There has been growing debate about the relationship between financial sector development and the economic growth process. This research attempts to explore the impact of financial market changes on the real economies of the Melanesian Spearhead Group (MSG) countries over the period 1970 to 2015. Financial markets in small developing economies tend to be less efficient and only provide narrower range of financial products and services. We employ a random effect model with general-to-specific sequential modelling procedure to re-examine FD-growth nexus. In line with financial intermediation theories, our results show that a well-functioning financial system is critical and has a significant effect on economic performance through enhancing the intermediation efficiency. A long-run equilibrium relationship between trade openness and economic growth is revealed; suggesting that trade liberalization programs in these countries may have direct positive effect on income growth. Policy-wise, we believe policy makers and government leaders, in partnership with development organizations, should work together to provide the enabling framework to facilitate the growth of an innovative financial system that will promote long-term financial sector deepening in these countries. This may include: mechanisms (such as credit reporting frameworks) to grow the banking and non-banking sectors; improving financial infrastructure and integration; enhancing skills and conditions in the informal sector; and enabling local condition for a better technological diffusion. This will all create a favourable environment for investment and trade which will in turn strengthen long-term economic prospects and outlook.


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