Financial Stock Market and Economic Growth in Developing Countries ...

International Journal of Business and Management

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Financial Stock Market and Economic Growth in Developing Countries: The Case of Douala Stock Exchange in Cameroon Boubakari Ake (Corresponding author) Shanghai University of Finance and Economics PO. BOX 200083, China E-mail: [email protected] Rachelle Wouono Ognaligui Shanghai University of Finance and Economics PO. BOX 200083, China E-mail: [email protected] Abstract In this article Sims’ causality test based on Granger definition of causality was used to examine causality relationships between stock markets and economic growth in Cameroon based on the time series data from 2006 to 2010. Our findings suggest that the Douala Stock Exchange still doesn’t affect Cameroonian economic growth. Research has been made in this topic and found positive relationship between financial stock market development and economic growth, but in Cameroon the purpose of the government to develop economy, by creating the Douala Stock Exchange is still not reached. After running variance decomposition test of Cholesky, we found systematic evidence that the market capitalization affects positively the GDP. Our paper comes up with the opportunity given to the Cameroonian government to understand that it is time to find financial policies, to encourage companies and develop financial stock market culture, and enhance to push companies to initiate IPO instead of bank loans when money is needed to increase their investment. Keywords: Market capitalization, Growth, Causality, IPO Introduction In the literature it is showed that developed economies had explored the two channels through which resources mobilization affects economic growth and development – money and capital markets (Samuel, 1996; Demirguc-Kunt and Levine, 1996). Economic growth in a developing economy hinges on an efficient financial sector that pools domestic saving and mobilizes foreign capital for productive investments. In the developing countries, industries need more funds to increase their investment so that they can meet globalization constraint. Hicks (1969) argues that in the nineteenth century, for the first time in history, many private investment projects were so large that they could no longer be financed by individuals or from retained projects. The financial stock market serves as a veritable tool in the mobilization and allocation of savings among competing uses which are critical to the growth and efficiency of the economy (Alile, 1984). Other researchers have showed that the stock market development positively influences the economic growth (Korajczyk, 1996, Levine and Zervos, 1998). Cameroon was characterized by the lack of financial institutions as a stock market that can allocate extra resources to the firms, help them to increase their investment and adapt their business to the globalization obligation. To solve this problem, in 2001, the Cameroonian government has decided to create the first financial stock market in Cameroon: the Douala Stock Exchange (DSX). Today three big companies have already introduced their capital in that market. The main purpose of this paper is to study the Douala Stock Exchange’s contribution in the Cameroonian economic growth. Firstly, we will present the literature review of the role of financial stock market in the economic growth (1); secondly we will present the Douala Stock Exchange (2) and the empirical study of the topic (3). 1. Financial stock market and economic growth: literature review Levine (1991) showed a positive relation between financial stock market and economic growth by issuing new financial resources to the firms. The financial stock market facilitates higher investments and the allocation of capital, and indirectly the economic growth. Sometimes investors avoid investing directly to the companies

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because they cannot easily withdraw their money whenever they want. But through the financial stock market, they can buy and sell stocks quickly with more independence. An efficient stock market contributes to attract more investment by financing productive projects that lead to economic growth, mobilize domestic savings, allocate capital proficiency, reduce risk by diversifying, and facilitate exchange of goods and services (Mishkin 2001; and Caporale et al, 2004). Further, Levine and Zervos (1998) found strong statistically significant relationship between stock market development and economic growth. The result of Filer et al. (1999)’ studies show that there is positive causal correlation between stock market development and economic activity. Many other researchers argue that there is a positive correlation between financial development and economic growth (Goldsmith, 1969; Shaw, 1973; McKinnon, 1973 and King & Levine, 1993). They found that financial development is an important determinant of future economic growth of a country. Atje and Jovanovic (1989) found also a significant impact of the level of stock market development and bank development. Joseph Schumpeter (1912)’s book was the most important and thorough one of the earlier contribution on financial development and economic development. For him, financial development causes economic development – that financial markets promote economic growth by funding entrepreneurs and in particular by channeling capital to the entrepreneurs with high return projects. 2. The Douala Stock Exchange in Cameroon (DSX) Having recognized the importance of financial system for economic growth, Cameroonian government has initiated financial sector reform program and has increased the efforts towards creating a stock market of the country to stimulate economic growth. Thus, the DSX has been created on December 1th 2001. The Douala Stock Exchange is a public limited company with a Board of Directors and capital of 1.8 billion francs CFA, of which 63.7% of the shares are held by private commercial banks, Credit Foncier of Cameroon and the Dutch bank FMO, 23% by public interests, and 13.3% by private insurance companies. Until 2006, its sole listing was SEMC (Société des Eaux Minérales du Cameroun). Now it also includes SAFACAM (Société Africaine Forestière et Agricole du Cameroun) and SOCAPALM (Société de palmeraies du Cameroun). According to Mouangue (2006), general manager of the DSX, the aim of the Douala Stock Exchange is to enhance and diversify the availability of finance, facilitate privatization programs and the granting of credit, widen the range of investment possibilities available to the public and to institutional investors and ensure the transparency of economic and financial information. However, in Cameroon, the main focus is on banking loans system. We think that Policy makers should equally encourage stock market development in order to encourage IPO for private companies. 3. Empirical study of DSX and economic growth

