metadata: authors: 0: author: Matin, Kazi M.
1: author: Wasow, Bernard
count: Kenya
docna: 0: docna: Adjustment and private investment in Kenya
docty: Policy Research Working Paper
subtopic: Macro-Fiscal Policy,Economic Adjustment and Lending,Public Sector Economics,Financial Regulation & Supervision,Trade Policy,Infrastructure Regulation,International Trade and Trade Rules,Rules of Origin,Infrastructure Finance,Infrastructure Economics,Public Finance Decentralization and
            Poverty Reduction,Infrastructure and Law,Trade and Multilateral Issues
teratopic: International Economics and Trade
abstracts: cdata!: The authors use an accelerator model to
            assess the determinants of private investment and to analyze
            how adjustment policies 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.  The authors 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 investor's access to them.  In
            addition, when cuts in government spending were undertaken
            to contain deficits, they fell disproportionately on capital
            expenditure, especially on physical infrastructure.  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.  They conclude that
            efficient fiscal adjustment and liberalization of imports
            will be critical for the recovery of private investment in Kenya.
geo_reg_key: 517191
repnme: repnme: Adjustment and private investment in Kenya
display_title: Adjustment and private investment in Kenya
listing_relative_url: /research/1992/03/699735/adjustment-private-investment-kenya
topicv3: Infrastructure and Growth m1326244 1083,Trade m1326924 698,Fiscal Policy m1327144 445,Trade Policy m1327640 776,Trade Guarantees m1505111 3906
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
origu: Policy Research Department
no_of_pages: 50
model_extractions: <!-- 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.

The Policy Research Working Paper Series disseminates the findings of work under way in the Bank. An objective of the series is to get these findings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necessarily represent official Bank policy.

Produced by the Policy Research Dissemination Center
# Table of Contents

|I.|I NTRODUCTION<br>...................................................<br>1|
|---|---|
|II.|INVESTMENT TRENDS<br>....................................<br>4|
|III.|DETERMINANTS OF PRIVATE INVESTMENT<br>.............................<br>7<br>Estimation Model ...............................................<br>7|
|IV.|ECONOMETRIC ESTIMATION OF INVESTMENT MODEL<br>.<br>.<br>14<br>Estimation Results<br>............................................<br>14<br>(i) For Total Private Investment<br>............................<br>i5<br>(ii) Components of Private Investment<br>.........................<br>20<br>Adjustment Policies Affecting Private Investment<br>.<br>.<br>23|
|V.|MODEL APPLIED: POLICY SIMULATIONS<br>.29<br>Impact of Real Devaluation<br>.32|
||CONCLUSION<br>.36|
||APPENDIX<br>.38|
||REFERENCES<br>.43|

* The authors would like to thank Yaw Ansu, Ian Bannon, Jaime de Molo, Robert Hindle, John Nash and Nemat Shafik for comments<sup>on an earlier</sup> version of the paper.
# I. INTRODUCTION

Many developing countries failed to maintain<sup>their investment rates in</sup> the 1980s. While adverse changes in<sup>the external environment has been</sup> important in some countries, adjustment<sup>policy aimed at restraining fiscal and</sup> current account deficits has been more<sup>important in others. In some countries</sup> private investment was 'crowded out' because<sup>the reduction in fiscal deficit</sup> was less than the reduction in external<sup>financing. In others, private</sup> investment was undermined because fiscal<sup>deficit reductions were not</sup> accompanied by equivalent reductions<sup>in current expenditure, resulting in</sup> declining public investment expenditure,<sup>especially on infrastructure.</sup> Similarly, attempts to reduce current<sup>account deficit without reducing fiscal</sup> deficit inhibited private investment because<sup>they made elimination of direct</sup> import controls difficult. Thus<sup>adjustment policies (or their absence) can</sup> influence private investment by affecting<sup>its key determinants.</sup> Theoretical models of the determinants<sup>of private investment have been</sup> applied to developed countries with a<sup>fair degree of success (Bischoff, 1969,</sup> 1971; Clark, 1979; Eisner, 1970, 1972;<sup>Hines & Costepharous, 1970).</sup> Nevertheless, empirical studies have<sup>not yet clarified which of these models</sup> is a more accurate representation of the way in which capital formation<sup>occurs</sup> in developed countries. This is more<sup>true of developing countries where the</sup> assumptions underlying the standard optimizing<sup>investment models are usually</sup> not applicable.1 tFor example the absence of well-functioning financial markets, the relatively larger role of<sup>the government in capital formation, distortions</sup> created by foreign exchange constraints<sup>and other market imperfections are</sup> contrary to the assumptions. In addition<sup>there is little or no data on stock</sup> of capital, labor force and wages,<sup>real financing rates etc. necessary to</sup>
E1mpirical studies on the determinants of private investment in developing countries have been few and far between. Most o4 theam have used a much more eclectic model of private investment designed to capture the distinctive institutional and structural features of those economies. They have combined the features of the flexible accelerator, neoclassical and structural models in an effort to emphasize the effects of resource constraints faced by private investors in developing countries. The results of those studies suggest that expected aggregate demand proxied typically by output, domestic credit constraint proxied by credit availability to private sector and physical infrastructure proxied by public investment expenditure are important determinants of private investment in developing countries (Sundrajan & Thakur 1980, TunWai<sup>& Wong 1982, Blejer</sup> & Khan 1984, Chhibber & Van Wijnbergen 1988, Musalam 1988, Shafik<sup>1990, Schmidt-Hebbel and Muller</sup> 1991). Adjustment policies affect private investment because they affect those determinants.

This paper departs from the existing empirical literature on determinants of private investment in two ways. First, we incorporate the effect of changes in the restrictiveness of foreign exchange allocation and changes in the real exchange rate, both of which are generally part of adjustment programs. While the impact of real exchange rate<sup>on private</sup> investment has been explicitly investigated for several countries including Chile (Solimano 1989) d Indonesia (Chhibber & Shafik 1990), the effect of foreign exchange constraint has generally been ignored in the literature. 2 Second, we examine the determinantof private investment for a Sub Saharan implement those models empirically.

