Business

This research paper is our own original work and has not been submitted for the award of degree in any other university.

Registration Number Name Signature

X75/4919/2016 Brenda Mutola ………………..

X75/4925/2016 Ephantas Muendo ……………….

X75/4969/2016 Zekoline Chepkoech ………………..

X74/4269/2016 Collin Oduor ………………….

X74/0386/2016 Suleiman Juma ………………….

This research project has been submitted for examination with my approval as the university supervisor.

Dr. Urbanus Kioko

Sign …………………………………………………………………………………..

Date ………………………………………………………………………………….

First, we acknowledge the Almighty God for Providence. We thank our supervisor, Dr. Urbanus Kioko, for guiding us in the writing of this research paper.

We dedicate this research paper to our parents.

TABLE OF CONTENTS DECLARATION ii ACKNOWLEDGEMENT iii DEDICATION iv LIST OF TABLES vii LIST OF FIGURES viii ABSTRACT ix LIST OF ABBREVIATIONS x CHAPTER 1 1 INTRODUCTION 1 1.1 Background to the Study 1 1.1.1 Public Debt 2 1.1.2 Economic Growth 3 1.3 Objective of the Study 4 CHAPTER 2 4 LITERATURE REVIEW 4 2.1 Introduction 4 2.2.1 Neoclassical Growth Theory 5 2.2.2 Dual Gap Analysis Theory 5 2.2.3 Keynesian Theory 5 2.2.4 Debt Overhang Theory 6 2.3 Empirical Literature 6 2.3 Overview of the Literature 8 CHAPTER THREE 8 RESEARCH METHODOLOGY 8 3.1 Research Design 8 3.2 Data 8 3.3 Conceptual Framework 8 3.4 Analytical Model 9 3.5 Econometric Issues 10 3.5.1 Pre-estimation test 10 3.5.2 Empirical tests 10 CHAPTER 4 10 RESULTS AND DISCUSSION 10 4.1 Descriptive Statistics 10 4.2 Empirical Results 11 4.3 Discussion 12 CHAPTER FIVE 13 SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS 13 5.1 Introduction 13 5.2 Summary and Conclusions 13 5.3 Policy Recommendations 13 5.4 Areas for Further Studies 14 REFERENCES 15

The aim of this study was to examine the impact of public debt on economic growth in Kenya. The study used time series data for the period 2000- 2015 and employed multiple linear regression model. The dependent variable was the growth of GDP. Independent variables were debt-to-GDP ratio, unemployment rate, inflation rate, real interest rates, and current account balance. The model was estimated using ordinary least squares (OLS) regression technique. The study concluded that without correcting for stationary trend, inflation rate and debt-to-GDP ratio have a significant negative effect on the growth of GDP. However, when the data is corrected for stationary trend, the study concluded that it is only the growth of potential output which has a significant effect on GDP. The study recommends inflation rate targeting and debt cuts in order to boost the growth of GDP as well as measures aimed at increasing land productivity, and capital efficiency, improving labor productivity and enhancing technical progress. The study identifies the impact of the growth of per capita debt on the growth of per capita output in Kenya and the relationship between primary balances and external borrowing as areas for further studies. Comment by Urbanus Kioko: Meaning? Why use potential growth? Comment by Urbanus Kioko: The main focus was Comment by Urbanus Kioko: Did you check if reduction in debts by say 10% would improve economic growth? Comment by Urbanus Kioko: Where is this recommendation derived from? Comment by Urbanus Kioko: Recommendations must be derived from the key study findings. These recommendations are not based on the study findings

GDP Gross Domestic Product

CBK Central Bank of Kenya

IMF International Monetary Fund

OLS Ordinary Least Squares

RGDP Real Gross Domestic Product

VAR Vector Autoregressive

ADM Autoregressive Distributed Model

WB World Bank

17

The government of Kenya has over time focused on ensuring a stable macroeconomic environment. In the realization of this, tThe government has always endeavored to stabilize the country’s economic growth as well as expand her fiscal space. With an expanded fiscal space, the government has increased borrowing both locally and externally. According to the Central Bank of Kenya (CBK), an increase in public debt may expose the country to both GDP growth shocks and rollover risk. Comment by Urbanus Kioko: Provide reference Comment by Urbanus Kioko: refernce Comment by Urbanus Kioko: give examples of these

