bolster the balance of payments. The inflow of foreign direct investment (FDI) has shown fluctuations through the yonks from 1974 to 2018, notably experiencing a decline from 2013 to 2016. These fluctuations and need to understand the causal relations among the variables motivated the need for the study. The principal goals of this research were to find and investigate the causal associations between FDI and a specific set of macroeconomic indicators. Additionally, a secondary aim involved estimating the interconnections among these variables through parameter estimation. Spanning 45 years from 1974 to 2018, the research provided a comprehensive temporal framework for conclusive results. Data from the World Bank were used for methodological consistency. To ascertain the stationarity of individual variables, a unit root test was used. Christopher Sims' theoretical framework, which employs vector autoregressive models, was used to estimate complex interconnections between variables. The Granger causality test, a statistical methodology widely used in econometrics, serves to ascertain the directionality of causality between variables. The empirical examination has revealed a mutually reinforcing correlation amongst foreign direct investment (FDI) influxes and economic development. Notably, exchange rates, FDI influxes, and interest rates significantly influenced inflation dynamics. Vector autoregressive estimates of independent variables' impact on dependent variables were statistically examined at a significance level of 0.05. Results indicated that economic advancement, quantified by gross domestic product (GDP), constructively and significantly influenced immediate FDI influxes. Current-year GDP and FDI influxes constructively impacted economic development in the subsequent year. Exchange rates directly affected inflation trends, while the volume of FDI investments and combined interest and exchange rates inversely related to current and subsequent year inflation rates. Current inflation rates influenced subsequent year interest rates. The research advocates attracting foreign investors to augment FDI influxes, thereby boosting economic development and mitigating inflation. Furthermore, raising interest rates emerges as a significant measure to counteract inflationary pressures.