The link between capital market and economic growth in Rwanda

The link between capital market and economic growth in Rwanda 1.1 Background Today most economies around the world are judged by the performance of their capital markets. The potential role of financial markets in economic growth has been well documented. Most African countries including those in Sub-Saharan Africa (SSA) have recently under gone financial sector reforms such as restructuring and privatizing of state owned banks and establishment of capital markets. In the literature there are different views on the link between capital markets and economic growth of a nation. North (1996) shows that, differences in economic institutions are the major sources of cross-country differences in economic growth and prosperity. High quality institutions have a positive influence on the depth and development of the financial sector of nations. This proposed research will mainly consult with the literature about the link between capital market and economic growth and the role that institutions play in capital markets and try to pinpoint and relate these to the Rwandan context. In developed capital markets households are the major participants as investors. Saunders and Cornett (2004) claimed that in the United States, households are the single largest holders of corporate stock. However, the capital markets of least developed countries are very shallow in terms of capitalization because of a limited number of listed companies and limited participation of households (savers) either due to lack of capacity or lack of awareness as to the capital markets. Therefore this study will also examine the impact of the households (savers) in the capital markets in least developed countries in Africa including Rwanda. 1.2 Statement of the Problem Despite a surge of global investor interest in the 1980s and 1990s, Africa has been bypassed by the massive international capital flowing to developing economies. Aggregate capital flows to developing countries have been rapidly exceeding official development assistance flows since 1980s. However, Africa remains the only developing region in which development assistance flows exceeds private capital flows (Senbet and Otchere, 2006). This was mainly attributed to the lack or absence of a well developed financial sector (capital markets, banks, finance companies, life insurance companies, and insurance companies) and the poor economic policies and institutions in African countries. Capital markets are a vital part of an economy making it possible for industry, trade and commerce to flourish without any obstacle in terms of resources. The financial markets serve a vital purpose in the growth and development of a company that wants to expand. For such companies with expansion plans and new projects in need of funding and investors looking for a better return, the financial market is the best platform. The private sector usually lacks access to credit facilities. Investment, growth and economic welfare are all too low in developing countries. This is more severe in Africa, particularly in Sub-Saharan Africa (Platt, 1998). Most African countries, particularly those in Sub-Saharan Africa, have recently undergone extensive financial sector reforms. The reform package includes restructuring and privatization of state owned banks, the introduction of private banking systems, along with bank supervisory and regulatory schemes, the introduction of a variety of measures to promote the development of financail markets; including money and stock markets (Senbet and Otchere, 2006). Rwandas economy primarily depends on agricultural productivity. The industry and service sectors are not entirely developed to push the economy towards higher growth. Rwandas long-term development plan, as articulated in Vision 2020, seeks to transform Rwanda into a middle-income country and an economic trade and communications hub by the year 2020. An effectively functioning financial sector is a fundamentally important and essential element for achieving this objective.   Rwanda seeks to develop a financial sector that is effective, in particular, by  expanding access to credit and financial services; enhancing savings mobilization, especially long term savings; and mobilizing long-term capital for investment. A key strategic goal of the Vision 2020 plan is to make Rwanda an economic trade and communications hub in the heart of Africa.   This will require significant investment in infrastructure in the form of roads, power, rail, airports and telecommunications.   These plans also call for the active participation and expansion of the private sector in Rwandas economy which will require long term investment in infrastructure and industry, which can only be provided through the mobilization of domestic savings through capital markets.   The Rwanda capital market now referred to as the Rwanda Over the Counter (OTC) market was established by the Capital Market Advisory Council in January 2008. It is from this perspective the researcher is undertaking this study to see the link between capital market and economic growth in Rwanda. How does Rwanda stand to benefit from this capital market? 1.3 Purpose of the study The main purpose of this thesis is to investigate and review the literature on the link between capital market and the economic growth and prosperity of a nation, particularly in Rwanda. This study will also examine the importance of institutions for the performance of capital markets and households (savers) contribution to the capital market so that companies can raise the required capital easily in a country where financing is limited to the banking sector and yet accessible only to a few big private companies and state owned enterprises. 1.4 Objectives of the study The objectives of this proposed study are mainly to find out: Whether capital market is an alternative towards the economic growth of least developed countries such as Ethiopia. The role of institutions toward the development of capital market. Whether households savings will make a real impact on the overall performance, liquidity, and market capitalization of the capital market in Rwanda. 1.5 Research questions This thesis is intended to answer the following questions: Is a capital market an alternative towards the economic growth of least developed countries in general and for Rwanda in particular? Will institutions be vital for the performance of capital market in Rwanda? Will domestic savings in Rwanda have a role to play in the capital market? 1.6 Scope of the study This study presents the different views as to the link between capital markets and economic growth, and the role that institutions play in the performance of capital markets. The focus being the capital market in Rwanda; it also investigates the impact of households savings on capital market in Rwanda. 1.7 Significance of the study The researcher intends to collect data in order to analyse the link between capital market and economic growth in Rwanda. This study will examine the role of institutions toward the development of capital market as well as the impact of the households (savers) in the capital market in Rwanda. Additionally, this research is to fulfill the requirement of the Masters degree in Business Administration. 1.8 Definitions of terms Financial sector: The Reserve Bank of Australia (www.rba.gov.au/Glossary/text_only.asp), defines financial sector as the sector of the economy that comprises financial institutions and financial markets. Financial institution: A company whose primary function is to intermediate between lenders and borrowers in the economy. (www.rba.gov.au/Glossary/text_only.asp). Institutions: in this proposed study institutions could be defined as follows: Definition 1 (Businessdictionary.com) Establishment, foundation, or organization created to pursue a particular type of endeavor, such as banking by a financial institution. Definition 2 (Businessdictionary.com) Consistent and organized pattern of behavior or activities (established by law or custom) that is self-regulating in accordance with generally accepted norms. For example, political institutions are involved with (and regulate) competition for power; and economic institutions (such as markets) encourage and regulate production and distribution of goods and services. Least Developed Countries (LCDs): In its latest triennial review of the list of Least Developed Countries in 2003, the Economic and Social Council of the United Nations used the following three criteria for the identification of the LDCs, as proposed by the Committee for Development Policy (CDP): a low-income criterion, based on a three-year average estimate of the gross national income (GNI) per capita (under $750 for inclusion, above $900 for graduation); a human resource weakness criterion, involving a composite Human Assets Index (HAI) based on indicators of: (a) nutrition; (b) health; (c) education; and (d) adult literacy; and an economic vulnerability criterion, involving a composite Economic Vulnerability Index (EVI) based on indicators of: (a) the instability of agricultural production; (b) the instability of exports of goods and services; (c) the economic importance of non-traditional activities (share of manufacturing and modern services in GDP); (d) merchandise export concentration; and (e) the handicap of economic smallness (as measured through the population in logarithm); and the percentage of population displaced by natural disasters. 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Pleskovic (Eds.), Annual World Bank Conference on Development Economics: Growth and Integration (Senegal Proceedings). Washington, D.C.: The World Bank. www.rba.gov.au/Glossary/text_only.asp Rwanda financial sector development program (2007). Retrieved January 12, 2011, from www.bnr.rw/ www.cmac.co.rw Businessdictionary.com http://www.un.org/special-rep/ohrlls/ldc/list.htm