2 The only two exceptions are Billsborrow's study of Colombian firms' investment behavior (Billsborrow 1977) and the multi-country study of private investment by Fry (1980).
African country, (a region that has been<sup>the focL of adjustment programs) by</sup> appLying a model of private investment<sup>behavior to Kenya.3</sup> 9Cenya presents an interesting case to study private investment<sup>because it has experienced</sup> relatively greater macro-economic stability and because it has suffered large declines in investment in the 1980s notwithstanding adjustment efforts during 1979-82 and again during 1987-90.

The paper finds that declining availability<sup>of credit to private sector,</sup> falling stock of public infrastructure capital and the relatively lower level of import allocations relative to the 1970s are<sup>the main factors behind the</sup> decline in the rate of private investment<sup>in the 1980s. Adjustment policies</sup> or rather, Kenya's inability to implement them<sup>contributed to this decline.</sup> The nature of fiscal policies played a key role.<sup>It is thus argued that</sup> reversing those policies is critical to the restoration<sup>of higher rates of</sup> private investment. Money financing of<sup>fiscal deficit has to be reduced and</sup> current expenditure, especially wage ea;.penditure, has to be cut so as to increase public capital expenditure, if private<sup>investment is to rise.' Though</sup> import liberalization decreases uncert:ainty of access to imported goods, the absence of efficient fiscal adjustmernt raises questions of future access.<sup>4</sup> Notwithstanding the initial adverse e~ffect of a real depreciation, it is found to have a favorable indirect impact on private<sup>investment in the long-run</sup> because it can relax the foreign exchange constraint<sup>and increase import</sup> allocations.

> 3Note that the sample of 24 countries in Blejer & Khan (1984) did not include a sub-saharan African cou try.

4Attempts to liberalize imports in 1980 were aborted in 1983. The most recent efforts to liberalize begoln in 1987. Thus quantitative allocations of imports has dominated most of thh period under<sup>study.</sup> 3
# II. INVESTMENT TRENDS

Kenya's total real investment has been on a declining trend since 1971. The decline has been particularly severe after 1978 following the collapse of the coffee boom and the East African Common Market. Total real investment fell by 7 percent of GDP between 1978 and 1988.5 As a share of real GDP, it was 10% in 1988 relative to 22% in 1971 and 17% in 1978.

Private real investment fell by 5 percent of GDP over the same period. (Figure l).j Private real investment was 5.8% of GDP in 1988 as compared to 14% in 1971 and 10.8% in 1978 (see Figure 1). This reduced the share of the private sector in Kenya's total investment from its peak of 63.6 percent in 1971 to around 50 percent in 1988.

Private investment in machinery and transport equipment has borne a disproportionate share of the burden of this decline. It has fallen from around 7 percent of GDP to 3.5 percent between 1978 and 1988 (see Figure 2). Thus the share of equipment in Kenya's private investment has decl_.ied from 66 percent to 61 percent over the same period.

5This is estimated as the ratio of real investment to real GDP. Total real investment fell by 6.4 percent of GDP in the 1980s from an average of 17.4% of GDP in the 1970s (i.e. 1971-81) to an average of 11.0% in the 1980s (i.e. 1982-88). Private investment fell by 4.2 percent of GDP in the 1980s relative to the 1970s, as compared to a fall of 2.2 percent of GDP for public investmenit.

4
<!-- Start of picture text --> real invo-stment/real GDP<br>C,-~~~~~~~~~~C<br>co<br>C,~~~~~~~~~~~~~~J<br>o -<br>sX "' > I4 X<br>co~~~~~~~~~~i<br>o~~c<br>co<br>'""L~~~~ z<br>'-9 ~ c<br>4,~~~~~~~~~~c<br>4,~~~~~~~~~~c<br>co~~~~~~~~~~~~~C<br><!-- End of picture text -->
Figure 2

# COMPONENTS OF PRIVATE INVESTMENT

<!-- Start of picture text -->
-<br>0.08<br>0  .o0 7 - .. . . . . . . . . . . . . .. . . . . . . . . . . . . . .. . . . . . .<br>-<br>'>  0.06  .<br><ES  0.03  . ...  .......<br>~  0.03  - -_  _...  _ _  _ _ _-......'...-...-....  -_  .<br>0.0  2<br>- -<br>0.01I-,,,  ,<br>78  79  80  81  82  83  84  85  86  87  88<br>6<br><!-- End of picture text -->

EQUIPMENT - BUILDINGS
# II. DET

# OF PRIVATE INVESTMENT

The model of private investment applied to Kenya is an eclectic version of the flexible accelerator model<sup>6</sup> designed to capture some of the key determinants of private investment behavior. The basic accelerator model is modified to provide greater emphasis on the effects of resource constraints faced by private investors in developing countries. It is assumed that such constraints iti respect of credit and foreign exchange affect the direction and speed of adjustment of actual capital stock to desired capital stock.

# Estimation Model

In the long-run steady state, private sector's desired capital stock (K,*) is assumed to be proportional to expected output (Y): (1) Kt - a(Y) There are two ways of deriving an investment function from the above equation (Blejer and Khan 1989). The first one specifies coeff, Aent "a" as a function of different variables. Gradual adjustment of actual to desired capital stock is obtained in a standard way by using a local quadratic approximation to adjustment costs, and the gradual change in actual capital shock is the investment function.

The alternative method, the one we use for this paper, keeps "a" constant, but assumes that the parameters of the quadratic adjustment cost function are a function of different variables. This formulation starts with 6Various problems restrict the applicability of a strictly neoclassical investment model to developing countries. See Footnote 1.

7
a partial adjustment function derived from a quadratic adjustment cost model as follows:

# (2) I¢l(t- Cto It.1)

where Ie is the desired level of investment in the steady state, which is given by

*3) Xct*El-(1-6)L]ht:

where L is the lag operator ar.d 8 is the proportional rate of depreciation.

