An analysis of the relationship between stock market development and economic growth in Zimbabwe

(1999-2009)

Department of
Finance

An analysis of the relationship between stock market development and economic growth in
Zimbabwe (1999-2009).

TINASHE J CHINGONZO
N007 1349Q
IN PARTIAL FULFILLMENT FOR BACHELOR OF COMMERCE HONOURS
DEGREE IN FINANCE

SUPERVISOR: MR MUTUNGWAZI

BULAWAYO, ZIMBABWE
2010/11 ACADEMIC YEAR

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

Abstract
The present paper examines the causal relationship between stock market development and
economic growth for the Zimbabwean economy for the period 1999-2009.This paper also
aims to provide further insights into the linkages between stock market development and
economic growth within the context of a dynamic general equilibrium framework of
informational asymmetries, endogenous contract choice and capital accumulation.
Desk research shall be applied to seek answers on the relationship between stock market
development and economic growth. Field analysis will be used in in-depth analysis of the
problem from experts of the financial market especially analysts from stockbroking firms, the
Zimbabwean Stock Exchange personel and the Central Statistics Office.

1.0 Introduction
The proliferation of stock exchanges now considers them one facet of a wider strategy for
developing national and even regional economies. According to Khan and Senhadji (2000), the
evolution of emerging stock markets has had a positive impact on the operations of banking
institutions and on economic promotion and hence their role should not be ignored. It is
envisaged that the development of emerging stock markets would assist economic development
through, helping economies to mobilise domestic savings to finance needed investments

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

(Levine,1996), providing access to global capital markets to the economys business firms,
expanding access to finance Small to Medium Enterprises who are the major economic activity
drivers, and extending financial services to the underserved ( Allan and Gale, 2000).
1.1 Background to the Study
The Zimbabwean economy which was largely hailed for its robust and sophisticated financial
system, sufferred a slump in rating as a result of a volatile macroeconomic environment that has
culminated in hyperinflation, foreign currency shortages, high unemployment levels and other
economic problems.
Against this background of economic meltdown and financial turmoil, the last decade have seen
the Zimbabwe Stock Exchange capitalisation mushrooming to highs not yet recorded in the
trading history of the stock exchange, a phenomenon referred by Greenspan (1999) as irrational
exuberance. The stock market as of the 17th of November 2008 had put forth percentile gains of
23.2 sextillion and 18.6 sextillion for the industrial and mining sectors respectively (The ZSE
Handbook 2010). However, it should be noted that the markets performance was a direct
function of the desire by investors to hedge against inflation with little regard to real economic
fundamentals. Thus as the herd mentality became the order of the day it became increasingly
difficult to understand how the market was sustaining such excellent performance in a
contracting environment.
Factors driving the ZSE indices nominal growth rates were Quasi Fiscal expenditures by the
Reserve Bank of Zimbabwe in the fom of ASPEF, Farm Mechanisation, Operation food security
and BACOSSI programmes, resulting in excess liquidity, which was eventually mopped out by
the stock market, an exponentially growing inflation rate, which eroded all local unit savings,
soaring exchange rates which culminated into ever escalating commodity prices, limited viable
and credible investment or spending options, taking into cognisant the fact that the property
market was heavily priced in foreign currency and far beyond the reach of many, highly
restrictive cash withdrawals by the RBZ saw locked up bank balances being churned towards the
ZSE as spending options withered in fast dollarising market. Over and above these factors excess
money supply growth ( Koning J P 2007) in the market that was not support in any form by
economic devlopment and waning confidence and bleak economic and political outlook

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

emanating from lethargy saw investors seeking solace from the equities market as a way of
preserving value for their funds.
In the years 2003, 2006 and 2007 the Zimbabwe Stock Exchange was rated the best performer
among emerging capital markets, in spite of the wide spread distress among the listed company
as a result of economic hardships (IFC, 2008). The explosive growth of the ZSE despite the
economic meltdown has attracted the wrath of authorities. In November 2008 the stock exchange
was suspended by the RBZ following allegations that the stock broking firms were working in
cahoots or would receive unfunded personal and bank cheques worth sextillions of dollars which
would be translated into strong marketbidding and eventually culminate into astronomical surges
of prices equities traded. According to the RBZ governer Gono Gideon (2008):
The Zimbabwe Stock Exchange has degenerated into the most poisonous vehicle through
which artificial wealth is being created, which in turn is fuelling inflationary impulses in the
economy.
The Zimbabwe Stock Exchange, ranked the second largest sophisicated stock market in the
Southern Africa region after the Johannesburg Stock Exchange and an envy of many, turned into
an explosive source of imaginary wealth being derived from mere trading of paper without
injecting significant cash flows into the underlying listed companies (RBZ, 2008). The stock
exchange came under attack from the RBZ on the suspicion that it was being used as a vehicle
for externalising foreing currency through arbitraging of dual listed shares

1.2 Statement of the Problem

The period under study has witnessed significant growth on the stock market amid economic
collapse in Zimbabwe. The present paper examines whether the traditional relationship between
stock returns and economic fundamentals has persisted over the past decade. Theoretically, stock
market valuation models suggest there should be close link between stock prices and real
economic activity. Some studies have found that movements in stock prices may have a
connection with real economic activity.

