Economic Growth and Financial Sector Development: Long-Run Structural Break Cointegration and Short-Run Equilibrium Relationships in the East African Community

Abstract

The EAC countries in a bid to boost economic growth (RGDP) and reduce poverty in the region, implemented several financial sector reforms, however, empirical findings have indicated that financial development (FSD) can have a positive, negative or no effect on economic growth. This study investigated this relationship for four EAC countries including Uganda, Kenya, Burundi and Rwanda using individual country Gregory-Hansen-Quandt-Andrews-Muwanga (GHQAM) cointegration procedure based on OLS/FMOLS estimations. The findings indicate that in the long-run: i). a cointegration relationship exists between financial development and economic growth but it has not been stable for the periods covered; and ii). the elasticity of economic growth to financial development was zero before and after the break for Uganda and Burundi but ranged between 0.000-0.3208 and between 0.2178-0.3063 for Kenya and Rwanda, respectively, implying an inelastic relationship for all four countries. In the short-run, RGDP did not adjust to changes in FSD in Burundi while 46.36%, 46.3% and 40.67% to 67.47% of the adjustment of the former to changes in the later occurred in the short-run in Rwanda, Uganda and Kenya, respectively. These results signal the need to review and enhance the transmission mechanisms through which financial development affects economic growth and put in place a favourable environment to ensure positive and elastic effects on economic growth.