The response of private invesement to the gap between desired and actual investment, as measured by the coefficient P, is assumed to vary systematically with economic factors that influence the ability of private investors to achieve the desired level of investment.7 Our hypothesis is that the response of private investors to that gap depends on five factors: (1) the availability of credit, (2) the availability of foreign exchange, (3) the real exchange rate, (4) the stock of public infrastructure capital and (5) macroeconomic instability.

7For example, the phenomenon of "crowding out" is captured through affecting the speed of adjugtment rather than through directly changing the desired level of real private investment.

8
**A** clear consensus has emerged in recent years that, in contrast to developed countries, one of the principal constraints on 1nsvestment in developing countries is the quantity, rather than the cost, of credit. The rates of t.-turn on investment in these countries typicslly tend to be quite high, whereas real interest rates on loans are kept low by goverrments for a variety of reasons. In such circumstances the investor cannot he expected to equate the current marginal product of capital to its se_-vice cost. Indeed, because the total amount of financing is limited and the price mechanism is not allowed to operate smoothly, it would seem legitimate to argue that the private investor in a developing country is generally restricted by the level of available bank credit.8 An increase in real credit to the private sector encourages real ,civate investment as is confirmed by several empirical studies (Fry 1980, Tybout 1984, Blejer and Khan 1984).

In most developing countries, both the Availability and the real price of foreign exchange affect private investment. This is because imports are often rationed and the cost of investment is influenced by the exchange zate and the uncertainty of access to foreign exchange.9 If foreign exchange for imports is not available on demand at the prevailing exchange rate because of import rationing, thean access to imports at a given exchange rate becomes $The rudimentary nature of capital markets in developing countries limits the financ.ing of private investmen **t** o the use of retained profits and bank credit. Of these, the flow of bank credit to the private sector is likely to be qu&ntitatively the most important. 9Several studies of developing countries have found that imports vary with the restrictiveness of import licensing which in turn varies with changes in stock of foreign exchange reserves (Hemphill 1980, Moran 1989). There is evidence that decisions of Government of Kenya on the restrictive-less of licensing is based on the size of reserves. For example in 1982/83 Kenyan government used an explicit "trigger mechanism" for moving items from restricted to unrestricted list. Movement of such items were triggered on reserve increases above 1.5 months import coverage.

9
uncertain. Increases in the restrictiveness of import rationing can reduce private investment in two ways. It can reduce private<sup>invetment because of</sup> longer queuing time and/or greater uncertainty of<sup>access to capital goods</sup> imports. It can also reduce investment demand because<sup>the expected</sup> profitability of investment is lowered by similar uncertainty<sup>of access to</sup> intermediate imports. Billsborrow (1977) finds evidence of<sup>the effect of</sup> import allocations proxied by reserves on firm investment<sup>in Colombia.</sup> Real depreciation affects private investment through several<sup>channels</sup> not all of which work in the same direction. First, real<sup>devaluation raises</sup> the cost of capital goods and acts like an adverse supply shock on investment, the size of which depends on the import content of investment (Buffie 1986, Branson 1986). Second, it raises the price of imported<sup>intermediate inputs.</sup> Both lower profitability of investment in the nontradable sector<sup>and thus slow</sup> down the adjustment response of private investment. On the other<sup>hand real</sup> devaluation can also raise investment by raising profitability of<sup>private</sup> investment in the tradable sector because it reduces the<sup>real product wage in</sup> terms of traded goods. Third, it raises demand for domestic<sup>output. Thus the</sup> net impact of real depreciation on private investment could go either way.10 This ambiguity is evident in empirical results. Most econometric studies find a negative impact of real depreciation on investment<sup>in the</sup> short-run but a positive impact in the long-run. For example,<sup>a short-run</sup> adverse effect is found by Musalam (1989) for Mexico, Solimano<sup>(1989) for</sup> Chile, Chhibber and Shafik (1990) for Indonesia. Faini<sup>and de Melo (1991)</sup> 10If capital is not wholly immobile between sectors, then total investment demand may fall or rise (Lizondo and Montiel<sup>1988) depending upon</sup> whether disinvestment in non-tradeable sectors is larger or smaller<sup>than the</sup> increase in investment in the tradeable sector.

10
using data for 24 countries confirm the same result. However all of the above find a positive impact of real depreciation over the longer\run. It is recognized that private and public investment are related. However, there is considerable uncertainty about whether, on balance, increases in total public sector investment raises or lowers private investment (Von Furstenberg and Malkiel 1977). Empirical evidence remains inconclusive. This is because public investment in production and in infrastructure can have opposite effects on private investment. However, it is being increasingly acknowledged that public investment in infrastructure is more likely to be complementary tc private investment because it raises the productivity of private capital. Several studies have examined this empirically (Aschauer 1990, Galbis 1979, Sundararajan and Thakur 1980, Blejer and Khan 1984, Chhibber and Van Wijnbergen 1988, Shafik 1991). Only a few studies do find evidence of a significant complementary relationship. 11 If public investment in infrastricture and private investment are complements, we would expect that the coefficient of adjustment of private investment would beccae larger as the rate of public investment in infrastructure increases, implying a faster response of private investment. Macroeconomic instability is also expected to have an adverse effect on private investment, largely due to the uncertainty it creates in the adjustment process.

> 1 1 Sundararajan and Thakur (1980) found the coefficient of the public sector capital stock in the private investment equation to be statistically insignificant in both countries (India and the Republic of Korea) of their sample. Shafik (1991) confirms this for Egypt.

11
On the basis of the arguments above, we can express the coefficient of adjustment in equation (2) as a function of the following voriables. A linear representation of this relationship would be _(4) A inbo-_ l) _(biACRt+baFXRESe+b3RERe + b#KPU+b 5_<sup>_VAR)_</sup>

# where

_ACR_ - flow of real bank credit to the private sector KPU- real public sector infrastructure capital stock FXRES - stock of real foreign exchange reserves RER - real exchange rate VAR - macroeconomic instability proxied by variability of macrovariables like RER and inflation Equation (4) states that the response of private investment to the size of the discrepancy between desired and actual investment depends on the magnitude of these five factors.12 The signs of the parameters in this equation are expected to be:

# _b1 -O b2 O 4.0_ b,O N-<O4

Substituting equation (4) into equation (2) yields 12See SundararaJan and Thakur (1980) for a similar formulation.

