Financial Development–Economic Growth Nexus: Evidence from South Asian Middle-income Countries

Abstract

In this article, we have tried to explore the relationship between financial development and economic growth, using a panel data of South Asian middle-income countries for the years 1980–2013. The macroeconomic data include real GDP index as an indicator of economic growth, proxies for financial development—domestic credit by banking sector/GDP, domestic credit to private sector/GDP, net inflows of FDI/GDP, M2/GDP and market capitalization/GDP and control variables such as fixed capital formation/GDP, investment/GDP, and inflation in consumer prices/GDP. The results indicate that the domestic credit provided by the banking sector has a significant association with economic growth in both directions but domestic credit to the private sector is associated with the economic growth in forward direction only, which confirms dearth in credit allocation in the region and suggests pathetic financial regulation and supervision. As far as the stock market developments are concerned, the results indicate that the stock market capitalization and liquidity have a significant role in growth and economic growth induces the stock market capitalization (size). Both the forms of investment (domestic and FDI) contribute significantly to economic growth in either direction. Stronger financial institutions, fixed capital formation and low inflation are crucial growth controlling factors.