Business Cycle and Financial Cycle Interdependence and the Rising Role of China in SAARC

Abstract

In this paper, we examine the dynamic interdependence via growth spillovers between financial cycle represented by real bank credit growth and business cycle as real GDP growth using dynamic spillover index of Diebold and Yilmaz (Int J Forecast 28(1):57–66, 2012). Using quarterly data on five SAARC (the South Asian Association for Regional Cooperation) countries over the period 1975Q4-2013Q4, the study reports following empirical regularities: First, there is a limited interdependence between business and financial cycles within SAARC nations. The pattern of dependence is almost homogeneous. Second, the results of across SAARC indicate that the magnitude of dynamic relationship is not as high as studies have reported in the case of other economic interests groups. Third, to credit-growth spillover, India appears to be the primary driver of economic and financial integrations followed by Bangladesh and Pakistan. Fourth, the spillover analysis between SAARC countries and China reveals that the directional interdependence is relatively higher than the SAARC alone. Among macroeconomic indicators, we find that government debt to GDP, inflation and interest rate are the primary determinants of credit growth spillover. Among financial development indicators, the number of mobile subscribers and number of bank branches as financial inclusion variables appears as significant determinants of credit growth spillover than the portfolio equity assets and remittances.