12
_(5) AZe=bo(It*-It_) +biACRt+FXRSt+b 3_<sup>_RER^t b_</sup> _4_<sup>_CPU+b_</sup> _5_<sup>_VAR_</sup> From equations (3) and (1) we have

# _(6) Ie-[1-(1-4)LJK=(t-(l-o)LlaY'_

and, therefore, we can obtain a dynamic reduced-form equation for gross private investment that includes expected demand, the change in real bank credit, stock of real reserves, real exchange rate, the stock of public infrastructure capital and macroeconomic instability as the explanatory variables:

> _(7) It-boa[l-(1-8) L] Yt' bvCRt'b 2_<sup>_PXES+.b_</sup> _3_<sup>_RER+b_</sup> _4_<sup>_KPU+b_</sup> _5_<sup>_VAR (l-bo) It1_</sup>

13
# IV. ECONOMETRIC ESTIMATION OF INVESTMENT MQDEL

We estimate the investment model in equation (7) by ordinary least squares (OLS) and by two stage least squares (TrLS). They yield similar coefficient estimates. Unlike earlier studies we use a stock variable for infrastructure, since it is more likely that private investment is affected by changes in the stock of capital rather than the figw of public investment. Similarly, instead of using current receipts of foreign exchange or current foreign exchange reserves we use lagged reserves in order to avoid any simultaneity bias.

The results suggest that lower availability of credit to the private sector and falling public infrastructure capital stock has reduced private investment over the 1980s. Similarly, lower foreign exchange reserves in the years following the collapse of the coffee boom has lowered capital imports. The negative supply-shock effect seems to dominate the impact of real depreciation. There is also econometric evidence to suggest that inability to control fiscal deficit and its money financing, as well as failure to restrain current expenditure crowded out private sector credit and lowered public investment in infrastructure.

# Estimation Results

Ordinary least square (OLS) and two stage least squares (TSLS) estimation used annual data on Kenya for the period 1968-1988.

To avoid spurious correlation and non-stationarity, the investment rate is used (i.e., share of investment in GDP) instead of the investment level. In 14
addition the real rate is used instead of the nominal investment rate.<sup>13</sup> In the case of TSLS the real exchange rate is instrumented by 1ts lagged value and by the lagged value of real non-fuel exports.

# (i) For Total Private Investment

All variables have the right sign in Table 2 and Table 3.14 The real exchange rate and the lagged foreign exchange reserves proxying for access to imports are consistently significant at 1% level in AUi regressions.15 So is real credit to private sector and public stock of infrastructure capital. The real interest rate, the index of macro instability and the lagged income growth rate variables are not significant. Specification (1) in Tables 2 and 3 which excludes them performs the best. Our confidence in this estimated private investment equation is supported by our tests for specification and stability.

13 lnvestment is expressed in real terms as is customary. Though some (Anderson 1981) have argued for using nominal values on the grounds that signals are transmitted in nominal terms and that it is difficult to represent the process by which these signals are translated from nominal into a real framework, most of their arguments are not relevant for Kenya. This is because Kenya has had a fairly steady rate of inflation and the private sector is likely to anticipate most price changes, whereas Anderson's nominal framework implies that all price movements are unanticipated.

14The matrix of correlations of the private real investment rate and each of the explanatory variables show only three variables to be highly correlated with the rate of real private investment with simple correlation of 0.8: the real exchange rate, the stock of foreign exchange reserves and the flow of foreign exchange receipts. These three variables all have strong time trends through the 1970s. Only one pair of ex2lanato=r variables is highly correlated, namely the current stock of foreign exchange reserves and the current real exchange rate probably suggesting that devaluations have been reserve driven contemporaneously. However, lagged reserves are not so correlated.

15The stock of foreign exchange resex-es performs better as a proxy for restrictiveness of licensing than the flow of foreign exchange receipts. The "t" statistic of all coefficients is higher, and the fit of the entire equation is improved. All equations that include reserves and the real exchange rate have adjusted R-squared of above 0.9.

15
# Table 2. OLS Estimation Results for Private Investment Function

# Dependent variable is real private investment/real GDP

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|Constant, C(1)|-2.406|-4.019|-2.390|-3.790|
|Real RateofInterest, C(2)|-|-0.849*<br>(-2.08)||-0.769*<br>(-1.82)|
|Flow of re4lcredi.to private<br>sector as a ratio to GDP, C(2)|0.065<br> <br>(4.02)|--|0.062"'<br>(3.80)|<br>--|
|Foreign Exchange Reserves<br>as a rati' to GDP, C(3)|0.332"'|0.353"'|<br>0.326|0.350**|
|(2 year sum, lagged 1 period)|(7.98)|(7.44)|(7.82)|(6.65)|
|Real Exchange Rate, C(4)|0.460"'|0.607"'|<br>0.452|0.557"'|
|(Trade weighted, 1985-<br>100)|(3.52)|(4.35)|(3.48)|(3.19)|
|Infrastructure<br>Public Capital|1.073**|0.516|1.102"'|<br>0.562|
|stock as a ratio to GDP, C(5)|(2.95)|(1.33)|(3.05)|(1.37)|
|Lagged GDP growth rate C(6)|--|--|0.994<br>(1.13)|1.270<br>(1.13)|
|R-BAR SQUARED|0.96|0.93|0.96|0.93|
|F-STATISTIC|103.8|69.0|84.0|50.5|
|DURBIN-WATSON|1.41|1.69|1.42|1.80|
|N|20|20|20|20|
|White Statistic|1.432|--|5.771||

Note: 1. All variables are in natural log.

