EFFECTS OF EXTERNAL TRADE SHOCKS ON ECONOMIC GROWTH IN KENYA

Abstract

Over the past decade, Kenya has experienced notable shifts in its trade patterns, characterized by instances of sudden disruptions and volatility. Kenya National Bureau of Statistics indicated that, Kenya has been experiencing unsteady economic growth because of external uncertainties. Therefore, this study examined the effects of external trade shocks on economic growth in Kenya. The key objectives were determining the effect of capital inflow shock on economic growth in Kenya, examining the effect of commodity price shock on economic growth in Kenya, assessing the effect of interest rate shock on economic growth in Kenya and finally establishing a moderating effect of exchange rate on the association between external trade shocks and economic growth in Kenya. Real business cycle theory was adopted as the key theory supported by dependency theory and purchasing power parity. The descriptive and correlational research design were employed to establish the direction and strength of the nexus. The research adopted time series data to show the systematic trend for the period of 14 years, ranging from 2008-2022. This period was the best time to cover trends on great economic phenomena such as great Russia-Ukraine crisis, COVID-19, sovereign European debt, and launch of Kenya’s vision 2030. The study employed secondary data drawn from World Bank, Central Bank of Kenya, and Kenya National Bureau of Statistics. Data was analyzed using E views software version 10 and results were presented in tables and figures. Descriptive and inferential statistics were used to describe the data trends and predict future occurrences from the findings. Pre-estimation diagnostics such as normality, stationarity, multicollinearity, correlational analysis and post-diagnostic tests were undertaken to summarize and interpret the findings. Correlational analysis result revealed that capital inflow shock and interest rate shock had a +ve significant effect; 0.7001(0.0000): 0.4300(0.0006) while commodity price shock had a –ve significant association, -0.2639(0.0416). Augmented Dickey Fuller and Dicky Fuller Generalized Least Squares, tests confirmed the presence of unit root at levels and stationarity at first difference for all variables apart from capital inflow shock which was integrated at I (0). Autoregressive distributed lag Bounds test for cointegration shows that F-statistics was 18.89621 greater than critical values in upper and lower bounds indicating cointegration and long-term relationship. Vector error correction model of the cointegrating equation was 0.1793219. Multiple regression results indicated that capital inflow shock and interest rate shock had a +ve significant effect on economic growth in Kenya with coefficients; 0.3022(0.0000); 0.6658(0.0000) while commodity price shock had a –ve significant effect 0.2019(0.0321) and exchange rate had a weak moderating effect on the relationship. The Breusch-Godfrey test for autocorrelation revealed that there was no serial correlation with p values > 0.05. The centered Vector Inflation Factor values were less than 10 hence absence of Multicollinearity. Breusch-pagan-Godfrey test had the p-value > 0.05 showing that there was no problem of heteroscedasticity. Jarque-Bera test for normality revealed that the series is distributed normally at 5% level of significance with p-values > 0.05. The cumulative sum test confirmed that the model was stable and fit for policy and decision making. According to these results, the study recommends that, the government need to attract more Foreign Direct Investments by setting favourable policies to boost capital inflows and invest more on domestic production to manage commodity prices and imports which makes the nation more vulnerable to shocks. Since interest rates spur economic growth, Central Bank should strategically set lending rate policies to valuate local currency as well as striking balance between controlling inflation rate and supporting sustainable economic growth. Based on current economic situation in Kenya, the government should enhance transparency, competition, and innovation in financial sector and foster favourable business environment to capitalize on interest rates.