Impact of Stock Market Development on Economic

Online Access: www.absronline.org/journals

Management and Administrative Sciences Review Volume 5, Issue 2 Pages: 86-97 March 2016

e-ISSN: 2308-1368 p-ISSN: 2310-872X

Impact of Stock Market Development on Economic Growth: Evidence from Lower Middle Income Countries Bilal1*, Songsheng Chen2, and Bushra Komal3 1. Ph.D Schloar, Department of Accounting, School of Management and Economics, Beijing Institute of Technology, Beijing, China 2. Professor and Director, Department of Accounting, School of Management and Economics, Beijing Institute of Technology, Beijing, China 3. Ph.D Schloar, School of Business, University of International Business and Economics, Beijing, China

Panel data models play an important role in consequence of stock market development on economic growth in lower-middle income regions. Stock market development represented through three indicators namely total stock value traded ratio (VTR), market capitalization ratio (MCR) and turnover ratio (TR). The panel data of 20 lower-middle income countries gathered from the period of 1990 to 2012. The study examines the impact of stock market development on economic growth by panel data techniques by fixed effects and random effects by applying Hausamn test. Overall results suggests that there is positive and significant impact of stock market development on economic growth. The findings show a positive relationship between stock market development and economic growth. This study also measures the exact impact of stock market development on growth of economy by control variables such as financial depth (FD), investment (INV), foreign direct investment (FDI), trade openness (TO) and inflation (INF) but stock market development which is TR (ratio of total value traded to the total value of listed shares) has insignificant relationship with economic growth. This study is very beneficial for making effective decisions about financial development, stock market development and economic development by prevailing stock market conditions of countries. Keywords: Stock market development, lower-middle income, economic growth Gel Classification: G1, O11 and O16

INTRODUCTION The stock markets are best channel that evaluates the company worth by evaluation of the company assets. The assessment of firms resources through the capital exchange offers the standards which

may be useful for other corporations and shareholders, hence increasing the depth and competence of company assets generally (Wachtel, 2002). Stock exchanges offer a vehicle for branch out

*Corresponding author: Bilal, Department of Accounting, School of Management and Economics, Beijing Institute of Technology, Beijing, China. E-Mail: [email protected]; [email protected].

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Manag. Adm. Sci. Rev. e-ISSN: 2308-1368, p-ISSN: 2310-872X Volume: 5, Issue: 2, Pages: 86-97

risk (Devereux & Smith, 1994; Obstfeld, 1995; SaintPaul, 1992). Paul (1992) proposed that an efficient capital market provides administrators with encouragements and put greater endeavor for screening uncertain proficient plans. Risk diversification by the international configuration of the equity markets is one major approach by which capital exchanges influence the monetary development (Demirgüç-Kunt & Levine, 1996b). The improved risk reduction in the course of globally incorporated equity markets may encourage financing of projects with greater return. For the reason that, greater return schemes relatively risky and equity markets enhances risk reduction as well as promote greater return schemes (Obstfeld, 1995). Levine (1997) has explored that financial structure makes trading easier through the liquidity and provides the prevarication and branch out the risk which is expected to accord in future with capital investment. Liquidity provides the easiness of trading operations and quickly transfers the assets into purchasing capacity at settled prices. Secondly, allocate resources in such a way where there is maximum utilization in the better way that carries the economic improvement. Merton and Bodie (1995) claimed that basic purpose of financial market is to aid in process of the reserves allocation in different time horizons, within an unsure environment. For example, stock markets facilitate firms to obtain required level of investment quickly through the market liquidity, which helps in the capital provision, investment and development (Adjasi & Biekpe, 2006). Thirdly, financial integration inspects managers and puts forth corporate control and ensures the better governance in corporations. Fourthly, assemble savings while Last is to make easy the substitution of merchandise and services. Fase (2001) proposed that the augmentation in the financial structure have larger significance on economic growth in growing economies than in advanced economies. This study endeavors to respond the empirical query of whether enhancement in financial sophistication is affiliated with economic expansion in the lower middle income region of the world. Because literature provides the incentives to focus on this region, as