2. The sample includes annual data from 1969 to 1988.

16
Table 3: TSLS Estimation Results for Private Investuient Function Dependent Variable is Real Private Investment/Real GDP

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|Constant|-2.414|-3.560|-2.470|-3.57|
|Real Rate of Interest||-0.785*<br>(1.84)||-0.733'<br>(-1.80)|
|Flow of Real Credit to pri<br>sector as ratio to GDP|vate<br>0.065"'<br>(4.02)||(3.80)|0.062"'|
|Foreign Exchange Reserves<br>as a Ratio to GDP<br>(2 Year Sum lagged 1 peri|<br>0.332"<br>(7.66)<br>od|0.376<br>(6.80)|0.323<br>(7.46)|0.360"'<br>(6.54)|
|Real Exchange Rate (Trade<br>Weighted 1985-100)|<br>0.462-'<br>(3.25)|<br>0.502<br>(2.63)|0.467"'<br>(3.72)|<br>0.508"'<br>(2.70)|
|Infrastructure<br>Public<br>Capital Stock as ratio to<br>GDP|1.073-<br>(2.95)|0.467<br>(1.13)|1.100"'<br>(3.05)|<br>0.547<br>(1.33)|
|Lagged GDP Growth rate|--|--|0.988<br>(1.12)|1.303<br>(1.15)|
|R-BAR SQUARE|0.96|0.93|0.96|0.93|
|DURBIN WATSON|1.31|1.68|1.42|2.00|
|N|20|20|20|20|

All variables are in logs. The real exchange rate is instrumented by lagged real exchange rate, and lagged real non-fuel exports. Data in parenthesis are the t-statistics.

17
The lagged GDP growth variable is insignificant; so are all other conventional proxies for expected demand. Its exclusion fro>: the regression improves the precision of other coefficient estimates without reducing the overa.l explanatory power of the equation (compare specifications (1) and (2) with (3) and (4) in Tables 2 and 3 (not shown in Table 2 or 3). This suggests within-year adjustment of capital stock.

Real interest rate is significant only at the 5% level. However its introduction makes the coefficient for infrastructure capital stock less precise and the private investment function less stable. F ther, as we show later the real rate of interest is not significant when the -,jations explaining the differing components of private investment viz: equipment and buildings investment are estimated separately. Furthermore when interest rate variable is replaced by the flow of credit to private sector as is done in specifications (1) and (3), the explanatory power of the investment function rises and all coefficients are significant et 1% level.<sup>16</sup> This is perhaps not surprising given that interest rates were administratively controlled in Kenya during this period. Changes in domestic money financing of fiscal deficit were thus reflected in changes in credit to private sector than in interest rates.

Relaxation of import access (proxied by higher lagged reserves in the equation) raises private investment but real depreciation reduces it.<sup>17</sup> The 16A visual inspection of the recursive coefficient plots show that all the four coefficient estimates for the equations that includes the rate of interest variable are more unstable relative to the equation that includes bank credit.

"<sup>7</sup> Branson using Kenyan parameters simulates the-impact of devaluation on investment and concludes that investment falls due to the supply shock effect of devaluation. (Branson 1986) 18
elasticity of the private investment rate with respect to reserves is around 0.35 and that with respect to the real exchange rate is in the range of 0.46 to 0.6.

The elasticity of privato investment with respect to credit availability is significant in all regressions. It is worth noting that this capW.ures changes in credit mainly for working capital and thus ignores the constraints on term credit for investment. The elasticity implied by the results is thus likely to be an underestimate of the total effect of credit availability.18 There is a strong complementary relationship between the stock of public infrastructure capital and private investment. Private investment is unit elastic with respect to infrastructure. Thus reductions in government investment expenditure on infrastructure, is likely to affect private investment with a lag since it will take time to affect shocK of capital. Efforts to restrain total public expenditure will thus affect private investment adversely if it reduces public investment in infrastructure and reduces the stock of infrastructure capital.

While we can read off the relevant elasticities from the coefficient estimates in Tables 2 and 3, the relative importance of each variable as a determinant of private investment is not obvious because of differences in the units of the explanatory variables. We thus compute standardized betas (Theil 1980) for each of the coefficients in two best specifications to indicate the relative importance of each variable in determining private investment. Table 4 reports the results.

18We could not obtain time series data oni medium term credit availability, which is likely to be a better determinant of investment.

19
# Table 4. Beta Coefficients of Private Investment Function (Ezeluding interest rate variable)

|Variables<br>Betas|S<br>|pecifications<br>|
|---|---|---|
||(1)|(3)|
|Flow of Real Credit|0.256<br>|0.280<br>|
|Foreign Exchange<br>Reserves|0.619<br>|0.648<br>|
|Real Exchange<br>Rate|0.273<br>|0.266<br>|
|Infrastructure<br>Capital Stock|0.182|0.181<br>|
|Income Growth|--|0.092|

Source: Computed from Table 2 In relative terms, changes in lagged foreign exchange reserves or rather in the changes in restrictiveness of import access has the greatest impact on private investment. Flow of real credit to private<sup>sector and real exchange</sup> rate changes come next. Though infrastructure capital stock had the highest value for elasticity (see Table 2 and 3) and flow of real credit<sup>the lowest,</sup> the relative importance of credit as a determinant of private investment is greater that infrastructure capital stock. Lagged income growth has the weakest effect.

# (ii) Components of Private Investment

Tables 5 and 6 reports the results of both OLS and TSLS estimation for the two components of private investment. The response of each of the two major components of private investment (i,e., equipment and buildings) to changes in reserves and in the real exchange rate are similar in both size and significance to that for total private investment. The same is<sup>not true for</sup> the other determinants.

