ABSTRACT
A great deal of literature from a number of studies established that stable financial system offers risk diversification and efficient capital allocation that leads to economic growth of a country and also the economic expansions caused by harnessing FDI as a source of external financing equally leads to economic growth. However, finance literature records that moderate and low rate of inflation positively affects growth of the economy but high and accelerating rate of inflation jeopardize growth within the economy. This study therefore seeks to determine the moderation effect of inflation on these relationships in the Kenyan set up. This study aims at establishing the moderating effect of inflation on the relationship between foreign direct investment, financial market development and economic growth in Kenya. Economic growth will be the dependent variable while FDI and financial market development are the independent variables. The study incorporated a macroeconomic variable (inflation rate) to moderate between the dependent and independent variable. The study anchored on Financial Intermediation Theory and the Eclectic Paradigm Theory. Secondary data collected for analysis from KNBS economic surveys, World Bank reports, central bank of Kenya’s reports, economic journals and annual economic survey reports for a period of 36 years 1980 to 2016. Correlation research design utilized in the study with a target population of six variables; GDP per capita income, FDI inflows, inflation rate, market capitalization/GDP, stock traded/GDP and domestic credit/GDP over a period of 36 years. Data analysis carried out using SPSS implementing descriptive and inferential statistics; the study findings revealed that the linear financial market development and foreign direct investment have positive effect on economic growth in Kenya. However, the interaction term between financial development and inflation rate has a negative on economic growth. The marginal effect of FDI evaluated on inflation rate resulted to a positive interaction term. In conclusion, the explanatory effect (adjusted R squared) increased signifying the presence of the moderating effect. Therefore, the study concluded that inflation moderates the relationship between FDI, financial market development and economic growth in Kenya. The study recommended development of policies to attract FDI in Kenya at moderate levels of inflation to result into a long-term benefit growth within the economy. In addition, to develop financial markets within a reduced level of inflation within the economy to enable achievement of long run economic benefit. Further research recommended on the moderating effect of other macroeconomic variables on the FDI growth nexus and financial market development and economic growth relationship.