Data

We have collected financial market development data from DSX website. Economic growth data has been collected from International Monetary Fund (IMF) and World Bank database. We used Boot, Feibes and Lisman (1967) derivation method to get quarterly data from annual data. ¾

Douala Stock Exchange Development

As Levin (1996) said, stock market development is measured by the total market capitalization (MC). Market capitalization equals the total value of all listed shares. From July 2006 to January 2010, the average market capitalization in DSX was FCFA 29.49 billion with highest capitalization of FCFA 93.73 billion in April 2009 and lowest capitalization of FCFA 2.43 billion in April 2007. The trend of the market capitalization is shown in the table 3. The trend of the shares’ value has been also increasing as resumed in the table 2. ¾

Douala Stock Exchange liquidity

Benchivenga, Smith and Starr (1996) have showed the positive role of liquidity provided by stock exchanges on the size of new real asset investments through common stock financing. The ability of investors to buy and sell securities easily is called the liquidity of the market. The liquidity is the main indicator of stock market development by showing how the market improve the allocation of capital and thus enhance the long-term economic growth. In the market with high liquidity, investors can buy and sell shares whenever they want, change their portfolio with less risk, and invest in new and more rentable projects. Total value traded ratio (TVTR) and turnover ratio (TR) are the most used measures to evaluate the stock market liquidity. From July 2006 to January 2010, the total trade value average of the DSX is (in FCFA billion) 0.0155 per annum with the highest value of 0.0435 in 2009 and lowest value of 0.0013 in 2006. Turnover ratio is used as an index of comparison for market liquidity rating and level of transaction costs. This ratio equals the total value of shares traded on the stock market per market capitalization. It is also a measure of the value of securities transactions

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relative to the size of the securities market. The Douala Stock Exchange had an annual average turnover ratio of 0.0007 (in FCFA billion) from 2006 to 2010. This low index reflects the relative illiquidity and the overall growth of the DSX. The trend has been summarized in Table 1 - Column 4. ¾ Gross Domestic Product (GDP) King and Levine (1993) reported results based on a study of 80 countries from 1960-89 using measures of economic and financial development respectively. They found a positive, statistically significant correlation between GDP per head and proxies of financial development. Methodology Levine and Zarvos (1996) found a strong relation between stock market and economic development; however, we need to find evidence from the implication of the stock market in the context of developing countries. Sims (1972)’s test, based on Granger (1969) definition of causality will be employed in this paper with a purpose to understand the relationship between stock market development and economic growth. According to Subhash and Mathur (1989), causality in the Granger sense (1969, 1980) is an appropriate methodology for examining whether stock market development causes economic growth, or vice versa. In Sims approach, Granger causality relationship is expressed in the following equations:

