ALEX PROJECT-D61-63181-2011 Final

55 Pages·2013·0.43 MB·English

THE RELATIONSHIP BETWEEN FINANCIAL DEEPENING AND GROSS
DOMESTIC PRODUCT IN KENYA: A CASE OF NSE LISTED FINANCIAL
INSTITUTIONS

BY

ALEX MUKUNDI

A RESEARCH PROJECT PRESENTED IN
PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF
MASTER OF BUSINESS ADMINISTRATION DEGREEOF
THE UNIVERSITY OF NAIROBI

NOVEMBER 2013
DECLARATION

I, Alex Mukundi, hereby declare that this project is my own work and effort and that it
has not been submitted anywhere for any award.
Signature: …………………………………... Date: …………………

ALEX MUKUNDI

D61/63181/2011

This research project has been submitted for examination with my approval as the
University supervisor

SUPERVISOR

Signature: …………………………………... Date: …………………

……………………………………….
Lecturer, Department of Finance and Accounting
UNIVERSITY OF NAIROBI

ii
DEDICATION

I dedicate this work to
My dad and my mum,
My loving wife and our children.

iii
ACKNOWLEDGEMENT

I am heavily indebted to various people and organizations for the success of this research
project. The material and non material support they gave to me during research are highly
appreciated. I take this opportunity to express my sincere thanks to each of these people
and organizations. First, the staff of the Jomo Kenyatta Library of the University of
Nairobi provided to me the opportunity to use the library facilities especially in the MBA
and the Electronic Library section.
Secondly, I wish to recognize that I could not have started and completed this research
successfully without the direction of my supervisor, Mr. Luther Otieno The advice on
what to do at each stage of this research right from the generation of the research idea, to
its conceptualization, to the drafting of the research proposal, to the analysis of samples
and preparation of the final report is highly valued.
Thirdly, the data of analysis was got from respondents in Kenya National Bureau of
Statistics, the World Bank and United Nations websites. It would not have been possible
to conduct an analysis and extract out the relevant finding if the data was not provided in
the first place.
Finally, I appreciate the people who worked on the materials cited in this study: those in
the wider scholarly world and those in the business school. I also wish to thank my
family that provided me with encouragement throughout the period I was conducting this
research.

iv
TABLE OF CONTENTS

Page
Declaration ……………………………………………………………………… ii
Dedication ………………………………………………………………...…….. iii
Acknowledgement ………………………………………………………..…….. iv
List of Tables…………………………………………………………..….…….. vii
List of Figures…………………………………………………………………… viii
List of Abbreviations……………………………………………………………. ix
Abstract……………………………………………………………………..…… x

CHAPTER ONE: INTRODUCTION……………………………………..…… 1
1.1 Background of the study…………………………………………………… 1
1.1.1 Financial Deepening…………..……………………………...…… 2
1.1.2 Gross Domestic Product ……….…….………………………...…. 2
1.1.3 Relationship between Financial Depth and GDP…………….….… 3
1.1.4 Kenya’s Financial Sector………………….……………………….. 4
1.2 Research Problem………………………………………………………..… 5
1.3 Research Objective…….……………………………………………...…… 6
1.4 Value of the study……………………………………………………..…… 6
CHAPTER TWO: LITERATURE REVIEW…………………………………. 8
2.1 Introduction ……………………………………………………………..… 8
2.2 Theoretical Review……..………………………………………………….. 8
2.3 Determinants of Economic Growth………………………………………... 10
2.4 Empirical Review……………………………………………………..…… 11
2.5 Summary of Literature Review…………………………………………… 16

CHAPTER THREE: RESEARCH METHODOLOGY…………………….… 17
3.0 Introduction……………………………………………………………..…. 17
3.1 Research Design ………………………………………………………..…. 17
3.2 Data Collection……………………………………………………………. 17
v
3.3 Data Analysis ……………………………………………………………… 18

CHAPTER FOUR: DATA NALYSIS AND FINDINGS………………………….…. 20
4.1 Introduction ……………………………………………………….…….… 20
4.2 Analysis of Data and Presentation of Findings……………..............……... 20
4.2.1 GDP Growth Rate………..……………………………………..…. 20
4.2.2 Market Capitalization….……………………………………....……21
4.2.3 Liquid Liabilities…..…………………………….…………………. 22
4.2.4 National Percentage Private Credit from Banks …………….…..… 22
4.2.5 Stock Turnover ……..…………………………..………………… 25
4.2.6 Correlation Analysis………………………………………………. 26
4.2.7 Regression Analysis………………………………………………. 26
4.3 Interpretation of the Findings……………………………………..………. 28
CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS…. 31
5.1 Summary ………….…………………………………………………... 31
5.2 Conclusions …………..…………………………………………….…. 32
5.3 Policy Recommendations ………….…………………………………... 33
5.4 Limitations of the Study ……………………………………………..… 34
5.5 Suggestions for Further Research……………………………….…… 35
REFERENCE………………………………………………………………..…… 36

