Financial Intermediation and Economic Growth: Evidence from Rwanda

Abstract

The relationship between financial intermediation and economic growth has been under investigation for decades. Some studies have been conducted using panels of countries with or without similar characteristics while others have been carried out on individual countries. In less-developed countries, the evidence about the link between financial intermediation and economic growth is particularly deficient. This study attempts to empirically investigate the possible cointegration and causal link between financial intermediation and economic growth in Rwanda, using quarterly data spanning from 1996Q1 to 2010Q4. A Structural Vector Autoregressive model is used to analyse the short-run dynamics between variables of interest. Findings of the study show evidence of a cointegrating relationship between financial intermediation and economic growth in the country. It is further observed that a shock to domestic private sector credit accounts for the largest proportion of fluctuations in real output growth, while the shock to potential liquidity comes second. This supports the supply-leading hypothesis in the intermediation link between financial sector development and economic growth in Rwanda, which suggests that the country can achieve significant economic growth if it reinforces incentives to attract businesses that can easily make use of the present financial services.