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«Trade openness-financial development nexus: Bounds testing approach and causality tests for Tunisia Khoutem Ben Jedidia 1 This paper addresses the ...»

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The Romanian Economic Journal

Trade openness-financial

development nexus:

Bounds testing approach and

causality tests for Tunisia

Khoutem Ben Jedidia 1

This paper addresses the issue of causal relationships between trade openness and

financial development in Tunisia over the period 1973-2013. We used the

Autoregressive Distributed Lag method considering the ratio of Liquid liabilities,

Private credit and Stock market capitalization as financial development indicators (all per cent of GDP). The sum of export and import as a percentage of GDP is the measurement of trade openness.

Our estimates imply that the long and short-run relationships are different. At long run, trade openness is stimulated by liquid liabilities level while it is negatively affected by the level of private credit and the stock market capitalization. In contrast, the main short-run responses of financial development and openness to international trade are not significant. Moreover, the results reveal a bi-directional causality between private credit and trade openness but a direct unidirectional causality running from financial intermediaries’ ability to mobilize funds, the size of stock market and trade openness in Tunisia.

The policy implications of this study appeared clear. The overcoming of the institutional weaknesses and the establishment of transparent rules are likely to improve the efficiency of the banking sector and the stock market and so to strengthen the foreign trade in Tunisia.

1Khoutem Ben Jedidia, Ph. D in Economics, Assistant Professor, Higher Institute of Accounting and Business Administration (ISCAE), Manouba, Tunisia and URED (Faculty of Economics and Management), Sfax, Tunisia, E-mail: khoutembj@yahoo.fr Year XVIII no. 58 December 2015 The Romanian Economic Journal Keywords: Financial development, Trade openness, ARDL, Tunisia JEL Classifications: F14, G10, G20, N77.

Introduction Several studies focus on relationships between financial development, trade openness and economic growth. However, until recently, the empirical linkages between trade liberalization and financial development have not received sufficient attention in the literature (Kar et al, 2014).

Nevertheless, the idea of an “optimal” level of financial development for an economy is currently highlighted (Beck et al, 2008; Beck and Feyen, 2013 among others). So, researches of factors which influence financial development are increasingly attractive.

Studies interested in the link between trade openness and financial development put out mixed conclusions. On the one hand, the openness-finance nexus relationship is demonstrated (e.g. Svaleryd and Vlachos, 2002; Huang and Temple, 2005, Tayebi and al, 2012).

On the other hand, Dritsakis and Adamopoulos (2004), Asongu (2010), David et al (2014)2 have not detected any causality evidence between trade openness and financial development.

Few empirical works have been carried out in the case of a specific country since cross-country and panel data studies have been dominant in the empirical literature of relationships between openness and financial development. Further, as argued by David et al (2014), the coverage of African countries in this topic is limit.

In Tunisia, steps towards financial and trade liberalization have been taken since the Structural Adjustment Program (SAP) in 1986. In 2 David et al (2014) investigate linkages between financial and trade openness and financial development in 34 Sub-Saharan African (SSA) countries covering a period of 1970–2009. After the control for GDP per capita and inflation, no general direct robust link between trade and capital account openness and financial development is noted.

Year XVIII no. 58 December 2015 The Romanian Economic Journal addition, Tunisia has chosen to substantially open up its economy.

Even after the Tunisian revolution in the early 2011, the trade (%GDP) remains high (103% in 2013).

So, in this paper, we targeted to examine the linkages between foreign trade and financial deepening in the Tunisian case. The goal of this paper is to investigate whether trade openness is a crucial step to enhance financial development and/or vice versa for the period 1973We used the Autoregressive Distributed Lag method considering the ratio of Liquid liabilities, Private credit and Stock market capitalization as financial development indicators (all per cent of GDP). The sum of export and import as a percentage of GDP is the measurement of trade openness. This empirical research may deepen our understanding of policy openness effectiveness and financial development in Tunisia and should help to craft sound policies for greater economic growth.

