Do Banks Steer Economic Growth in Emerging Markets? Empirical Evidence from Zimbabwe

Abstract

Tests of the finance-growth nexus to date have not been conclusive on the nature & direction of the relationship between economic growth and financial sector development. A number of studies on the role played by banks in economic development have shown considerable variation across countries. In this paper we empirically examine the causal and nature of relationship between financial sector development and economic growth in Zimbabwe for the period 1980 to 2006; using time series analysis namely Granger Causality tests in a Vector Autoregressive (VAR) framework. All variables were tested for stationarity using the Augmented Dickey–Fuller (ADF) Test and became stationary in levels, 1^st difference and 2^nd difference. A general uni-directional relationship was found to exist running from banking sector development to economic growth in Zimbabwe hence the supply-leading hypothesis is supported. The study recommends that policy makers should come up with policies that steer continuous growth of the banking sector. In this regard the government could reduce its borrowings from the domestic money market, promote a savings culture by encouraging banks to increase their deposit rates (through moral suasion) and attract more deposits for onward lending to the private sector and improve the country’s low credit risk rating to lure foreign investors.

Keywords: Banks, Economic Growth, Unit root Tests, Granger Causality, VAR