ABSTRACT

Kenya is seeking to meet the Sustainable Development Goals-2030 agenda. The serious challenge to this course remains the soaring debt obligations, capturing a significant portion of the national budget. Kenya has been borrowing externally at higher rates and continually expanding the debt ceiling. The government will therefore in future spend a significant portion of its revenue repaying the debts at the cost of important local investment. The government is therefore limited to fully fund critical sectors of the economy that will spur sustainable growth and investment opportunities; key to widening the tax base. This has an overall implication on the country’s revenue, income, employment and poverty levels. Many researchers have recommended that external debt is one of the key sources of financing capital formation in developing countries. However, debt repayment can have adverse effect on capital formation and gross domestic product in a country. Although all the studies done on Kenya have found out that external debt has negative effect on economic growth, the channel through which the effect of debt is transmitted have not been examined. This study examined the effect of foreign debt service on GDP in Kenya through savings and capital formation transmission channel. The first specific objectives of this study is, what is the effect of external debt servicing on Kenya’s capital formation? The second objective is, what is the effect of external debt servicing on gross domestic growth in Kenya? Longitudinal research design was adopted where time series data on external debt, capital formation was analyzed. Time series properties of the data was checked in terms of stationary tests, and the standard diagnostic tests of regression such normality, autocorrelation, multicollinearity and specification. Regression of capital formation on lagged debt service was carried out which indicated negative relationship between the two variables. Regression of gross domestic product on labour and predicted capital was done, the results obtained was that, debt service affect gross domestic product negatively through its effect on capital formation. It was recommended among others that policies of the government should therefore be guided towards reducing debt stock. It is important for policy makers to be cautious on implementation of projects that raise public debt and there should be controlled measures on debt management profiles especially in government expenditure by evaluating funded projects to gauge the utilization of funds. Also, reducing the rate of borrowing by sourcing alternative means of financing projects was recommended.