the researchers had not put more intension to conduct their studies in this region that is why past studies not support enough evidences about the influence of capital market growth on economic development. Therefore, it presents an excellent opportunity to conduct research in the lower middle income countries. It is renowned that in growing economies, equity markets are in a position to assemble domestic funds and utilize them effectively. Hence equity markets plays a critical act for the growth of economy in developing economies (Pardy & Mundial, 1992). The proves of finance impacts is not more significant within developed economies as it is among the developing economies (Wachtel, 2002). It is also said that finance influence varies systematically with the respect of inflation condition within the countries (Rousseau & Wachtel, 2002). In present era, modernizations in the scrutiny of panel data also provided the many ways to explore the forceful connection between equity markets and enlargement of economy across different economies (Rousseau & Wachtel, 2000). This is the major focus and objective of this thesis because it fills space in literature by providing empirical evidences on region of lower middle income countries while taking into account the panel data analysis. The rest of the paper is organized as follows; Section 2 provides a concise review of literature. The methodology and data is introduced in section 3 while section 4 contains discussion and results. Lastly section 5 concludes the study. REVIEW OF LITERATURE Most recently economists and policymakers have again showed their interest to know about what factors brings the economic development while taking into account the financial development because world stock markets have showed a booming trend in the their development. DemirgüçKunt and Levine (1996b) argued that emphatically evidences showed a increasing trend in world stock market capitalization that lift from the level of dollar 4.7 trillion to dollar 15.2 trillion, as well as the total traded value, on every world's exchange, raised from $1.6 trillion in 1985 to$9.6 trillion in 1994. In the same way level of equity investment

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also climbed up to $39 billion in 1995 from $0.1 billion in 1985. This predicts the boom in world stock market but emerging markets make up an excessively large quantity of this boom. Researchers have found an important role of financial structure and claimed that financial system is most vital factor with effect the economic growth in the positive sense it helps in mobilizing of savings, exercise the corporate control, diversifying the risk and allocating capital. Demirgüç-Kunt and Levine (1996b) described that financial arrangement develops with the passage of the time. Goldsmith (1969); Gurley and Shaw (1955) pointed out that firstly capital investments are given to bank intermediated debt finance as there prevails the economic growth and afterward to the stocks markets as another source of raising external investments. Financial advancement and growth have relation with modern reinforcement of interest that shoots from endogenous growth models which stated as growth is self-supporting (Arestis, Demetriades, & Luintel, 2001). Stock markets plays the key role for economic growth by promoting savings, further direct this financing into fruitful savings, that also persuade capitalists to enhance effectiveness of savings (Bonser‐Neal & Dewenter, 1999). In this prospective, many researcher proposed positive relationship between economic growth and financial market activities (Adefeso, Egbetunde, & Alley, 2013; Adjasi & Biekpe, 2006; Ake, 2010; Arestis et al., 2001; Atje & Jovanovic, 1993; Caporale, Howells, & Soliman, 2003; GC, 2006; Goldsmith, 1969; Jung, 1986; King & Levine, 1993b; Levine & Zervos, 1996; Mohtadi & Agarwal, 2001; N'Zué, 2006; Nazir, Nawaz, & Gilani, 2010; Nowbutsing & Odit, 2011; Osamwonyi & Kasimu, 2013; Rousseau & Wachtel, 2000; Shahbaz, Ahmed, & Ali, 2008; Usman & Alfa, 2013). Stock markets are the more significant factors that play the vital part in the progress of economy even though issuance of equity only carries the limited investment funds. Levine and Zervos (1996) suggested stock market growth importance regarding economic development and also found a significant direct relationship between long term economic development and equity market growth. Demirgüç-Kunt and Levine (1996a) was of the view that the value of stock market expansion for output

growth with take into account the 44 emerging and developed countries for the period of 1986-1993 and found that in various economies the extent of equity market improvement greatly influenced with the expansion of depositories, nonbank financial organizations, and pension subsidizes, insurance firms. Levine and Zervos (1998) was of the view that pragmatic correlation among various constraints of equity market growth, banking depth, and economic development in long run and found that equity structure liquidity and financial depth were directly and considerably associated with economic development. On the other side, market capitalization, volatility and market integration were not significantly associated with economic growth. Rousseau and Wachtel (2000) the relationship of stock markets and economic development with regard to look at the directions of causality which proved that capital markets enhance the economic growth firstly, through the exit process for venture investors, secondly they put forward liquidity for investors that results in international diversification, thirdly by providing companies with right to use the permanent capital that to be invested in large projects, and finally by creating information about the excellence of probable investments. Arestis et al. (2001) investigated association of equity structure growth with economic development for limiting the impacts of banking depth and equity structure volatility and found that equity markets may be capable to exert their impact in economic advancement but their effect is small in comparison to the banking system. Khalifa (2002) suggested that the direction and nature of financial growth with economic expansion and strongly hold up the vision that financial expansion and economic development are equally casual and this causality is bidirectional. Caporale et al. (2003) was proposed the relation of equity market development with economic development in some selected economies like Korea and Malaysia also argued that equity market is fundamental in encouraging economic development in emergent countries. Beck and Levine (2004) examined the influence of equity markets as well as financial institutions lying on economic development and claimed that equity structure and depository directly impact economic improvement and these results are not because of

