FINANCIAL SECTOR DEVELOPMENT AND ECONOMIC GROWTH IN SSA: INSIGHTS WITH NEW DATA

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CHAPTER ONE: INTRODUCTION

            Background of the study

The debate about the significance of the financial sector to economic growth has been on-going for decades. In recent times, the interlinkages between financial sector development, poverty alleviation and economic growth provide compelling reasons why the financial sector is essential to developing countries especially those in sub – Saharan Africa. Mu, Phelps and Stosky (2013) found that deeper financial markets are beneficial to growth as the development of these markets improve financial intermediation and enable economic stability in the sub-region. Furthermore, the increase in funds and an improvement in the efficiency of the financial sector in SSA is reported as good for sustainable growth (Mlachila, Cui, Jidoud, Newaik, Radzewicz-Bak, Takebe, Ye & Zhang, 2016).

Inasmuch as there is extant literature documenting the relationship between the financial sector and economic growth, it is crucial to revisit the nexus because the widely used proxies to measure financial sector development either use the depth of a financial sub-sector or monetary aggregates. Due to unavailability of data, previous studies have used measures that represent a component of the financial system (Levine, 2003). The financial depth variables include liquid liabilities to gross domestic product, domestic credit to the private sector and stock market capitalisation while the monetary aggregates include broad and narrow money.

The problem is that these proxies do not reflect the financial intermediary role of financial institutions and markets which is the essential feature of the finance-growth nexus debate (De Gregorio & Guidotti, 1995) and may not provide a holistic picture of the financial sector. Von

Furstenberg and Fratianni (1996) argued that there is no consensus on the type of indicators for financial development. Cihak, Demirguc-Kunt, Feyen and Levine (2013) also pointed out that the empirical measurement of the financial sector development is quite challenging thus the use of the different dimensions as the basis of reporting on the level of financial development. This argument thus provides an insight into the need for a proxy that encapsulates all financial institutions and markets.

Svirydzenka (2016) introduced financial development indices that capture the depth, access and efficiency dimensions of the financial sector which this study adopts. First, it is essential to clarify that financial development is used synonymously with financial sector development in this study. The concept is also based on the definition of Sahay et al. (2015) which referred to financial development as a “combination of depth, access, and efficiency”. Conceptually, this definition reflects the multidimensionality of financial intermediaries.

Financial sector development is vital to the sustainable development discourse because an inclusive finance sector which is a by-product of a well-developed financial sector is instrumental to poverty reduction (Imboden, 2005). A higher degree of financial development reduces the barriers that affect access to external capital and lessens the financial constraint faced by enterprises (Caballero & Krishnamurty, 2001).

Mukhopadyay, Arizala, Haines, Newiak, Pani and Willems (2016) argued that an improvement in financial development will stimulate an additional annual economic growth by about 1 and a half percentage points. Consequently, the volatility associated with growth will be mitigated as financial sector development improves. Thus, the development of the financial sector can propel

SSA countries to attain the level of economic growth similar to developing countries with similar structural and macroeconomic fundamentals.