Policy makers and economists around the world argued that in a government in financing a budget deficit, a government may opt between raising taxes and borrowing. Expansionary governments, however, find raising taxes to be unpopular. Thus, taxes remain largely untouched. Rather than cut down on expenditures, the government then chooses to borrow thus incurring public debt. Since, governments work in perpetuity, a debt in the present period will most likely be serviced by future governments. Ideally, debt burden is transferred to future generations. Comment by Urbanus Kioko: reference Comment by Urbanus Kioko: is this the situation in Kenya? The statement may not always hold, and it may vary from country to country. Cite some examples of countries that have maintained taxes constant and instead opted for expansionary policy Comment by Urbanus Kioko: what is the composition of the public debt

According to the International Monetary Fund (IMF) and the World Bank, a debt is sustainable if an increase in debt-to-GDP ratio is matched with an increase in primary surpluses. A decline in debt-to-GDP ratio, on the other hand, should be matched by increase in primary deficits. The IMF has further revealed that primary surpluses are more likely in economies experiencing higher national savings compared to national investments. Comment by Urbanus Kioko: what are these primary surpluses? Comment by Urbanus Kioko: Provide references Comment by Urbanus Kioko: As above

Debate remains rife on the impact of public debt on economic growth. According to Keynes, an increase in public debt serves as an economic stimulus thus fostering economic growth. Keynesian economists are of the view that it is always the government’s responsibility to facilitate increase in output. Post World War 2 period, for instance, sawa number of European states borrow externally to rebuild their economies in the Marshall plan of 1948. Market fundamentalists, however, believe that an increase in public debt crowds out the private sector thus reducing private sector investment hence a decline in economic growth. This argument is largely hinged upon the notion of domestic borrowing. New Keynesians counter such an argument in their assertion that the government may be using otherwise idle resources. Other scholars including Barro posit that based on debt neutrality, changes in public debt have no effect on the growth of output. Comment by Urbanus Kioko: reference Comment by Urbanus Kioko: does this still stand? Is govt better than private sector? Comment by Urbanus Kioko: What is this? Comment by Urbanus Kioko: Comment by Urbanus Kioko: This is not correct english Comment by Urbanus Kioko: Reference

Public debt is any financial obligation including bonds and loans assumed by the government, where it agrees to make interest and principal payments on certain dates. Public debt can be raised both externally and internally. Internal debt refers to debt borrowed by the government within the country from individuals, banks, and corporations. Internal debt in Kenya consists of treasury bills and bonds. Debt due to be paid to lenders outside the country is referred to as external debt. Comment by Urbanus Kioko: reference Comment by Urbanus Kioko: reference

Public debt in Kenya has been on the rise between 2000- 2003 after which it declined between 2003- 2007. After 2007, debt-to-GDP ratio rose steadily until 2010. Growth of GDP has remained relatively low and stable during the period although it was slightly affected by the financial crisis of 2007- 2008. Comment by Urbanus Kioko: reference

Figure 1: GDP growth and debt-to-GDP ratio over time

According to the Central Bank of Kenya, public debt was approximately KshsSH. 6 trillion by the end of 2018. This was indicative of 15.2% increase. Similarly, the country’s budget deficit increased to 7.4% from 6.8% while debt per capita more than doubled over the period 2017- 2018. Comment by Urbanus Kioko: show growth in pubic debt in absolute numbers Comment by Urbanus Kioko: source Comment by Urbanus Kioko: increase from what? Comment by Urbanus Kioko: Refeernce

