External Debt and Capital Flight in East Africa

Abstract

Capital flight remains significant for public officials in East Africa member states, especially since the emergence of the foreign debt crisis and the associated drastic decline in capital inflows from developed nations and Bretton Woods institutions. Given their smaller resource base, debt accumulation and budget deficit, the problem of capital flight in developing nations requires examination. The study examined the effect of accumulating external debt on capital flight in East African countries that includes Kenya, Tanzania, Uganda, Rwanda, and Burundi using panel data for the period 1988 to 2018. The study was guided by the debt-overhang theory that helped to analyze the motive of fleeing capital from developing economies to developed countries as a result of foreign debt accumulation. Secondary data was sourced from World Bank and Statistical Abstract reports. Ordinary least squares technique combined with the fixed effect estimation approach was used during analysis. The fixed effect regression findings reported that external debt had a positive and significant effect on capital flight in East African countries. A substantial fraction of the borrowed funds is being captured by African political elites who in turn channel the cash abroad in form of capital flight, thus, increased capital outflow indebts citizens through increased external debt to finance public spending. From the result, the policymakers should pursue debt financing, that is, EAC states should borrow from new lenders at a relatively lower interest rate and use the proceeds from the new loan to repay the old loans to avoid the risks of external loan defaults, so as to reduce the debt effect on capital flight. Keywords: Capital Flight, External Debt, Debt Crisis, Investment, Debt-overhang Theory, Debt Financing DOI: 10.7176/JESD/13-6-04 Publication date: March 31 st 2022