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the prospective biases encouraged through simultaneity, omitted indicators and unnoticed economic specific effects. Dritsaki and Dritsaki-Bargiota (2005) was of the view that the correlation between financial expansion, banking sector and economic enhancement in Greece and found a bilateral causal association of credit market development with economic growth while unidirectional causality was predicted between economic development and equity market growth but no correlation was predicted between the equity market and banking sector growth. Adjasi and Biekpe (2006) used the dynamic panel data arrangement to investigate the significance of stock structure growth on economic development in fourteen African economies and analyzed a positive association between equity market growth and economic development. Shahbaz et al. (2008) investigated the relationship of stock market growth with economic development for emerging economy and establish a strong relationship between stock market expansion and economic enlargement. In long run bi-directional measures present stock market advances with economic magnification. Conversely, they found a unidirectional causality that is through stock market improvement to economic development in short term. Nazir et al. (2010) look into the connection of stock market enlargement with economic expansion in context of Pakistan from time of 1986 to 2008 and claimed that economic development can be achieved through the raise in the market capitalization of economy with the growth in size of equity market as in case of Pakistan. Ake (2010) explored the causality between equity market growth and economic development and argued that if equity market is more liquid or active then there is present direct association of equity market with economic expansion. Conversely, causality connection refused for the economies where the equity market is undersized and less liquid. Nowbutsing and Odit (2011) suggested the linkage of stock market enlargement with economic expansion in economy of Mauritius and found that equity market improvement has direct impact on economic development in Mauritius, in short and long run. Adefeso et al. (2013) proposed the association between equity market expansion and

economic enhancement and initiate that equity market growths furthermore banking movements were cointegrated with economic escalation in Nigeria. Osamwonyi and Kasimu (2013) examined the causal connection and the trend of causality of stock market expansion with economic development in Ghana, Kenya and Nigeria for era from 1989 to 2009. They found that equity market development and economic expansion has no casual association in the economy of Ghana and Nigeria, while in Kenya a bidirectional causal connection found between equity market advancement and economic development. Usman and Alfa (2013) explored the linkage between stock exchange market and economic growth and found that the market capitalization, value traded and economic expansion is direct in the long run for the case of Nigeria. RESEARCH METHODOLOGY In this study, panel data of 20 Lower-Middle Income countries for the time period of 1990 to 2012 are collect form world development indicators. The data is collected from the publication of World Bank known as World Development Indicators and from official website of State Bank’s of the respect countries. This study consists of similar crosssectional units (countries) over the same time period in the panel data which. There are a lot of tools for performing analysis with panel data but fixed effects model and random affects model are two most significant techniques for panel data in field of econometrics. Many researchers provided different justifications for adopting these techniques in context of literature about panel data. When random sample is used during analysis in panel data, the most suitable practice is fixed effects model and random effects model. Dougherty (2007) proposed a mechanism for researcher selecting a regression model in panel data would be preferred random sample from population then ought to be utilized both panel data approaches like random effects model and fixed effects model. When researcher used approaches of panel data, they have to run Hausman’s specification test for analysis, meanwhile this test shows significant effect than researcher ought to reject the null hypothesis. The

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differences are found in coefficients of panel data which are not systematic and mainly select the suitable model which is fixed effects model and then stop. In nutshell, Hausman’s specification test result gives an insignificant finding then researcher further use apt technique as random effects model instead of fixed effects model and also depart towards more testing. When researcher opts for random effects model then they ought to apply more suitable technique like as Breusch Pagan Lagrange multiplier test. If this technique produces significant outcomes then researcher reject the null hypothesis and mainly suitable model is random effects model. Conversely, if this technique shows not significant outcomes than mainly apt model for analysis is Ordinary Least Square (OLS) regression. According to suggested criteria for choosing a suitable model, the researcher considered both panel data approaches random effects model and fixed effects model then run Hausman’s specification test to decide most suitable model from two models. In a panel data, intercept varies across cross sectional units and slope coefficients are constant in fixed effects model. In contrast, random effects model that are cross-sectional unit as well as variation within cross-sectional unit of panel data. The fixed effects model for this study is as follows; 1. GDPit= β0i + β1MCit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit 2. GDPit= β0i + β1VTit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit 3. GDPit= β0i + β1VTit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit The random effects model for this study is as follows; 4. GDPit= β0 + β1MCit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit + eit 5. GDPit= β0 + β1VTit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit + eit 6. GDPit= β0 + β1VTit+ β2FDit+ β3INFit + β4FIDit + β5TOit++ β6INVit+ uit + eit Where;

