GLOBAL FINANCIAL CRISIS, THE CAPITAL MARKET AND ECONOMIC GROWTH IN NIGERIA

By Abdul ADAMU Department of Business Administration, Faculty of Administration, Nasarawa State University, Keffi, Nasarawa State Nigeria uooba1009@gmail.com adamuabdulmumeen@yahoo.com Tel. +2348029445391, +2348064851648.

Abstract
The global financial crisis began in industrialized countries and quickly spread to emerging market and developing economies. Investors pulled capital from countries and caused values of stocks and domestic currencies to plunge, pushing economies worldwide either into recession or into a period of slow economic growth. Thus, this paper examines the relationship between Gross Domestic Product and All Share Index of the Nigerian Stock Exchange during the period of the global financial crisis. The study uses quarterly time series data between 2007 and 2009 which were tested and found to be stationary as well as cointegrated. Ordinary Least Square regression was used in the analysis and it was found that there is a negative relationship between gross domestic product and stock market indices in Nigeria during this crisis period. It was recommended that there is need to strengthen the regulation of the market in order to restore investors confidence and cushion the effect of the meltdown on the economy.

INTRODUCTION The global financial crisis was triggered by credit crunch within the US sub-prime mortgage market and spread and deepens in several countries. Countries around the world approached it with a concern for practical results, prompting emergency funding support for relevant sectors, thereby mitigating the impact of the crisis on economies as well as avoiding the entire collapse of the international financial system (Ajakaiye & Fakiyesi, 2009). In the first year of the crisis, developing countries including Nigeria were relatively unaffected by the subprime related crisis on the basis of their generally strong economic fundamentals and lack of exposure to the toxic financial products that undermined the balance sheets of financial institutions in advanced countries. But since August 2008, they have come under severe pressure. Access to international credit has dried up, their currencies have depreciated on average by 20 percent and stock markets have tumbled by 30-50 percent (Bhattacharya, Dervis & Ocampo, 2008). This is as result of the globalization of the financial markets. The global financial crisis has caused huge losses and dislocation in the developed countries of the world, but in many of the developing countries, especially in Africa, it has pushed people into poverty and threatening them with starvation. The crisis is being transmitted to the poorer countries through declining exports, falling commodity prices, reverse migration, shrinking remittances from citizens working overseas, withdrawal of credit by the internationally active banks, and investor fear and herding that led to the decline of capital market indices all over Africa. The capital market is one of the sectors that have generated a lot of research interest due to its activities and the likely impact it may have on economic growth of any nations. According to Wikipedia (2008), The capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year. The capital market includes the stock

market (equity securities) and the bond market (debt). But it is the stock market that is more developed in Nigeria, as such capital market is mostly referred to as stock market in this study. Since the global financial crisis have slowed down the activities of the capital market due to capital flight and contagion, there is need to reexamine the relationship between the capital market and economic growth during this period of the crisis. Thus, this section is the introduction and the next section is the statement of the problem, followed by objectives of the study, then literature review and methodology. This is followed by result and discussions and finally, conclusion and recommendations. STATEMENT OF THE PROBLEM The global financial system has witnessed rapid growth and substantial structural change during the last decade leading to globalisation of financial markets. The integration of financial markets has accentuated the rapid flow of capital across borders as well as magnified the contagious effects of the financial crisis with wide implications for transmission of financial policies on the domestic economy and internationally. One sector that the impact of the crisis was visible is the capital market and this is because of the initial response of our policy makers to the crisis which was rather meek as they argued that the economic fundamentals are strong and that the country is insulated. As the global financial crisis intensified significantly in September 2008, liquidity dried up in many financial markets including Nigeria, equity prices fell sharply worldwide, and a number of large financial institutions collapsed or came close to bankruptcy. These financial strains have increasingly led to downward pressure on economic activity worldwide. While a large number of developed economies are already in recession, growth in many developing countries is decelerating significantly. These make many researchers to rethink the impact of the capital market on economic growth in both developed and developing countries. In the last two decades, the link between capital market and economic growth is a subject of high

