Effect of external debt on inflation: the case of Kenya, Tanzania and Uganda

Abstract

High inflation is considered to be a threat to growth of emerging countries. However, most of these countries need to borrow in order to cater for budget deficits and sustain economic growth. The aim of this study is to empirically investigate the effect of external debt on inflation in Kenya, Uganda and Tanzania for the period 1988-2018. Other independent variable is included, broad money growth rate, and analysed if it helps in explaining the relationship between external debt and inflation. The study uses a balanced annual panel data obtained from World Bank International Financial Statistics and Data Files. The variables are tested for stationarity to establish their order of integration and select a suitable model. Two tests are done for robustness, Engle and Granger, and Johansen's Cointegration to test for availability of co-integration relationship among the variables. A Vector Error Correction Model {VECM) is employed to estimate long run dynamics and Granger Causality to test if the co-integrated variables can help in predicting each other. The results show that external debt has a positive long-term effect on inflation and that money growth helped in explaining this relationship. Moreover, it was found that there is a unidirectional causality between external debt and inflation. This causality was found to be homogeneous. It is therefore necessary for governments to effectively manage external debt so as to avoid negative economic circumstances which may affects other countries in the region .