20
Table 5. OLS Estimation Results for Components<sup>of Private Investment</sup>

|Dependent variable<br>is Real Priv. Investment/GDP in:|Buildi|ngs|Equip|ment|
|---|---|---|---|---|
||(1)|(2)|(3)|(4)|
|Constant|-4.080|-3.826|-2.639|-2.637|
|Flow of real credit to private<br>sector as a ratio to GDP|-0.014<br>(-0.72)||0.106*<br>(3.90)|* 0.105**<br>(3.76)|
|Foreign exchange reserves as<br>a ratio to GDP|0.319"'<br>|0.308"'<br>|0.326*<br>|* 0.325**<br>|
|(2-year sum, lagged 1 period)|(6.75)|(6.94)|(4.67)|(4.46)|
|Real exchange rate|0.458"'<br>|0.456"'<br>|0.519*<br>|0.518"<br>|
|(trade weighted, 1985-<br>100)|(3.11)|(3.14)|(2.36)|(2.28)|
|Public infrastructure<br>capital<br>stock as a ratio to GDP|0.825'<br>(2.01)|0.979<br>(2.80)|1.422*<br>(2.33)|1.426*<br>(2.25)|
|Lagged growth of GDP|1.872'<br>(1.88)|1.74<br>(1.80)||0.149<br>(0.09)|
|R-BAR SQUARED<br>F STATISTIC|0.92|0.92|0.91|0.90|
|DURBIN-WATSON|2.27|2.24|1.96|0.97|
|N|20|23|20|20|

Notes: 1. All variables are in natural logs and the<sup>interest rate</sup> variable is dropped as it is insignificant<sup>at 10%.</sup> 2. The sample includes annual data from<sup>1969 to 1988.</sup> 21
Table 6. TSLS Estimation Results for Components<sup>of Private.\Investment</sup>

|Dependent variable<br>is Real Priv. Investment/GDP|Build|ings|Equipm|ent|
|---|---|---|---|---|
||(1)|(2)|(3)|(4)|
|Constant|-4.699|-4.806|-2.416|-2.396|
|Flow of real credit to private<br>sector as a ratio to GDP|-0.014<br>(-0.75)|--|0.106*<br>(3.70)|* 0.106**<br>(3.91)|
|Foreign exchange reserves as<br>a ratio to GDP<br>|0.291**<br>|0.264"'<br>|0.335*<br>|* 0.337*"<br>|
|(2-year sum, lagged 1 period)|(5.79)|(5.83)|(4.42)|(4.63)|
|Real exchange rate|0.586"'|= 0.672**|0.472*<br>|0.469*<br>|
|(trade weighted, 1985-<br>100)|(3.59)|(5.13)|(1.92)|(1.97)|
|Public infrastructure<br>capital|0.845'<br>|1.049<br>|1.419*<br>|* 1.413"<br>|
|stock as a ratio to GDP|(2.01)|(2.89)|(2.24)|(2.31)|
|Lagged growth of GDP|1.826'<br>|1.586<br>|0.166<br>|--|
||(1.78)|(1.58)|(0.11)||
|R-BAR SQUARED|0.92|0.92|0.90<br>|0.91<br>|
|F STATIFT'C|43.4<br>|58.8<br>|34.9<br>|46.7<br>|
|DURBIN-irSON|2.29|2.15|0.98|0.97|
|N|20|21|20|20|

Though public infrastructure capital stock is significant for both components of private investment, the coefficients<sup>are significantly higher</sup> for equipment investment. This is quite plausible<sup>since manufacturing</sup> dominates equipment investment and the profitability<sup>of manufacturing</sup> investment appears to be more dependent on infrastructure. On the other hand, changes in the availability of credit does not affect buildings<sup>investment.</sup> This is surprising. One possibility is that it<sup>reflects the effect of</sup> restrictions on credit flows to housing and real<sup>estate investment. However,</sup> 22
given what we know about the fungibility of credit in Kenya, this is not plausible. The other possibility is that these investors u e their own retained earnings because it is a useful way of understating taxable earnings. In any case it appears from the data that<sup>the impact of private sector credit</sup> availability on total private investment arises from its effect on equipment investment.19

# Adiustment Policies Affecting Private Investment

Fiscal policy, nominal exchange rate policy and trade policy constitute the core components of most adjustment programs.<sup>Changes in thesepolicies</sup> affect credit availability, infrastructure investment and reserves which in turn affect the speed and direction of investor response to the gap between actual and desired capital stock.

"<sup>9</sup> Again, this may be because most capital equipment are imported and the process of importing is highly credit-intensivb **e** cause of the time-consuming process of importing.

23
At the simplest level, an increase in fiscal deficit without additional inflow of foreign savings, must lead to either an increase 4n private savings or a decrease in private investment.20 How much of the change is borne by a decrease in private investment depends on how fiscal deficits affect the availability of credit to the private sector.21 A clear negative relationship between bank credit to private sector and the size of the fiscal deficit and/or by flow of real credit to public sector which finances the fiscal deficit establishes the empirical link between fiscal policy and private investment. Table 7 provides results of regressions that attempt to estimate the link between fiscal policy and real credit to, private sector.

2This is evident from the standard national income identity. (G-T) _ (Sp - Ip) + (K-X) Fiscal deficit - net private savings + foreign savings 21Probably the most powerful instrument through which credit to private sector is crowded-out is the use of ceilings on total bank credit and on credit to government. Credit to the private sector is residually determined after accommodating the financing needs of the government. Central Bank's control over the minimum levels and composition of liquid reserves of commercial banks and non-bank financial institutions provide another instrument for channelling credit to government in Kenya.

24
# Table 7: Fiscal Deficit and Private Sector Credit

|Dependent Variable|Real Private<br>Share|Sector Credit as<br>of GDP|Real Credit<br>to Private<br>Sector|
|---|---|---|---|
||1968-88<br>(1)|1974-88<br>(2)|1968-88<br>(3)|
|1. Constant|-0.69|-1.42|-1831.5|
|2. Fiscal Deficit/GDP|-0.39<br>(2.26)|--|--|
|3. Growth of GDP|25.7*<br>(1.92)|--|--|
|4. Real Credit to Public<br>Sector/GDP||-0.52<br>(2.11)||
|5. Real Lending Rate|||-644.4"<br>(-1.95)|
|6. Real Credit to Public<br>Sector||--|-0.41"<br>(-2.03)|
|7.Real GDP|||0.07**<br>(2.91)|
|Adjusted R<sup>2</sup>|0.39|0.45|0.68|

All coefficients related to the financing of fiscal deficit confirm the "crowding out" effect of increased fiscal deficit. Thus if fiscal adjustment is successful in reduci.ng deficits, the availability of credit to private sector will improve and private investment will rise. However, if reduction in deficit is undertaken through reduction in expenditure and this is disproportionately borne by government's investment expenditure especially on infrastructure, as has happened in Kenya private investment will fall.

