ABSTRACT
Despite the stock markets’ pivotal role towards economic growth, stock market development in Kenya and its contribution to economic growth is still an issue of great concern to policy makers and scholars. The Kenyan stock market is characterized by a small number of listing, lack of sophisticated infrastructure, narrow range of tradable instruments and very low liquidity. Moreover, the market is highly volatile as evidenced by high volatility in key market indicators during the period under study. Foreign investors play a significant role towards stock market development by enhancing the value of stocks and their liquidity. Hence, the study sought to establish the effect of foreign financial inflows on stock market development at the Nairobi Securities Exchange, Kenya. The Specific objectives of the study were to assess the effects of Foreign Direct Investment, Foreign Equity Portfolio, Foreign Debt Portfolio and Diaspora Remittances on stock market development at the Nairobi Securities Exchange, Kenya. The study further assessed the mediating effect of foreign investor participation on the relationship between foreign financial inflows and stock market development as well as the moderating effect of political risk on the relationship between foreign financial inflows and stock market development. The study was anchored on the Base Broadening theory, Foreign Direct Investment Dependence theory, Neoclassical Theory of Investment, Trade Off theory and the Pure Self Interest theory. The study adopted a positivism philosophy as well as causal research design methodology. The study adopted a census approach and time series data for the period 2008-2018 was obtained from Capital Markets Authority quarterly statistical bulletins, Central Bank of Kenya monthly reports, Nairobi Securities Exchange annual reports and the United Nations Conference on Trade and Development website, using a secondary data collection schedule. To ensure non-violation of the assumptions of classical linear regression, the following diagnostic tests were conducted; Normality, Heteroskedasticity, Autocorrelation, Stationarity and Multicollenearity and Model Stability test. The data was then analysed using correlation analysis, Modified Least Square Regression analysis and the Autoregressive Distributed Lag Model. The Modified Least Squares regression analysis was used in testing the direct effects of foreign financial inflows on stock market development while the autoregressive distributed lag model was used to test for existence of long run and short run cointergration with the aid of E- views
9.5 and SPSS 23 statistical software. The direct effect test indicates that diaspora remittances and foreign debt portfolio had positive and significant effect on stock market development whereas foreign direct investment had a negative and significant effect on stock market development. Foreign equity portfolio inflows however had negative but insignificant effect on stock market development at the Nairobi Securities Exchange, Kenya. The mediating effect of foreign investor participation on the relationship between foreign financial inflows and stock market development was not statistically significant. However, foreign investor participation was positive and significant as a predictor of stock market development. Political risk was not significant both as a predictor of stock market development and as a moderator in the relationship between foreign financial inflows and stock market development at the Nairobi Securities Exchange. The autoregressive distributed lag test results support the existence a significant short run positive effects of all foreign financial inflows on stock market development as evidenced by the negative and significant coefficient of the Error Correction Term (ECT). However, in the long run only diaspora remittances and foreign debt portfolio had a significant positive effect on stock market development while foreign direct investment had a significant negative effect on stock market development. The effect of foreign equity portfolio on stock market development was equally negative but insignificant in the long run. In view of the foregoing findings, the study recommends that the Kenyan government needs to devise measures that would boost foreign investor confidence and thus attract increased diaspora remittances and foreign debt portfolio investment. Additionally, the Capital Markets Authority needs to implement policy measures that will attract active participation of the local investors to invest at the Nairobi Securities Exchange. This will give the bourse more stability, liquidity and subsequently lead to increased value of stocks listed at the market.
CHAPTER ONE INTRODUCTION
Background of the Study
The stock market provides a framework upon which investors can diversify their investments and a platform upon which corporate institutions can raise additional funds. The stock market is therefore an important component of the capital market that mobilizes surplus liquidity and ensures that funds are channeled towards productive corporate users (Rahman & Mustafa, 2017). The stock market does not only spur economic growth but also aides in poverty reduction by providing a wide range of risk mitigation and investment products at reduced transaction cost (Oziengbe & Ovueffyen, 2013). Development of financial markets leads to improved quality and quantity of investments thus quicken the pace of economic growth and improves the living standards of the citizens (Nera & Eke, 2017). The Kenyan economic blue print of vision 2030 aims at transforming the country into a newly industrialized middle income country that provides high quality life to its citizens. Moreover, the vision 2030 envisions an efficient and transparent stock market. This huge milestone is to be achieved through the deepening of the financial markets by expanding the bond market, equity market and leveraging on remittances and other long term foreign capital inflows (Republic of Kenya, 2007).
Despite the stock markets’ pivotal role towards economic growth, stock market development in Kenya and its contribution to economic growth is still an issue of great concern (Republic of Kenya, 2016). Emerging capital markets are typically characterized by a small number of listing, lack sophisticated infrastructure and have a narrow range of tradable instruments (Hearn & Pearse, 2006). Further, the emerging capital markets are characterized by small capitalization and low liquidity levels (Aduda et al., 2012). The Kenyan stock market is not exceptional from
the other emerging African capital markets. According to Nyangoro (2013), the Nairobi Securities Exchange market is characterized by small size and very low liquidity. Further, the stock market demonstrates significant structural and regulatory weaknesses (Ngugi, Amanja & Amana, 2013).
In the period 2008-2018, the number of listed firms at the Nairobi Securities Exchange (NSE) increased by twelve firms from 55 listed firms in the January 2008 to 67 listed firms as at December 2018 giving an average annual increase of approximately one firm per year (CMA, 2018). The number of listed firms at the NSE is very low in comparison to other African Markets like the Nigeria Stock Market with 170 firms, Johannesburg Stock Exchange with 379 firms and the Egyptian Exchange Market with 221 firms as at December, 2018 (World Bank, 2018). The stock market is equally characterized by high volatility as evidenced by the frequent erratic shocks in key stock market performance indicators for the period 2008-2018. The worst decline however is experienced in the year 2018 with a loss in market capitalization of Kshs. 419 Billion. During this period, foreign investors’ flight from the Nairobi Securities Exchange, attributed to the aftermath of the prolonged 2017-2018 general elections wiped out a significant portion of investor wealth pushing the stock market to the lowest point in over a decade (NSE, 2018).
Globally, the effect of excessive volatility on stock market development is demonstrated by Wall Street Crash of 1929, Black Monday of 1987 and the Global Financial Crisis of 2008 (Calson, 2006; Helleiner, 2011; Frankel & Saravelos, 2012). The Wall Street Crash also known as the “Black Tuesday” is regarded as the deepest and longest downtown in the history of financial market considering its duration and the aftermath effects (Wang & Huang, 2012). In 29th October, 1929 the stock prices collapsed completely with over 16 Million stocks disposed off by investors on a single day of trading at the New York Stock Exchange (Economic times, 2019).
So bad was the situation to the extent that trading machines could no longer handle huge volumes of stocks traded (Klein, 2001). A total of 30 Billion USA dollars was lost and thousands of investors completely wiped off. The aftermath of market crash saw the collapse of nearly half of all the American financial institutions and by 1932 all the stocks were worth only 20 percent of their value before 29th October, 1929 with the unemployment levels declining by 30 percent (Salsman & Richard, 2004).
