Capital Flow Composition and Domestic Private Investment in Kenya: The Moderating Effect of Political Risk

Abstract

Domestic private investment plays a critical role in capital formation, productivity enhancement, and sustainable economic development in Kenya. However, the ability of external capital inflows to stimulate domestic private investment may depend on the political and institutional environment within which investment decisions are made. Although existing studies have examined the effect of foreign capital inflows on investment outcomes, limited attention has been given to how political risk conditions the relationship between different components of capital flows and domestic private investment. This study examines the moderating role of political risk in the relationship between capital flow composition and domestic private investment in Kenya. Using annual time-series data covering the period 1990–2024, comprising 35 observations, the study applies the Autoregressive Distributed Lag (ARDL) model and hierarchical moderated regression analysis to estimate both direct and interaction effects. The direct-effect results indicate that foreign direct investment inflows (β = 0.312, p = 0.014), portfolio equity inflows (β = 0.171, p = 0.038), and remittances (β = 0.205, p = 0.026) have positive and significant effects on domestic private investment, while external debt inflows have a negative and significant effect (β = -0.244, p = 0.024). The direct-effect model explains 68.4% of the variation in domestic private investment. More importantly, the moderation results demonstrate that political risk significantly alters the relationship between capital flow components and domestic private investment. Specifically, political risk significantly weakens the effects of foreign direct investment (β = -0.148, p = 0.041), portfolio equity inflows (β = -0.126, p = 0.031), and external debt inflows (β = -0.112, p = 0.029) on domestic private investment. However, political risk does not significantly moderate the relationship between remittances and domestic private investment (β = -0.074, p = 0.167). The final hierarchical moderation model explains 80.1% of the variation in domestic private investment. The findings demonstrate that political risk is a critical conditioning factor determining whether different forms of capital flows translate into productive private investment. The study contributes to the capital flow and investment literature by shifting attention from the volume of external finance toward the institutional conditions that shape its effectiveness. The findings highlight the importance of political stability, policy credibility, and investment certainty in enhancing the contribution of foreign capital to Kenya’s private-sector development.