APPENDICES………………………………………………………………..….. 40
Appendix I: GDP Growth rates of Kenya …………………..……………...…. 40
Appendix II: Market Capitalization………………………………………….…. 41
Appendix III: National Percentage Liquid Liabilities (M3)…………….…… 42
Appendix IV: National Percentage of Private Credit……………………..….. 43
Appendix V: Stock Turnover Ratio…………………………………………..….. 44
Appendix VI: Gross Domestic Product…………………………………………. 45

vi
LIST OF TABLES
Page
Table 4.1: Summary Statistics for GDP Growth Rate…………………………….. 20
Table 4.2: Summary Statistics for Market Capitalization…………………………. 21
Table 4.3: Summary Statistics for National Percentage Liquid Liabilities……...… 23
Table 4.4: Summary Statistics for Percentage Credit from Banks……………..….. 24
Table 4.5: Summary Statistics for Stock Turnover………………………………… 25
Table 4.6: Correlation Matrix……………………………………………………… 26
Table 4.7: Regression Analysis……………………………………………………. 28

vii
LIST OF FIGURES
Figure 4.1: Time Series Plot for GDP Growth Rate (%)……………………..….… 21
Figure 4.1: Time Series Plot for Market Capitalization (%)………………..……… 22
Figure 4.2: Time Series Plot for Percentage Liquid Liabilities (%)…………..…… 23
Figure 4.3: Time Series Plot for National Private Credit (%)………………..……. 24
Figure 4.4: Time Series Plot for Stock Turnover (%)………………………..……. 25

viii
ABBREVIATIONS AND ACRONYMS

GDP Gross Domestic Product
ARDL Autoregressive Distributed Lag
DFCK Development Financial Corporation of Kenya
DFI Development Financial Institutions
DTM Deposit-Taking Microfinance
EADB East Africa Development Bank
FSD Financial Sector Deepening
FSDI Financial Sector Development Index
GIRF Generalized Impulse Response Function
GMM Generalized Method of Moments
ICDC Industrial and Commercial Development Corporation
IDB Industrial Development Bank
KBA Kenya Bankers Association
KIE Kenya Industrial Estates
NBFI Non-Bank Financial Institutions
NSE Nairobi Securities Exchange
NSSF National Social Security Fund
OLS Ordinary Least Square
R&D Research and Development
RSA Republic of South Africa
SACU Southern African Customs Union
SURE Seemingly Unrelated Regression Estimation
TSLS Two-Stage Least Squares
US United States (of America)
VAR Vector Autoregressive
VDC Variance Decomposition
VECM Vector Error Correction Model
ix
ABSTRACT

Theory predicts close and positive relationship between financial deepening and growth
in GDP. However, empirical evidence, however, presents varied positions. This study
aimed at establishing the relationship between financial deepening and GDP growth in
Kenya since theoretical positions and available evidence were not in universal agreement.
The research was a time series regression analysis across a period of 20 years from 1993
to 2012. In this research, GDP growth rate was the dependent variable while the
independent variables were the components of financial market development and
deepening, namely, market capitalization, liquid liabilities, private credit from banks and
stock turnover. The study used the multiple regression model regressing GDP growth rate
against market capitalization, liquid liabilities, private credit from banks and stock
turnover. The analysis was done at 95% confidence level. The significance of the
constant term of the regression and the coefficient of each of the independent variables
was tested using t-tests while the significance of the whole regression was measured
using the F-test. The degree to which the variation in independent variables explained the
variation in GDP growth was measured by the coefficient of determination. The research
established that the economy would still grow at 6.18% independent of market
capitalization, liquid liabilities, private credit from banks and stock turnover. It was also
established that 1% rise in liquid liabilities would result in 0.17% drop in GDP.
Increasing stock turnover by 1% would lead to 0.038 % rise in GDP growth rate. A 1%
rise in market capitalization would lead to 10% rise in GDP growth and a 1% rise in
private credit would drive 5.4% rise in GDP growth. The regression model captured the
relationship between GDP growth and market capitalization, liquid liabilities, private
credit from banks and stock turnover. This was established by the F-test which was
statistically significant indicating close relationship between financial deepening and
GDP growth. However the coefficient of determination indicated that the variation in
GDP growth was poorly explained by the variation in the independent variable. It is,
therefore, recommended that strategies to enhance financial deepening be put in place as
a mechanism of stimulating economic activity in Kenya.
x