Effects of the Financial Sector on Botswana’s Economic Growth

Abstract

The link between financial sector development and economic growth has been extensively debated in economic literature, with some researchers claiming that a well-developed financial sector promotes economic growth and others arguing that economic expansion drives financial sector development. This research looks at the causal link between financial development and economic growth in Botswana from 2000 to 2018. Given Botswana’s position as an upper-middle-income nation with a thriving financial industry, knowing this link is critical for policymaking and economic planning. To examine this link, the research uses the Auto-Regressive Distributed Lag (ARDL) bounds-testing technique, which is well-suited for small sample sizes and can handle variables integrated at various orders, I (0) or I (1). Stationarity was determined using three-unit root tests: the Augmented Dickey-Fuller (ADF), Phillips-Perron (PP), and Kwiatkowski-Phillips-Schmidt-Shin (KPSS). The research also uses Granger causality tests to determine the direction of causation between financial development (as measured by Finance and Business Services, FBS) and GDP growth. The results show that GDP and financial development are integrated at order I (1), implying non-stationarity at levels but stationarity after initial differentiation. The ARDL limits test finds no long-run cointegration between financial development and economic growth, indicating that although they interact, their connection does not last in the long run. However, short-run findings suggest a bidirectional causal link, with financial development influencing GDP growth and vice versa. The results have significant policy consequences. The lack of long-run cointegration shows that finance sector changes may not be sufficient to produce sustainable economic development in Botswana. To promote economic resilience, policymakers should prioritise increasing financial inclusion, tightening banking rules, and encouraging capital market growth. Furthermore, the study adds to the finance-growth literature by presenting actual data from a growing African country, filling gaps in previous studies. This research emphasises the relevance of short-term banking sector actions in boosting economic development. While the financial sector contributes to economic performance, long-term growth plans in Botswana should include fundamental economic changes, regulatory improvements, and financial innovations to maximise development benefits.