The novelty of this study is two-fold. (1) To the best of our knowledge, this is the first study focusing on trade openness-financial development nexus in Tunisia. (2) This paper employs ARDL methodology suggested by Pesaran et al. (2001) for testing the impact of globalization on financial development and/or vice versa for an example of low and middle income countries3.

The rest of this paper is organized as follows: Section 2 presents a short literature review. Section 3 analyses trade openness and financial development in Tunisia. In section 4, we display the empirical analysis.

The discussion of results is carried out in section 5. Section 6 finally offers some conclusions and policy recommendations.

As suggested by Kim et al (2010), the finance long-run effect on trade is higher in less financially developed countries than in more developed countries.

–  –  –

2. Literature review Many papers have explored relationships between trade openness and financial development.

Greater financial development level increases country openness (e.g.

Beck, 2002; Becker and Greenberg, 2005; Altaee et Al-Jafari, 20154).

Likewise, using monthly data for the period 1989- 2007, Kar et al (2014) concluded to uni-directional causality from trade openness to financial development in Turkey. Finance and openness relationships may present a bi-directional causality (Gries et al, 2009)5.

The financial development and trade openness interact through many channels. Most works state indirect linkage notably through economic development6.

Rajan and Zingales (2003) emphasized the role of the supply-side factors. In fact, trade is able to weakening the incumbents’ powers to block financial development since more firms are able to benefit from the opening. Rajan and Zingales (2003) argued that special interest groups (incumbents) preclude to financial development since they vested interest in a closed financial sector and oppose the financial market development.

Furthermore, the channel through which trade and financial development interact is based on demand-side factors. In their theoretical work, Blackburn and Hung (1998) showed that more trade increases the number of new producers who need to finance their activities which in return spurs financial development. In another 4 Using Vector Autoregressive technique, the empirical study of Saaed and Hussain (2015) asserts that money supply is the only instrument of financial development that seems to cause trade openness in Kuwait for the period 1977-2012.

5 Kim et al (2011) conclude to a “two‐way causal relationship” between financial development and trade openness for a panel of 70 countries over the period 1960– 2007.

6 Ginebri et. al. (2001) are among few researchers emphasizing direct relationship

–  –  –

perspective, Do and Levchenko (2004) found that trade openness affects the demand for external finance. This induces the financial depth in wealthy countries. Conversely, they argued that in poor countries which import financially intensive goods, a higher trade might slow financial development. Besides, a more trade openness leads to a demand for new financial products such as instruments for trade finance and risk hedging (Svaleryd and Vlachos, 2002).

Countries with relatively developed financial systems are likely to promote export industries that are highly reliant on finance (Svaleryd and Vlachos, 2005). Likewise, financial development level affects the balance structure (Beck, 2002). A relatively high level of financial development is associated with exporting manufacturing-goods.

Hence, financial development is an important determinant of export performance (Becker and Greenberg, 2005).

Overall, increasing trade openness is expected to have a positive impact on financial development. It leads to efficiency effects followon internal and external scale economics benefits, reduces rent seeking (Lee, 1993), promotes competition, threatens the incumbent’s vested interests (Rajan and Zingales, 2003), provides accessibility to international capital markets, develops market discipline as well as creates new demand for external finance (Do and Levchenko, 2004).

Nevertheless, trade can foster financial development and/or vice under many conditions. Trade must be associated with financial openness (Rajan and Zingales7, 2003; Baltagi et al, 2009). In same vein, Fukuda (2014) found that while the single impact of either trade or financial openness is uncertain, the simultaneous opening of both contributes to financial development. David et al (2014) demonstrated that trade openness is more important for financial development in Sub-Saharan African countries with better institutional quality since Their empirical evidence for a sample of twenty-four countries during 1913–1999 shows that when an economy opens up to trade while its capital account is closed (trade openness without financial openness), this is unlikely to deliver any financial development.

