The Kenya development plan 2007 projected an annual economic growth rate of ten percent for the next twenty five years. To achieve this objective, the capital market was identified as a critical avenue that could be used to mobilize investment funds required for implementation of vision 2030 projects. The government therefore has been implementing financial deepening strategies aimed at quickening the pace, development and contribution of the capital market. However, despite the well-intended and recurring government interventions, the capital market is still narrow, shallow and thin. This is evidenced by a slow growth in number of listed companies at NSE over the years and limited long term financial instruments such as bonds, derivatives, global depository receipts and exchange traded funds. This study therefore, examined the effect of financial deepening on capital market development in Kenya. Specific study objectives were to determine the influence of financial depth, market liquidity, financial openness, and financial access on capital market development in Kenya. The philosophy that was used in this study was positivism paradigm. The study used explanatory and non- experimental research design. The study utilized secondary time series data extracted from Capital Market Authority, Kenya National Bureau of Statistics and the Central bank of Kenya annual reports for the period 1990-2015. Based on the outcome of unit root test, time series data model (ARDL-ECM) was used in the study to define both short and long run financial deepening effects on capital market development in Kenya. Data analysis was aided by use of EViews 9.0 version. The mediating effect of gross domestic savings was tested using Baron and Kenney stepwise regression. In addition, Bauer and Curran product term was used to determine the interaction between variables. Further, since there was co integration among variables, Granger Test was carried out to establish the direction of the causal link between financial deepening and capital market development in Kenya. The ARDL-ECM coefficients revealed that financial depth and market liquidity has positive significant bearing on capital market development. Consequently, financial deepening as measured by financial access and openness has adverse but significant influence on development of capital market in Kenya. The mediation results revealed that gross domestic savings does not mediate the link between financial deepening and development of the capital. The researcher found a positive significant interaction between financial deepening and the market development. The study recommends the Central Bank in Kenya should use expansionary monetary policies as this increases money supply in the economy hence inducing capital market development. Consequently, the CMA should provide a more enabling trading environment that will enhance the speed and ease of buying and selling securities at the NSE thus increasing market liquidity. Further, the CMA should enhance access to the market by increasing more platforms for trading and also create more investor awareness on capital market product so as to increase their uptake.
CHAPTER ONE: INTRODUCTION
Background of the Study
Capital markets are fundamental components of well-functioning financial arrangements and important means for national growth (Osamwonyi, 2005). This is because these markets yield capital for long run projects. In fact, domestic markets enhance the execution of fiscal, monetary, and exchange rate policy (Laeven, 2014). Capital market undertakings play a key part in defining the level of economic undertakings in developing and developed economies, by providing and efficiently allocating resources for ventures, providing suitable platform to engender top business practices that end up expanding investment and developing the economy (Osamwonyi &Kasimu, 2013).
In view of this therefore, the development of capital market is vital in both developed and evolving economies as overall economic performance is strongly related to state of its capital market. Indeed, solid capital market is important since proposed and observed literature has revealed a positive relationship between market development and economic growth (Beck & Levine, 2004; Chakraborty &Ray, 2006).Sound and developed capital market attracts foreign direct investment in domestic industry and contributes to economic growth. (Oshikoya & Ogbu, 2003).
The bonds market for instance, is an another avenue for raising funds for public and private sector in funding long term projects such as housing and infrastructure development. Besides, the domestic bond market is used to facilitate large fiscal
shortages without turning to financial repression or international borrowing with a risk of exchange rate. (Turner, 2002).
On other hand, derivative markets enable increased access to finance by allocating finances to the most suitable investments; enable financial risk management by providing businesses with the choice of obtaining insurance against price fluctuations and enhance financial market deepening and assist economies to meet the challenges of globalization by contributing to development of capital market and influencing cross border flows (Mbungu, 2015). However, despite these potential benefits to borrowers, investors and the government, the development of capital markets in emerging economies has remained varied. Some nations have been able to grow large and liquid domestic capital fairs; while some have had their domestic markets deteriorate raising question on positive impacts of financial deepening (Berkes & Panizza, 2012).
Capital Market Development Globally
According to Schmukler et al., (2008) some countries have experienced development of their domestic markets from 1990 to 2007 before the worldwide financial crunch in 2008 that hit the world markets. However, most emerging countries did not have meaningful development as the one observed by developed states. Some nations even had real deterioration of domestic markets in terms amount of companies listed and market liquidity (Wilton, 2013).
Differences in the expansion of the capital fairs is also seen by income levels, mainly in the growth of local private bond markets. For instance, while local private bonds
amounted to 30 percent of bonds unpaid in high income economies and 25 percent of bonds due in upper middle income nations, it only resulted to 4.5 percent of bonds unsettled in lower middle income countries by 2012.Stock market capitalization in low income countries reduced to 20 percent of GDP from 24 percent of GDP in 1994 in 2012.The international debt issues has also grown more rapidly in low income economies than local bond, this signifies international borrowing and security issuances continue to be more attractive means of raising funds for many investors in these countries (Leaven, 2014).