and

Where X is an indicator of stock market development, Y denotes economic growth and the subscripts t and t-i denote the current and lagged values. 4. Empirical results According to the results in the table 4, the Douala Stock Exchange does not affect GDP in Cameroon; this may be due to the few numbers of companies listed in the DSX. We found high probabilities for all stock market variables, which means that the null hypothesis are accepted, thus, market capitalization, total trade value ratio and turnover ratio do not granger cause GDP. The lowest value of the probability is 0.5955 which is far from zero, so that we can reject the entire relationship hypothesis between the Douala Stock Exchange and Cameroonian GDP. Nevertheless, in order to understand which variable of financial market affects much GDP evolution, Cholesky ordering test has been made to find variance decomposition of the GDP over 8 period’s time. The results in table 6 show that the market capitalization affects at higher proportion the GDP. As we can see, for the first period, the market capitalization contribution in the GDP’s variation is 87.98 %. It means that the objective of the government to increase GDP’s evolution can be reached by increasing market capitalization. Our results show that the Douala Stock Exchange proxies don’t affect economic growth in Cameroon. We can understand those results by the fact that the market is still not active in Cameroon. Cameroonians don’t have stock market culture yet; the main financial system is banks loans when money is needed. 5. Conclusion The present endeavors investigated relationship between Douala stock exchange and Cameroonian economic growth through GDP evolution using quarterly time series data from 2006-2010. We used Granger-Causality tests to find links between DSX development variables and Cameroonian GDP. Our findings suggest that there is no relationship between Douala stock exchange and economic growth for Cameroon. The results indicated that stock market is not influencing Cameroonian economic growth because Granger-Causality estimation doesn’t confirm the bi-directional causality between stock market development and economic growth in the case of Cameroon. Our results do not match with the other author’s findings who confirm a positive relationship between stock market development and economic growth. As published in 1993, Robert King and Ross Levine reported results based on a study of 80 countries from 1960-89 using measures of economic and financial development respectively. They found a positive, statistically significant correlation between GDP per head and proxies of financial development. Patrick (1966) also found a two-way causation between financial and economic variables. Our results can be explained by the low value of market liquidity which means that the

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Douala Stock Exchange is not active enough as to boost Cameroonian economy. If the aim of the creation of the Douala Stock Exchange was to attract investors and help company to increase easily their capital, we can conclude that the purpose is far from to be reached. We suggest to the Cameroonian government to encourage companies to introduce their capital in the Douala Stock Exchange and also to introduce the national companies instead of other forms of privatization in the hands of foreign investors. As the variance decomposition showed, if the Cameroonian government increase market capitalization by introducing public companies to Douala Stock Exchange, the Cameroonian economy will also grow up. In order to encourage companies to introduce their capital in the DSX, we think that policy makers should remove impediments to stock markets, such as tax, legal, and regulatory barriers. One of the reasons Cameroon has a small stock market is low saving rate. To promote stock market development, government should encourage savings and investment by appropriate policies. Therefore, equal importance must be given to both, bank-based financial sector and market-based stock market of the economy. The findings of this study have been constrained by the limited number of observations of time series due to the newness of Douala Stock Exchange and in addition, the causality used in the study is "Granger causality". Thus, the need of further research is obvious in order to get more evidence about the impact of stock markets on economic growth and vice versa in Cameroon. References Atje R., and Jovanovic B. (1989). Stock Markets and Development. European Economic Review, 37, 632-640. Benchivenga V. R., Smith, B. D., and Starr, R. M. (1996). Equity Markets, Transaction Costs, and Capital Accumulation: An Illustration. The World Bank Economic Review, Vol. 10(2), pp. 241-265. Bencivenga V. R., Bruce D. Smith and Ross M. Starr. (1996). Equity Markets, Transaction Costs, and Capital Accumulations: An Illustration, The World Bank Review, 10 (2):241-265. Boot, J.C.G., Feibes, W., and Lisman, J.H.C. (1967). Further methods of derivation of quarterly figures from annual data. Applied Statistics, 16, 65-75. Borensztein, E., and De Gregorio, J., J.W. Lee. (1998). How Does Foreign Investment Affect Growth? Journal of International Economics, 45.pp.115-135. Demirguc-Kunt A. (1994). Developing Country Capital Structure and Emerging Stock Markets, Policy Research Working Paper, WPS 933, July. Dickey, D. A., and W. A. Fuller. (1981). Likelihood Ratio Statistics for Auto regressive Time Series with a Unit Root, Econometrica, Vol. 49, No. 4. Filer, Hanousek and Nauro. (1999). Do Stock Markets Promote Economic Growth? Working Paper, No.267 Filler, Randall K., Jan Hanousek and Nauro F. Campos. (1999). Do Stock Market Promote Economic Growth?, The William Davidson Institute (University of Michigan Business School). Working Paper Series, No. 267 September. Goldsmith R. W. (1969), Financial Structure and Development, New Haven, Conn, Yale University Press. Granger C. W. J. (1969). Investigating Causal Relations by Econometric Models and Cross Spectral Methods. Econometrica, Vol. 37, pp.424-438. Greenwood J., and B. Smith, (1996). Financial Markets in Development and the Development of Financial Markets. Journal of Economic Dynamics and Control, Vol. 21: 145 -81. Greenwood, Jeremy and Bruce Smith. (1997). Financial Markets in Development and the Development of Financial Markets. Journal of Economic Dynamics and Control, pp. 145-181. Gregorio, Jose De and Pablo Guidotti. (1995). Financial Development and Economic Growth. World development, Vol. 23, 433-448. Hicks John. (1969). A Theory of Economic History. Clarendon Press. Hsiao C. (1981). Autoregressive Modeling and Money-Income Causality. Journal of Monetary Economics, 7: 85-106. Joseph A. Schumpeter. (1912). The nature of money. German Economic Review, 8, 348-52. King R. G. and Levine R. (1993). Finance, Entrepreneurship and Growth. Journal of Monetary Economics, Vol. 32. Levine R. (1991). Stock Markets, Growth, and Tax Policy. Journal of Finance, Vol. 46(4), pp. 1445-1465

