Kenya’s Economic Growth and Foreign Financial Flows: Is Institutional Quality Important?

Abstract

The moderating effect of institutional quality on the relationship between foreign financial flows and economic growth in Kenya is examined experimentally in this article. The primary international financial flow variables examined in the study were capital flight, illegal financial flows, external debt, and foreign direct investment. 31 observations were obtained from the analysis of annual secondary time-series data from 1994 to 2024. A hierarchical regression approach was used to test the direct and moderating effects among the selected variables. The results showed a significant negative correlation among capital flight, illicit financial flows, and economic growth, indicating that financial leakages limit productive economic activity, reduce public revenue, and constrain domestic investment. On the other hand, there was a positive and significant correlation between economic growth and both external debt and foreign direct investment. This suggests that growth can be supported by external borrowing and foreign investment when they are focused on productive sectors. Additionally, the regression results showed that the relationship between international financial flows and economic growth was strongly attenuated by institutional quality. Stronger institutional quality reduced the harmful influence of capital flight and illicit financial flows while strengthening the positive effect of external debt and foreign direct investment on growth. The findings provide useful insights for policymakers, government agencies, financial regulators, investors, and development partners in Kenya. Strengthening institutional quality is critical for ensuring that international financial flows contribute positively to sustainable economic growth. This calls for improved governance, stronger anti-money laundering systems, transparent debt management, better tax enforcement, and investor-friendly regulatory frameworks. By incorporating foreign capital flows and institutional quality within Kenya's growth environment, the study adds to the expanding body of scholarship.