Financial flows volatility and economic growth in SSA countries: Extended case of Rwanda

Abstract

Previous research has documented a positive relationship between financial flows and economic growth, but the volatility of financial flows, a common feature of financial flows, has not attracted similar attention. This paper examines the effect of the volatility in financial flows on economic growth for 23 Sub-Saharan African (SSA) countries in general and for Rwanda in particular. The paper uses annual data covering the period 2000-2019, transformed into non-overlapping 3-year averages for the case of SSA, while quarterly data covering the period 2000Q1 to 2019Q4 is used for the case of Rwanda. Our empirical estimations begin with the construction of the financial flows volatility indicator using the Z-score metric. The generated financial flows volatility measure is then incorporated into the growth regression, along with other growth determinants. For the SSA case, we estimate the dynamic panel growth model relying on the Bias-Corrected Least Squares Dummy Variable (BC-LSDV) estimator. The empirical findings show that financial flows accelerate growth, a result that is consistent with those reported in the empirical literature. However, despite the fact that financial flows volatility appears negative, it is not statistically significant, implying that financial flow volatility does not seem to affect economic growth in SSA countries. For the case of Rwanda, we employed single equation cointegration based estimators such as Dynamic Ordinary Least Squares (DOLS), Fully Modified Ordinary Least Squares (FMOLS), and Canonical Cointegration Regression (CCR) as complementary models to estimate the long-run effect of financial flows volatility on economic growth. All the disaggregated capital flows and the control variables such as investment share to GDP and government expenditure to GDP are positive and statistically significant. Financial volatility measure negatively affects economic growth in Rwanda. In as much as financial flow volatility does not affect economic growth in the case of SSA, the negative effect is evident for Rwanda, suggesting that capital flows management policies limit potential financial flow volatility that would emanate from excessive and short-term capital flows should be pursued.