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Levine R., and S. J. Zervos. (1995). Stock Market Development and Long-Run Growth. World Bank Economic Review, Vol. 82, No. 4, 942-963. Levine R., and Zervos S. (1996). Stock Market Development and Long-Run Growth. The World Bank Economic Review, Vol. 10(2), pp.323-339 Levine Ross. (1997). Financial Development and Economic Growth: Views and Agenda. Journal of Economic Literature, Vol. 35, 688-726. Levine Ross and Sarah Zervos (1998). Stock Markets, Banks, and Economic Growth, American Economic Review 88:537-558. Luintel, Kul and Mosahid Khan (1999). A Quantitative Reassessment of the Finance-Growth Nexus: Evidence from a Multivariate VAR, Journal of Development Economics, 60: 381-405. Mirakhor, S., and R.M. Lillanueva (1990). Market Integration and Investment Barriers in Emerging Equity Markets, World Bank Discussion Paper, No. 216, 221-255. Mishkin Frederic S. (2001). The Economics of Money, Banking, and Financial Markets, 6th ed. New York: Addison Wesley Longman. Nyong, Michael O. (1997). Capital Market Development and Long-run Economic Growth: Theory, Evidence and Analysis. First Bank Review, December 1997: 13-38. Patrick H. T. (1966). Financial Development and Economic Growth in Underdeveloped Countries, Economic Development and Cultural Change, Vol. 14, pp. 174-189. Pierre Ekoulé Mouangue. (2006). [Online] Available: http://www.douala-stock-exchange.com/motdir_us.php Rajan, R.G., and Zingales L. (1998). Financial Dependence and Growth, American Economic Review, 88, 559-586. Rousseau, Peter and Paul Wachtel. (1998). Financial Intermediation and Economic Performance: Historical Evidence from Five Industrialized Countries, Journal of Money Credit and Banking, pp. 657-678. Samuel, Cherian. (1996). Stock Market and Investment: The Governance Role of the Market, The World Bank Review, Vol. 10, N° 2. Shaw E. S. (1973). Financial Deepening in Economic Development, New York: Oxford University Press. Sims G. (1972). Money, Income and Causality, American Economic Review, Vol 62, pp. 540-552. Subhash C. Sharma & Ike Mathur. (1989). do stock market prices affect mergers?, Managerial Finance, Vol.15 Number 4. Surya Bahadur G. C., and Suman Neupane. (2006). Stock Market and Economic Development: a Causality Test. Journal of Nepalese Business Studies, Vol.3, No.1. Table 1. Market Capitalization Ratio, Total Value Traded Ratio, Turnover Ratio and GDP from 2006 to 2010 Date (quarterly) Market Capitalization 2.5300 2006q2 2.8474 2006q3 2.5300 2006q4 2.4978 2007q1 2.5760 2007q2 3.0342 2007q3 3.0342 2007q4 3.0342 2008q1 4.0213 2008q2 21.3451 2008q3 22.9485 2008q4 92.8876 2009q1 88.4420 2009q2 85.5853 2009q3 82.7987 2009q4 82.7249 2010q1 Data source: www.douala-stock-exchange.com

