The depth of financial integration and its effects on financial development and economic performance of the SACU countries

The study investigates the relationship between financial integration, financial development and economic growth in the SACU countries. The empirical analysis commenced with an examination of the degree of financial integration in each of the SACU countries using a battery of tests. Overall, the results provide overwhelming evidence that shows that individually the financial sectors of the SACU countries are highly integrated and are becoming increasingly more so. The indicators also highlight a clear asymmetry in the capital flows among the banks in the SACU countries with the capital flows significantly favouring South Africa and Namibia more than the other countries, which is attributed to the underlying characteristics of these countries, especially their weak institutional development. The results further confirm the dominant role of South Africa among the SACU. Furthermore, the interest rates analyses unambiguously indicate a hierarchy of integration of the financial systems of each member state with that of South Africa, with Namibia at the top, followed by Swaziland, Lesotho and Botswana in that order. Moreover, the results suggest that the prevailing integration between the financial systems stems from both policy convergence and market convergence. However, apart from Namibia, the evidence suggests limited arbitrage activities between the countries, which might result from both weak institutional development and limited investment opportunities and inability of investors to explore such opportunities in the smaller countries. The empirical analyses of the relationships between financial development, financial integration and economic performance based on cointegration and error correction modelling techniques using the Johansen approach produce mixed results among the SACU countries. On the relationship between financial development and output growth, the results vary from country to country and depend on the measure of financial development used. Overall, the results lend some support for supply-leading finance as proposed by Patrick (1966) across the SACU countries. On the effects of FD, the weight of evidence suggests a negative long-run causal effect of financial development, especially using the credit indicator, on output level in the SACU countries. The tests for the effect of the deposit indicator on the output level were largely inconclusive, with the exception of Swaziland, where a robust positive effect was found. The weak effect of financial development on economic growth is attributed to inefficiencies in the credit allocation mechanism due to weak regulations, banking supervision and underdeveloped financial systems as well as political, institutional and structural problems in some of the countries. The results further confirm a long-run relationship between financial development and financial integration across the SACU countries. The results also confirm a strong feedback relationship between financial development and financial integration across the countries. Overall, the effect of financial integration on financial development and vice versa is ambiguous and varies across the SACU countries. In addition to the variation across the countries, the evidence depends on the kinds of stock of capital and measure of financial development used. Hence, it is difficult to conclude in general whether financial integration is a complement or substitute to domestic financial development across the SACU. Lastly, the results show that in the four countries, output is predominantly endogenous while financial integration is mainly exogenous. This suggests a limited feedback relation from output to financial integration. Regarding the effects of financial integration on the output level, the results are mixed; the effects vary from country to country and depend on the types of capital. The effect of FDI was negative in Botswana, positive in South Africa but ambiguous in Swaziland. The ratio of foreign assets of banks has an ambiguous effect in Botswana, Lesotho and South Africa while no effect was detected in Swaziland. Lastly, the ratio of foreign liabilities of banks has a positive effect in Lesotho and Swaziland and a negative effect in South Africa, while the effect is ambiguous in Botswana.