Modeling Causality Between Financial Deepening and Poverty Reduction in Egypt

Abstract

This study deals with the linkages between financial development and poverty reduction in Egypt using data for the period of 1975Q1–2011Q4. The stationarity properties of the variables are tested by applying Zivot–Andrews structural break unit root test. The structural break autoregressive distributed lag-bounds testing approach to cointegration is used to examine long run relationship between the variables. Our results show evidence of cointegration which confirms the presence of long run relationship between financial deepening, economic growth and poverty reduction. The results indicate that financial development reduces poverty when domestic credit to the private sector is used as proxy for financial development. The direct channel that financial sector development can lead to enabling the poor to access or broaden their access to financial services, such as credit and insurance-risk services, is therefore confirmed in case of Egypt. Furthermore, the indirect channel where financial sector development contributes to poverty reduction through economic growth is also confirmed for Egypt. This is only found when M2 is used as a proxy for financial development and infant mortality per capita as proxy for poverty. While our results show that the causal relationship between financial development and poverty reduction in Egypt is sensitive to the proxy used to measure these variables, the results show that the poverty-reduction programs are desirable in Egypt, not only because they reduce poverty but also because they possibly lead to further development of financial sector in long run. Furthermore, our results show that appropriate reforms aimed at developing a financial sector in Egypt that is well-organized and spread throughout the country can help reduce poverty by availing more domestic credit to the poor.