FINANCIAL – REAL SECTORS NEXUS: EMPIRICAL EVIDENCE FROM THE ECONOMIC COMMUNITY OF WEST - PowerPoint Presentation

Slide1

FINANCIAL – REAL SECTORS NEXUS: EMPIRICAL EVIDENCE FROM THE ECONOMIC COMMUNITY OF WEST AFRICAN STATES

04/08/2016

BYAbdulsalam Abubakar (PhD)DEPARTMENT OF ECONOMICS

COLLOQUIUM PRESENTATION

Slide2

OUTLINE OF THE PRESENTATION

INTRODUCTION

2. OVERVIEW OF THE ECOWAS ECONOMY3. LITERATURE REVIEW4. METHODOLOGY5. RESULTS AND DISCUSSIONS6. CONCLUSIONS AND POLICY IMPLICATIONS

Slide3

Slide4

BACKGROUND

Financial development: critical for long-term economic growth

- Through its effect on capital accumulation and productivity - However, currently, only physical capital is consideredFinancial system in ECOWAS is largely under-developed, in 2010: - Broad money/GDP 37% (African average 38%) - Private credit/GDP 21% (African average

24%)Weak economic performance - Average GDP per capita was only US$ 669.5 (African average US$ 1669)

Slide5

From the perspective of endogenous growth models

- Weak economic performance of ECOWAS is due to low human and physical capital accumulation, and productivity - Human capital, average HDI below 0.449 (African average 0.475) - Physical capital also low, gross fixed capital formation 22% of GDP - Low human and physical capitals apparently

lead to low productivityPoor performance of both financial system and real economy, has raised important issues pertaining to the regions’ quest for growth- Is financial system having any influence on the real economy?

- Through which channels?

- Which

of financial development and output

precede

the

other? These issues motivate this study - To explore the financial-real sectors dynamic relationship in the ECOWAS region

BACKGROUND CONT.

Slide6

PROBLEM STATEMENT

Low financial access in ECOWAS region

- Only 3.86% and 13.32% of adult population borrow from and have accounts with formal financial institutions - Only 19.51% of firms maintain a line of credit and 56.73% of them identified access to finance as their major constraintImmediate cause: under-development of the ECOWAS financial system

Its consequences - Low levels of capital accumulation and productivity - Poor economic performance, as indicated by low GDP per capita The above issues indicate - Structural

problems

of financial

development and its

influence

on

output in

the ECOWAS region - These are major policy concerns, which this study seek to highlight

Slide7

RESEARCH OBJECTIVES & QUESTIONS

The broad objective of the study is to

investigate the effect of financial development on the real economy of ECOWASSpecific objectivesS/No.RESEARCH OBJECTIVES RESEARCH QUESTIONS

1To determine the impact of financial development on output in ECOWAS regionWhat is the impact of financial development on output in the ECOWAS region?2

To identify the channels through which the effect of financial development is transmitted to the real economy

Through which channels do financial development influences the real economy?

3

To determine the causality relationship between financial development and output in the ECOWAS

What is the causal relationship between financial development and output in the ECOWAS?

Slide8

HYPOTHESES OF THE STUDY

The previous research objectives and questions are formulated into the following testable hypotheses

H01: Financial development does not have any significant impact on output growth in the ECOWAS regionH02: The accumulation of physical and human capitals and productivity, do not mediate the impact of financial development on output in the ECOWAS regionH

03: There is no causal relationship between financial development and output growth in ECOWAS

Slide9

SCOPE OF THE STUDY

Financial Sector comprises of many institutions, markets & regulatory agencies etc.But the study concern financial developmentSpecifically, monetary and banking sector development

There are only three stock and Bond markets availableAlso the study is at macro levelAnd covers 11 ECOWAS member states; Liberia, Cabo Verde, Guinea and Guinea Bissau were excludedStudy period is 1980-2011; based on data availability

Slide10

Slide11

MAP OF AFRICA SHOWING ECOWAS’s LOCATION

Slide12

GEOGRAPHY AND DEMOGRAPHY OF ECOWAS

Geography

- ECOWAS formed in 1975, member states are - Francophone: Benin, Burkina Faso, Cote d’Ivoire, Guinea, Guinea Bissau, Mali, Niger, Senegal and Togo

- Anglophone: Cabo Verde, Gambia, Ghana, Liberia, Nigeria and Sierra Leone - Total surface area 5, 112, 903 km2, - 17% of the total African land massDemography

