Relationship between Budget Deficit and Current Account Balance in Kenya
Abstract
As a rule of thumb, current account deficit should not exceed 5% of GDP. If it exceeds, it must raise concerns about its sustainability. In Kenya, current account balance deficit increased to 10.5% of the GDP by 2014 and 8.3% in 2015. Unsustainable current account deficits are a potential recipe for a currency crisis and current account reversal which have negative implications on macroeconomic stability of a country. The purpose of this study is to examine the effect of budget deficits on current account deficits in Kenya. The specific objectives were to establish relationship between budget deficits on current account deficits in Kenya, to find out the short term or a long run relationship among the variables and to identify direction of the causality. The study was guided Keynesian Theory and Ricardian theory. An explanatory research design was adopted. The study covered the period of 1970 to 2017. The study used data from secondary sources including WDI, KNBS and Economic Surveys. Descriptive statistics such as mean and standard deviation was used to perform data analysis. EVIEWS was used in the analysis. Autoregressive Distributed Lag model was used to estimate the best model. The speed of adjustment towards long run equilibrium was 44.6484% implying that the system will get back to long run equilibrium at the speed of 44.6484%. The study concluded that budget deficit have a significant long run effect on Current account deficit and also Current account deficit have a significant long run impact on Budget deficit. The study concluded that there exist a short run relationship between budget deficit and current account balance. For Kenya to progress the study advocates for favorable current account balance by reducing persistent deficits and achieving current account balance sustainability, several policy options should be applied. Deliberate export oriented approaches through product diversification and international trade promotion to ensure that our products can be competitive in the international markets. For Kenya to progress the study advocates for favorable current account balance by reducing persistent deficits and achieving current account balance sustainability, several policy options should be applied. Stability in exchange rate and low inflation are critical in ensuring productivity growth.
Kew words: budget deficits, causality, current account deficits.
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