AN INVESTIGATION OF THE RELATIONSHIP BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH IN NAMIBIA A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN ECONOMICS OF THE UNIVERSITY OF NAMIBIA BY SYLVIA KINYONDO 200321587 APRIL 2018 SUPERVISOR: PROF. J.P. S. SHEEFENI ABSTRACT The study investigates the relationship between financial development and economic growth in Namibia. It employed an auto-regression distributive lag modelling approach on quarterly data for the period 1995 to 2014. The study used the following variables, namely: ratio of broad money supply to gross domestic product, real gross domestic product (GDP), saving and interest rate. Firstly, the results of the unit root tests showed a combination of integration of order zero and one. Secondly, the results for co-integration revealed the existence of a long-run stable relationship among the variables. Thirdly, the ratio of broad money supply to gross domestic product was found to have a negative and statistical significant relationship with economic activity. This suggests a negative relationship between financial development and economic activity in Namibia. Similarly, real interest rate and saving were also found to have a negative and statistically insignificant relationship with economic activity. On the contrary, the lagged real gross domestic product was found to have a positive and statistically insignificant relationship with economic activity. ii ACKNOWLEDGMENTS Firstly, I would like to thank the Almighty God for providing me with good health and blessings that were all essential throughout my study period. I would also like to express my sincere gratitude to my supervisor Prof. J.P.S. Sheefeni for all the guidance, immense inputs and knowledge. I could not have wished for a better supervisor. I would also like to thank the University of Namibia Economics department and the committee for all the constructive comments and expertise that was availed during my research writing. Lastly, my heartfelt-thank you-goes to my beloved family; my husband P.N. Mwilima, my children Shadrick, Ciara and baby Jayne who was born during the study period. I thank them for their support, tolerance and understanding during the whole busy study period. My appreciation will be incomplete if I do not thank my mother Paschazia Kinyondo and my brother Josephat Kinyondo for all the prayers and encouraging words that kept pushing me forward. iii DEDICATION I would love to dedicate my thesis to my late father, Hon. Sebastian Rukiza Kinyondo, and my children. My father instilled the value of education and that it is the only inheritance for us which we should be proud of, as nobody will take it from us. To my children, I pass on to you, and encourage you to work even harder as the sky is the limit. iv DECLARATION I, Sylvia Kinyondo, hereby declare that this thesis is a result of my own research and that neither part of it has been submitted for a degree in any learning institution. Neither part of this thesis may be copied nor transmitted in any form without the prior authorization of the author, or The University of Namibia. I, Sylvia Kinyondo, grant The University of Namibia the right to reproduce this thesis in ways as seen appropriate, for any person or institution requiring it for study and research. ……………………………… Date ………………………. Sylvia Kinyondo v ACRONYMS ADF Augmented Dickey Fuller AgriBank Agricultural Bank of Namibia ARDL Autoregressive Distributed Lag BoN Bank of Namibia CBS Central Bureau of Statistics CMA Common Monetary Area CUSUM Cumulative Sum of Recursive Residuals CUSUMQ Cumulative Sum of Square Of Recursive Residuals DBN Development Bank of Namibia ECM Error Correction Model GDP Gross Domestic Product RGDP Real Gross Domestic Product GIPF Government Institution Pension Fund JSE African Security Exchange Association KPSS Kwiatkowski-Phillips-Schmidt-Shin M2 Broad Money Supply vi MRLGHD Ministry of local government, housing and rural development NAMFISA Namibia Financial Institutions Supervisory Authority NSX Namibia Stock Exchange OLS Ordinary Least Square PP Phillips-Perron RIR Real Interest rate SAV Saving Table of Contents ABSTRACT ............................................................................................................................... ii vii Acknowledgements ....................................................................................................................iii Dedication .................................................................................................................................. iv Declarations ................................................................................................................................. v List of Acronyms ...................................................................................................................vi-vii CHAPTER ONE .........................................................................................................................1 1. Introduction ............................................................................................................................. 