Effect of sovereign credit ratings on foreign direct investment to Kenya: the moderating role of institutional quality.

Abstract

Foreign direct investment (FDI) plays an important role in the economic growth of nations through capital inflows, technology transfer, and job creation. However, FDI to Kenya has remained relatively low and volatile. This study examined the effect of sovereign credit ratings and rating outlooks on FDI into Kenya, with the moderating role of institutional quality. The study also controlled for macroeconomic factors, including GDP growth, inflation and trade openness. Using annual time-series data for the period 2006 to 2023, the study employed a quantitative explanatory design and employed Ordinary Least Squares (OLS) regression analysis to examine the effect of sovereign credit ratings and rating outlooks on foreign direct investment in Kenya. The results indicated that sovereign credit ratings and rating outlooks do not have a statistically significant direct effect on FDI into Kenya. While the inclusion of macroeconomic control variables improved the models' explanatory power, their individual effects were not statistically significant. However, when institutional quality was introduced as a moderating variable, a significant interaction effect was observed between sovereign credit ratings and institutional quality. This suggests that the influence of sovereign credit ratings on FDI depends on the quality of a country's institutions, highlighting the importance of governance, regulatory effectiveness, and institutional credibility in attracting foreign investment. The study contributes to the existing literature by integrating sovereign credit ratings, rating outlooks, and institutional quality to explain FDI in the Kenyan context. The findings underscore the importance of strengthening institutional quality while maintaining a stable macroeconomic environment to support sustainable FDI into Kenya.

Keywords: Foreign Direct Investment, Sovereign Credit ratings, Rating Outlooks, Institutional Quality, Signaling theory, Institutional theory, Kenya