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

The fact that the stock market has been upward in nature when the economy is not doing sowell
highlights that some problems exists. Harvey and Bekaert (1997) and Levine (1996) pointed out
that efficiency and liquidity are of paramount importance in the role of stock market in
promoting economic growth. Stock market illiquidity, inefficiency, high volatility and lack of
integration with world markets hamper the role of the stock market in promoting economic
growth.
1.3 Research Objectives
The present paper aims to examine whether the relationship between stock market growth and
real economic activity holds in Zimbabwe under the following objectives:
Linkages between stock prices and each of the key macroeconomic variables, inflation,
money supply growth production and Gross domestic product, will be tested for the
period 1998-2008.
Special attention is paid to examining whether there is a long run relationship between
stock prices and the macroeconomic variables.
The paper seeks to find out if the factors that were spurring share price growth before
dollarisation period are the same as those factors affecting growth the stable period.
The research will focus on the bidirectional relationship between the stock market and
economic fundamentals.
The research will also seek to evaluate the signifiance of the primary market of the stock
exchange in discharging its duties of raising capital for production.
This research seeks to address the question of whether the Zimbabwe Stock Exchange is
effective in playing its major developmental role of mobilising and allocating scarce
capital resources for economic growth in context of Zimbabwe.
1.4 Research Questions
The research will seek to answer the following questions
Is there a breakdown in the relationship between stock market returns and economic
fundamentals?
Is the Zimbabwe Stock Exchange the barometer of economy of Zimbabwe?
Does the stock market act as a signal for real activity?
How significant is the breakdown or the relationship between the two varialbles?

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

What is the degree, strength and significance of the correlationbetween economic growth
and stock market development indicators such as liquidity and the size of the stock
market?
How well does the stock market react to economic fundamentals?
How well does the economic fundamentals of GDP and industrial production react to
changes in stock market variables such as liquidity and size?
How efficient is the stock market in financing economic activity
1.4 Statement of Hypothesis
The research will be based on the following major hypothesis:
H: The relationship between stock market development and economic growth
broke down.
H: The economic relationship between stock market performance and economic
fundamentals is strong.

1.5 Significance of the research

Although the stock market has been in existence since 1946, most research studies on the ZSE
has concerntrated on predicting stock prices, other have looked at maximising returns through
porfolio diversification of holdings on the local bourse, and yet others concentrated on the
applicability of asset pricing models on the ZSE. The few who took the same line as the author
choose to concentrate on the secondary market indicators ignoring the role of the primary
market. This research is important because it provides a comprehensive study of all the financing
activity of the stock market.
Futhermore most previous studies on the subject concentrated on single directional relationship
between the stock market and economic indicators, Enisan A and Olusifayo (2008) examined the
long run and causal relationship between stock market development and economic growth for
seven countries in sub-Saharan Africa. And Murerwi C.T.F, Dambaza M.and Ngwerume G
(2007) explored the relationship between macroecomic fundamentals and the performance of the

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

ZSE. This research is of significance since it will investigate the directional relatioship between
the stock market performance and economic performance with the view of coming up with
recommendation for improvements in the role of finance in growth.
The research will provide an insight into operations and effectiveness of the Zimbabwe Stock
Exchange as an input into operations of the real Zimbabwean economy.
The researcher will be able to partially fulfill the degree programme requirements that, a project
be undertaken in the final year of study. It is also an opportunity for the researcher to develop
research skills, which will be a good foundation for his dissertation at Masters Level.
1.6 Scope of Study
The causality relationship and co-intergration between financial development and economic
growth has been buttressed with convincing empirical and anecdotal evidence. Much of the past
studies have concentrated on the role of banks with little attention being given to stock markets.
In line with the research objectives this study research will revisit the relationship between the
stock categories for effective analysis. Firstly analysis of the primary market activity covers the
period 1998-2008. Analysis of the primary market activity covers total funds raised, how it was
allocated sectorally, and the frequency with listed companies raise finance from the stock market.
This study mainly concentrated on establishing how effective the capital market is in raising
finance for companies and in effective allocation of the finance through the primary market.
Secondly the study looked at the robustness of the relationship between stock market peformance
as proxied by growth of the industrial index and macro economic variables of inflation, money
supply growth and GDP growth. Thirdly the research will also evaluate the robustness of the
GDP growth and stock market development factors of liquidity and size.
1.7 Limitations
In carrying out this research the author expects to encounter some difficulties in accessing some
information which might be considered sensitive while some information might not be available
due to non publication. Relatively high adminstration costs and time limitation might be other
constraints.
2.0 Literature review

