Dynamic interaction between financial development and natural resources: Evaluating the ‘Resource curse’ hypothesis

Abstract

The role of natural resources in promoting economic and financial activities is important for attaining country's economic growth. The study used different natural resource rents, domestic investment, trade openness, per capita income and their resulting impact on financial development in order to assess ‘financial resource curse’ hypothesis in Pakistan by using a consistent time series data from 1975 to 2017. The study employed ARDL-Bounds testing approach that is fairly worked under different order of integrated variables and displayed short- and long-run parameter estimates. Further, the study used VAR decomposition analysis to generate Impulse Response Function (IRF) and Variance Decomposition Analysis (VDA) to assessed forecasted variance and error shocks over a next 10 year time period. The results show that, in the short-run, initial level of forest rents and oil rents supported the ‘natural resource abundance’ hypothesis, as both the rents substantially increases country's financial development, however, in the long-run, there is a negative relationship of coal rents, forest rents, natural gas rents, and oil rents with domestic credit to private sector (DCPS), which confirmed the ‘natural curse hypothesis’ in a country. The domestic investment in the form of gross fixed capital formation (GFCF) largely supported the financial activities with all given resource rents in the models, while country's per capita income unable to signify its positive impact on DCPS under the resource curse environment during the study time period. The other results show that coal rents and oil rents decreases broad money supply whereas natural gas rents decreases market capitalization to validate ‘financial resource curse’ hypothesis in a country. The results of IRF and VDA approach confirmed the viability of both the competing natural resource theories (i.e., financial resource curse and financial resource blessing hypothesis) under financial development in the next 10 year time period.