Economic growth is the change in the production of goods and services and reflects an economy’s productive capacity. That is, growth of real output indicates the health of an economy and is an enabler towards the realization of economic development. In practice, economic growth is examined from the supply side although its characterization follows demand side economics. Based on supply- side economics, growth of output is a function of growth of labor and growth of capital. From the demand side, however, economic growth is analyzed based on changes in the business cycle. That is, the economy is at boom and growth is positive if actual output exceeds potential output. Similarly, real output falling below potential output is characteristic of recessions and slumps and is typical of declining growth. Comment by Urbanus Kioko: Provide references, and perhaps theories backing these statements

Kenya’s GDP grew steadily in the period 2002-2007 before declining from 2007-2008. This decline in GDP could be due to global financial crisis of 2007/2008 and post-election violence in Kenya that undermined production. The economy picked up from 2009 to 2011 before once again slumping in 2012. Comment by Urbanus Kioko: Use the graph above to explain. Also explain the factors where the growth is low, and factors contributing to decline and increase as shown in the graph

1.2 Statement of the Problem

With a rise in public debt and relatively stable economic growth, debate is rife on the effects of increased public borrowing on the economy. The government remains optimistic of the economy’s resilience to meet debt obligations. Policy makers and economic think tanks, both locally and abroad, however, are pessimistic about debt and fiscal sustainability. Economists in general have over the years held divergent views on debt- GDP dynamics. In the 1960s and 1970s, for example, it was argued that proper utilization of debt in developing countries fosters economic growth. The extent to which growth is realized, however, varied from one economy to another. Comment by Urbanus Kioko: reference

Debt accumulation by a number of emerging economics coupled with economic stagnation or decline in economic growth led to a rethinking in the 1980s. It was later established jointly by the World Bank and the IMF that debt accumulation in an economy experiencing declining growth struggling with economic growth shock further devastates it. Pankaj et al (2011) argued that a country’s growth of GDP determines its level of debt sustainability. Comment by Urbanus Kioko: rethinking in terms of what? Provide reference Comment by Urbanus Kioko: rewrite this sentence Comment by Urbanus Kioko: where is the problem? You have not shown the gap? Several similar studies have been undertaken in the country, what is the gap that y=the team is addressing?

The main objective is to determine the impact of public debt on economic growth in Kenya. The specific objectives of the study are the following:

(i) To determine the relationship between public debt and GDP growth.

(ii) To determine the relationship between public debt and current account balance. Comment by Urbanus Kioko: This is not clear from the background information and statement of the problem

(iii) To determine the relationship between current account balance and growth of GDP.

1.4 Significance of the Study Comment by Urbanus Kioko: Here you are required to show what your contribution to new information/knowledge is, importance of the findings to policy makers and planners, new evidence to be generated by the study, benefit to researchers etc

Makau (2012) suggested the effect of public debt on economic growth as an area for further studies. In his study, he did not incorporate primary surplus. Moreover, his study covered the period ending 2010. According to IMF (2014), debt sustainability framework ought to incorporate an assessment of a country’s primary balances. This study, therefore, contributes to the existing body of knowledge by analyzing the effect of public debt on the growth of GDP by using more recent data.

This chapter is subdivided into twohree sections, namely; (a.) theoretical literature, (b.) empirical literature, and (c.) literature overview. The first section presents various scholarly debates and discussions relevant to the topic. The second section captures the empirical findings from previous studies. The last study presents a summary of the literature.

2.2 Theoretical Literature

Economic growth has previously been addressed in a number of models including Solow (1956) and Swan (1956) neoclassical growth model, dual gap model, and Keynes (1936). Theories of economic growth are modifications of Cobb & Douglas (1928) production function. Public debt theories include debt overhang theory, debt neutrality theory, and the classical theory.

Solow (1956) and Swan (1956) developed this theory. According to the neoclassical growth model, the level of technical progress is determined outside an economic system. Capital and labor are, however, endogenous variables. Growth of output is analyzed in per capita terms with output per capita being a function of capital per capita. An economy with low initial capital per capita grows faster than one with high capital per capita. Capital accumulation continues until the steady state is achieved. With an increase in the stock of capital, investment increases since investment is an increasing function of capital. Similarly, an increase in per capita output increases the savings.

