Impact of Public Debt on Private Investment in East Africa: Do Institutions Matter?

Abstract

The East African countries have ambitious development strategies to transform their economies to high income levels. In order to realize these high economic growth levels, governments have put in place development strategies to boost public investment in mega infrastructural projects, institutions and various incentives to augment private sector development. Larger percentages of these governments’ budgets are financed by public debt which may impact on Private Investment. Domestic borrowing may crowd out private investors and continued debt accumulation may also result in high taxation rates to service debt. With the increasing public investment, development of institutions, ventures like the structural adjustment programmes, and highly indebted poor countries initiatives, the private investment have not realized much output. Taking into account that there is increasing infrastructural development, then public debt is bound to rise. However, institutions may play a role in the efficient allocation of resources and lowering the cost of doing business. This study, using a panel of four countries for the period between 1992 to 2015, with ARDL Panel Model using data from World Bank and IMF databases, established that Public Debt crowds-out Private Domestic Investment and Foreign Direct Investment in the long run. The magnitude of the impact is greater for Private Domestic Investment compared to Foreign Direct Investment. In order to bring out the importance of institutions in determining Private Investment levels, corruption-control is interacted with public debt. The regressions with the interaction term indicate that both PDI and FDI improve when institutional quality improves. Since corruption control is seen to improve the private investment levels, governments need to enhance efficiency in resource utilization for public programmes that compliment Private Investment.

Credit availability to private sector, GDP and corruption-control were found to be significant and positively related to Private Domestic Investment. Therefore policies in line with an improvement in fiscal policies, financial development, good governance and general macro-economic stability would be crucial in promoting Private Investment in East Africa. KEY WORDS: Public Debt, Private Domestic Investment, Foreign Direct Investment, Corruption-control