THE EFFECT OF DOMESTIC DEBT ON FINANCIAL MARKET DEVELOPMENT IN MALAWI

Abstract

This research investigates the effects of domestic debt on financial market development in Malawi over the period 1981-2021.The study employed the autoregressive distributed lag (ARDL) model by Pesaran and Shin (1999) to account for short and long- term effects. The results show evidence of a negative impact of domestic debt on financial market development though statistically insignificant. In this light the study recommends a reduction in domestic indebtedness by the government of Malawi, for further accumulation of debt will lead to increased interest rates therefore leading to crowding out of private investment. The study further recommends additional efforts from the government and the Reserve Bank of Malawi in developing financial markets in Malawi by adopting new and improved reforms for financial institutions, evident through positive relationship found between foreign direct investment and financial market development in the short-run. Developed financial markets will not only encourage capital inflow into the country from private investors, it will also lead to economic development through availability of foreign exchange allowing Malawi to be able to trade with other countries on the international market, in the end increasing the GDP which will consequently lead to economic growth. In the long-run foreign direct investment might cause inflation in the country leading to the reserve bank of Malawi (RBM) to increase interest rates in response to high inflation, however this increase in interest will cause the rate of borrowing to be expensive therefore cause crowding out of private investment. Hence, the negative relationship between foreign direct investment and financial market development in the long-run. In this case the paper also recommends foreign direct investment only to a threshold of 0.421% in the short-run where it does not crowd out domestic private investment.