If required investment is lower than planned savings, capital per capita increases until the steady- state level of capital per capita is achieved. Similarly, if planned savings are lower than required investment, capital per capita reduces until the steady- state level is achieved. In a technology neutral economy, a shift in steady state equilibrium to the right necessitates the use of external capital. Thus, a country that was initially at equilibrium but later experienced a rightward shift will need to rely on external capital. Put differently, the country will have to borrow externally.

According to IMF (2014), sustainable economic development is when the country uses her own national savings to finance investment activities. That is, national savings must exceed national investments. It is, however, not always possible for countries to have sufficient savings to offset investments. This negative savings- investments gap forces countries to borrow externally. In doing so, caution must be exercised to ensure that foreign resources equal domestic savings. This, however, may not materialize since foreign resources may exceed domestic savings thus resulting in a negative domestic savings- foreign resources gap. Further accumulation of foreign resources may result in unsustainable public debt which may stifle economic growth in future. According to IMF (2014), this might largely be as a result of domestic savings shrinking farther as they are used to repay the loan rather than be employed productivity within the country.

Keynesian (1936) argued that savings affect growth of GDP through the channel of investment. With low levels of savings, investments tend to be low resulting in low levels of growth output. A country having low levels of national savings, thus, has to borrow to finance an increase in the level of investments. According to Keynes (1936), public debt positively affects growth of output through the deployment of borrowed funds to productive purposes. Keynes (1936) further paves the way for the government to borrow locally in what is otherwise referred to as idle financial resources.

Reinhart & Rogoff (2012) argued that accumulation of huge public debts results in economic stagnation. According to Kehoe & Prescott (2007), failure of a government to run debt- stabilizing primary balances plunges an economy into recession and at times even in depression. A rise in debt-to-GDP ratio without necessary primary balances may result in primary balance shock. Similarly, GDP growth shock may force a country to negotiate more debt thereby worsening debt stress situation as well as further stifling economic growth. Thus, debt overhang hinders economic growth.

A number of previous empirical studies established disagreements in the relationship between public debt and economic growth. While some studies found no significant relationship between GDP growth and public debt, others concluded that a negative relationship exists between them. These studies employed a variety of data with differing time periods. Some studies, for instance, employed time series data while others used panel data. Comment by Urbanus Kioko: Cite some of these studies Comment by Urbanus Kioko: Cite these studies

Egbetunde (2010) studied the relationship between public debt and economic growth in Nigeria using time series data for the period 1970- 2010. The study employed a vector autoregressive (VAR) model. The study established that Granger causality exists between public debt and economic growth in the long run. In the short run, however, there is no relationship.

Woo & Kumar (2010) studied the long run impact of public debt on growth of GDP in advanced and emerging markets using panel data for 30 countries from 1970- 2010. The study employed panel regression techniques. The study concluded that an inverse relationship exists between initial debt and subsequent growth of GDP. The impact of debt on growth of GDP was, however, found to vary, being smaller in advanced economies and bigger in emerging economies. The inverse relationship was attributed to large debts slowing down the growth of labor productivity through the channel of investment.

Akram (2011) studied Pakistan’s borrowing habits and economic deterioration. The study used time series data for the period 1990- 2005 and employed the autoregressive distributed model (ADM). External debt was found to have a significant negative impact on investment and per capita GDP both in the short- and long- run. Domestic borrowing, on the other hand, was found to have a significant negative relationship with investment but not GDP.

Gorgievski (2015) studied the impact of public debt on the economic growth in Macedonia using time series data for the period 1999- 2014. Ordinary least squares regression technique, vector error correction method, and Johansen co-integration test were employed. The study established that a significant negative relationship exists between initial debt and economic growth in the long run. In the short run, however, the relationship was not significant.

Panizza & Presbitero (2014) studied causal effect of public debt and economic growth in OECD countries using panel data covering 14 countries for the period 1990- 2012. They employed instrumental variable (IV) approach. The study concluded that a negative relationship exists between public debt and growth of GDP. This was largely attributed to endogeneity in the model which disappeared once the model was corrected.

