Financial Development and Economic Growth in Developing Countries: Evidence from Saudi Arabia

This study investigates the long-term and short-term relationships between capital market development and economic growth in the Kingdom of Saudi Arabia (KSA) for the period from January 1993 to December 2009. It employs a wide range of vector autoregression (VAR) models to evaluate the importance and impact of capital market development on economic growth. We used real GDP growth rates and None Oil GDP as proxies for economic growth and the stock market index (SMI), the bank credits to the private sector (BCP) and the broad money supply (M2) as proxies for the capital market development. The VAR models indicate a positive and significant long-term causal relationship between capital market development and economic growth. Granger causality tests show that economic growth Granger-cause capital market development and vice versa when using the real GDP growth rate variables. The study implications are as follows. Firstly, investment in real economic activities leads to economic growth. Secondly, the stock market might hinder economic growth due to its volatile and international risk sharing nature, low free-floating share ratio, number of listed companies and the domination of Saudi Individual Stock Trades (SIST) characteristics. Thirdly, policymakers should seek to minimise stock market volatility and fluctuations, increase both the free-floating share ratio and number of listed companies and shift investment domination toward corporate investors by considering its effect on economic growth when formulating economic policies. Fourthly, the banking sector might hinder economic growth due to its lack of small and medium enterprises lending and shareholder concentration issues. Finally, policymakers should seek to encourage banks toward more involvement in small and medium enterprises SMEs’ lending, which will strengthen the private sector role