Financial market performance and growth in Africa

Financial market performance and growth in Africa

Article Type: Editorial From: African Journal of Economic and Management Studies, Volume 7, Issue 2.

Introduction

Financial market performance has frequently been cited in the economic literature as a key requirement for enhancing economic growth (Bencivenga and Smith, 1991; King and Levine, 1993; Chakraborty, 2008). The dominant understanding is that a well-functioning financial system contributes to growth by mobilizing savings and channeling them through its financial intermediaries to investors that have identified productive investment opportunities (Ndikumana, 2001; Adjasi and Biekpe, 2006). It also reduces the costs of gathering, processing, and monitoring investment information, and therefore helps reduce problems of asymmetric information that are inherent in the relationships between investors (Naceur and Ghazouani, 2007). This influences resource allocation within and between sectors, thereby producing structural dynamics that enhance the overall productivity and employment creation within an economy (Chenery et al., 1986). Financial intermediation has poverty implications as well. Previous studies have shown that countries with well-functioning financial systems see poverty levels drop more rapidly than those without strong financial systems (Beck et al., 2011). It is in this light that studies of financial sector development and performance in Sub-Sahara Africa (SSA) deserve academic and policy attention.

Prior to the 1980s the financial sectors in SSA countries were generally described as underdeveloped, risk averse, highly concentrated in urban areas, and offering only a limited range of financial services (Andrianaivo and Yartey, 2009). But since the beginning of the 1980s several SSA countries have adopted policies aimed at creating environments that are conducive to financial intermediation. These include strengthening the institutional framework for banking regulation, promoting monetary policy autonomy, and establishing central bank credibility (Ndikumana, 2001). The results have been relatively impressive. The dominance of state-owned financial institutions has been drastically reduced, restrictive regulations have been dismantled, and new financial products as well as innovative delivery systems have been encouraged. At a regional level, there have been growing cross-border banking activities with the rapid development of networks of pan-African banks. All these have significantly changed the financial landscape in SSA.

The past two decades have also registered heightened interest in monetary integration in SSA. For example, there is the West African Economic and Monetary Union (WAEMU or Union Économique et Monétaire Ouest-Africaine, as it is called in French) with its members pegging their West African CFA franc, first to the French franc, and now to the euro. There is also the Communaute Economique et Monetaire d’Afrique Centrale (CEMAC) with Cameroon, Chad, Republic of Congo, Central African Republic, Equatorial Guinea, and Gabon as members. Furthermore, six member countries of Economic Community of West African States (Gambia, Ghana, Guinea, Liberia, Nigeria, and Sierra Leone) decided in 2000 to establish the West African Monetary Zone (WAMZ). The plan is that it will eventually be merged with WAEMU. The Southern African Development Community also plans to establish a monetary union in 2016 and to have a single currency by 2018. There are also plans in the East African Community to establish a monetary union by 2025. Ultimately, these regional initiatives are expected to result in the establishment of single monetary zone for Africa, with an African Central Bank by 2028 (see United Nations Conference on Trade and Development, 2014).

Despite the noteworthy developments of SSA’s financial sectors during the past two decades, there are still challenges in many different areas. The financial systems remain small, in both absolute and relative terms. For example, Andrianaivo and Yartey (2009) inform that while bank credit to the private sector is nearly 100 percent in most developed economies, it represents barely 15 percent in SSA countries. The general assessment is that the financial depth and breadth in SSA is the lowest in all regions of the world.

The value of the papers presented in the present volume of AJEMS must be seen against this backdrop. They all provide empirical investigations into aspects of the financial sectors and their performance in specific SSA countries and therefore add to the limited empirical knowledge on this important dimension of SSA’s economic growth.