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

Stock markets have of late become the central focus of development economists and policy
makers because of the perceived benefits they provide to the economy either directly or
indirectly. Encouraging a vital capital market does more for a national economy than simply
bring new capital ( The Iran Daily, 2005). Stock markets have been cited as the barometer of
economic activities. Consequently, active stock markets may be relied upon as measures of
changes in the general activities of the economy (Munyukwi, 2002; Obadan, 1995). The
importance of a healthy and vibrant national stock is underlined by numerous studies showing
that a developed banking system and a robust stock exchange not only promote economic
growth, but also predict it. Shambira S (2005), in relation to the Zimbabwean Stock Exchange,
asserts that.the stock exchange is a necessary part of the modern economy and its growth and
vibrancy promotes economic growth.
Nowadays, the lack of a well-developed stock market would be a particulary serious
disadvantage for any economy (Duisenberg, 1999). Stock markets provide
portfoliodiversification for investors which allow individual firms to engage in specialised
production, with resulting efficiency benefits which promote economic growth (Acemoglu and
Zilibotti, 1997; Bekaert and Harvey, 1997). As stated by Perotti and Van Oijen (1999), stock
markets allow diverse equity ownership which creates a constituency for political stability, which
in turn, promotes growth.
According to Levine (1996), stock markets can potentially raise savings and investment rates by
introducing new instruments that might better meet savers needs and by pooling the small
savings of many individuals to fund investments in large-scale projects that otherwise might not
be undertaken. The idea of developing a stock market is to provide reasonable cheap finance to
entrepreneurs while offering a chance to own a business to those investors who do not have the
flair to establish a company (Okereke-Onyiuke, 2000).
The recent development of interest in African stock markets is also predicated on the notion that
they be used for efficient allocation of savings to productive investment. Stock markets act as
conduits through which savings mobilised are allocated efficiently to competing productive
sectors through the signalling effect of stock markets are important in efficient cross-sectional
allocational of resources in a population of heterogenous individuals with different risk
preferences such as Africa. Allen and Gale (2000) purported that debt finance or bank loans may

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

not be available to some firms make the economy flourish but yet they are at competitive
disadvantage to large firms when it comes to securing loans from banks. Greenspan (1999)
documents that emerging stock market are crucial to developing countries because they augment
bank finance by providing equity capital to the disadvantaged sectors thereby effectively acting
as spare-wheel finance
Adding to the points above, Osinubi (1998) pointed out that the liquidity of the stock market
facilitates profitable interaction between the stock market and the money market in that shares
become easily acceptable as collateral for bank lending thereby boosting credit and investment.
Indeed, Levine and Zervos (1998) provide robust evidence that stock market liquidity is the most
important factor through which stock markets promote economic growth. Liquid stock markets
increase to the incentive to get information about firms and to improve corporate governance,
thereby facilitating growth (Kyle, 1984; Holmstrom and Tirole, 1993). Levine (1996) argued that
multiple regression procedures could be used to forecast economic growth even after accounting
for a variety of non-financial factors that influence growth. The empirical evidence strongly
supports the belief that greater stock market liquidity boosts-or at least precedes-economic
growth.

3.0 Research Methodology

This research is an explorative research that seeks to explore the relationship between macro
economic fundamentals of GDP growth, inflation, money and stock market performance (index
growth). The research also explores the relationship between stock market development
indicators and economic growth in thecontext of Zimbabwe. This research is predominantly a
desktop study and will utilise mainly secondary data. This design is chosen because data already
exists, from published sources that include ZSE publications, CSO publications, equity
researchers, textbooks, journals, annual reports, statistical tables as well as policy documents.
The main sources of secondary data for this study will be ZSE publications and websites,
monetary policy statements, RBZ bulletins and websites, CSO publications, listed companies
published accounts and research publications.
3.1.1 Questionaires

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

The researcher shall also use research questions to attempt and come up with solutions to
research questions. The questioneers shall be designed specifically to be filled by astute market
participants. These include:

Equities analysts
Central Statistical Office statisticians
Zimbabwe Stock Exchange analysts
Securities commission analysts
Fund managers.

3.1.2 Interviews
Interviews shall form an intergral part of the research methodology techniques. Interviews shall
be carried out in most sectors of the economy. The bulk of the targeted interviewees shall come
mainly from the stock broking firms, ZSE, CSO, SECZ and academics ( lecturers,undergraduate
students, masters students). All responses shall be taken down by the researcher and used as
abasis to come up with recommendations to the problem statement.

