Estimating the Causal Relationship between Financial Development and Economic Growth in Nigeria

Abstract

This paper examined the causal relationship between financial development and economic growth in Nigeria and South Africa by employing co integration test, VECM and granger causality test using the data of annual time series for the period 1980-2014. The objective of the study is to examine the applicability or otherwise of stage of development hypothesis of financial development by Hugh Patrick (1966) in both countries which states that the direction of causality between financial development and economic growth changes over the course of development. The result of granger causality indicates a unidirectional causality running from financial development (DCPSGDPN) to economic growth in Nigeria and a bidirectional causality from financial development (DCPSGDPS) to economic growth in South Africa validating the Supply leading hypothesis of financial development by Hugh Patrick (1966) .This study therefore concludes that supply-leading phenomena (Finance-led growth) is evident in both Nigeria and South Africa economies. The Johansen multivariate co integration test indicates 2 co integrating vectors in both countries, showing a long run relationship between ratio of broad money supply to GDP (M2GDP), ratio of domestic credit to private sector to GDP (DCPSGDP),real interest rate(RLINTR) and economic growth (GDPPC). The VECM result shows that the ratio of broad money supply to GDP has no significant impact on economic growth in Nigeria and South Africa but the ratio of domestic credit to private sector to GDP has significant impact on economic growth in both countries. This study therefore recommends that priority should be given to the development of the financial sector in Nigeria and South Africa.