1 1.1 Orientation of the Study .......................................................................................................1-2 1.2 Statement of the Problem …………….…………………………..……………………….....3 1.3 Objective of the Study ……………..………………………………………………………...3 1.4 Hypothesis ………………………………………………………..………………………….3 1.5 Significance of the Study …………………………………………………………………....4 1.6 Limitations of the Study ……………………………….…………………………………….4 1.7 Organization of the Study ………………………………………..………………………. 4-5 CHAPTER TWO………………………………………………………………………….……6 2. An overview of Economic Development and Financial Structure in Namibia ……….……....6 2.1 Introduction...…………………………………………………………………………... ........6 2.2 Economic development in Namibia ……………………………………………………….6-9 2.3 An overview of financial structure in Namibia …………………………………………..9-10 2.3.1 Bank of Namibia ……………………………………………………………………...10-11 2.3.2 Commercial banks …………………………………………………………………..……10 2.3.3 Saving bank …………………………………………………………………………...11- 12 2.3.4 Development finance institutions …………………………………………………….12-13 2.3.5 Non-Bank financial institution ………………………………………………………..13-14 2.3.6 Namibia stock Exchange ……………………………………………………………..14-15 2.3.7 Micro Finance Institutions ………………………………………………………….. …..15 viii 2.4 Conclusion…………………………………………………………………………… …15-16 CHAPTER THREE…………………………………………………………………………...17 3. Literature Review…………………………………………………………………………….17 3.1 Introduction ………………………………………………………………………………...17 3.2 Theoretical review ……………………………………………………………………...17-21 3.3 Empirical Literature …………………………………………………………………….21-31 CHAPTER FOUR……………………………………………………………….............……32 4. Research Methodology ……………………………………………………………...………32 4.1 Introduction ………………………………………………………………………………...32 4.2 Data Sources ………………………………………………………………………………..32 4.3 Measurements of variables ……………………………………………………………..32-33 4.4 Empirical Framework and Model specification ………………………………………...33-34 4.5 Data analysis ……………………………………………………………………………….34 4.5.1 Stationarity ……………………………………………………………………………34- 36 4.5.2 Co-integration ………………………………………………………………………...36-37 4.5.3 Testing for Stability of Long-run relationship ………………………………………...…37 4.5.4 Estimating Short-Run Coefficients …………………………………………………...37-38 4.6 Conclusion ………………………………………………………………………………….38 CHAPTER FIVE……………………………………………………………………………....39 5. Estimation and Results Interpretation ……………………………………………………….39 5.1 Introduction… ……………………………………………………………………………...39 5.2 Unit root tests……. ……………………………………………………………………..39-40 5.3 Co-integration test ………………………………………………………………………40-41 ix 5.4 Stability of Long-run relationship……………………………………………………….43-44 5.5 Conclusion ………………………………………………………………………………….44 CHAPTER SIX ………………………………………………………………………………45 6. Conclusion and Policy Implication ……………………………………………………….…45 6.1 Introduction...…………………………………………………………………………….…45 6.2 Conclusion …….. …………………………………………………………………………..46 6.3 Policy implication ………. ………………………………………...…………………...46-47 6.4 Areas for Further Research REFERENCE……………………………………………………………………………...48-56 x CHAPTER ONE: INTRODUCTION 1.1 Orientation of the study Financial development is broadly known for enhancing economic growth by improving the size, quality, stability and access to financial systems. This has been made possible through financial intermediaries, who receive deposits from investors with extra money and uses the funds to give to those with insufficient amounts. The deposits received is used to carry out major projects that cannot be carried out by individuals. In addition, financial intermediaries encourage savers to save by offering them with more attractive incentives and have been remarkably good at enabling risk sharing through diversifying portfolio. They also manage selling low risk assets and buying high risk assets (Levine, 2005). Liquid capital market let savers hold bonds or equity as it can easily be transformed to cash when the need to access arises (Hicks, 1969). Therefore effective financial systems facilitate growth through efficient allocation of resources. Since independence, financial sectors in Namibia were categorized as being one of the main contributors towards tremendous growth in the economy. Its contribution to the gross domestic product (GDP) rose from 2.0% in 1990 to 3.6% in 2000, and further to 4.3% in 2010 (BON, 2011). Namibian financial systems like any other country, includes financial institutions which comprises