3.1.3 Sampling Techniques

In trying to come up with near to accurate information, the research quetioneers and interviews
shall be carried out with analysts from well known stock broking firms and have greater number
of years in the industry. This shall therefore be stratified sampling.
In the case of academics, the sampling population shall constitute mainly of students and
lecturers chosen randomly, but strictly with financial astuteness.
3.2.0 Models
The Granger Casuality Test (1969) shall be employed to test for the causal relationship between
two variables. This test states that, if past values of a variable y significantly contribute to
forecast the future value of another variable x then y is said to Granger cause x. conversely, if
past values of x statistically improve the prediction of y, then we can conclude that x Granger
causes y. The test is based on the following regressions:

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

yt = 0 + Kyt-k + lxt-l + ut

(1)

xt = 0 + kyt-k + lxt-l + t

(2)

where yt and xt are the two variables, ut and vt are mutually uncorrelated error terms, t denotes the
time period and k and l are the number lags. The null hypothesis is l0 and k0 for at
least some ls and ks. If the coefficient ls are statistically significant but ks are not, then x
causes y. In the reverse case, y causes x. But if both l and k are significant, the causality runs
both ways.
3.3.0 Data presentation and Analysis
The research findings shall be presented mainly in the form of pie charts, bar graphs and line
graphs. Statistical data shall first be tabulated. Pie charts, bar graphs and line graphs gives a
quick pictorial sentiment of the research findings and they are easy to interpret. However, these
techniques may obscure some vital information as estimates may be used to draw these graphs so
as give a finer view of a graph.

4.0 Expected Results

The study expects to get both quantitative and qualitative results. Quantitative resultsexpected
are as follows:
The multiple regression equation of the relationship between stock market industrial
performance and inflation, GDP, money supply growth and interest rates;
The multiple regressionof the relationship of the GDP growth and stock market
development indicators of liquidity and size;
The proportion and significance of capital raised from the stock exchange viz a viz other
forms of finance.
5.0 Bugdets
This research will be carried out under the budgets expected below;
Time Bugdet

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

ACTIVITY
Research Proposal
Chapter 1-3
Data collection
Data analysis
Report Generation
Report submission

TIME ALLOCATED
One week
Four weeks
Three weeks
One week
One month

BEGIN
03 December 2010
11 December 2010
09 Jan 2011
31 Jan 2011
08 February 2011

Monetary Bugdet
ITEM
Tuition
Research Proposal
Data collection
Final report
Other
Grand Total

QUANTITY
1 Semester
1
1
2

COST(US$)
375-00
5-00
50-00
30-00
15-00
475-00

END
10 December 2010
08 Jan 2011
30 Jan 2011
07 February 2011
09 March 2011
01 April 2011

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

6.0 References
Arrow, Kenneth. The role of Securities in the Optimal Allocation of Risk Bearing, Review of
Economic Studies, 1964, pp.91-96
Atje, Raymond and Boyan Jovanovic. Stock Markets and Development, European Economic
Review, volume 37, 1993, pp.632-640
Demetriades, Panicos O. and Khaled A. Hussein. Does Financial Development Cause Economic
Growth? Time Series Evidence from 16 countries, Journal of Development Economics, volume
51, 1996, pp. 387-411.
Demirguc-Kunt, Asli and Vojislav Kamsimovic. Law, Finance, and Firm Growth, Journal of
Finance, volume LIII, number 6, December 1998, pp. 2107-2137.
Harris, Richard D.F. Stock Markets and Development: A Re-Assessment, European Economic
Review, volume 41, 1997, pp. 139-146
Levine, Ross and Sara Zervos. Stock Markets, Banks, and Economic Growth, American
Economic Review, volume 88, number 3, pp. 537-558.
Markowitz, Harry. Portfolio Selection, The Journal of Finance, March 1952

An analysis of the relationship between stock market development and economic growth in Zimbabwe
(1999-2009)

Nourzad, Farrokh: Financial Development and Productive Efficiency: A Panel Study of

Developed and Developing Countries, Journal of Economics and Finance, volume 26, number 2,
Summer 2002, pp. 138-149.
Pagano, The flotation of companies on the stock market: a coordination faiure model,
European Economic Review 37, 1101-25.
Roubini, N and Sala-I-Martin, The Relation between Trade Regime, Financial Development and
Economic Growth, Mimeo, Yale University, 1991
Ryrie, William, Stock markets and their role in economic development, The Stock Exchange
Review, February 1991( the text of the second P.J. Jeejeebhoy Memorial lecture, 1990).