Abstract
Previous research has lamented on both the importance and the symbiotic relationship between financial sector performance and the state of a country’s economy. Findings of these studies are generally in concert in that the performance of the financial sector is intertwined with macroeconomic indicators. There is, however, a difference in opinion on the precise nature of the relationship between these sets of variables. This difference of opinion has led to the development of three parallel strands of theory: demand-driven relationship; supply-driven relationship; and economic developmental stage. To the extent that an understanding of the precise nature of the relationship between these critical variables would promote economic growth, it was found imperative to investigate the phenomenon in the context of a developing economy. This paper examines the causal relationship between the financial sector index and GDP in Botswana. The study uses data over a period of 10 years (2003-2013). This study timeframe is significant because previous research does not incorporate the critical periods in financial markets history over which the global economy experienced the economic cycle of the boom years (2003-2006), followed by a recession (2007-2010) and finally the recovery period (2010 and beyond). This financial cycle provides a unique opportunity for new insights into how financial sector performance relates to the economy. The findings are suggestive of an existence of a stable long-run relationship between the financial sector and the economy. In addition, the results show that the economy granger-cause the financial sector index with no reverse causality observed. Policy implications of these findings are discussed in the paper.
Highlights
The importance of the role played by capital markets in the global economy is undisputable
There are three important observations from the literature: (i) a relationship does exist between financial development and economic growth, (ii) there is a causal effect in the nature of this relationship; (iii) countries are heterogeneous and cross-country studies in Africa are inconclusive; and (iv) a country‟s stage of economic development is mediating factor in the relationship, i.e. while developed nations tend to show a bi-directional causality relationship between financial development and economic growth, least developing countries (LDCs) tend to show causality running from financial to economic development and no reverse causality
Time series data was for Real Gross Domestic Product (GDP) figures was obtained from the Bank of Botswana (BoB) archives while figures used to construct the Financial Sector Index (FSI) were obtained from the Botswana Stock Exchange (BSE) daily trading summary
Summary
The importance of the role played by capital markets in the global economy is undisputable In this context, investors, policy-makers and the academia have played different roles in forming opinions and understanding the symbiotic relationship between financial sector performance and the state of an economy. Investors, policy-makers and the academia have played different roles in forming opinions and understanding the symbiotic relationship between financial sector performance and the state of an economy Fundamental to this discourse is the search for the „holy grail‟ of market efficiency. Numerous studies have been conducted on this subject matter and many findings documented, albeit with contradictory outcomes. It is this lack of consistency in the results from previous studies that warrants further investigation. The third school of thought argues for interdependent relationship and adopts a bidirectional causality approach in analysing the relationship between financial sector development and economic growth (Rousseau & Vuthipadadorn, 2005)
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