Empirical Analysis Of Financial Development To The Economic Growth In Pakistan

This study attempts to empirically analyze the financial development to the economic growth in Pakistan. The sample is comprised of period 1961-2011(51 year Observations). Error Correction Models(ECM) approach has been used to investigate the desired relationship between time-series of financial Growth and Economic growth of Pakistan accompanied with other control variables. The study finds out that the variable of financial development i.e. liquid liabilities has positive and significant influence over GDP growth of Pakistan over the period of 1961-2011. At the same time interest rate and financial reform dummy are also found to be positively significant in effecting the GDP growth of Pakistan. The findings of this study have both theoretical and practical significance for the discussion on financial market development and access to finance for corporations of Pakistan. As it is highlighted in chapter 3 that research done in many emerging economies have undertaken large efforts to expand the scope and depth of their financial markets and to liberalize their financial sectors as a way to complete and increase the provision of financial services. So following this, in Pakistan many economists have predicted big changes to further liberalize and develop the financial markets and institutions. While these developments will certainly bring important changes, my findings will surely incorporate in the best possible effective financial policy. Expanding financial markets will tend to directly benefit the largest firms(among the already large publicly listed firms) that are able to reach some minimum threshold size for issuance. More widespread direct effects might be more difficult to elucidate.Moreover, this study has following innovation points in consideration: 1) domestic financial sector of Pakistan can plays a pivotal role in ensuring that international capital flows do indeed promote economic growth. This fact is consistent with the result of positive and significant relationship between Gross fixed Capital formation and GDP growth. 2) Positive and significant relationship between liquid liabilities GDP suggest that broader set of emerging economies, just like Pakistan, with plenty of growth opportunities, receiving large inflows of foreign capital and with thousands of firms listed in the stock market, a large number of firms can directly absorb the financial market efficiency in more appropriate manner. 3) Inflation significantly affects the economic development. This could suggest that it might be difficult for a broad set of corporations from smaller and slower-growing countries to benefit from financial market development. Even for those firms that have increasingly listed in public capital markets, the degree of secondary market activity is rather limited. Furthermore, the indirect effects on smaller firms still need to be understood and quantified. 4) This study also finds out that one of the reasons behind slow economic growth was interest rate ceiling and requirement of high reserves and restrictions in the credit allocation. As results show that there is positive relationship between economic growth with deposits, lending and savings, and a negative relationship with inflation and interest rates. But after the government financial reforms, the structure of banking system has changed tremendously. Local private banks are in operation after government privatized the nationalized banks. In result better performing banking sector is now helping Pakistan to achieve higher growth rates.Shortcomings of the study is the fact that more work needs to be done to have a good benchmark of how many firms should be receiving financing from financial. Although this premise has been gaining popularity in recent years, there has been no available econometric evidence, to the author’s knowledge, to support it. As financial integration becomes a reality for an increasing number of developing countries, it is important that we develop a better understanding of how international capital flows affect economic growth and how the domestic financial sector influences this process. This study takes a first step in that direction. Unavailability of data for other related variables makes it difficult to find out the real relationship between the financial sector and economic growth of Pakistan. Also the instability in government policies towards the financial sector makes it hard to measure the true relationship in given circumstances.Furthermore, it is evident from the results that financial efficiency has a significant impact on the banking sector and economic growth. For balanced credit ratios between the government and private sector, interest rate must be market oriented. Based on the findings following important policy implication can be driven: 1) if policymakers want to promote growth, then attention should be focused on long run policies, for example, the creation of modern financial institutions, in the banking sector and the stock markets. 2) The financial markets affect the cost of external finance to the firm and, therefore, their effects should be materialize through facilitating the investment process. 3) Unless conditions for low-cost investment are created, long run growth is impossible. 4) There should be suitable interest rates to generate deposits which can be easily utilized to fulfill the requirement of investments and therefore people have the opportunity to deposit their money with the banks instead of investing anywhere else. 5) Government should take concrete measures to control the inflation for the betterment of economic development, by using monetary policy. 6) The central bank should decrease money supply to decrease inflation.