Financial development and economic growth amid external shocks in the East African community

Purpose This study explores how external shocks, particularly fluctuations in global food and oil prices shape inflation, financial development, and economic growth. Design/methodology/approach The study applies the Bayesian Global Vector Autoregressive (GVAR) on data spanning from 2011q1 to 2022q4. Findings The results show that interdependence from EAC countries is strong, standing at (r = 0.55–0.70), with inflation, GDP growth and non-performing loans being indicators of high connectivity. Indeed, results show that external shocks affect all EAC countries similarly and simultaneously, though severity varies based on country-specific factors. The effects of external shocks on inflation, financial development, and growth are found to be temporary, peaking between the 3rd and 7th quarters before falling. A positive standard error unit shock to global food and oil prices corresponds to a decline in GDP growth from 0.4 percent to 1.0 percent for all five countries of the EAC, starting from the second quarter. However, after the 8th quarter, GDP growth returns to its normal path over the medium term. Global oil shock effects last longer than those of global food shock. Practical implications Re-evaluate trade finance, commodity supply, and foreign reserve policies to ensure short- and medium-term macroeconomic stability. In addition, policy coordination is key in the presence of external shocks, as the mitigation measures need to be taken by different stakeholders such as the central banks and other public institutions. Social implications In terms of potential societal impact, strengthening coordination mechanisms among EAC central banks—particularly in harmonizing monetary policies, managing inflation more effectively, and maintaining financial stability during global shocks—can enhance borrowers’ and households’ ability to service loans. This contributes to income protection and poverty reduction. Likewise, advancing financial inclusion through the expansion of digital financial services, improvement of credit infrastructure, and increased access to finance for SMEs can boost economic resilience and promote inclusive growth across the region. Originality/value This study examines the link between external shocks, domestic prices, financial development, and economic growth using the BGVAR (Bayesian Global Vector Autoregressive) model, which captures global spillover effects. By focussing on the EAC where all countries are net importers of oil and food, it provides insights into the timing, magnitude, and cross-country impact of shocks. The findings offer valuable guidance for policymakers on monetary and fiscal responses, including social safety nets, buffers, subsidies, and central bank rate adjustments.