ABSTRACT

Kenya has witnessed increased financial integration following capital liberalization in the late 1980s which led to increased foreign private capital flows. Financial integration is considered to complement domestic investment, enhance economic growth and reduce macroeconomic volatility by promoting credit and risk diversification. However, private capital can enhance macroeconomic volatility by exposing domestic market to external volatility. Despite Kenya experiencing increased financial flows, economic growth remains low compared to other economies in Africa experiencing large capital flows. For the past four decades, Kenya has been experiencing volatile and low economic growth even in the phase of increased capital flows in the 2000s hence it is crucial to identify the effects of the country’s financial integration on the economic growth. The motivation was based on the financial integration effects based on economic growth on the conflicting views, specifically to the Kenyan economy when it was operating a managed capital account (1970 to 1992) and when the capital account was liberalized (1992-date). The study covered the period 1970 to 2015 because it is the period in which data was available and the county witnessed significant increase in foreign financial inflows especially in the last decade (2000-2010). Qualitative data for the period 1970 to 2015 was applied in identifying the effects of the foreign direct investments & portfolios investments on economic growth in achieving the first and the second objective of the study. The study made use of three explanatory variables in testing the key performance rate of the Kenyan economy in the global market economy. The study’s third objective involved the investigation of the impacts of the financial integration on growth volatility where Nelson’s EGARCH model was used. The study found that foreign direct investment influences growth. Results from the regression showed that foreign direct investment coefficient as the ratio of gross domestic product per capita was positive and statistically significant while portfolio investment coefficient as the ratio of gross domestic product per capita was positive and statistically insignificant. However, portfolio inflows contribute positively and significantly to economic growth volatility.The study recommends that the government should provide an environment that can attract long term foreign direct investments and maintain stable macroeconomics policies in enhancing growth.