Existing literature has dealt inadequately with the causality issue in the link between financial development and economic growth. The paper investigates the empirical link between financial development and economic performance for the case of the small island developing state of Mauritius, using a unique time series data set for the period 1952-2004. The analysis uses a Vector Error Correction Model (VECM) framework, which allows for dynamic and feedback effects. The results suggest that financial developments have been contributing to the output level of the economy in both short- and long-run. It, thus, highlights the economic importance of financial development and provides new evidence for the case of island economies using recent cointegration approach.

The importance of financial sector in the economic development has received much attention in recent literature. A strong consensus has emerged in the last decade that well-functioning financial intermediaries have a significant impact on the economic growth (see King and Levine, 1993a, b; Levine, 1997; Levine and Zervos, 1998; Neusser and Kugler, 1998; Levine et al., 2000; and Wachtel, 2003). However, until now most studies have focused on the cases of developed countries, and it is only lately that scholars have been implicitly dealing with the issue of causality and dynamics in the financial development and economic growth link. Studies using time series analysis for the cases of developing countries have been scarce and to our knowledge no studies have been performed for the case of small island developing states. Empirical findings from the cases of developed countries are not directly applicable and relevant to the island states given their special characteristics and vulnerability. Thus, the aim of the paper is to investigate the empirical link between financial development and economic performance for the case of the small island developing state of Mauritius using a unique time series data set for the period 1952-2004 and allowing for dynamics. It hopes that the study provides new insights and evoke further discussions on the subject.

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