- Total

estimated population of 305 million in 2010

- Annual growth rate

of 2.67

% - The most populated region of Africa

Slide13

OVERVIEW OF THE ECOWAS REAL ECONOMY

Structure of the economies - Dominated

by agriculture and minerals mining - Commodities; cocoa, cotton, crude oil, diamond, iron ore etc. - Low domestic processing due to low industrial capacity - Services & agriculture major

contributors to GDP (79.7% in 2010) - Huge and dynamic informal sectorKey Macroeconomic variables - Moderate economic growth and inflation (5.6% & 5.5% in 2010) - Low savings and investment (14.7% & 21.9% of GDP in 2010)Public sector

- As the major

economic

actor

- But faced with low revenue and high expenditure - Hence negative fiscal balance and high debt profileExternal sector - High

import relative to

export,

- Hence

, negative trade and current account

balances

- FDI

and other

capital

flows on the rise, but devoid of local

content

Slide14

MONETARY & FINANCIAL SECTORS OF ECOWAS

Monetary institutions and monetary policy

- Single central bank in WAEMU zone (BCEAO) - Issues currency and conducts monetary policy - Constrained by CFA arrangements - To deposit 65% foreign reserve in operating account at French treasury

- Uses segregated reserve requirement and reverse repo operations - Monetary policy in non-WAEMU takes different approaches - Each country has its own central bank - Adopt various tools and strategies to implement monetary policy

- Ranging

from reserve requirement to inflation

targeting

Slide15

Financial Sector

- Generally bank-based; foreign banks dominance in

WAEMU - Banks and related institutions constitutes almost 90% of total financial sector assets - Low levels of deposits and credits to private sector; less than 25% of GDP - Banks have high taste for government securities - Private sector faces financing challenges, despite excess liquidity in banks - Banks charge high collateral

for private loan, sometimes up to 100% of principal amount and high interest rate - But government sometimes interfere with credit allocation - Capital market plays limited role - The only three stock exchange markets have low capitalisation and turnover - Bond market blossoming; trading largely in short-term government securities

- Minimal corporate bond

- Small but growing MFIs, increasing financial access

Slide16

Slide17

THEORETICAL LITERATURE (FINANCE-OUTPUT)

Author(s)

HypothesesPostulation(s)Bagehot (1873/1999) Money market development , enable the flow of capital across England from less productive to the high productive regions

Schumpeter (1934/1983) Supplying-leading hypothesisBanker intermediate between entrepreneurs willing to form new business and the owners of capitalRobinson (1952)demand-following hypothesis

W

here

finance follows growth leads

Patrick (1966)

mutual dependence hypothesis

Relationship

among financial development and economic growth is reciprocalMcKinnon (1973) and Shaw (1973)

Financial repression hypotheses

Repressed

financial system impede economic growth

Greenwood and Jovanovic (1990)

Paradigm

T

he

degrees of financial development and economic growth are endogenously determined

Bencivenga and Smith (1991)

multiple assets-endogenous growth model

Introduction

of financial intermediaries, shifts the composition of savings towards capital

Pagano (1993)

Model

Financial development improves saving rate, the portion of saving absorbed for investment and the marginal productivity of investment

Slide18

EMPIRICAL LITERATURE (FINANCE-OUTPUT)

Author(s)

CoverageMethodologyMajor Findingsde Gregorio (1996)OECD and developing countries

Panel regressionAccumulation of human capital is lower in countries where borrowing constraints are high; experience lower economic growthRioja and Valev (2003)Developed & developing countries, 1961-1995General Method of Moments (GMM)Finance influences growth via productivity & capital accumulation, in developed and developing countries respectively

Christopoulos and Tsionas (2003)

10 developing countries

Panel cointegration and FMOLS

F

inancial

depth wields an equilibrium relationship with economic growth

Kiran, Yavuz and Güriş (2009)

10 emerging countries, 1968 to 2007

Panel cointegration

Financial

development have positive and significant influence on economic growth

Ahmed (2010)

15 SSA, 1976-2005

panel cointegration and the FMOLS

F

inancial

development Granger cause economic growth

Slide19

EMPIRICAL LITERATURE (FINANCE-OUTPUT)

Author(s)

CoverageMethodologyMajor FindingsEsso (2010)ECOWAS region, 1960 to 2005

Gregory and Hansen (1996) cointegration testLong-run relationship between financial development and economic growth, with different direction of causalityHakeem (2010)eight SSA countries, 1970-2000fixed effect, random effects and maximum likelihoodF

inancial

development have no strong impact on growth, but physical and human capital have

Dufrenot

, Mignon, and

Peguin-Feisolle

(2010)

89 countries, 1980 to 2006Cointegration techniqueFinancial development positively influences economic growth in developed countries, but negatively in developing countries

Baliamoune-Lutz (2010)

18 SSA economies, 1960-2001

cointegration and VAR estimations

Stage of development irrelevant in the link between finance and growth

Gaye (2013)

ECOWAS region, 1985 to 2010

fixed and random effects approaches

P

rivate

credit exerts positive effect on real GDP per capita than broad money

Slide20

Slide21

THEORETICAL FRAMEWORK

Augmented endogenous growth model by Lucas (1988)