Eberhardt & Presbitero (2015) studied heterogeneity and non-linearity of public debt and growth using a large panel of 118 countries over the period 1960- 2012. They employed panel regression technique. The study established that a negative long run relationship exists between public debt and GDP growth across countries. Within countries, however, the relationship is inexistent. Comment by Urbanus Kioko: Ensure that this work has not been plagiarized

Saifuddin (2016) studied the effect of public debt on economic growth in Bangladesh using time series data for the period 1974- 2014. The model was estimated using time series least squares (TSLS) regression technique. The study concluded that public debt has an indirect positive effect on economic growth. This was attributed to the effect public debt had on investment.

Kobey (2016) studied the effect of public debt on economic growth in Kenya using time series data for the period 1993- 2015. The study employed linear regression model and the coefficients were estimated using ordinary least squares regression technique. He concluded that public debt is negatively related to economic growth. This relationship was however found not to be significant.

Ngugi (2016) also studied the effect of public debt on economic growth in Kenya using time series data for the period 1980- 2013. She employed ordinary least squares regression technique. The study concluded that domestic debt has a negative effect on the growth of GDP. This was attributed to the crowding out effect that shrunk the private sector. Similarly, a positive relationship was found to exist between external debt and GDP growth. This was attributed to healthier loans from global financial markets.

Theoretical literature reveals a divergence of opinion on the effect of public debt on economic growth. Keynesian and neo-classical theory indicates that public debt fosters economic growth. Dual gap theory and debt overhang, however, indicate that accumulation of public debt stifles economic growth.

Empirical literature indicates a discrepancy with some studies indicating a significant negative relationship between GDP growth and public debt. Other studies establish a non-significant relationship. Domestic debt is found to have a negative effect on the growth of GDP while external debt positively affects GDP growth. To sum it up, this study seeks to establish whether public debt has a significant effect on GDP growth in Kenya using more recent data.

The study used descriptive research design. Descriptive research, in general, describes the features of a phenomenon or population under the study. Descriptive research design is appropriate to this study since it captures the relationship between public debt and economic growth. Comment by Urbanus Kioko: Used or will use?

This study will use secondary, time series data from the central bank of Kenya, the national treasury, IMF, and the World Bank. For purposes of currency, the data will cover the period 2000- 2015. The data will be checked for outliers and cleaned using Turkey’s approach. Comment by Urbanus Kioko: See 3.1 1st sentence Comment by Urbanus Kioko: This is not proper language Comment by Urbanus Kioko: Explain how this works

Cobb & Douglas (1928) conceptualized output as a function of labor and capital. Keynes (1936) conceptualized economic growth as a function of government expenditure. Using national output as a proxy to economic growth, Keynes (1936) presented the following model:

Y=C+I+G+NX

Where Y= national output, C= private consumption, I= private investment, and NX= net exports.

………………………………………………………………………………………… (1)

Keynes (1936) argued that government borrowing affected government expenditures. Thus, public debt affects economic growth through government expenditures.

The IMF (2014) conceptualized economic growth as a function of growth of potential output, real effective exchange rate, primary balance, and debt-to-GDP ratio. Their model was given by: Comment by Urbanus Kioko: From the studies reviewed, which frameworks were used, and which one will be used for this study?

y= α0+ α1*r+ α2*d+ α3*p/d Comment by Urbanus Kioko: use equation formulas

Where y= growth of GDP, d= debt-to-GDP ratio, p= primary surplus

…………………………………………………………………………………. (2)

Equations (1) and (2) provide the conceptual framework for this study.

Previous studies including Makau (2012) and Akram (2015) relied upon Sala-i-Martin (2005) model in analyzing the effect of public debt on economic growth. According to Sala-i-Martin (2005), economic growth is a function of interest rates, exchange rates, debt-to-GDP ratio, and private sector investment. This study will employ a modified version of Sala-i-Martin (2005) given by: Comment by Urbanus Kioko: you should cite these in section 3.4

Yt = α0+ α1Gt+ α2Dt+ α3CABt+ α4UNt+ α5RIRt+ α6INFLt+Et Comment by Urbanus Kioko: use standard approach of writing equations

