Impact of financial market development on economic growth: evidence from Sri Lanka

Abstract

The study focuses on the impact of financial market development (FMD) on economic growth in Sri Lanka. The study investigates positive association flows from finance to growth, called the “supply-leading hypothesis”, in different directions such as positive, negative, bidirectional and neutral. FMD impact is considered in both depth and efficiency aspects. Natural logarithms (Ln) form of all gross domestic production in real terms, total domestic credit, percentage of loans and advances to total deposits, inflation index, market capitalisation of listed domestic companies and money supply as liquidity indicator are concerned, first being the dependent variable, next two as depth indicators and last three explanatories as efficiency indicating variables. Changes in both private sector production volume Index and government expenditure are also included into the model as independent variables to represent the non-financial market impact. Secondary monthly time series data published by the Central Bank of Sri Lanka from January 2008 to June 2019 of 138 observations are analysed using the E-views version 10. The ARDL model is applied. The study suggests a significant long-run impact of FMD on economic growth in Sri Lanka. Furthermore, inflation hinders the FMD. Up to the bearable limit, financial depth positively affects, while the higher degree of financial depth negatively influences economic growth in Sri Lanka. The impact of the non-financial market is comparatively insignificant on economic growth.