IMPACT OF FINANCIAL SECTOR DEVELOPMENT ON ECONOMIC GROWTH IN RWANDA (2000-2015)

There have been heated debate empirical and theoretical debates as regards to the impact of financial sector on the growth of the economy in a country. While some studies concluded that financial sector drives economic growth, others have urged that it is economic growth that drives financial sector development. This work examines the impact of financial sector development on economic growth in Rwanda. It focused on the impact of financial sector development and bank deepening variables such as availability of credit to the private sector, bank deposits, interest rate and broad money and control variable Gross Fixed capital formation and real gross domestic product as variable for economic growth. The empirical analysis builds on quarterly data covering the period 2000Q1-2015Q4, using various econometric techniques such as Augmented Dickey Fuller (ADF) test, Johansen Multivariate Co-integration Test and vector error correction model. The major findings show that development in financial sector variables i.e private sector credit, bank deposits and gross fixed capital formation positively affect economic growth proxied by Real Gross Domestic Product. In addition, Empirical evidence linking financial sector development to economic growth has revealed a positive strong relationship between financial sector development and economic growth. The empirical results indicate that financial sector development granger causes economic growth in Rwanda, confirming the supply leading hypothesis. The Johansen co integration test revealed that a unit increase in gross fixed capital formation increase real gross domestic product by 0.64%, credit to private sector by 0.37% and bank deposits by 24% respectively. The variable of Bank Deposits has stronger effect than other variables as proved by the study. Findings are plausible because all variables are one of main drivers of growth in Rwanda. The results of Impulse response and variance decompositions also show a positive and significant effect of financial development on economic growth. This result is consistent with a number of earlier studies reviewed in the literature that found financial sector variables to positively affect real gross domestic product. The study therefore, recommends policies that improve access