GDPit = Economic Growth (real per capita GDP annual growth rate) of country i at time t. MCit = Market Capitalization (ratio of value of listed domestic shares on domestic exchanges as the percentage of GDP) of country i at time t. VTit = Total Value Traded (ratio of value of the trades of domestic shares on domestic exchanges as the percentage of GDP) of country i at time t. TRit = Turnover Ratio (ratio of value of the trades of domestic shares on domestic exchanges to the value of listed domestic shares) of country i at time t. FDit = Financial Depth (Domestic credit to private sector as percentage of GDP) of country i at time t. INVit= Investment (Gross capital fixed formation) of country i at time t. FDIit = Foreign Direct Investment as Percentage of GDP of country i at time t. TOit = Trade openness (ratio of import plus exports to GDP) of country i at time t. INFit = Inflation (Annual change in consumer prices) of country i at time t. β0i = y intercept of country i uit = Error Term of country i at time t. β0 = Intercept term of the panel. uit = Between country error term. eit = Within country error term. Many researcher proposed that the size of country is represented by growth variable and also calculated via yearly country GDP growth in terms of percentage (Aggarwal, Demirgüç-Kunt, & Pería, 2011; Fayissa & Nsiah, 2012). The market capitalization is “ratio of the total value of the listed shares in the stock market to the gross domestic product which estimate the size of the local stock market” (Bekaert & Harvey, 1997; Bekaert, Harvey, & Lundblad, 2001; Levine & Zervos, 1998). Market liquidity found in literature in the two forms, one proxy is total value traded as the total value of shares traded relative to GDP and other is turnover ratio, the ratio of the market capitalization to the total value of share traded. While financial sector depth is first controlling variable, which is measured as domestic credit to private sector in the form of percentage of GDP. Other control variable includes; investment

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measured as the ratio of gross fixed capital formation to nominal GDP. FDI is measured by means of ratio of net inflows of foreign direct investment to GDP. The trade openness is calculated in terms of percentage by ratio of trade to GDP. The inflation is measured through “annual customer prices in terms of percentage”. DATA ANALYSIS The descriptive statistics of Lower-Middle Income countries is provided in table 1 appendix 1. The economic development variable that is dependent variable has 285 observations of 20 countries. The average age of this variable is 2.65% with standard deviation 3.47% which means very high dispersion is exist in this panel from -0.82% to 6.12%. The lowest value of this variable is -14.42% while largest is 15.66% in this panel while the descriptive statistics of all other variables is given. TABLE 1 HERE The correlation among the variables in case of developing countries is presented in table 2 appendix 1. The purpose of this correlation matrix is to examine relationship among stock market development and economic growth and for detection of multicollinearity in models. TABLE 2 HERE The first aim of this table is to examine the relationship and results indicate that there is a direct relationship among stock market development and economic growth according to all three indicators of stock market development (MCR, VTR and TR). But in case of TR the impact of stock market liquidity on economic growth is positive but insignificant. The second and most important purpose is to detect multicollinearity by looking at relationship among independent variables. The cut point is that the relationship between two independent variables is not more than 0.8 and significant. But the highest relationship among independent variables here is 0.7747 and significant between value traded and turnover ratio which is less than cut point.

The results of panel data models given in table 3 which shows that stock market development has positive aand significant impact on economic growth in Lower-Middle Income countries. The most important role is played by the market capitalization ratio(MCR) and value traded ratio(VTR) for the development of the economy, which shows the market development and ease in the trading activities in the stoch exchanges respectively. These two variables of stock market are very important because they have the poditive and significant relationship with the economic growth of the country. However, turnover ratio (TR) also has positive influence on the growth of economy but relationship is insignificant. TABLE 3 HERE These results of panel data models given in table 3 which shows that stock market development has positive aand significant impact on economic growth in Lower-Middle Income countries The most important role is played by the market capitalization ratio and value traded ratio for the development of the economy, which shows the market development and ease in the trading activities in the stoch exchanges respectively. These two variables of stock market are very important because they have the poditive and significant relationship with the economic growth of the country. However, turnover ratio (TR) also has positive influence on the growth of economy but relationship is insignificant. DISCUSSION AND CONCLUSION This study investigates the association of stock market expansion and economic development with panel data analysis. Research found that stock exchanges have a major role in economic development especially for the region of LowerMiddle Income countries. That vital affect is obvious from the enhancement in the stock exchange capitalization as well as increase in value of shares traded total, as stock exchange capitalization, its liquidity and active trading played a greater role in economic progress of Lower-Middle Income region. The findings are incompliance with literautre, as many studies have proved positive and significant impact of stock market development on economic

