Financial Sector Development In Nigeria And Economic Performance

Project and Seminar Material for Economics

Abstract

The purpose of this study is to examine the effect of the Financial Sector development on the economic performance in Nigeria. The Time series data from 1986-2015 was imputed into the regression equation using some econometric techniques like Augmented Dickey Fuller(ADF) test, Johansen Co-integration test, Ordinary Least Square Regression. The result shows that Financial sector development variables: market capitalization, credit to private sector, Inflation, trade openness affect positively the Economic performance variable– Gross Domestic Product. This result is in consonant with some earlier studies reviewed in the literature that found financial sector development variables to affect positively gross domestic product.

Chapter One

Introduction

1.1 Background to the Study

The relationship between economic growth and financial development has been the subject of both theoretical and empirical analysis in economic literature for a long period of time. Although there are numerous studies examining this relationship, there is no consensus on the effect of financial development on economic performance. A number of theories indicate that financial development leads to economic growth. Studies that support this view include those of Habibullah and End (2006); Galindo (2007), Ang (2008); Giuliano and Ruiz-Arranz(2009) and Nkoro and Uko (2013). These studies maintain that a well-structured financial sector creates strong incentives for investment and also fosters trade and business linkages and technological diffusion.

This is mainly through mobilizing savings for productive investment which thus promotes economic growth. Another school of thought believes that economic performance translated to growth creates demand for financial services and therefore economic growth precedes financial development. Studies that advocate this view include Sunde (2013), Odhiambo (2008), etc. Another strand holds that financial advancement plays a minimal role, if any, on economic performance in relation to growth (Lucas, 1988) and Adusei (2012). However, in the recent past, there has been empirical evidence that there exist a bi-directional relationship between economic performance and financial development Fowowe (2010), Rachdi and Mbarek (2011).

The financial sector of any economy in the world plays a vital role in the development and growth of the economy. The development of this sector determines how it will be able to effectively and efficiently discharge its major role of mobilizing funds from the surplus sector to the deficit sector of the economy. This sector has helped in facilitating business transactions and economic development (Aderibigbe 2004).

A well-developed financial system performs several critical functions to enhance the efficiency of intermediation by giving information, reducing transactions and monitoring costs. If a financial system is well developed, it will enhance investment by identifying and funding good business opportunities, mobilizes savings, enables the trading, hedging and diversification of risk and facilitates the exchange of goods and services. All these result in a more efficient allocation of resources, rapid accumulation of physical and human capital, and faster technological progress, which in turn results in economic growth. Development in the real sector, as noted by Ajayi (1995), influences the speed of growth of the financial sector directly, while the growth of the finance, money and financial institutions influence the real economy. The economic growth is a gradual and steady change in the long-run which comes about by a general increase in the rate of savings and population (Jhingan 2005). It has also been described as a positive change in the level of production of goods and services by a country over a certain period of time.

Economic performance is measured by macroeconomic variables which are translated to economic growth that ultimately measures the increase in the amount of goods and services produced in a country. An economy is said to be growing when it increases its productive capacity which later yield more in production of goods and services (Jhingan 2003). Economic growth is usually brought about by technological innovation and positive external forces. It is the yardstick for raising the standard of living of the people. It also implies reduction of inequalities of income distribution. Oluyemi (1995) regards the financial sector of any economy as an engine of growth that could greatly assist in the promotion of rapid economic transformation. It can be concluded that no economy can ever develop without an appreciable growth in the financial sector. An efficient financial system is essential for building a sustained economic growth and an open vibrant economic system. Countries with well-structured financial institutions tend to grow faster; especially the size of the banking system and the liquidity of the stock markets tend to have strong positive impact on economic growth (Beck and Levine, 2002 in Nnanna, 2004)

1.2 Statement of Problem

The Nigerian financial sector, like those of many other less developed countries, was highly regulated leading to financial disintermediation which retarded the growth of the economy. The link between the financial sector and the growth of the economy has been weak. The real sector of the economy, most especially the high priority sectors which are also said to be economic performance drivers are not effectively and efficiently serviced by the financial sector. The banks are declaring billions of profit but yet the real sector continues to get weak thereby reducing the productivity level of the economy. Most of the operators in the productive sector are folding up due to the inability to get loan from the financial institutions or the cost of borrowing was too outrageous. The Nigerian banks have concentrated on short term lending as against the long term investment which should have formed the bedrock of a virile economic transformation. Since the adoption of the Structural Adjustment Programme (SAP) in 1986, in an attempt to quicken the recovery of the economy from its deteriorating conditions, a great deal of interest has been shown in the activities and development in the financial sector. This is so because the restructuring of this sector was a central component of the SAP reform.

