Macroeconomic Factors and the Performance of the Manufacturing Sector in Kenya

Abstract

The share of the manufacturing sector in Kenya's GDP has been declining for over  a decade starting from a high of 12% in 2011 to a low of 7% in 2024. This decline raises concerns about Kenya's ability to attain its Vision 2030 goal of becoming a middle-income country by the year 2030. This study therefore investigates the effects of the macroeconomic factors on the performance of the manufacturing sector in Kenya. The macroeconomic factors considered include inflation, exchange rate and interest rate. The study also controlsfor the effects of foreign direct investment and gross fixed capital formation on the country's manufacturing output-to-GDP ratio. Annual time-series data from 1970 to 2024 is used. Some variables are integrated of order zero, whereas others were are integrated of order one. In addition, the autoregressive distributed lag bounds test reveals the absence of a long-run relationship among the variables. These characteristics informsd the choice of a short-run autoregressive distributed lag model. The results show that the coefficient on the first lag of the natural logarithm of the manufacturing output-to-GDP ratio is positive andstatistically significant. The coefficient is alsoless than one, illustrating a stable dynamic adjustment process. The coefficients on inflation and the exchange rate is negative and statistically significant. Specifically, the estimates show that a 1% increase in inflation leads to a 0.042% decrease in the manufacturing output-to-GDP ratio, ceteris paribus. Similarly, inflation in the previous period reduces the current manufacturing output-to-GDP ratio by approximately 0.044%. In addition, a 1% increase in the exchange rate leads to a 0.3% decrease in the manufacturing output-to-GDP ratio in both the current and subsequent periods. These results imply that inflation and the exchange rate are the macroeconomic factors the determine  the manufacturing performance in Kenya. Based on these findings, the study recommends that policymakers should prioritise maintaining low inflation and a stable exchange rate. This can be achieved by strengthening macroeconomic policy coordination between the Central Bank of Kenya and the National Treasury to ensure that monetary, fiscal and exchange-rate policies are mutually supportive.