Ernest Mashinda Chisongo

This study investigates the impact of Government domestic borrowing on private sector credit and economic growth in Kenya over the period from 1998 to 2010.  The study also seeks to determine the threshold for Government domestic borrowing at which it begins to impact private sector credit negatively.  There is no unanimity as to whether Government domestic borrowing crowds out private sector credit and consequently leads to low investment and low economic growth.  This study is guided by the theory of the impact of public domestic debt on private sector credit and economic growth.  The objectives of the study included determining the impact of Government domestic borrowing on private sector credit, determining the threshold at which Government domestic borrowing begins to impact negatively private sector credit and GDP growth, determining the impact of inflation on GDP growth and private sector credit and determining the impact of GDP growth on private sector credit and that of private sector credit on GDP growth. 

 Using quarterly time series data, the study uses 2 Stage Least Squares, 3 Stage Least Squares and Generalised Method of Moments of Instrumental Variable estimation due to the feedback relationship between GDP growth and private sector credit.  The study found a significant negative relationship at the 1 percent significance level between Government domestic borrowing and private sector credit in Kenya.  This implies that Government domestic borrowing crowds out private sector credit.  It was also found that as Government domestic borrowing increases beyond a threshold ratio of about 9 percent of GDP and beyond a growth rate of about 25 percent per annum, it begins to negatively impact private sector credit and economic growth.  The study also found a significant bi-directional positive relationship between private sector credit and GDP growth.  The study also found that inflation has a significant negative impact on private sector credit.  In addition, the study revealed that inflation in Kenya is growth inhibiting as it impacts negatively on GDP growth.Based on the findings of this study, it is recommended that the Government of Kenya should manage its domestic borrowing to avoid crowding out private sector credit.  The level of Government domestic borrowing at an average of 32 percent of GDP is higher than is required, hence the need for reduction in public domestic debt accumulation and expanding the domestic credit market.