Effect of Financial Development on the Mauritius

Chapter One

Introduction

The introduction chapter of this dissertation provides the justification and purpose of the study, explains the research problem itself, defines the research objectives and highlights the scope of the study.

1. Background to the research

Policymakers and financial experts usually acknowledge that financial development- that is, a well-functioning financial system contributes to economic growth. A well-organised financial system can encourage economic growth through several channels by providing effective financial institutions and markets that help to overcome market resistance introduced by information asymmetries and transaction costs.

Empirical studies on the link between financial development and economic growth have been analysed mostly by cross country cases until lately because of lack of enough time series data for developing countries. These researches have shown regularly that financial development is an important determinant of economic growth. However, even though the conclusion of these studies provides an appropriate guideline for the finance-growth nexus, it cannot be applied to all economies, as each specific country is regulated by its own financial institutions and policies. In this dissertation we are going to analyse the finance-growth relationship for one country only, Mauritius).

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The island of Mauritius is a fascinating country to study, because Mauritius over the past four decades have evolved from a mono-crop economy, depending on the production of sugar-cane to a mixed economy, pushed by export-oriented manufacturing, tourism and hospitality and the more recent developing sectors – financial services and Information Communication and Technology. Mauritius is considered an upper middle income group in the Sub-Saharan Africa (developing only). It has been upgrading its position in international indexes for the rule of law (first in the Sub-Sahara Africa on rule of law index), investment (14^th worldwide on the ease of starting a business and the strength of investor protection) and ease of doing business (ranking 19^th of 183 countries on the 2012 Doing Business Index).

Since the late 1980s, the financial sector has been transformed to become the fourth pillar of the Mauritian economy, with the set up of the Stock Exchange in 1989 and the Financial Services Commission in 2001. Mauritius has created various bodies to regulate the financial sector in its various aspects and substantial efforts have been made to revamp the legislative framework in the non-banking financial services sector by introducing amendments and new pieces of legislation. On a macroeconomic level Mauritius has also been doing well in the light of the world crisis in recent years. The government of Mauritius has attempted to mitigate the negative consequences of the global economic crisis through an appropriate policy mix. Thus, as the financial sector has a very important role to play in the development of the economy, this means that we have a good database for sufficient number of years to tackle this study.

2. Purpose of the study

Researches in the finance-growth nexus have been mainly on whether financial development has a positive effect on economic growth in Mauritius. In this context, we have tried to go deeper in this study by empirically analysing the co integration and causal link between financial development and economic growth in Mauritius and determining the effect of financial development and economic growth on each other by applying impulse response functions and variance decomposition techniques.

The study analyses the effect of financial development on economic growth in Mauritius and covers the period 1981 to 2012. The period coincides with the rapid growth of the financial services sector in Mauritius in the 1980s, and is sufficiently long and allows comparison with other studies.

3. Aims, Objectives, Research Questions and hypotheses
   1. Research objectives

The main aim of this study is to determine the effect of financial development on economic growth for Mauritius. The following specific objectives will be answered:

• To investigate whether the increase in domestic credit to the private sector to Gross Domestic Product (GDP) has led to improvement in GDP per capita.
• To investigate whether the increase in GDP per capital has led to the increase in domestic credit to the private sector to GDP.
• The long run and short run relationship between economic growth and financial development.
• The response of domestic credit to the private sector to GDP to shocks from the different variables used in the study
• The response of GDP to shocks from the different variables used in the study.

2. Research questions

Throughout this study we will try to find solutions to the following questions:

1. Does financial development lead to economic growth in Mauritius or does economic growth lead to financial development?
2. Is there a bi-directional causality between financial development and economic growth in the short-run and long-run?

3. Research hypotheses

Research Hypotheses considered in the study:

1. H₀: The financial development and economic growth indicators are not stationary

H₁: The financial development and economic growth indicators are stationary

2. H₀: There is no co integration equation among the variables used in the study

H₁: There is co integration equation among the variables used in the study

3. H₀: There is short run causality running from independent variables to dependent variables

H₁: There is no short run causality running from independent variables to dependent variables, which means that there is long run causality.

4. Scope of the study

The study examines the relationship between financial development and economic growth in Mauritius and covers the period 1981 to 2012. The period starts almost in the same time that the economy of Mauritius was undergoing reforms in the financial sector with the creation of the Stock Exchange of Mauritius and later on the creation of the Financial Services Commission.

5. Overall structure of the dissertation

This dissertation has been organized into five chapters. The first chapter was an introduction to the proposed research. The second chapter will provide some relevant details on the financial development and economic growth in Mauritius. The third chapter will perform a review of theoretical concepts and empirical tests conducted worldwide concerning the financial development and economic growth with special attention to developing countries. The fourth chapter will describe the methodology to be used for the proposed study, the data gathering process together with analysis performed on same and the results will be interpreted graphically with discussions. The fifth and final chapter will draw conclusions from the study with some practical recommendations.

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