It is evident that the empirical studies which focus on the link between financial sector development and economic performance show mixed results and this may be attributed to the estimation methodologies and quality and span of data used as well as the direction of causality. In Nigeria, there are few empirical studies that focus on the effect of financial sector development on economic performance using time series data. In addition, these studies do not examine the short-run and long-run effect of financial sector development on economic performance. While a significant number of empirical studies in which Nigeria is included use paneland cross-section data to examine the relationship between financial sector development and economic performance, there is no consensus on the findings. This may be due to the fact that these countries have different levels of financial and economic development. More so, the previous studies have not adequately addressed the problem of financial sector development as it affects economic performance. The research work, therefore, intends to complement the existing empirical studies by using time series approach with a view to shedding more light on this important relationship, by focusing on the effect of financial sector development on economic performance.

1.3 Objectives of the Study

To analyze the impact of financial sector development on Nigeria economic performance.
To assess the causal relationship between financial sector development and economic performance (i.e. which is causing which).

1.4 Hypothesis of the Study

HO1: The Nigerian financial Market does not Granger cause economic growth in Nigeria.
HO2: Economic growth does not Granger cause the growth of the Nigerian financial Market.

1.5 Significance of Study

There have been several studies on the financial sector development and economic performance. However, most of the studies consider one component of the financial sector in relation to economic performance. Many studies have been conducted on Capital market and economic performance, banking credit and economic performance and likewise foreign direct investment and economic performance. The use of one component of the financial sector like banking credit or capital market as a representative of the entire financial sector is inadequate, because the essence of the financial sector which is that of intermediation cannot be solely performed effectively by one subsector of the financial system like banking or capital market neither can it be handled by foreign direct investment alone.

Therefore, the gaps that prompted this study are, first, the fact that most studies conducted previously in Nigeria on the financial sector and economic performance used only one component of the financial sector. Taking one component of the financial sector to represent the whole financial sector will not be an adequate sample of the entire financial sector.

1.6 Scope of Study

The main focus of the study is financial sector development and economic performance in Nigeria. Within the period (1985-2015), the country has witnessed a tremendous development in her financial sector. This period relevantly covers the era of liberal economic policies and also the advent of Structural Adjustment Programme (SAP) as it affects the economy as a whole. More so, the effect of the financial sector development will not be appreciated without relating it with economic performance.

1.7 Limitations of Study

The efficiency and effectiveness of this research work is limited among other things to estimations as well as data and information obtained from government and corporate bodies. The study is limited due to a number of constraints involving time and resources which make it mandatory for the researcher to make do with the most relevant macroeconomic and financial indicators.

Chapter Five

Summary of Findings, Conclusion and Recommendations

5.1 Summary of Findings

The study examined the causal relationship and impact of financial sector development on economic performance in Nigeria using alternative sets of financial sector development indicators. The findings of the study reveal the following: Theoretical and empirical literature reviewed in this study document three categories of evidences, they are: First, a unidirectional (one-way) causality from financial sector development to economic performance. Second, there is a unidirectional causality from growth to financial sector development. The third alternative is the co-evolution (bidirectional causality) between economic performance and financial sector development hypothesized in both early and some recent literature. For instance, a number of models argued that the process of growth has a feedback effect on financial markets by creating incentives for further financial sector development, which means that the two variables are endogenously determined. Our causality result is expected to confirm at least one of these arguments. It should provide evidence that indicate the argument our finding is consistent with.