In which the accumulation of physical and human capitals account for long-run growth The financial sector facilitates capital accumulations by mobilising and allocating funds and easing borrowing constraintsFurthermore, the model also assumed technological progress to be endogenousThis assumption opens the scope for financial development to stimulate long-run growth

By improving the productivity of investmentThe financial sector enables this through:Processing and evaluating information on prospective investments, Thereby allocating funds to projects with the highest marginal product of capital

Slide22

MODEL SPECIFICATION

Growth accounting on the basis of the endogenous model -

Is concerned with how variation in output is due to physical and human capital accumulation and efficiency of investment - This is a basis to evaluate how the financial sector influences the real economic growth Aggregate production function - Following Mankiw

, Romer, and Weil (1992) and de Gregorio (1996) - In intensive form that is in per worker terms yields - Taking the log and differentiating over time, gives the growth rates

Slide23

MODEL SPECIFICATION CONT.

In eqn. 3, output growth is divided into three

components - Total-factor-productivity, growth in physical and human capital accumulations Adapting physical and human capital growth from Pagano (1993) and de Gregorio (1996) - And representing output growth &

productivity by ygt & agt, yieldsFrom eqn. 4, financial development can influence output growth - By raising the proportion of savings channelled to investment

- The

marginal productivity of capital and

increasing human capital

- By

easing borrowing constraints

Slide24

Variables

Description/Measurement

Previous LiteratureFinance-growth (1980-2011)Broad money, financial and banking sectors deposits and credits, ratio of bank credit to bank deposits (GFD)Captures financial depth, intermediation activities and efficiency; measured as ratios of GDPAziakpono, 2003; King and Levine, 1993a; Levine and Zebros, 1998; Levine, 2003; Hakeem, 2009

Physical capital (ADI)Capital accumulation, gross fixed capital formationKing and Levine (1993a) and Caporale, Howells and Soliman (2003)Productivity (UNIDO)

Productivity of investment, total factor productivity

Neusser

and

kugler

(1998) and Ahmad and Malik (2009)

Government

Expenditure (ADI)Public sector, total governement expenditureHassan, Sanchez and Yu (2011) and Ahmad and Malik (2009)

Trade

Openness (UNCTAD)

Sum of exports and imports

Hassan, Sanchez and Yu (2011) and

Dufrenot

, Mignon and Penguin-

Feissolle

(2010)

Foreign Drect

Investment (UNCTAD)

10% and above of foreign equity holding

Barajas,

Chami

and

Yousefi

(2010) and

Ang

and

McKibbin

(2007)

VARIABLES

AND DATA

Slide25

VARIABLES AND

DATA CONT.

VariablesDescription and MeasurementPrevious LiteratureInflation (ADI)Macroeconomic stability, CPI Law and Habibullah (2006), Gaye (2013)

Human capital (UNESCO Institute for statistics)Human capital development, total school enrolmentHakeem (2010), Barajas, Chami and Yousefi (2010) and Bangake and Eggoh

(2010)

Slide26

ESTIMATION TECHNIQUES

Objective(s) addressed

MethodApproachesPrevious StudiesPreliminary analysis; properties of the data and

integration order ,to avoid spurious regression, prepares towards addressing objectives 1 to 3. Panel Unit Root Testa) Levin, Lin and Chu (2002)

Ahmed (2010);

Bangake

and

Eggoh

(2010);

Bokpin

(2010); Christopoulos and Tsionas (2003); Kiran, Yavuz, and Güriş (2009).b) Im,

Pesaran

and Shin (2003)

c) Breitung (2000)

d) Maddala and Wu (1999)- Fisher-ADF test

e) Choi (2001)- Fisher-Phillips Perron test

To establish

long

run equilibrium

relationship, partly address

objectives

1 and 2.

Panel Cointegration Test

a) Kao (1999)

Ahmed (2010); Bangake and Eggoh (2010); Christopoulos and Tsionas (2003); Kiran, Yavuz, and Güriş (2009).

b) Pedroni (1999, 2000 and 2004)

Magnitude, significance of the impact of finance on output and channels of influence, help in achieving objectives 1

and

2

Estimation and Inference

a) Fully Modified OLS (FMOLS)

Ahmed (2010); Bangake and Eggoh (2010); Christopoulos and Tsionas (2003); Kiran, Yavuz, and Güriş (2009).

b) Dynamic OLS (DOLS)

Direction

of causality

between finance and

output,

addressed

objective

3

Panel Granger Causality Test

Dumitrescu-Hurlin

(2012) Granger non-causality test

Bozoklu

and

Yilanci

(2013) and

Naik

and

Padhi

(2014)