Cosimo Magazzino’s study explores the relationship among fiscal variables (net lending, government expenditure, and revenue) and economic growth in the West African sub-region. He used various econometric techniques to analyze yearly data for the period between 1980 and 2011 in 15 West African countries. The results indicate that government expenditure and revenue show pro-cyclical effects in most of the countries in the sub-region. He also observed a weak long-run relationship between government expenditures and revenues in the WAMZ countries. The author advocates for greater intra-African trade and regional integration as instruments for harnessing the benefits of the monetary unions. He also envisages that such developments can form the basis for creating an African Monetary Fund that can play an oversight role and curb financial instability within the region.

Simplice Asongu analyzes the effects of monetary policy on economic activities (output and prices) in the CEMAC and WAEMU franc zones. He argues that serious disequilibria in a monetary union result from arrangements not designed to be robust to a variety of shocks. He uses vector autoregression within the frameworks of vector error-correction models and Granger causality models to estimate the long-run and short-run effects, respectively. The findings show that monetary policy variables do affect prices both in the short and the long-run in the CFA zones. Furthermore, compared to the CEMAC region, the WAEMU zone’s monetary authority is found to have more policy instruments for offsetting output shocks but fewer instruments for the management of short-run inflation.

Emmanuel Carsamer’s study examines the dynamic sources of volatility transmission in the foreign exchange market in SSA. The key findings of the study are that, the SSA financial market is more prone to shock from outside than within the region. Furthermore, macroeconomic surprises tend to influence volatility transmission and co-movements with significant impacts on trade balance, interest rate, and gross domestic product. The findings therefore provide additional evidence in support of the low level of financial development on the sub-continent and the challenges that exist in exchange rate policy implementation. On the basis of these findings the author observes that high degree of trade openness does not only increase the foreign exchange co-movement, but it also increases currency risk exposure. He recommends that the regulatory authorities should introduce guidelines that accord investors an acceptable level of currency stability.

Rafiu Adewale Aregbeshola has studied the role of local financial market on economic growth in three African regions – the northern, the southern, and the western regions. He used data generated from the African Development Indicators between 1980 and 2012 for the study. The results show some regional variations in the effects of financial market development on economic growth – the effects are stronger in the northern and western regions than in the southern region. Based on the findings, he concludes that financial market development is significantly more important as a growth driver in less developed countries than in developed ones. He also argues that, in contrast to the conclusions from previous studies, strong economic development appears to be the prerequisite for financial market development – and not the reverse. Thus, SSA needs to grow its economy in order to achieve financial market development.

Zerayehu Sime Eshete examines structural change and perpetual growth in Ethiopia, using a recursive dynamic Computable General Equilibrium model. The premise of the study is that despite Ethiopia’s remarkable economic growth in recent years (average growth rate of 11.2 percent since 2004), growth has not resulted in a structural and dynamic shift from agricultural sector to other high productivity sectors. Although growth in the service sector has been notable in recent years, investments tend to go to low productive sub-sectors such as domestic trade, hotels, and real estate businesses. There is, therefore, the need for re-channeling of resource to high productivity segments of the service sector if the economy is to achieve more sustainable growth, rapid structural change, and welfare gains.

Godfred Alufar Bokpin, Lord Mensah, and George Owusu-Antwi study whether investors can time their investments on the Ghana Stock Exchange (GSE) in order to improve their financial gains. They used the GSE all-share index from November 1990 to August 2012 to examine the day of the week effect on the stock market. The study reveals the presence of day of the week effect on the GSE, specifically, highest returns on Tuesday and lowest on Thursday. But, the significance of the variations appears not to be robust across time since different sub-periods with different trading days per week showed different results. The findings have led the authors to observe that investors in the stock market may not be able to adopt investment strategies that yield abnormal returns by timing the market. It appears to them more reasonable for investors to adopt a long-term investment strategy by holding a diversified market portfolio and profit from the compound effect of interest rate.

Abdul Alhassan and Kwaku Ohene-Asare study competition and bank efficiency in 26 Ghanaian banks, using data envelopment analysis to estimate technical and cost efficiency scores, controlling for bank size, lending, income diversification, tangibility, leverage, and profitability. The results show that competition exerts a positive influence on cost efficiency and there is convergence in both technical and cost efficiency. The authors therefore advise bank managers to adopt efficiency enhancing strategies that will help lower the interests charged on loans.