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growth (Adefeso et al., 2013; Adjasi & Biekpe, 2006; Ake, 2010; Arestis et al., 2001; Beck & Levine, 2004; Caporale et al., 2003; Caporale et al., 2004; GC, 2006; Levine & Zervos, 1996, 1998; Mohtadi & Agarwal, 2001; N'Zué, 2006; Nazir et al., 2010; Nieuwerburgh et al., 2006; Nowbutsing & Odit, 2011; Osamwonyi & Kasimu, 2013; Rousseau & Wachtel, 2000; Shahbaz et al., 2008; Usman & Alfa, 2013). These findings confirm that if there is developed stock market structure then it is certain that financial sector of their countires is in boost in addition to the growth of economy. Theese are valuable for students of lower-middle income countries, public organization, financial markets, financial analysts, and researchers for making effective decisions regarding financial development, equity market expansion and economic development.

REFERENCES

Financial markets in these countries can take help from this study and make operational policies for effective channelization of economic growth. The major limitation in this study is non-availability of complete recorded data of stock market development maintained by World Bank. To measure the exact influence of stock market improvement on economic development in LowerMiddle Income region is only possible if researcher has complete set of data record which include in the countries of this region. Secondly, results of this study can not be generalized to the other economies which are not come under the head of LowerMiddle Income region, as developed and industrialized economies. The upcoming studies will be focused on issue that does stock exchange capitalization ratio (MCR) and its liquidity total stock value traded ratio (VTR) as well as turnover ratio (TR) affect the economic growth in different regions regarging the Icome level or industrial and emerging economies.

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ACKNOWLEDGEMENT Professor Chen acknowledges financial support from the National Natural Science Foundation of China (NSFC-71372016).

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APPENDIX Table 1: Descriptive Statistics Variable

Obs

Mean

Std. Dev.

Min

Max

GDPit

285

2.652401

3.466051

-14.42093

15.66234

MCRit

285

22.96823

21.95098

0.7813968

146.8556

VTRit

285

8.791535

19.35682

0.0011213

128.6458

TRit

285

30.49339

68.3318

0.0137492

497.4025

FDit

285

29.78382

16.56209

4.838176

84.36731

INVit

285

14.94795

6.193894

2.402659

40.19699

FDIit

285

3.419708

4.6779

-3.284961

53.81077

TOit

285

76.21345

34.42438

15.23902

203.8294

INFit

285

9.854013

8.724587

-4.523273

80.75014

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Table 2: Correlation Matrix of Lower-Middle Income countries Variable

GDPit

MCRit

TRit

VTRit

TOit

INFit

FDit

FDIit

GDPit

1

MCRit

0.177*

1

TRit

0.0463

0.168*

1

VTRit

0.176*

0.557*

0.775*

1

TOit

0.025

-0.188*

-0.375*

-0.367*

1

INFit

0.066

-0.163*

-0.052

-0.122**

0.086

1

FDit

-0.002

0.403*

-0.018

0.158*

-0.060

-0.361*

1

FDIit

0.264*

-0.095

-0.151**

-0.122**

0.493*

0.110*

0.155*

1

INVit

0.409*

0.245*

0.002

0.153*

0.199*

-0.043

0.188*

0.304*

INVit

1

Notes: Correlation with ** and * is significant at 5% and 1% level of significance (two tailed) respectively.

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Table 3: Panel Data Models. Variable

Model 1 (MCR) FE

RE

SMDi

0.0378*

0.0382*

TOit

0.0411**

0.0029

INFit

-0.0089

-0.0142

FDit

-0.0732**

-0.0571**

FDIit

0.1698*

0.1613*

INVit

0.1437**

0.1763*

Constant

-1.8124

0.0990

F/ Wald test

10.42*

R2

0.101

Hausman’s test

14.89*

Model 2 (TR)

Model 3 (VTR)

FE

RE

FE

RE

0.0021

0.0015

0.0219**

0.0262*

0.0476**

0.0017

0.0452**

0.0049

-0.0041

-0.0105

-0.0032

-0.0086

-0.0528

-0.0358

-0.0567**

-0.0411

0.1590*

0.1454*

0.1645*

0.1529*

0.1957*

0.2213*

0.1721**

0.1954*

-2.8973

-0.3512

-2.3918

-0.1888

61.05*

15.60*

35.06*

16.15*

366.61**

0.207

0.079

19.03

0.092

0.215

16.68**

14**

Notes: Observations = 285 and ** and * mean that variable is significant at 5% and 1% level of significance (twotailed) respectively.

97