MACROECONOMIC EFFECTS OF FINANCIAL DEEPENING BETWEEN 1990 TO 2023 ON ECONOMIC GROWTH IN KENYA

Abstract

Financial deepening has been found to stimulate economic growth by its capability to mobilize investments, thereby making financial resources readily available and, hence, raising efficiency. However, the reviewed empirical literature on the relationship between financial deepening and economic growth is not very clear in Kenya. The primary objective of the study is to examine the macroeconomic effect of financial deepening on economic growth in Kenya. The specific objectives are to determine the effect of credit to the private sector, stock market capitalization, commercial bank liquidity liabilities, broad money supply, and commercial bank deposits on the growth of the economy in Kenya. The study employed the following theories: the Endogenous Growth theory, the Neoclassical theory, Financial Liberalization Theory, Supply Leading theory. The study employed an explanatory research design and used secondary data from the World Bank and KNBS, with data spanning from 1990 to 2023. The data was subjected to stationarity and cointegration tests to test if the time series has stationary and long-run properties. Autoregressive Distributed Lag (ARDL) model estimation technique was used to achieve the research objectives. The ARDL regression results show that in the long run credit to the private sector 0.41(p-value 0.00<0.05), stock market capitalization 0.04(p-value 0.00<0.05), bank deposit 1.419(p-value 0.00<0.05), liquidity liabilities 0.004(p-value 0.00<0.05), broad money 1.55(p-value 0.00<0.05) and deposit interest rate 0.08(p-value 0.00<0.05) have significant positive effect on economic growth. In contrast, inflation rate -0.08(p-value 0.00<0.05) has a negative impact. In the short run, credit to private sector 0.15(p-value 0.01<0.05), stock market capitalization 0.02(p-value 0.03<0.05), bank deposit 0.84(p-value 0.00<0.05), broad money 0.30(p-value 0.02<0.05) and interest rate 0.03(p-value 0.00<0.05) are positively related to economic growth while inflation rate -0.03(p-value 0.00<0.05) has a negative impact. Liquidity liabilities - 0.0004(p-value 0.15>0.05) is negatively related to economic growth but statistically insignificant in the short run. Further, the results show a relationship between financial deepening and GDP growth in Kenya. Thus, the policymakers should improve the money supply in the economy to stimulate economic growth. This could be achieved through policies encouraging savings and investment and broadening the financial instruments available to the public. Financial institutions should be incentivized to innovate and offer various attractive savings and investment products to different population segments. By doing so, they can mobilize more funds from the public, which can then be channeled into productive investments that drive economic growth.