The granger causality results at lags 7 reveals some evidence of causal links between financial sector development indicators and economic performance in Nigeria in the period under review. Specifically, the results from causality test at lags 7 show that value of transaction and turnover ratio each drives real GDP with no reverse or feedback effect. Thus, this supports the evidence of unidirectional causal link from these two indicators to real gross domestic product. In essence, the general causality results imply that financial sector development do cause economic performance in Nigeria. This result is consistent with the dominant view and is in line with those theories that support the finance – led growth hypotheses. That is it is in support of supply leading hypothesis, financial repression hypothesis and Harrod – Domar growth theory argument. This thesis, more or less,confirmed the conclusions of earlier works on the importance of the financialsystem which could be traced back to the works of Bagehot (1873), Schumpeter(1912), Hicks (1969), (McKinnon and Shaw, 1973), Fry (1988), Roubini and Sala-i-Marti (1992), Harrison et al (1999), Christopoulos and Tsionas (2004), Nieuwerburgh, et. al., (2005), Mishra, et. al., (2010), Odeniran and Udeaja, (2010) and Usman and Adejare, (2012). Results obtained from empirical studies conducted using data from Nigeria that were consistent with the supply-leading argument, include Aigbokhan (1996), Adam and Sanni (2005), Okpara (2010), Adelakun (2010) Afees and Kazeem (2010) and Kolapo and Adaramola (2012).

The co-integration result implies that there exists a significant long-run relationship between financial market and economic performance variables. There exist four vectors or four different linear combinations of the financial market indicators that can drift together roughly at the same time with the RGDP. The significant long run relationship is identified to be between market capitalization and RGDP as well as other variables. This suggests that in the Long-run, economic performance determines financial sector development. This is in agreement with the demand following hypothesis, ie this result supports the demand led theory of finance – growth nexus. Empirical studies reviewed in this study confirming the existence of long run relationships between financial sector development and economic performance comprises; Levine and Zervos (1996), Agbawn (1998), Nieuwerburgh, et. al., (2005), Apergis et. al, (2007), Okpara (2010), Afees and Kazeem, (2010), Mishra, et. al., (2010), Ogege and Ezike (2012) and Kolapo and Adaramola (2012).

5.2 Conclusion

This study investigated the impact of the financial sector development on the growth of Nigerian economy. Empirically, we have been able to investigate the causal link between the capital performance indicators, with a number of the variables/indicators of financial reforms not generating the expected impact even though their direction of movement and pattern of effectiveness can be said to be shaped by some fundamental characteristics of the economy. At a more robust lag; ie lags 7, a one way causal relationship running from value of transaction
(VT) and turnover ratio (TOR) to RGDP is found. VT is significant at 1% level, while TOR at 10% level. We therefore, conclude that there is some evidence of causal relationships between financial sector development and economic performance in Nigeria as indicated by these indicators during our sample period. Results obtained were consistent with the supply-leading argument, giving rise to a conclusion in the work that financial sector development resulting from increases in financial institutions and financial resources, following financial liberalization, has stimulated growth in the real sector.

The co-integration result obtained shows the existence of a long run relationship between the growth of the economy proxied by real gross domestic product and the financial market indicators. The one period lag of the market all share index, capitalization, value of shares traded and turnover ratio, does not impact significantly on the growth of the RGDP. The study therefore, reached a conclusion that financial sector development and growth in Nigeria have a significant long run relationship; the variables are co – integrated. The economic implication of the finding suggests a need for more focus on the enhancement of the financial market so as to engender greater growth of the economy. This could be achieved through enlightment campaign on the importance of the financial market to the industrialists/small scale investors and more relaxation of the stringent entry requirements of the companies into the Nigerian Stock
Exchange.

5.3 Policy Recommendations

In order for the Nigerian financial market to be pivotal force in the growth and development, of the Nigerian economy the following suggestions or recommendations are put forward.

The government is therefore advised to put up measures to stem up investors‟ confidence and activities in the market and more foreign investors should be encouraged to participate in the market for improvement in the declining market capitalization so that it could contribute significantly to the Nigerian economic performance.
Maintain state of the art technology like automated trading and settlement practice, electronic fund clearance and eliminate physical transfer of shares.
There is also need to restore confidence to the market by regulatory authorities through ensuring transparency and fair trading transaction and dealing in the stock exchange. It must also address the reported case of abuse and sharp practices by some companies in the market.
To boost the value of transactions in the Nigerian financial market, there is need for availability of more investment instruments such as derivatives, convertibles, future, and swaps options in the market.
Given the present political dispensation, all the tiers of government should be encourage to fund their realistic developmental programme through the financial market. This will help in boosting the activities of the financial market, as well as the financial sector. Also, it will redirect the resources that may be used in other spheres of the economy.