Financial-Real Sectors Nexus in ECOWAS: Empirical Insights

1. COLLOQUIUM PRESENTATION FINANCIAL – REAL SECTORS NEXUS: EMPIRICAL EVIDENCE FROM THE ECONOMIC COMMUNITY OF WEST AFRICAN STATES BY Abdulsalam Abubakar (PhD) DEPARTMENT OF ECONOMICS

2. OUTLINE OF THE PRESENTATION • INTRODUCTION 2. OVERVIEW OF THE ECOWAS ECONOMY 3. LITERATURE REVIEW 4. METHODOLOGY 5. RESULTS AND DISCUSSIONS 6. CONCLUSIONS AND POLICY IMPLICATIONS

4. BACKGROUND • Financial development: critical for long-term economic growth - Through its effect on capital accumulation and productivity - However, currently, only physical capital is considered • Financial systemin 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)

5. BACKGROUND CONT. • 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 productivity • Poor 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

6. 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 constraint • Immediate 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

7. RESEARCH OBJECTIVES & QUESTIONS • The broad objective of the study is to investigate the effect of financial development on the real economy of ECOWAS • Specific objectives

8. 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 region • H02:The accumulation of physical and human capitals and productivity, do not mediate the impact of financial development on output in the ECOWAS region • H03:There is no causal relationship between financial development and output growth in ECOWAS

9. SCOPE OF THE STUDY • Financial Sector comprises of many institutions, markets & regulatory agencies etc. • But the study concern financial development • Specifically, monetary and banking sector development • There are only three stock and Bond markets available • Also the study is at macro level • And covers 11 ECOWAS member states; Liberia, Cabo Verde, Guinea and Guinea Bissau were excluded • Study period is 1980-2011; based on data availability

11. MAP OF AFRICA SHOWING ECOWAS’s LOCATION

12. 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 mass • Demography - Total estimated population of 305 million in 2010 - Annual growth rate of 2.67% - The most populated region of Africa

13. OVERVIEW OF THE ECOWAS REAL ECONOMY • Structure of the economies - Dominated by agriculture and minerals mining - Commodities; cocoa, cotton, crude oil, diamond, iron oreetc. - Low domestic processing due to low industrial capacity - Services & agriculture majorcontributors to GDP (79.7% in 2010) - Huge and dynamic informal sector • Key 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 profile • External 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

14. 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

15. 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

17. THEORETICAL LITERATURE (FINANCE-OUTPUT)

18. EMPIRICAL LITERATURE (FINANCE-OUTPUT)

19. EMPIRICAL LITERATURE (FINANCE-OUTPUT)

21. 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 constraints • Furthermore, the model also assumed technological progress to be endogenous • This assumption opens the scope for financial development to stimulate long-run growth • By improving the productivity of investment • The financial sector enables this through: • Processing and evaluating information on prospective investments, • Thereby allocating funds to projects with the highest marginal product of capital

22. 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

23. 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, yields • From 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

24. VARIABLES AND DATA

25. VARIABLES AND DATA CONT.

26. ESTIMATION TECHNIQUES

28. RESULTS AND DISCUSSIONS OBJECTIVE 1: To determine the impact of finance on output • Broad money as a measure of overall financial depth - having negative impact on output - Due to inflationary pressure • Financial 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 output • Bank 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

29. OBJECTIVE 2: To identify the channels through which finance influence output • Financial development promoting output mostly through physical capital accumulation • Financial development (credits) also influences output, through human capital - By easing borrowing constraints - Household access to financial resources and better plan expenditure on human capital accumulation • On 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 region • To 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

30. 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 increase • Bank credit and the ratio of bank credit to bank deposit causes output • Bidirectional 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

32. CONCLUSIONS • Narrower measures of financial development have positive impact on output in ECOWAS • While 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 roles • While bank credit causes output, output on other hand causes broad money and bank deposit growth • Bidirectional causality among output, financial sector deposits and credit

33. POLICY IMPLICATIONS • Growth of money supply be aligned with the real economic activities • Financial 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 economy 3. 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

35. JOURNALS

36. CONFERENCES ATTENDED