The Causality Relationship Between Financial Sector Profitability and the Botswana Economy

Abstract

Previous research has lamented on both the importance and the symbiotic relationship between financial sector performance and the state of a country’s economy. Findings of these studies are generally in concert in that the performance of the financial sector is intertwined with macroeconomic indicators. There is, however, a difference in opinion on the precise nature of the relationship between these sets of variables. This difference of opinion has led to the development of three parallel strands of theory: demand-driven relationship; supply-driven relationship; and economic developmental stage. To the extent that an understanding of the precise nature of the relationship between these critical variables would promote economic growth, it was found imperative to investigate the phenomenon in the context of a developing economy. This paper examines the causal relationship between the financial sector index and GDP in Botswana. The study uses data over a period of 10 years (2003-2013). This study timeframe is significant because previous research does not incorporate the critical periods in financial markets history over which the global economy experienced the economic cycle of the boom years (2003-2006), followed by a recession (2007-2010) and finally the recovery period (2010 and beyond). This financial cycle provides a unique opportunity for new insights into how financial sector performance relates to the economy. The findings are suggestive of an existence of a stable long-run relationship between the financial sector and the economy. In addition, the results show that the economy granger-cause the financial sector index with no reverse causality observed. Policy implications of these findings are discussed in the paper.