25
Nominal exchange rate actions and fiscal policy, especially changes in level and composition of government expenditure affect the Neal exchange rate. Changes in nominal exchange rate is often an integral part of adjustment programs for purposes of altering the real exchange rate. Since countries like Kenya import the bulk of their machinery and equipment for investment, the cost of investment depends on the relative price of investment good imports. The elasticity of the relative price of investment goods with respect to the real exchange rate has been important in many countries (Faini and de Helo 1991). The result for Kenya is shown in Table 9.

26
Table 9. Relative Price of Investment Goods and the Real Exchange Rate

|(1968--1988)<br>Degendent Variable: Investment Defl|ator/GDP Deflator|
|---|---|
|(1)|(2)|
|Constant<br>5.257|1.987|
|Real Exchange Rate<br>-1.127|-0.422w|
|(-9.79)|(-1.96)|
|ConstructionPrice<br>--|1.042*<br>(3.08)|
|Adjusted R<br>0.83|0.91|
|Durbin Watson Statistic 1.42|1.92|
|AR (1)|0.342|
||(1.48)|

Notes: All variables are in logs and data in parenthesis show the t-statistics. Construction price is the ratio of construction deflator to GDP deflator and real exchange rate is 1985 trade weighted (top 20 partner) index.

The results suggest that a real depreciation will have a substantial adverse effect on private investment in the short to medium run by raising the cost of capital. However, this adverse effect must be balanced against 27
whatever efficiency-enhancing effect results from lower distortion in the price of investment goods.

In Kenya's case there is also some evidence (specification 2) that domestic price of construction has also raised the relative price of investment goods. This is consistent with other studies of Kenya's coffee boom (Bevan et al) where they find that accelerated increases in domestic investment financed by coffee boom revenues raised the price of construction due to low short-run price elasticity in this sector.

28
# V. MODEL APPLIED: POLICY SIMULATIONS

Since the coffee boom of the 1970s virtually<sup>all factors have worked</sup> against private investment. Thus policy simulations<sup>confirm that if policies</sup> involving money financing of deficit and public<sup>investment were unchanged</sup> relative to 1978, Kenya would have had substantially higher private investment rates in the 1980s. However, if reserves fell<sup>as it actually did, private</sup> investment would remain considerably lower notwithstanding<sup>fiscal adjustment.</sup> It is a moot point whether reserves would<sup>decline as much as it did if fiscal</sup> adjustment was successful. Policy simulations<sup>also show that though real</sup> depreciation has an adverse direct effect on<sup>private investment it has a</sup> favorable indirect effect in the medium term,<sup>because depreciation helps to</sup> relax the foreign exchange constraint.

Fiscal Policy and Import Liberalization Fiscal policy directly affects two of<sup>the determinants of private</sup> investment in Kenya: credit availability to<sup>private sector and public stock</sup> of infrastructure capital.22 Policy simulations (using equation (1) of Table 3 and unchanged 1978 values for credit and infrastructure)<sup>show that private</sup> investment in the 1980s (e. g. 1982-88) would,<sup>on average, have been around</sup> twenty three percent higher than they were<sup>in that period if these two fiscal</sup> variables had maintained their 1978 levels<sup>in the 1980s. Figure 3 shows that</sup> 22By applying the estimated coefficients froim equation (1) to the actual values of real private sector credit and infrastructure capital stock, we find that around two-fifth of the decline in<sup>private investment between 1978 and</sup> 1988 is explained by these two variables.

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# SIMULATION WITH CONSTANT FISCAL POLICY

<!-- Start of picture text --> (Simulations: 1978 - 1988)<br><!-- End of picture text --> <!-- Start of picture text --> 0.11 -<br>0.1 ,<br>0.09<br>0.0<br>0-<br>0<br>-~0.08<br>0.0<br>0.05-<br>1978 1980 1982 1984 1986 1988<br><!-- End of picture text --> 0 Actual (fitted) + 1978 Credit & Infro

**30**
**Figure** 4

# EFFECT OF POLICY ON INVESTMENT

<!-- Start of picture text --> (Actual Vs Simulations)<br><!-- End of picture text --> <!-- Start of picture text --> 0.11 O. 11<br>0.09<br>0.0<br>000<br>0.08<br>0.07<br>1978 1980 1982 1984 1986 1988<br>0 A + B O C A D<br><!-- End of picture text --> <!-- Start of picture text --> C<br><!-- End of picture text --> <!-- Start of picture text --> 0 A<br><!-- End of picture text --> <!-- Start of picture text --> O C A D<br><!-- End of picture text -->
restoring availability of credit to the private sector has a dominant effect, both because it is a relatively more important determinant of Kenyan private investment and because it declined substantially in the 1980s. Thus if Kenya had succeeded in adjusting i.e. in restraining money-financing of fiscal deficit and in controlling expansion of current expenditure at the cost of capital expenditure, private investment would have fared better.

Figure 4 helps to highlight the fact that appropriate fiscal adjustment (e.g. 1978iwould not be sufficient to raise investment to 1980 levels). The simulations show what would have happened to investment as both fiscal policy variables are restored to their 1978 level. For example private investment rate in 1985 could be nearly twice the actual rate of 5.5% of GDP: with only real credit to private sector maintained at 1978 level. Private investment rate would be 7.3% (line B), with both credit and infrastructure maintained (i.e. graph C if fiscal adjustment succeeded in maintaining them) instead of the actual of 5.5% shown in base run A.

