**1. Introduction**

Some empirical studies have emphasized the fundamental role of institutional quality, level of financial development, per capita income and inflation in moderating the impact of financial development on economic growth in developed and developing countries (e.g., Arcand et al. 2015; Ehigiamusoe et al. 2018; Law et al. 2018; Law and Singh 2014). However, the role of the real exchange rate or its volatility on the finance-growth nexus has not been thoroughly explored. The economic benefits of financial development could vary with the level of the real exchange rate. This is because real exchange rate has the capacity to influence economic growth. For instance, some studies reported that real exchange rate has a positive impact on economic growth (e.g., Razmi et al. 2012; Rodrik 2008; Tarawalie 2010), whereas other studies documented a negative linkage (e.g., Bleaney and Greenaway 2001; Conrad and Jagessar 2018; Elbadawi et al. 2012) or insignificant relationship (e.g., Tang 2015). Moreover, Aghion et al. (2009) showed that real exchange rate volatility has a negative impact on productivity growth, while Vieira et al. (2013) revealed that high real exchange rate volatility has a negative impact on economic growth, albeit the impact of low volatility is positive. However, Comunale (2017) noted that exchange rate volatility does not have any robust effect on GDP growth.

Besides its direct effect on economic growth, studies have shown that real exchange rate and financial development could have a dynamic relationship. Lin and Ye (2011) posited that financial development has a significant effect on the choice of exchange rate regime, whereas Katusiime (2018) reported that exchange rate has a significant effect on the growth of private sector credit. Thus, countries with less developed financial markets are more likely to adopt a fixed exchange rate, while countries with higher levels of financial development are more likely to adopt a flexible system, which in turn determines the exchange rate. Moreover, Fujiwara and Teranishi (2011) reported that financial market friction replicates persistent, volatile and realistic hump-shaped responses of the real exchange rates. They concluded that financial market development is a strategic component to understand real exchange rate dynamics. Specifically, Tang and Yao (2018) showed that financial structure, which reflects the proportion of direct financing and indirect financing, plays a crucial role in the relationship between exchange rates and stock prices.

Furthermore, Jayashankar and Rath (2017) argued that there is a significant relationship among the stock market, foreign exchange market and money market in emerging economies to the extent that positive or negative shocks that affect one market could be quickly transmitted to another market via contagious effect. However, they concluded that the empirical connection among these markets is insignificant at lower scales, but robust at higher scales. Moreover, it had been argued that financial development has the capacity to alleviate the adverse effects of the real exchange rate and its volatility on productivity growth. Uncertainty in the real exchange rate worsens the negative effect of domestic credit market constraints (see Aghion et al. 2009). Particularly, Elbadawi et al. (2012) showed that financial development has the capacity to alleviate the negative effects of the real exchange rate overvaluation on economic growth.

Therefore, the specific objective of this paper is to examine the effects of the real exchange rate and its volatility on the finance-growth nexus in the West Africa region. Fundamentally, it seeks to determine the marginal effects of financial development on economic growth at various levels of the real exchange rate and its volatility. In this regard, this paper differs from previous studies and makes a significant contribution to the existing literature. Unlike Levine et al. (2000) that focused mainly on the finance-growth nexus in some selected developed and developing countries, our paper focuses on the finance-growth nexus in developing economies (i.e., West African region). In addition, we augmen<sup>t</sup> the finance-growth nexus with real exchange rate (or its volatility) as well as the interaction term between financial development and real exchange rate (or its volatility). This enables us to determine whether the finance-growth nexus varies with the level of the real exchange rate (or its volatility), an issue that was not explored in Levine et al. (2000). To the best of our knowledge, the only paper that used an interaction term between real exchange rate and financial development is Aghion et al. (2009), but they focused on whether the effects of the real exchange rate on productivity growth vary with the level of financial development in some selected countries. However, our paper focuses on whether the impact of financial development on economic growth varies with the level of the real exchange rate (or its volatility) in the West African region. Moreover, we determine the marginal effects of financial development on economic growth at various levels of the real exchange rate (or its volatility), an issue that was not explored in Aghion et al. (2009). This is fundamental because the marginal effect enables us to determine the changes in economic growth caused by simultaneous changes in both financial development and real exchange rate (or its volatility), which is essential for policy formulation (see Brambor et al. 2006; Law et al. 2018; Ehigiamusoe et al. 2018).

Hence, the motivation of this paper is that previous studies have neglected the moderating role of the real exchange rate or its volatility on the finance-growth nexus. Although some studies have shown that financial development has a positive impact on economic growth in the West African region (see Ehigiamusoe and Lean 2018; Ratsimalahelo and Barry 2010), it remains unclear whether this impact varies with the level of the real exchange rate or its volatility. Moreover, most past studies on real exchange rate and its volatility focused mainly on their direct effects on economic growth (see Elbadawi et al. 2012; Iyke 2018; Rodrik 2008; Vieira et al. 2013), while their indirect effects via the financial sector have not been thoroughly explored. To capture the indirect effects, we employ multiplicative interaction model where we interact real exchange rate (or its volatility) with financial development. Brambor et al. (2006) recommended the use of multiplicative interaction model whenever there is a conditional hypothesis (when the relationship between two variables depends on the value of another variable).

The scope of this study is limited to the West African region because several West African countries have employed financial sectors reforms and policies to stimulate greater depth and breadth of the financial markets, create better access to financial resources, and provide efficient supervisory and regulatory frameworks. In recent decades, there have been privatization of commercial banks, liberalization of interest rates, recapitalization of financial institutions and technological innovations aimed at repositioning the sector with a view to enhancing economic growth. The recent reforms notwithstanding, the financial system in the West African region is still largely bank-based, small and undiversified compared to the financial systems in advanced and emerging economies. For instance, during the 1980–2014 period, the average level of financial development (measured by credit to the private sector relative to GDP) in the region was 15.43% compared to 29.85%, 36.32%, 86.06% and 124.28% in South Asia, Middle East and North African region, European Union and high income countries, respectively.

Secondly, in the past three decades, many West African countries have attained significant improvements in their economic growth compared to the 1960s and 1970s. The region has experienced average annual GDP growth of 5 percent, which is higher than the average GDP growth rate in several advanced and emerging economies (see IMF 2014). Therefore, the financial sector could probably be one of the sectors that contribute to this impressive growth.

Moreover, this paper is further motivated by the high and volatile real exchange rate in the West African region. For instance, the real exchange rate has plummeted significantly in the past three decades averaging 1639.9 in 2015 compared to 41.3 in 1980. On a country-by-county basis, the real exchange rate deteriorated from 9.7 to 99.3 in Cape Verde; from 83.5 to 597.8 in Benin; from 124.5 to 600 in Mali; and from 78.7 to 7834 in Sierra Leone in 1980 and 2015, respectively. In addition, most of these countries experienced substantial volatility in their real exchange rates during the period. Hence, this study seeks to provide insights into the influence of the real exchange rate on the finance-growth nexus in the West African region, an issue that has not received adequate attention in the extant literature.

Finally, since West Africa is the largest region in Sub-Sahara Africa in terms of population, it is fundamental to study this region since anything that adversely affects it could have negative effects on the African continent or the larger international community. Hence, the findings on West African countries could be invaluable to other developing or emerging economies that want to accelerate economic growth via financial sector development and the real exchange rate.

Besides this introduction, the remaining parts of the paper are divided into four sections. The methodology is contained in Section 2, while the empirical results are presented in Section 3. The discussion and policy implications of the findings are presented in Section 4, while Section 5 concludes the study with some policy recommendations.

#### **2. Data and Methodology**
