Does Financial Development Improve Fiscal Balance in Sub-Saharan Africa? The Muted Economic Growth Synergy

Abstract

Persistent fiscal imbalances in SSA continue to constrain sustainable development and weaken the effectiveness of counter-cyclical fiscal policies. This study examines the effect of financial development on fiscal balance, with particular attention to the moderating role of economic growth. The analysis employs System GMM estimation within a dynamic framework consisting of fiscal revenue, fiscal expenditure, and fiscal balance equations using an unbalanced panel of 30 SSA countries over the period 2005 to 2023. The findings show that while financial development has a positive and significant effect on both fiscal revenue and expenditure, the overall effect on fiscal balance remains insignificant, as the change in fiscal revenue is offset by the change in fiscal expenditure. Similarly, the interaction between financial development and economic growth, as well as institutional quality, remains statistically insignificant. The results further reveal that economic growth, natural resources, the real effective exchange rate, and foreign direct investment growth improve fiscal balance whereas foreign aid and public debt growth significantly worsen it. In contrast, formal fiscal rules, inflation, and the COVID-19 pandemic do not exert a sufficient significant effect on fiscal balance. The findings suggest that SSA countries should strengthen their financial sectors by improving the access, efficiency, and depth of financial institutions and markets, while also enhancing their integration with the broader productive economy. At the same time, implementing debt controls to manage excessive expenditure, ensuring fiscal balance improvement to support long-term growth and development goals.