Slide27

Slide28

RESULTS AND DISCUSSIONS

OBJECTIVE 1: To determine the impact of finance on outputBroad money as a measure of overall financial depth

- having negative impact on output - Due to inflationary pressureFinancial sector deposit also having negative effect on output - Allocation of funds, largely to public

sector - And few well-connected firms and individuals - Which triggers financial crisis and hence reduce outputBank deposit & private credit having positive impact on output - More robust when

funds

mobilisation is matched with

allocation

- When

financial intermediaries are efficient

- In transforming large portion of deposits into credit

Slide29

OBJECTIVE 2: To identify the channels through which finance influence outputFinancial

development promoting output mostly through physical

capital accumulationFinancial development (credits) also influences output, through human capital - By easing borrowing constraints - Household access to financial resources and better plan expenditure on human capital accumulationOn the contrary, financial deposits have weak

and even negative effect on human capital accumulation - Low deposit rate paid by banks - Loss of savings arising from financial crises in the regionTo a lesser extent, financial development influences output through productivity - Thereby, validating the argument that in developing countries - Financial

intermediaries have less capacity to evaluate

projects

- And bank loans are largely based personal connection

Slide30

OBJECTIVE 3: To determine the causal relationship between finance and output

Output growth Granger causes monetary growth and bank deposit

- As output increases, level of income also increases - Thus causing savings with the banking sector - Bank deposit being a component of broad money cause it to increaseBank credit and the ratio of bank credit to bank deposit causes

outputBidirectional causality: financial sector deposit and credit and output - Activities of non-bank financial intermediaries - Leading to increase in output, in turn, leads to more deposits in and loans from such institutions

Overall, financial

development and output mutually dependent

- Growth

process benefits from financial

development

- Which provides basis for increase in savings, - Thereby leading to more financial development

Slide31

Slide32

CONCLUSIONS

Narrower measures of financial development have positive impact on output in ECOWASWhile broader measures have negative impact on output

Physical capital accumulation is the major channel through which financial development influences output Human capital and productivity serving lesser rolesWhile bank credit causes output, output on other hand causes broad money and bank deposit growth Bidirectional causality among output, financial sector deposits and credit

Slide33

POLICY IMPLICATIONS

Growth of money supply be aligned with the real

economic activitiesFinancial policy reforms - Should aim at increasing access to finance and financial services - To both household and private sectors - By eliminating/mitigating the factors that hinder access to finance - Also be reciprocated by corresponding reforms in the structure

of the real economy3. Banks and other financial intermediaries - Should enhance their capacities to effectively evaluate projects - Such that the productivity channel can work 4. Policy incentives be provided to financial institutions - To enable them provide more loans to household sector

- Especially human capital/education related loans

Slide34

Slide35

JOURNALS

S/N

Paper TitleJournalRemarks1

Financial Development, Human Capital Accumulation and Economic Growth: Empirical Evidence from the ECOWASProcedia - Social and Behavioural Sciences 172(2015). (Scopus)Published2

Sectoral Impact of Bank Credit in Malaysia:

ARDL

Modelling Approach

Pertanika

J. of Soc. Sci. and Hum

., 25(S

). (Scopus)Accepted

3

Impact of Financial Development on Priority Sectors of the Nigerian Economy

Economic

Change and

Restructuring (Scopus)

Currently

addressing

reviewers comments

4

Institutional and Macroeconomic Determinants of Financial Development in the OIC Countries: A System-GMM Approach

Global Business and

Economic Review (Scopus)

Currently

addressing

reviewers comments

5

Financial Development and Endogenous Growth in Developing Economies: A Re-assessment using Panel Cointegration Approach

Journal

of

Economic

Studies

(Scopus)

Undergoing review process

Slide36

CONFERENCES ATTENDED

Papers Presented

ConferencesThe differential impact of financial development on priority sectors of the Nigerian economy2ND International Conference on Islamic Economics and Economies of the OIC Countries (ICIE 2013), 29th - 30th January, 2013, Prince Hotel and Residence, Kuala Lumpur, Malaysia

Differential impact of banking sector development on real sector output: A comparative analysis of Nigeria and Malaysia15th Malaysian Finance Association Conference, (MFA 2013)-Financial challenges and economic growth; the way forward, 2nd – 4th June, 2013, Sime Darby convention centre, Kuala LumpurFinancial Development, Human Capital Accumulation and Economic Growth: Empirical Evidence from the Economic Community of West African StatesGlobal Conference on Business and Social Science, 15th to 16th December, 2014, Connexion @ Nexus, Bangsar South, Kuala Lumpur Malaysia

Sectoral Impact of Bank Credit in Malaysia: ARDL Modelling Approach

2

ND

Global Conference on Business and Social Science, 17

th

to 18

th September, 2015. Bali Indonesia