Impact of International Remittances on the Financial Sector Development and Economic Growth of Kenya

Abstract

Existing literature on remittances and its effects on financial development and economic growth is inconclusive due to the fact that economic conditions, remittances inflows and the state and size of the financial sector vary from one country to another. This paper examines the effect of international remittances on the development of the financial sector and the overall economic growth of Kenya using Vector Error Correction Model. This research work has two equations, with the dependent variable on the first equation being Gross Domestic Product, a common proxy for economic growth. On the second equation the dependent variable is Financial Development. The time-series data used was collected from secondary sources and is annual and covers the period between 1975 and 2014. The Vector Error Correction Model is used in the main empirical estimation. The VEC model estimation results indicate that international remittances have a negative but insignificant impact in the short run and a positive and significant effect on the growth of the GDP in the long run. The Granger causality tests reveal that remittances do not Granger-cause economic growth. The Variance decomposition test predicts that in the long run remittances grow in significance to account for only 1.8264 per cent of the variations in the GDP. The VEC model estimation results for the second model of this research reveal that in the long run, remittances have a positive and significant effect on financial sector development. The Pairwise Granger causality test also shows that remittances Granger-causes financial development at 5 per cent level of significance. The variance decomposition procedures show that in the long run, remittances increases in influence in explaining up to 0.9503 per cent of the variations in Kenya’s financial development.