Enhanced import allocations proxied by reserves at levels of 1978 would make the largest contribution to restoring investment rates. Difference between Graphs C and D in Figure 4 shows the size of this contribution. In 1985, it could raise investment from 7.8% to 10.5% of GDP.

# Impact of Real Devaluatior

Though the sign of real exchange rate in the private investment equation is negative, policy simulations suggest that the overall effect of real depreciation in the medium-term would be favorable. The favorable inuirect effect arises from the relaxation of foreign exchange constraint that occurs 32
due to depreciation-induced improvement in trade balance. A simultaneous equation model would have captured this indirect<sup>effect eas1ly.</sup> In its absence, we try to capture this<sup>in an ad hoc manner. Real</sup> depreciation affects both export<sup>supply and import demand, the magnitude of</sup> which depend on their price-sensitivity.<sup>This influences trade balance and</sup> thus foreign exchange reserves.<sup>3</sup> We use the estimated export supply and import demand equations shown in Table<sup>10 in conjunction with the estimated</sup> private investment function to simulate<sup>the effects of real depreciation.</sup> Figure 5 compares the behavior of private<sup>investment under one-shot and</sup> gradual real depreciation. The no depreciation<sup>(baseline) scenario captures</sup> essentially the effect of lagged reserves.<sup>The one-shot 15% real depreciation</sup> in year T and the gradual<sup>24</sup> 15% real depreciation<sup>equally phased over three</sup> years (T, T+1 and T+2) are shown (see<sup>Figure 5).</sup> 3Host of the positive effects of real depreciation<sup>on reserves comes out</sup> of decreases in total non-fuel imports. This<sup>is because price elasticity of</sup> exports is much lower than imports. Given<sup>Kenya's past policy regime and the</sup> resulting predominance of relatively inelastic<sup>exports (e.g., coffee, tea,</sup> sisal) in Kenyan exports, this is not surprising.<sup>The neeffect of</sup> depreciation on imports is adjusted for the<sup>increase in imports that results</sup> from higher export earnings and reserves.

24Since real depreciation is a function of nominal depreciation and demestic fiscal monetary policy stance, gradual<sup>real depreciation could also</sup> be viewed as slow "pass through" of<sup>a large nominal devaluation.</sup> 33
# Real Depreciation and Investment

<!-- Start of picture text --> Sudden vs. Gradual Depreciation<br>1.3 -<br>1.25 - _ _ _ _ _ _<br>o =1.2-<br>02 0<br>1.1<br>1.05-<br>c<br>0.95-<br>0<br>OL .<br>0.95<br>4.,~~~~~~~~~~~~~~~~~~~~~.*<br>0 .8 5 _ _ _ _ _ _ _ _ _ _ _ _ _ _<br>T T+1 T+2 T+3 T+4 T+5<br>years after depreciation (1988)<br>0 Gradual + Sudden Baseline<br><!-- End of picture text -->
Table 10: Estimated Export Supply and Import Demand Functi;ns

|Dependent Variable|Real<br>Non-Fuel<br>Exports|Real<br>Non-Fuel<br>Imports|
|---|---|---|
|Sample|1967 to 1988|1966 to 1988|
|Constant|9.107|0.7z4|
|Export Price/GDP Deflator (t-l)|<br>0.135*<br>(1.675)||
|Import Price/GDP Deflator||-1.135--<br>(3.56)|
|Actual Trend/Real Output (t-l)|<br>-0.349"'<br>(3.020)||
|Real Exchange Rate|-0.279<br>(3.726)|-0.468<br>(2.15)|
|Real Output||1.067"'<br>(5.52)|
|Flow of Forex||0.587<br>(5.52)|
|Dummy for 1986|0.156**<br>(3.073)||
|Adjusted R<sup>2</sup><br>Durbin Watson|0.82<br>1.81|0.80<br>1.45|

Note: All variables except dummies are in logs.

A one-shot raJl depreciation of 15% lowers private investment sharply but returns to the no-depreciation baseline level in two years. A similar pattern is obtained for the gradual real depreciation. However, the gradual 35
case implies a lower initial decline in private investment, a delayed recovery relative to the one-shot case: after the initial decline,.private investment rises to equal the no-depreciation investment path in two and a half years. Though gradual depreciation retards the investment response relative to oneshot depreciation, in the medium term real depreciation encourages private investment.

# CONCLUSION

Failure to implement adjustment policies after the collapse of the - coffee boom and the common market undermired private investment. Though Kenya has experienced relatively greater macroeconomic stability than other SubSaharan countries, her fiscal performance, both during and after the 1970s boom, leaves a lot to be desired. Her failure to control current expenditure has adversely affected public investment in infrastructure. It has also undermined her ability to reduce the fiscal deficit, and the money financing of that deficit. The latter in turn has reduced the flow of real credit to the private sector. Furthermore higher fiscal deficits arising from uncontrolled current expenditure has at worst generated pressures for raising 2A major qualification to this analysis in-addition to the assumptions, lies in the fact that the reserve impact excludes f_q.l from both export and import, which has been an unstable factor in the actual path of Kenya's reserves.

36
import controls and has at best undermined credibility of trade liberalization.26 Both enhanced uncertainty of private investors' access to imported capital goods.

Thus efficient fiscal adjustment and increased liberal import allocations will be critical to raising private investment in Kenya. Fiscal deficits should be reduced preferably through reductions in current expenditure that exceed reductions in total expenditure.

Such fiscal adjustment is likely to provide the biggest payoff in terms of private investment. It would raise public investment expenditure including that on infrastructure, and reduce money financing of deficit, both conducive to enhancing private investment. Furthermore, sustained trade liberalization would be facilitated by such fiscal adjustment which would in turn reduce uncertainty of access to imports for private investors.

26 Private investors may not respond to the liberalization-induced rise in profitability of tradable sector because poor fiscal performance raise serious questions about the sustainability of liberalizaEion. Even if private investors do view the trade liberalization as credible increased fiscal deficits or lower infrastructure investment will have an offsetting negative influence on profitability of private investment.

37