Year XVIII no. 58 December 2015 The Romanian Economic Journal more openness might increase vulnerabilities to shocks in an environment of weak supervision.

3.Experiencing Openness and Financial Development in Tunisia

3.1. Trade Openness in Tunisia In the seventies, Tunisian authorities practiced favor tariff exemption for import of machinery and equipment. The aim was to develop the Tunisian industry notably manufacturing. But, the severe crisis in 1986 made Tunisia adopt an IMF Structural Adjustment Program focusing on liberalization policies. In this context, many reforms in favor of gradual liberalism were applied such as investment liberalization, public firms’ restructuration, tax reforms, trade liberation by removing import and export licenses and establishing bilateral/multilateral trade agreements. Tunisia has signed agreements with General Agreement on Tariffs and Trade (GATT) in 1990 and the Agreement on World Trade Organization (WTO) in 19958. In the late of 1990s, Tunisia strengthened its integration in the international economy considering the foreign trade as an engine of economic growth (African Development Bank Group Report, 2014). However, the main measure was the Association Agreement with European Union signed in 1995.

The trade barriers had dropped gradually for industrial goods and others to disappear on January 20089.

In the trade policy, we have noted a switch from import substitution policies to export promotion. Previously, the tariffs were the key instrument of trade policy to create protective environment for industrialization. Conversely, the new trade policy has tried to reduce anti-export bias and promote export processing zones stimulated by 8Furthermore, Tunisia is a member of the Multilateral Investment Guarantee Agency (MIGA).

The country has concluded bilateral trade agreement with proximally 81 countries notably with the Member States of the European Free Trade Association (EFTA), Greater Arab Free Trade Area (GAFTA)....

This agreement was the first between the EU and a Mediterranean partner.

Year XVIII no. 58 December 2015 The Romanian Economic Journal

–  –  –

Source : Financial Statistics, Central Bank of Tunisia and World Development Indicators.

Since the mid-1980s, import ratio and export11 ratio have had consistent co-movements. Tunisia presents a serious external trade deficit due to a sharp drop in traditional exports (e.g. crude oil and phosphates), the importation of most capital equipment and the increase of disposable income leading to a surge in consumer goods imports.

10Taxes on imported goods and services reached 15 % in the 80 and dropped to 5% in the end of decade 2000. Currently, the Tunisian dinar is not a fully convertible currency, although it is convertible for current account transactions. The exchange rate regime is classified as stabilized and aimed at avoiding the build-up of inflationary process.

11 The export-oriented strategy in Tunisia ended up creating a new constituency, which has a stake in export (Bechri and Naccache, 2003).

Year XVIII no. 58 December 2015 The Romanian Economic Journal

3.2. Financial Deepening in Tunisia The Structural Adjustment Program (SAP) initiated in 1986 aimed at a general economic liberalization. Many reforms have been carried out in order to liberalize the banking sector such as the abolition of the Central Bank authorization for loans in 1988, the abolition of financing public firms at preferential conditions, the liberalization of bank margin in 1994, the modernizing and restructuring the public banking system (increase of the minimum capital requirement, the consolidation of financial fundamentals of the banking sector…).

Among the reforms promoting the Tunisian stock market : tax reduction on profit for listed companies (from 35% to 20%), new regulation for issuing bond in 1988, creation of placement companies in 1992, institution of rating agencies in 1996 and the financial security law in 2005. Furthermore, foreign investors were permitted to purchase shares in resident firms or indirect investment through mutual funds etc… Generally, the financial sector indicators continually improved over time. There is a substantial increase in the level of credit to the private sector (Fig. 2), which averaged 58.55 per cent of GDP during the period of 1973–2013.

–  –  –

Source: World Bank. World Development Indicators and Financial Statistics, Central Bank of Tunisia We observed a noticeable increase of liquid liabilities while the stock market capitalization remained small (Fig.2). The latter represented only 18.5 per cent of GDP in 2013.

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