Discussion Paper No. 239 of 2020 on Assessing the Impact of Private Sector Credit on Economic Growth in Kenya

Abstract

In many economies, private sector credit plays a critical role by efficiently allocating resources for investment and is considered to be an engine of economic growth. This study examined the impact of the interest rate cap on credit uptake by different sectors and also the impact of private sector credit on economic growth. The HP filter, ARDL approach to cointegration are used to assess these impacts. The results show that capping of interest rates led to an average decline of total credit by about 4.3 per cent per month from its precapping level. In terms of sectoral credit uptake, the ARDL estimates reveal that, on average, the agriculture sector experienced the largest decline of about 5.4 per cent relative to other sectors. The study finds that there is a positive and significant long-run and short-run relationship between access to private sector credit and real GDP growth in Kenya. The elasticity of real GDP growth with respect to private sector credit is about 0.25 and is statistically significant and economically important. This relationship suggests that the short fall in private sector credit (of approximately 4.3%) following the introduction of interest rate caps is associated conservatively with a shortfall in real GDP growth of about 1.1 per cent relative to the baseline (pre-capping period). This is a massive drag on growth and jobs, holding back the country from making progress in promoting inclusive growth. The findings from this paper go a long way in plugging a huge information gap on the part of policy makers on the impact of interest rate caps on growth in Kenya. Policies to enhance access to private sector access remains top priority, including during the COVID-19 pandemic. Accelerating private sector’s contribution is extremely important especially at a time when public sector investment is constrained and the economy reeling from the impact of corona virus. Policies to support firms to access liquidity and credit remain very critical both during the crisis phase and more importantly during the recovery phase.