Some future research directions

The received economic wisdom from the papers presented in this volume and many other published studies on the financial systems in Africa is that as an economy grows, financial intermediaries (including banks) need to grow and become more sophisticated in their ability to channel resources to high-return activities. But in spite of the useful insights produced by in these studies, the debate regarding the development of the financial system and economic growth in SSA remains unsettled. Additional research is therefore required to inform policies and strategies. Here are some suggestions for areas of future research.

First, it has been argued by some scholars that the small size of SSA economies does not allow financial service providers to reap the benefits of scale economies (Beck et al., 2011; World Bank, 2013). Furthermore, the banking sector has hitherto been unwilling or unable to tap into the large "under/unbanked" segments of populations across the sub-continent thereby keeping large segments of the economy non-monetized and creating space for the informal financial sector to flourish. Since the liabilities of size will remain a problem for many years to come, research is required to find innovative approaches to deepening and broadening financial services and extending their outreach beyond the urban centers of SSA. For example, demand for payment transactions must be stimulated within and between the economies in order to make such services commercially viable. Innovations such as the cell phone-based M-Pesa in Kenya and Mzansi accounts in South Africa must serve as inspirations to entrepreneurs and researchers to think outside the boxes, so to speak, in order to develop new viable service delivery mechanisms.

Second, it has been suggested that the magnitude of the challenges faced by the financial sectors varies across the sub-continent. Beck et al. (2011) inform that there are critical differences between the financial systems in low- and middle-income SSA countries. Middle-income countries are characterized by a much larger outreach of banking systems, a larger variety of financial services, and a diversification of financial institutions and markets. However, the outreach of formal financial services is very much limited in the low income countries. There is a need for additional comparative studies of financial systems in SSA to create a pool of knowledge about best practices of the better functioning financial systems and to disseminate this knowledge to inform policies in the lower income countries.

Third, previous studies have shown that the performance of the financial sector is closely linked to fiscal and monetary policies pursued by individual governments and regional groups with the view to regulate the value, supply, and cost of money within a given country. Cosimo Magazzino’s study reported in this volume also lends credence to this perspective. It shows that there is a link between fiscal variables (net lending, government expenditure, and revenue) and economic growth in West Africa. There is, however, limited knowledge about the channels through which fiscal policy variables impact growth in SSA countries. This also provides an area for further empirical investigation.

Fourth, Asongu’s study adds to the stream of research suggesting that the feasible mix of government expenditure and financing arrangements may be influenced by membership of monetary unions, since such unions impose budget discipline and strict rules of compliance to convergence on their member countries (Masson and Pattillo, 2002).The literature suggests that there are challenges in operating within monetary unions for small developing economies. Although a monetary union may reduce divergences of fiscal and monetary policies across countries, individual countries may lack the institutional and regulatory mechanisms that monitor compliance and hold government behavior in check. Since SSA aspires to have increasing number of monetary unions in the near future, there is the need for additional empirical knowledge about how these monetary unions can be effectively managed, bearing in mind the current challenges of the various financial sectors.

Finally, it has been noted that one of the main objectives of pursuing monetary unions in Africa is to boost regional integration, particularly intraregional trade, and investments. Despite the efforts that have been made to promote regional integration on the continent SSA has not made much progress, particularly in fostering regional trade. Following the data from the United Nations Conference on Trade and Development, the 14 top-performing regional groupings worldwide have an average share of 42 percent of intra-group trade in their total trade with the rest of the world, while Africa’s regional economic communities’ average is 10 percent (United Nations Conference on Trade and Development, 2015). An International Trade Centre report (International Trade Centre, 2012) suggests that reducing the cost and time required to export goods by half, would boost SSA’s GDP by more than US$ 20 billion annually in 2025 and increase SSA’s trade by up to 51 percent. Taking advantages of these enormous growth potentials require studies that can provide insights into the challenges facing SSA countries in effectively using monetary unions to promote regional trade.

John Kuada

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