Where Y=growth of real GDP, G= growth of public expenditure, D= debt-to-GDP ratio, UN= unemployment rate, INFL= inflation rate, CAB= current account balance, RIR= real interest rates, E= error term, t= time, α= regression coefficient

The model will be estimated using ordinary least squares regression (OLS) technique. According to Tobit (2019), OLS technique is preferred in estimating time series data. This will be accomplished with the help of Excel, STATA, and R software. Comment by Urbanus Kioko: provide a summary of variables used, their definition, measurement, and apriori expected effect on the dependent variable

Tobit (2019) argues that using data with a non-stationary trend results in spurious results. The variables will thus be tested for stationary trend using unit root test aided by Augmented Dickey- Fuller (ADF) test. The null hypothesis is the statement that a unit root is present implying that the trend is not stationary. Presence of a non-stationary trend will be corrected using the difference operator.

The estimated model will be tested for individual and joint significance of the regression co-efficients. This is important since discussion of the results hinges upon variables and/ or coefficients that have either economic or statistical significance.

Table 1 presents descriptive statistics as well as correlation between growth of GDP and the other variables. The mean indicates that on average, debt-to-GDP ratio was the highest followed sequentially by log negative current account balance, unemployment rate, real interest rate, inflation rate, GDP growth, and growth of government expenditures. Standard error indicates that debt-to-GDP ratio was the most volatile followed by real interest rate, growth of government expenditure, inflation rate, GDP growth, and unemployment rate. Minimum and maximum values provide information about the range. Based on this, real interest rates and growth of government expenditures were negative at some point. Similarly, there was neither deflation nor negative growth of GDP over the period. Comment by Urbanus Kioko: ???

The last column shows the coefficient of correlation between GDP growth and the other variables. Based on this, a positive relationship exists between GDP growth and log negative current account balance. GDP growth is negatively related to the following variables: debt-to-GDP ratio, unemployment rate, inflation rate, growth of government expenditures, and real interest rates. Comment by Urbanus Kioko: ???

Analysis of variance (ANOVA) indicates that 55% of the variations in GDP growth are explained by variations in debt-to-GDP ratio, unemployment rate, log negative current account balance, real interest rate, inflation rate, and growth of government expenditures. This figure, however, drops to 16% when adjusted for the number of predictors suggesting a possibility of irrelevant variables in the model. When log negative current account balance was replaced with current account balance, the overall fitness of the model improved with adjusted R- squared increasing from 16% to 30%. Thus, the model having current account balance was preferred to the one with the logarithm of current account balance. This, however, did not affect the joint significance of the coefficients since although probability >F dropped from 33% to 16%, it still remained greater than the 10% level of significance. Comment by Urbanus Kioko: Why do use logs? How did you transform the variables into logs, and why? Comment by Urbanus Kioko: This is where you should provide interpretation of each coefficient, indicating whether it is significant and to what level?

From economic theory, the intercept stands for growth of potential output. Statistically, the intercept was found not to be significant. The coefficients of debt-to-GDP ratio and inflation rate were found to be statistically significant using original data. However, in adjusting for non- stationary trend, only the intercept was found to be statistically significant. The estimates indicate that potential GDP grew by approximately 5.4%. Comment by Urbanus Kioko: You do not interpret this intercept, Comment by Urbanus Kioko: This section need to be improved,

Pre-estimation tests included data cleaning and test for a stationary trend. The stationary trend was tested using Augmented Dickey- Fuller (ADF) test in STATA. A non- stationary trend results in spurious results. Variables having non- stationary trend were corrected using the difference operator until a stationary trend was achieved. After pre-estimation, descriptive and summary statistics were examined using STATA software.

Overall significance of the model was based on F- statistic and p- value from the F- distribution. The p- value was estimated at 15.72%. This value is greater than the 10% level of significance. The study concludes that the model is not fit for the data. Individual significance of the coefficients was based on the t- statistic and p- value from the student- t distribution. Using the t- statistic, absolute values were compared with t=2 with the decision rule being the rejection of non- significance for t>2. P-value approach was based on comparing computed p-values with the level of significance at 10%. The decision rule was given by the rejection of non- significance for p- value > 10%. The study concludes that debt-to-GDP ratio and inflation have a statistically significant effect on the growth of GDP. The study further established that debt-to-GDP ratio and inflation rate each has a negative relationship with the growth rate of GDP since they have negative coefficients.