interest among academics, policy makers and economists around the world. There have been attempts to empirically assess the role of stock market and economic growth and it has varied in methods and results. Adjasi and Biekpe (2005) found a significant positive impact of stock market development on economic growth in countries classified as upper middle-income economies. In the same way, Chen and Wong (2004) elaborates the nexus between stock returns and output growth and found that the rate of stock returns is a leading indicator of output growth. Arestic, Demetriades and Luintel (2001) using time-series on five industrialized countries also indicates that stock markets play a role in growth. Various studies such as Spears (1991), Levine and Zervos (1998), Atje and Jovanovic (1993), Comincioli and Wesleyan (1996), and Demirguc-Kunt and Levine (1996) have supports the view that stock markets promote economic growth. With well-functional financial sector or banking sector, stock markets can give a big boost to economic development (Rousseau & Wachtel, 2000; Beck & Levine, 2003). There are also alternate views about the role stock markets play in economic growth. Apart from the view that stock markets may be having no real effect on growth, there are theoretical constructs which shows that capital market development may actually hurt economic growth. For instance, Stiglitz (1985), Shleifer and Vishny (1986), Bencivenga and Smith (1991) and Bhide (1993) notes that stock markets can actually harm economic growth. Despite all the alternative views, empirical works continue to show largely some degree of positive relationship between stock markets and growth. These studies largely based on period of stable economic growth and economic boom. Only few studies have been conducted during the period of the current global financial crisis to show the relationship between the capital market and economic growth especially in the context of Nigerian stock market, and those conducted studies do not show clear conclusion regarding its impact on economy. Adamu (2010) finds that that stock returns during the crisis period is highly volatile due to loss of investors confidence. Though, his study may be significant in other cases, it is of less significance here as it is only talking about volatility of returns and not relationship between stock market and economic growth. This study will try to fill this void

by looking at the impact of the capital market on economic growth during the period of the global financial crisis. OBJECTIVES OF THE STUDY The general objective of this study is to examine the impact of the Nigerian capital market on economic growth of Nigeria during the period of the global financial crisis and the specific objectives are:
i. To examine the pattern of performance of the Gross Domestic Product and Nigerian Stock

Exchange All Share Index during the period of global financial crisis.
ii. To examine the relationship between Gross Domestic Product and the Nigerian Stock

Exchange All Share Index during the period of the global financial crisis. LITERATURE REVIEW Nature of the Global Financial Crisis Nanto (2009) observes that financial crises of some kind have occurred sporadically virtually every decade and in various locations around the world. Financial crises have occurred in countries ranging from Sweden to Argentina, from Russia to Korea, from the United Kingdom to Indonesia, and from Japan to the United States. Each financial crisis is unique, yet each bears some resemblance to others. In general, crises have been generated by factors such as an overshooting of markets, excessive leveraging of debt, credit booms, miscalculations of risk, rapid outflows of capital from a country, mismatches between asset types (e.g. short-term dollar debt used to fund long-term local currency loans), unsustainable macroeconomic policies, off-balance sheet operations by banks, inexperience with new financial instruments, and deregulation without sufficient market monitoring and oversight (Abubakar, 2008; Dell Arriccia, Igan & Laeven, 2008; Wikipedia, 2008; and Nanto, 2009). Apart from the factors mentioned above which are believed to have generated financial crises, some

