Financial development, inclusion, credit supply and economic growth: an empirical study of East Africa

Abstract

This study investigates the dynamic linkages between financial sector development, financial inclusion, credit supply, and economic growth in East Africa, drawing on financial intermediation theory, endogenous growth and finance–growth nexus models. It examines how improved financial infrastructure enhances credit access and inclusion, thereby influencing long-term growth. Using annual panel data from 1990 to 2023 for Burundi, Ethiopia, Kenya, Rwanda, Sudan, Tanzania, and Uganda, composite indices for financial development, credit supply, and inclusion were constructed via Principal Component Analysis. Dynamic heterogeneous panel models, including pooled mean group, mean group, and dynamic fixed effects were applied, with robustness checks using fully modified ordinary least square, canonical cointegration regression, feasible generalized least square and Dumitrescu and Hurlin causality tests. Results show financial development significantly boosts inclusion and credit in the long run, with credit supply positively linked to growth, though high lending rates constrain expansion. Causality test reveals a long-run unidirectional link from financial development indicators to growth, with no short-run effects. Policy implications highlight deepening reforms, raising incomes, and regulating interest rates and public spending to foster inclusion and sustainable growth, while addressing regional disparities and structural barriers.