Financial liberalization is one of the most controversial aspects of economie liberalization programmes. From the neo-classical point of view, liberalizing financial market would stimulate savings and hence physical capital formation and would foster economie growth. While sorne empirical findings have associated financial liberalization with economie growth, others have found no correlation between financial sector liberalization and growth. The later has gone further to state that financial variables are negatively related to growth. Studies by King and Levine (1993), Savvides (1995), Alan (1989), Seck and EL NIL (1993), Ghatak and Siddiki (1997) and De Gregorio et al (2002) have found positive relationship between financial liberalization and economie growth.
However, studies by Berthelemy and Varoudaskis (1998) and Laroch and alli, (1994) do not confirm the existence of a positive relationship between financial liberalization and growth. The various studies are presented below:
King and Levine (1993) use a cross-sectional data and analysis on a sample of eighty (80) countries over the 1960- 1989 periods to show that financial development has a positive effect on growth. The financial development is identified by four variables:
1) M2/GDP ratio
2) The ratio of deposits in banks and reserves with the Central Bank 3) The ratio ofprivate sector credit /total domestic credit
4) The ratio ofprivate sector credit /GDP Four indicators are used to measure growth:
a) Per capita GDP growth rate b) The growth of the capital stock c) Investment/GDP ratio
d) Pro x y variable to measure total factor productivity.
The main conclusion of that study is that these four variables have a significant positive effect on growth.
In another empirical study usmg a sample of twenty eight (28) African countries, Savvides (1995), finds that financial deepening measured by the ratio of broad ~oney to GDP (M2/GDP) is positively related to growth. The size of the financial sector contributes significantly to economie growth. An increase in the ratio of M2 by 10 percent raises the annual per capita GDP growth by 1.8 percent.
In a more comprehensive study for the World Bank, Alan (1989) analyzed the relationship between average three to six months rates ( deflated by the CPI rate of inflation) and average real GDP growth from data on four LDCs over the longer period (1965-1985). He classified countries qualitatively according to whether their real deposit rates of interest were positive, moderately negative, or strongly negative for each period (1965-1973) and (1974-1985). However, Gelb's (1989) work went further in incorporating monetary and investment-saving variables and in using point estimates for interest rates effects to undertake further quantitative analysis. He found a strong positive correlation with GDP growth rate for the period 1965-73. In the sub - period 1974-85, average GDP growth rate was 5.6 percent for countries with positive real interest rates while those with moderately negative real interest recorded 3.8 percent and only 1.9 percent for those with strongly negative real interest rates.
TABLE3: COUNTRIES WITH POSITIVE/ NEGATIVE INTEREST RA TES
1965-1973 1974-1985
NEGATIVE NEGATIVE
INDICATOR POSITIVE MODERATELY STRONGLY POSITIVE MODERATELY STRONGLY
REAL INTEREST RATE 3.7 -1.7 -13.7 3.0 -2.4 -13.0
~ Real interests were calculated from nominal rates according to the following formula [(1 + r )1(1 + P) -1 ]* 100, where ris the nominal deposit rate and p is the inflation rate. Inflation is the percentage change in the CPI. M3 is currency plus the sum of non-bank deposits of the public at all identified deposit - taking institutions. Real saving is the gross domestic saving deflated by the average annual CPI rate. Volatility of inflation is the absolute deviation of the inflation rate from its level the year before.
Seck and EL NIL (1993), in their study on Financial Liberalization in Africa, adopted a panel data approach of the main target variables identified by Mckinnon -Shaw to nine African countries. The overall empirical evidence lent credence to the fmancial repression hypotheses that real deposit rates have a positive impact on financial savings and investment which, in turn affect growth positively. The main variables included in the model are as follows:
Growth: real GDP growth, REALDEP: real deposit rate= (l+R)/ (l+p*)-1
where R= nominal deposit rate, p* = ex post inflation rate, INVGDP: Gross investment relative to GDP, SAVEGDP: Gross savings relative to GDP, CAGDP: Current account relative to GDP, FINSAV: growth in M2 relative to GDP, DEPRA: deposit rate, INFL:
inflation rate measured with the consumer Priee Index and PERCAP: GNP per capita.
In contrast, Berthelemy and Varoudakis (1998), use a panel data regression based on a panel set covering eighty - two (82) countries and 30 years (1960-1990). Their results do not confirm the existence of a positive relation between financial development and growth, be it through savings mobilization or through the quality of its allocation. They therefore use a multiple equilibra model to show that there is a threshold effect. That is, under a certain level of financial development, growth is lower and the catching up (in the sense of Barro) is more di ffi cult. They come to the conclusion that un der a certain level of education and M2/GDP ratio, the catching up mechanism does not function.
Laroche, Lemoine and alii (1994), use a cross-section data and catching up equations.
Their findings are totally opposed to Levine's results. Financial variables are negatively
between 1975 and 1990 was not accompanied by a strong growth. On the contrary, in this period growth slowed down.
''A host of empirical studies have been carried out and the general findings in most cases
support the Mckinnon and Shaw hypothesis namely that liberalized financial regimes are associated with faster economie growth [ Levine (1977), Fry (1995)]. However, most of the studies are based on neo-classical growth theory (NGT). The dependence on NGT weakens the significance of the positive relationships between financial variables and economie growth, since the presence of diminishing retums to capital as predicted by NGT dictates that long run growth rates in per capita income will not be enhanced by an increase in the level of saving and investment. This type of limitation ofNGT motivates the emergence of endogenous growth theory (EGT), which predicts that FL (King and Levine, 1993) along with investment in physical and human capital, (Romer, 1986) enhances economie growth.
Ghatak and Siddiki (1997), examme the impact of financial liberalization and endogenous growth in the form of an increase in real interest rates and in financial deepening (broad money relative to GDP) on the rate of economie growth in Bangladesh using endogenous growth model. The overall result supports the prediction that human capital (HC), M2 relative to GDP represented by (FD), and real deposit rate (DR) have a statistically significant and positive impact on real growth rate in the long run. The study concludes that the short run insignificant impact of FD may be due to the fact that there is a time delay in the transfer of available funds from the financial system to investment. .
Another study by De Gregorio, et al (2002), support the previous work by Rajan and Zingales (1996), in a panel data context which found that financial development allows for the provision of cheaper funds which tends to benefit and stimulate the growth of the economy. The study stated that financialliberalization is an instrument that under certain conditions, promotes financial sector dev.elopment and through it can stimulate the relative growth rate of the sectors that rely on extemal funding. The study concluded that
if a proper legal institution is in place, the impact of liberalization on growth can be notable.