Linkage Between Capital Market Development and Economic Growth free essay sample

The capital market is an integral part of the financial system that provides efficient delivery mechanism for mobilization and allocation, management and distribution of long-term fund (Sunday O. E. Ewah and Judey Bassey). The capital market is a market for long-term debt and equity securities, where business enterprise and government can raise fund for long-term investments. It is normally divided into two broad categories: the stock market and the bond market (Central Bank of Lesotho Economic Review 2009). According to Tokunbo S.Osinubi (2000), the stock market is reported to perform some functions which promote the growth and development of an economy. It plays a pivotal role in mobilizing idle fund from surplus economic unit and channels such fund into deficit unit for investment in long-term project. The supplier of funds are basically individuals and corporate bodies who subscribe to capital market instrument as a way of adding value to their unused financial resources while the deficit unit i. We will write a custom essay sample on Linkage Between Capital Market Development and Economic Growth or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page e. the end users of the fund are government and corporate bodies as individual cannot approach the capital market for fund. Equally, the capital market provides ideal source for corporate bodies and government to pool monies from people and corporate bodies to finance capital intensive project which its internal purse cannot cope with. Akingboungbe (1996) opined that the importance of the capital lies in its financial intermediation capacity to link the laggard sector of the economy with the active sector. According to him, the absence of such capacity robs the economy of investment and production of goods and services for societal advancement. Capital market in any nation exists to provide long-term funds for government and corporate bodies for development purpose. It deals with long-term financial instruments which include equities or stocks, debentures, government bonds and derivatives like future options. In the capital market, the stock in trade is money which is often viewed as the lubricant of the economy and which can be raised through various instruments such as right issues, debt instrument, equity offering as well as through the stock exchange. This is a pointer to the fact that the capital market provides the wherewithal with which the goal of economic growth can be actualized, and equally held the key to economic prosperity of any nation. A virile capital market is capable of assisting a nation to muster financial resources and skills for rapid growth and development. The capital market is viewed as engine of growth in most countries. Empirical research by CBL Economic Review 2009 indicated that the capital market connects monetary sectors with the real sector and therefore facilitates growth in the real sector and economic development. The CBL economic review adduced the following as the fundamental channels through which capital market is connected to economic growth: First, capital markets increase the proportion of long-term savings (pension, funeral savings) that is channeled to long-term investment. Capital market enables contractual savings industry to mobilize long-term savings from small individual households and channel them into long-term investment. It fulfils the transfer of current purchasing power, in monetary forms from surplus sector to deficit sectors, in exchange for reimbursing a great purchasing power in future. In this way, the capital market enables corporations to raise funds to finance their investments in real estate. The implication will be an increase in aggregate consumption and hence growth and development. Second, capital market also provides equity capital and infrastructure development capital that has strong socio-economic benefit through development of roads, housing, energy, telecommunication, etc. These projects are ideal for financing through capital market via long-term bonds and asset backed securities. Moreover, capital market promotes public-private partnership to encourage private sector participation in productive investment. The need to shift economic growth from public to private sector has become inevitable as resources continue to diminish . It assists the public sector to close the resource gap, and complement its effort in financing socio-economic development through raising long-term project based capital. It also attracts foreign portfolio investors who are critical in supplementing the domestic savings levels. It facilitates inflow of foreign exchange into the domestic economy. Furthermore, the CBL Economic review 2009 equally asserted that countries with developed capital market have higher economic growth than countries without. An instance cited to justify this position is South Africa, the country with the largest and most developed capital market in Africa in terms of market capitalization which is experiencing faster growth compared to other countries with less-developed capital market. In Nigeria, the capital market seems not to have contributed so robustly to economic growth as the empirical research of the CBL Economic review and the predict of endogenous growth model which envisage positive correlation between the development of the capital market and economic growth both suggested. The capital market in Nigeria started rolling in 1960 when the Nigeria Stock Exchange was opened. It metamorphosed from the Lagos Stock Exchange which had been created in 1959 based on the recommendation of the Barback Committee set up by the then federal government. However, the Nigeria capital market has enjoyed a decade of unprecedented growth in the past five years. Going by the annual report of the Nigeria Stock Exchange (NSE) the total market capitalization has increased by over 90%though, this feat was short lived by the decline of 45. 