Financial Sector Development in Ethiopia and Its Effect on Domestic Investment: An Empirical Investigation

Abstract

It is widely agreeable that investment is the engine for growth. Similarly, financial institutions play a critical role to stimulate economic growth by mobilizing financial resources and availing it to investors. This study investigated “the effect of financial sector development on domestic investment in Ethiopia for the years 2000-2022.” Broad Money Supply as a measure of Financial Depth, Bank Credit to Bank Deposit as a measure of Banks’ Intermediation Efficiency, and Domestic Credit to the Private sector as a measure of Financial Activity were used as an alternative measure of financial sector development. Using an Autoregressive Distributed Lag (ARDL) model and running all relevant pre and post estimation tests, the results of the study justified a different effect of financial sector development on domestic investment as the measurement of financial sector development varied. In this regard, Financial Activity has a positive and significant effect on domestic investment in the long run. However, it has a negative and significant effect in the short run. Conversely, both financial depth and intermediation efficiency have a negative and significant effect on domestic investment in the long run. Similarly, financial depth has a negative and significant effect on domestic investment in the long run. The researcher recommended that government should monitor the supply of money so that inflation will be controlled and domestic investment will be enhanced. Besides, banks should expand credit to the private sector by intensifying their resource mobilization endeavour so that domestic investment will be enhanced in the long run. However, decision makers should exercise caution when selecting financial sector development metrics as a tool for promoting domestic investment.

Keywords: Financial Depth, banks intermediation efficiency, Financial Activity, ARDL

DOI: 10.7176/DCS/9-1-05

Publication date:March 31^st 2024