economic theories that have explained financial crises includes the Coordination games, Minskys theory, and Herding and Learning models. Krugman (2008) sees Coordination games as a mathematical approach to modelling financial crises that have emphasized the need for positive feedback between market participants' decisions. Positive feedback implies that there may be dramatic changes in asset values in response to small changes in economic fundamentals. While Minskys theory says that financial fragility is a typical feature of any capitalist economy and its levels move together with the business cycle, Herding and Learning models explained that asset purchases by a few agents encourage others to buy too, not because the true value of the asset increases when many buy, but because investors come to believe that the true asset value is high when they observe others buying (Avery & Zemsky, 1998; Chari & Kehoe, 2004; Cipriani & Guarino, 2008). Capital market and economic growth Theoretically, a growing literature argues that capital market development boost economic growth. Greenwood and Smith (1996) show that large stock markets can decrease the cost of mobilizing savings, thus facilitating investment in most productive technologies. Bencivenga, Smith and Starr (1996) and Levine (1991) argue that stock market liquidity (the ability to trade equity easily) is crucial for growth. Moreover, Kyle (1984) and Holmstrom and Tirole (1993) argues that liquid stock markets can increase incentives for investors to get information about firms and improve corporate governance. Finally, Obstfeld (1994) shows that international risk sharing through internationally integrated stock markets improves resource allocation and can accelerate the rate of growth. Stock markets contribute to the mobilisation of domestic savings by enhancing the set of financial instruments available to savers to diversify their portfolios. In doing so, they provide an important source of investment capital at relatively low cost (Dailami & Atkins, 1990). In a well-developed stock market, share ownership provides individuals with a relatively liquid means of sharing risk when investing in promising projects. Stock markets help investors to cope with liquidity risk by allowing those who are hit by a liquidity shock to sell their shares to other investors who do not

suffer from a liquidity shock. The result is that capital is not prematurely removed from firms to meet short-term liquidity needs. Capital markets accelerate economic growth by providing a boost to domestic savings and increasing the quantity and the quality of investment (Yartey, 2008). In particular, stock markets can encourage economic growth by providing an avenue for growing companies to raise capital at lower cost. In addition, companies in countries with developed capital market are less dependent on bank financing, which can reduce the risk of a credit crunch. The stock market is also expected to make available long term investment to be financed by funds provided by individuals, many of whom wish to make them available for only a very limited period, or who wish to be able to withdraw them at will (Baumol, 1965). Critics of stock market argue that stock market liquidity may negatively influence corporate governance because very liquid stock market may encourage investor myopia. Since investors can easily sell their shares, more liquid stock markets may weaken investors commitment and incentive to exert corporate control (Bhide, 1994). These problems are further magnified in emerging market countries with their weaker regulatory institutions and greater macroeconomic volatility. These serious limitations of the stock market have had led many analysts to question the importance of the system in promoting economic growth in emerging markets (Aruwa, 2009). A study by Osinubi and Amaghionyeodiwe (2003), using Nigerian data, provides some dissenting evidence that stock market development statistically had no significant effect on economic growth in Nigeria during the period 1980 to 2000. They interpreted the results to mean that the Nigerian Stock Market was unable to make significant contribution to rapid economic growth because of the existence of certain policies that blur the effectiveness of the vehicle or transmission mechanism through which stock market activities influence economic growth. Interestingly, the significant growth recorded in most of the exchanges in the region, from 2000 to 2008, have invalidated the claims made by Osinubi and Amaghionyeodiwe (2003) and have instead projected the hypothesis

tested by Adjasi and Biekpe (2006). However, critics on the role of stock market in economic development concentrate more on the fact that without efficient and well-developed financial system, the acclaimed benefits may not be realised. In developing and inefficient systems, for instance, the stock market may not be able to reflect real fundamentals and may mislead investors from making optimal investment decisions. In such situation, stock market growth may not be able to influence meaningful development in the general economy. Aruwa (2009) opines that most emerging markets like Nigeria do not have a well functioning market. Not only are there inadequate government regulation, private information gathering and dissemination firms as found in more developed and regulated stock markets are inadequate. Moreover, Tirole (1991) avers that young firms in emerging stock markets do not have a long enough track record to form a reputation. As a result, share prices in emerging markets are arbitrary and volatile. Empirical evidence indicates that share prices in emerging markets are considerably more volatile than in advanced markets (El-Erian and Kumar, 1995). Despite this volatility, large corporations have made considerable use of the stock market. METHODOLOGY This study is based on quarterly time-series data for the period of 2007 and 2009. The variables used are quarterly Gross Domestic Product (GDP) as proxy for economic growth and All Share Index (ASI) as proxy for the performance of the stock market. These data are published by National Bureau of Statistics (NBS), Security and Exchange Commission (SEC) and Central Bank of Nigeria (CBN). The data properties are estimated using Augmented Dickey-Fuller (ADF) stationarity test and Johansen cointegration test. The Ordinary Least Square (OLS) is used in the study to show the relationship between Gross Domestic Product (GDP) and All Share Index (ASI) for the period of the study. The model specification for the relationship between the capital market and economic growth for this

study is presented below:

RESULTS AND DISCUSSIONS Pattern of performance of Real GDP and All Share Index (ASI) The magnitude of Gross Domestic Product (GDP) and All Share Index (ASI) for the period under study is given in figure 4.1 below. In the first three quarters of 2007, GDP grows consistently and dropped again for three quarters until the second quarter of 2008. This was the period that most countries including Nigeria felt the impact of the crisis. Fig 4.1 Quarterly GDP and ASI (2007 2009)
240000 200000 160000 120000 80000 40000 0 07:01

07:03

08:01

08:03

09:01 ASI

09:03

GDP

The growth continues slightly again until the first quarter of 2009 but after that the GDP has continues to record positive growth consistently. This is due to improvement in economic situations as policy response by government started yielding the desired results. Similarly, the All Share Index (ASI) recorded a consistent growth between the first quarters of 2007 until the first quarter of 2008. This situation could be explained by the fact that most developing countries have not started feeling the heat of the crisis and the policy makers were preaching insulation and strong economic fundamentals. After this period, the ASI started dropping and

increased slightly in the second quarter and continues to drop thereafter. This is as a result of the effect of the global financial crisis which affected investors confidence. Stationarity and Cointegration test The test for stationarity using the Augmented Dickey-Fuller (ADF) test statistics shows that both ASI and GDP are stationary at 5% critical value. The result of the stationary test is shown in table 1 below. Table 1: Stationarity test Variables GDP ASI ADF test statistics -3.638987 -2.428138 Critical value @ 5% -3.2195 -1.9890 Order of differentiation I(0) I(1)

Source: E-view results The table 2 below shows the cointegration test results which shows that GDP and ASI are cointegrated there is a long run relationship between the variables (ASI and GDP). Table 2: Johansen Cointegration test Max-Eigen Critical Value Critical Value @ Variables Trace statistics statistics @ 5% 5% GDP ASI 17.01319 14.07 17.99360 15.41 Max Eigen and Trace test indicates 1 cointegrating equation(s) at the 5% level Source: E-view results Since the Gross Domestic Product and All Share Index satisfied the stationarity condition and cointegrated as well, we further our analysis by running the test of regression. Ordinary Least square regression results The least square regression equation is given below and the other estimate of the results is depicted in table 3 below. lnGDP = 13.523 0.142*lnASI This result shows a negative relationship between GDP and ASI between 2007 and 2009 i.e. the period of the global financial crisis. This is consistent with a priori expectations that the relationship between these two variables should be negative due to slow economic growth during the period of

the crisis. Table 3: Ordinary Least Square result

Dependent Variable: GDP Included observations: 12 Variable Coefficient ASI -0.141829 C 13.52269 R-squared 0.143921 Adjusted R-squared 0.058313 Std. Error t-Statistic 0.109386 -1.296599 1.155569 11.70219 Mean dependent var S.D. dependent var Prob. 0.2239 0.0000 12.02535 0.148186

Source: E-view result The result shows o = 13.523 which is the intercept. This is the base level of prediction when the ASI is equal to zero. A unit change in All Share Index (ASI) leads to about 14% decrease in Gross Domestic Product (GDP). This shows that there is a negative relationship between GDP and ASI. The value of the standard error of 1 exposes the insignificant nature of 1, when viewed from the angle of rule of thumb since the value of the standard error is greater than the value of 1. The Adjusted R2 of 0.0583 shows that only 6% of the variability in GDP is explained by the ASI which indicates a bad fit. However, the Durbin-Watson test indicates the absence of serial correlation. In sum, the result indicates a negative relationship between Gross Domestic Product (GDP) and All Share Index (ASI) during the period of global financial crisis. That is, the capital market contribution to economic growth during the crisis was negative and this is why most economies of the world including Nigeria recorded downward trend in their growth rate. This would be consistent with the study of Stiglitz (1985), Shleifer and Vishny (1986), Bencivenga and Smith (1991) and Bhide (1993). Although, their studies were not during financial crisis but according to their argument, capital market development may actually hurt economic growth. CONCLUSION AND RECOMMENDATIONS The purpose of the study is to examine the relationship between the capital market and economic growth in Nigeria during the period of the global financial crisis and also to examine the performance pattern of GDP and ASI for the period of 2007 2009. The result of this study reveals that there is a negative relationship between capital market and economic growth during the period of the crisis. The finding that decreases in ASI leads to about 14% decrease in GDP is important in