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Total Trade Ratio 0.0028 0.0012 0.0000 0.0000 0.0008 0.0056 0.0056 0.0000 0.0016 0.0462 0.0196 0.0221 0.0381 0.0978 0.0161 0.0127

Turnover Ratio 0.0011 0.0004 0.0000 0.0000 0.0003 0.0019 0.0018 0.0000 0.0004 0.0022 0.0009 0.0002 0.0004 0.0011 0.0002 0.0002

GDP 2,338.2740 2,353.9860 2,371.9320 2,394.3450 2,462.9980 2,462.9980 2,510.7260 2,565.9000 2,625.5420 2,687.4180 2,750.0380 2,600.1930 2,595.7190 2,609.6900 2,631.9880 2,670.2190


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Table 2. Evolution of the shares value in DSX from 2006 to 2010

Table 3. Evolution of market capitalization in DSX from 2006 to 2010

Table 4. Granger Causality test Direction of Causality

Obs.

MC Granger Causes GDP GDP Granger Causes MC TR Granger Causes GDP GDP Granger Causes TR TVTR Granger Causes GDP GDP Granger Causes TVTR TR Granger Causes MC MC Granger Causes TR TVTR Granger Causes MC MC Granger Causes TVTR TVTR Granger Causes TR TR Granger Causes TVTR

15 15 15 15 15 15 15 15 15 15 15 15

F-Value

Causality

0.00257 9.61912 0.29746 0.12427 0.11313 2.14275 0.00270 0.28971 0.04080 4.81130 0.43911 0.76885

No Yes No No No Yes No No No Yes No Yes

Prob.

0.9604 0.0092 0.5955 0.7306 0.7424 0.1689 0.9594 0.6002 0.8433 0.0487 0.5201 0.3978

Lags

1 1 1 1 1 1 1 1 1 1 1 1

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Table 5. Correlations GDP 1.00 0.55 0.12 0.47

GDP MC TR TVTR

MC

TR

0.55 1.00 (0.19) 0.61

TVTR 0.47 0.61 0.33 1.00

0.12 (0.19) 1.00 0.33

Table 6. Variance decomposition of the GDP for two years Period

S.E.

MC

TVTR

TR

GDP

1

16.83

87.98

2.66

3.61

5.75

2

19.27

88.06

1.39

2.14

8.40

3

20.53

88.52

1.05

2.48

7.94

4

24.67

82.10

3.82

5.83

8.26

5

27.16

81.26

4.39

6.18

8.17

6

30.75

81.38

4.28

5.90

8.43

7

35.98

81.25

4.30

5.98

8.47

8

37.80 79.55 5.74 6.37 Cholesky Ordering: MC TVTR TR GDP

8.34

Table 7. Descriptive Statistics

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MC

TVTR

TR

GDP

Mean

31.42733

0.016892

0.000696

2539.498

Median

3.527763

0.005624

0.000420

2580.810

Maximum

92.88757

0.097838

0.002163

2750.038

Minimum

2.497846

0.000000

0.000000

2338.274

Std. Dev.

38.92811

0.025765

0.000720

128.6618

Skewness

0.742528

2.147226

0.904528

-0.201008

Kurtosis

1.650848

7.159045

2.437616

1.826197

Jarque-Bera

2.683732

23.82665

2.392640

1.026286

Probability

0.261357

0.000007

0.302305

0.598611

Sum

502.8372

0.270276

0.011135

40631.97

Sum Sq. Dev.

22730.97

0.009958

7.78E-06

248307.9

Observations

16

16

16

16