8% in market capitalization recorded in 2008. According to the NSE, the impressive performance of the capital market can be attributed to some reasons: First, the bank consolidation exercise which introduced a minimum capital requirement for banks stimulated the performance of the capital market as it has encouraged most banks to choose the stock market. Equally, the privatization policy has also significantly impacted on the performance of the capital market. Even though with this scenario, the Nigeria capital market is yet to keep pace with the trend across the globe. According to Sule Ndanusa the Director General of the Securities and Exchange Commission, the Nigeria capital market is still a small market by international standard as its equity listing and market capitalization stood at 196 and $7billion respectively. This size of the Nigeria capital market is affected by the continuous depreciation of the naira. While the global trend dictates that the market capitalization of the capital market should be nearer the GDP or be above it, the market capitalization of the Nigeria capital market hovered around 60% and 39% respectively for 2007 and 2008 (NSE Annual report2009) respectively compared to that of South Africa which stood at 239%. Thus, a lot still need to be done to make the Nigeria capital market the engine of growth for the Nigeria economy. Given the scenario in the Nigeria capital market, the point of departure of this study is to examine the linkage between capital market development and economic growth with a view to explore the channels through which the capital market in Nigeria can be made engine of growth while addressing problem inherent in its operation. In the word of Adebiyi (2005), capital market in developing countries often suffer from classical defect such as illiquidity, lack of equity capital, bank dominated economies and lack of investor’s confidence in the capital market. The situation in the Nigeria capital market is not different as the predominant problem revolves around low market capitalization as well as illiquidity as most research works have revealed (e. g. Emenuga 2004, Judey Bassey and Sunday E. Ewah). This is coupled with the more serious obstacle of non-strengthening of the channels of transmission from financial development to economic growth such as financial depth(ratio of financial asset to national income), advanced financial structure(moving from bank and non-bank ntermediaries to stock market ), size as well as the efficiency of the financial system . The description of the Nigeria capital market as a small market by international standard as well the dominant roles which banks still play in the financial system at the expense of other financial intermediaries lends credence to this viewpoint. Several recent overviews of the link between financial market development and economic growth affirm positive correlation between financial market development and economic growth. But, in Nigeria evidences to this effect are weak, inconclusive and non-definitive. For instance, Sunday O. E. Ewah and Jude Bassey (2004) concluded that capital market has growth inducing potential but it has not contributed to economic growth owing to such problems such as low market capitalization and illiquidity. In similar vein, efforts were equally made by Nyong (1997) to develop an aggregate index of capital market development and use it to determine its relationship with long-term growth in Nigeria. The study employed a time series data between 1970 and 1974. The result of the study reveals that capital market is negatively and significantly correlated with long-run growth in Nigeria. The result also showed that there exist bi-directional causality between capital market development and economic growth. However, Levine and Zervos (1996) established positive relationship between the measure of stock market development and long-run growth rates. Ariyo and Adelegan (2005) contended that the liberalization of capital market contributes to the growth of the Nigeria capital market but its impact at the macro-economy is negligible. That is, the question of the channels through which capital market development correlate with economic growth has not been given detailed attention in empirics literature in Nigeria as most available empirical analysis in this direction are cross-country study and more so, are conducted for Asian and European economy. Such works include Jose De Gregorio et al (2003) Dipendra Sinha et al Saray Joy et al (2002) . A more potent proof of the scanty of evidence on the channel of transmission from financial development and economic growth can be found in the word of Valpy FitzGerald (2006) who stated that financial development and economic growth are clearly related and this relationship has occupied the mind of economists from Smith to Schumpeter, although the channels and direction of this relationship has remained unresolved in both theory and empirics literature. Thus, the absence of empirical analysis in this direction has left a serious gap that needed to be filled with a research enquiry. Following the foregoing from the few empirical evidences sighted above which reveal inadequacy and lack of agreement among analysts about the sine-qua-non role of capital market in economic growth coupled with scanty of literature on channels of transmission from financial development to growth and the pervasive problem of decline in market capitalization and illiquidity which characterize the Nigeria capital market as reflected in Nigeria Stock Exchange Annual report(2009), it becomes important to turn the searchlight on the capital market and every other thing that accompany or propel it with a view to empirically examine how linkage between capital market development and economic growth as well as the channels of transmission from capital market development to growth can be pursued to bring the dream of economic growth to fruition.