that it provides additional pointers to policy makers to take a second look at the economic role of the capital market especially in the face of economic crisis. To sustain the impact of the capital market on economic growth in the face of economic meltdown, the following recommendations are made. There is need to strengthen the regulation of the market in order to restore investors confidence and cushion the effect of the meltdown on the economy. With this, the activities in the capital market will bounce back and the necessary contribution to economic growth can be sustained. The depth of the market should be improved by developing other segment of the market. The fixed income security and derivative markets should be made active to cushion the effect of fall in stock prices. The regulatory authority should temporary ban short sales of stock and government should purchase stock. The essence of this kind of policy is to avoid panic selling and discourage those that would rush to sell their stocks in order to minimise their losses. REFERENCES Abubakar, M. (2008) The Implication of Global Financial Crisis on International Marketing Unpublished M.Sc. Assignment on International Marketing Bayero University, Kano. Adamu, A. (2010) Global Financial Crisis and Nigerian Stock Market Volatility in Mainoma, M.A., Aruwa, S.A.S. and Tende, S.B.A. (ed.) Conference Proceeding on Managing the challenges of global financial crisis organised by Faculty of Administration, Nasarawa State University, Keffi between 9 11 March. Vol. 1 pg 102 113. Adjasi, C.K.D. and Biekpe, N.B. (2005) Stock Market Development and Economic Growth: The Case of Selected African Countries Working Paper, African Development Bank. Ajakaiye, O. & Fakiyesi, T. (2009) Global financial crisis Discussion paper 8: Nigeria Oversea Development Institute, London. Aluko, M. (2008) The global financial meltdown: Impact on Nigeria's capital market and foreign reserves retrieved from www.google.com on 14 January, 2010. Arestis, P.; Demetriades, P.; Liuntel, K. B. (2001) Financial Development and Economic Growth: The Role of Stock Markets Journal of Money, Credit and Banking, 33(1):16-41. Aruwa, S.A.S (2009) Can the Stock Market Predict Economic Activity in Nigeria? Journal of Finance and Accounting Research Vol. 1 No. 3 pp. 68-78. Atje, R. and Jovanovic, B. (1993) Stock Markets and Development European Economic Review,