Barro (1996) concluded that inflation has a significant but negative effect on the growth of per capita output. Kasidi & Mwakanemela (2013) similarly established that inflation has a significant negative effect on economic growth. Kigumo (2005) concluded that a significant negative relationship exists between inflation and economic growth.

Eberhardt & Presbitero (2015), Panizza & Presbitero (2014), and Ngugi (2016) concluded in their studies that a significant negative relationship exists between public debt and economic growth. These findings, however, conflict those of Kobey (2016) who established that the relationship was not significant, Eberhardt & Presbitero (2015) and Akram (2011) who concluded that the relationship does not exist.

This chapter captures a summary of the research paper, conclusions from the empirical findings, and policy recommendations as well as areas for further studies.

The purpose of this study was to examine the impact of public debt on economic growth in Kenya. The study used time series data for the period 2000- 2016 and employed multiple linear regression model. Growth of GDP was the dependent variable while the following were the independent variables: debt-to-GDP ratio, unemployment rate, current account balance, growth of government expenditures, inflation rate and real interest rates. The variables were first tested for a stationary trend and corrected in the event of presence of a non-stationary trend. Thereafter, the model was estimated using ordinary least squares (OLS) regression technique.

The study established that 55% of variations in GDP growth were attributed to variations in the independent variables used in the model. The study further concluded that current account balance has no significant effect on the growth of GDP. Debt-to-GDP ratio and inflation rate were, however, established to have a significant negative effect on the growth of GDP. This findings, however, were established to hold only when the model is not corrected for a stationary trend. After correcting for a stationary trend, only the intercept was found to be statistically significant with a coefficient of 5.4%. The study, therefore, concludes that growth of GDP depends on the growth of potential output which is approximately 5.4%.

A significant negative relationship between debt-to-GDP ratio and GDP growth implies that the growth of GDP declines with an increase in debt-to-GDP ratio. That is, as more debt accumulates, GDP declines. The government should thus cut down borrowing in order to prevent crowding out of the private sector and to foster growth of GDP. Moreover, the government should withhold debt servicing to prevent withdrawal of productive resources from the economy.

A significant negative relationship between inflation rate and GDP growth indicates that output declines as price levels rise. That is, increase in price levels beyond certain limit distorts the incentive for producers to increase output as well as for households to consume due to distortion of purchasing power. The government should thus tame inflationary pressures to be within the 2-7% level recommended by Keynes (1935). The study recommends inflation targeting as a way of ensuring that price adjustments do not distortion the purchasing power of consumers not disincentives producers to increase output.

A significant positive relationship between GDP growth and the intercept implies that growth of GDP is hinged upon the growth of potential output. Thus, to increase GDP growth, the study recommends the government to put in place measures that improve labor productivity, enhance technological progress, increase capital efficiency, and increase the productivity of land.

This study examined the effect of public debt on economic growth in Kenya using debt-to-GDP ratio and the growth rate of GDP. Debt-to-GDP ratio is, however, not a good indicator of the debt burden falling on individuals. The study, therefore, identifies the impact of growth of per capita debt on the growth of per capita output in Kenya. Recent debt sustainability framework by the International Monetary Fund and the World Bank incorporate primary balances in analyzing debt. The study, thus, identifies the relationship between primary balances and external borrowing in Kenya as another area for further studies.

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GDP Growth

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 3.8 0.5 2.9 5.0999999999999996 5.7 6.5 6.9 1.5 2.7 8.4 6.1 4.5999999999999996 5.9 5.4 5.7 debt-to-GDP ratio

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 52.23 56.22 61.84 60.13 53.8 48.34 43.98 38.369999999999997 41.47 41.1 44.4 43.05 40.81 42.24 48.6 48.8

Year

%