<!-- Start of picture text --> F _ Policy Research<br>< _ ~~Trade Policy<br>WPS 878<br><!-- End of picture text -->

- - This paper a product of the Trade Policy Division, Country Economics Department is part of a research project funded by the Bank's Research Support Budgct, "Sustainability of Trade Reforms in Structural Adjustment Loans," (RP0675-32). Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Dawn Ballantyne, room N10-023, extension 37947 (March 1992, 45 pages).

Matin and Waso use an eclectic version of the basic accelerator model to assess the determinants of private investment aiid to analyze how adjustment policies (or their absence) affect those determinants. Their model emphasizes the effect of resource constraints on private investment behavior, including that arising from foreign exchange rationing.

Econometric estimation of the investment model with Kenyan data for 1968-88 suggests that Kenya's failure to implement adjustment policies after the collapse of the coffee boom and the breakup of the East African common market reduced private investment sharply in the 1980s. Declining real credit to private sector, falling stocks of public infrastructure capital, and lower availability of imports were the main causes of reduced private investment.

Matin and Wasow argue that inadequate fiscal adjustment was a key failure of policy. With direct competition between public and private sectors for limited financial resources, fiscal deficits preempted funds and restricted private investors' access to them. In addition, when cuts in government spending were undertaken to contain deficits, they fell disproportionately on capital expenditure, especially that on physical infrastructure. And liberalization of foreign exchange rationing, impeded by the exogenous fall in export receipts, could not be implemented because of inadequate fiscal adjustment. Thus insufficient and uncertain access to imports was a major factor behind the decline in private investment.

Though real depreciation is found to have a direct negative impact on investment, the authors use simulations to show that it has a positive indirect effect on private investment in the medium term because such depreciation relaxes the foreign exchange constraint on imports.

Matin and Wasow conclude that efficient riscal adjustment and liberalization of imports will be critical for the recovery of private investment in Kenya. Efficient fiscal adjustment should reduce fiscal deficits so that expenditure cuts are structured to protect and even expand expenditure on physical infrastructure. This would require substantial reduction and rationalization of current expenditure. Import liberalization will also have the expected favorable impact on investment because such liberalization will be perceived as credible and sustainable when accompanied by efficient fiscal adjustment.

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