Vol. 37 No. 2/3, pp. 632-40. Avery, C., and Zemsky, P. (1998) Multidimensional Uncertainty and Herd Behavior in Financial Markets American Economic Review 88, pp. 724-748. Benchivenga, V. R. and Smith, B. D.(1991) Financial Intermediation and Endogenous Growth The Review of Economic Studies, Vol. 58, pp 195-209. Bencivenga, V. R., Smith, B. D. and Starr, R. M. (1996) Equity Markets, Transaction Costs, and Capital Accumulations: An Illustration The World Bank Review 10(2):241-265. Baumol, J.W. (1965) The Stock Market and Economic Efficiency Furham University Press, New York. Bhattacharya, A., Dervis, K., and Ocampo, J.A. (2008) Responding to the Financial Crisis: An Agenda for Global Action Paper prepared for Global Financial Crisis Meeting Columbia University, New York, November 13, 2008 Sponsored by Friedrich Ebert Stiftung (FES) and Co-hosted by FES and the Initiative for Policy Dialogue (IPD). Bhide, A. (1994) The Hidden Costs of Stock Market Liquidity Journal of Financial Economics, Vol. 34, No. 2, pp. 31-51. Chari, V., and Kehoe, P. (2004) 'Financial crises as herds: overturning the critiques' Journal of Economic Theory 119, pp. 128-150. Chen, Lee and Wong, L. (2004) Is Rate of Stock Returns a Leading Indicator of Output Growth? In Case of Four East Asian Countries available at www.google.com on 17/06/10 Cipriani, M., and Guarino, A. (2008) 'Herd Behavior and Contagion in Financial Markets' The B.E. Journal of Theoretical Economics 8(1) (Contributions), Article 24, pp. 1-54. Comincioli, B. and Wesleyan, I. (1996) The University Avenue Undergraduate Journal of Economics, Sample Issue. DellAriccia, G., Igan, D., and Laeven, L. (2008) The Relationship between the Recent Boom and the Current Delinquencies in Subprime Mortgage CEPR Discussion paper, London: CEPR retrieved from www.google.com on 24/11/08. Demirg-Kunt, A. and Levine, R. (1996) Stock Market, Corporate Finance and Economic Growth: An Overview The World Bank Review 10(2):223-239. El-Erian, M. and M.S. Kumar (1995) Emerging Stock Markets in Middle Eastern Countries Paper presented at the World Bank Conference on Stock Markets, Corporate Finance and Economic Growth, Washington DC, February 1617. Greenwood, J. and B. Smith (1996) Financial Markets in Development and the Development of Financial Markets Journal of Economic Dynamics and Control, Vol. 21, 145 -81. Krugman, P.(2008, Oct. 27) 'The widening gyre', New York Times. Kyle, A.S. (1984) Market Structure, Information, Futures Markets, and Price Formation In Storey, G. G., Schmitz, A., and Sarris, A.H. (ed) International Agricultural Trade: Advanced Reading in Price Formation, Market Structure, and Price Instability, Westview Boulder, Colorado.

Levine, R. (1991) Stock Markets, Growth, and Tax Policy Journal of Finance, Vol. XLVI: 14451465. Levine, R., and S. Zervos (1998) Stock Markets, Banks, and Economic Growth American Economic Review, Vol. 88, 537-58. Nanto, D.K. (2009) The Global Financial Crisis: Analysis and Policy Implications Congressional Research Service USA retrieved from www.crs.gov on 22/05/10. Obstfeld, M. (1994) Risk-taking, Global Diversification, and Growth American Economic Review 84 (5, December) 1310-1329. Osinubi, T. S., and Amaghionyeodiwe, L. A. (2003) Stock Market Development and Long-run Growth in Nigeria Journal of African Business, Vol. 4(3): 103-129. Rousseau, P. and Wachtel, P. (2000) Equity Markets and Growth: Cross-Country Evidence on Timing and Outcomes, 1980-1995 Journal of Banking and Finance, pp. 1933-1957. Stiglitz, J.E. (1985) Credit Markets and the Control of Capital Journal of Money, Credit and Banking. Tirole, J. (1991) Privatization in Eastern Europe: Incentives and the Economics of Transition In Blanchard, O. J. and Fisher, S. S. (eds) NBER Macroeconomics Annual 1991, The MIT Press, Cambridge, MA. Wikipedia (2008) Global financial crisis available @www.wikipedia.com Yartey, C.A. (2008) Well Developed Financial Intermediary Sector Promotes Stock Market Development: Evidence from Africa Journal of Emerging Market Finance. APPENDIX i. Quarterly All Share Index and Gross Domestic Product (2007 2009) YEAR ASI GDP 2007Q1 38899.34 135774.66 2007Q2 48477.24 142790.46 2007Q3 51765.07 173067.48 2007Q4 52653.35 182618.50 2008Q1 61833.56 142071.40 2008Q2 59992.05 150862.20 2008Q3 50054.96 183678.82 2008Q4 36367.61 195590.14 2009Q1 23577.85 148470.58 2009Q2 24875.85 161748.41 2009Q3 23802.76 196670.54 2009Q4 21608.54 210146.92 Source: CBN and NBS, 2009