Financial Development and Growth: An Empirical Analysis on Emerging Market Economies

Financial development has a potential to engineer the growth, with its indirect collateral benefits.

SarthakLuthraOctober20,2015

Source:HaverAnaly;cs,Ci;Research

Table of Contents

•  Background and Introduction

•  Literature Review

•  Methodology

•  Scope

•  Conclusion and Policy Implications*

Growth effects through financial developments have been studied via indirect channels such as capital accumulation and productivity growth; 1980s and 1990s witnessed a phase of financial liberalization and financial development, which is broadly regarded as a means to engender competition and growth However, Financial development and integration increases the probability of crisis, by making an economy more vulnerable to capital shocks •  Micro level lending becomes more risky •  Macro level, banking becomes more risky due to greater fluctuations in

the interests rates and exchange rate

Background and Introduction

Appropriately, this paper attempts to discuss growth affects of financial development in emerging market economies and provide a perspective for India.

Policy Relevance: •  Financial policies in terms of financial development and financial integration •  Domestic financial policies and its impact on growth •  Policy towards reducing vulnerability to external and internal shocks

•  Financial development and growth relation experiencing a trade-off between empirical evidence and theoretical prediction

•  Conventional growth theory highlights the importance of capital accumulation as a driving force behind output per worker and per capita GDP

•  The indefiniteness via positive and negative effects of finance on growth seems to depend on the spatial and time dimension of the investigation, measurement methods related to financial indicators, and econometric strategy

•  Growing significance of thresholds of financial depth and institutional establishment

•  The relation between financial development and its growth effects has been widely researched in the past literature. However, there is a dearth in appropriate quantification of growth impulses that are generated by financial development.

The research reviews an extensive literature of financial development and growth and provides a framework on the depth and structure of financial developments in the emerging market economies.

Literature Review

Majority of the EMEs experienced the uptake in financial development post 1990 era, with ease of capital controls, deregulation, increased foreign direct investments, remittances, and opening of the equity markets. The study covers 27 EMEs from The World Bank Global Financial Development Database (1960-2011) The research also encompasses World Economic Outlook database by International Monetary Fund (IMF). The database captures macroeconomic indicators with analysis and projections will 2020 Using an empirical approach (Fixed effects Regression analysis) This research captures the effect of financial development indicators in EMEs: •  Private credit by deposit money banks to GDP (%) •  Deposit money bank assets to deposit money bank assets and central bank assets

(%) •  Liquid liabilities to GDP (%) •  Stock market capitalization to GDP (%) •  Bank credit to bank deposits (%) •  Remittance inflows to GDP (%) on Per Capita GDP

Methodology

•  Reviewing the link between financial development, financial liberalization and growth;

•  Empirically analyze the relationship between growth and financial development in EMEs and India respectively;

•  Discuss the merits and demerits of financial sector openness, along with risks and opportunities associated with financial development;

•  Financial globalization and development, and its relation with the economic growth can be better analysed by studying indirect collateral benefits that feeds through institutional quality, credit/GDP ratio, trade openness, stock market turnover, and macro economic policy.

Scope

•  Financial development feeds into economic growth through indirect collateral benefits.

•  The financial indicators studied are significant towards economic growth

•  India’s per capita GDP has been in positive direction with liquid liabilities, domestic money banks’ asset to GDP, domestic credit to private sector, stock market capitalization, and bank credit to deposit ratio

•  Given the level of financial development, robust financial institutions play an important role in mitigating external shocks

•  It has also been observed that a few EME, are witnessing reversal in financial opening, which may not be a healthy sign for the sector. Appropriately, policies pertaining to capital controls will help mitigating financial distortions.

•  The objective of policy should no longer be primarily to raise total depth of credit to GDP, but the focus instead should be on ensuring that the credit is of high quality in the sense that it is directed to the highest-return activities.

Outcomes

References

•  Financial Liberalization: What Went Right, What Went Wrong, The World Bank, 2005

•  Financial Sector And Growth In Emerging Asian Economies, Asian Development Bank, William R. Cline, 2015

•  Stock Market Development And Economic Growth In India: An Empirical Analysis, P. Srinivasan, 2014

•  Thresholds In The Process Of International Financial Integration, M. Ayhan Kose, Eswar S. Prasad, Ashley D. Taylor, 2009

•  Financial Globalization: A Reappraisal, M. Ayhan Kose, Eswar Prasad, Kenneth Rogoff, And Shang-jin Wei ︎, 2009

•  IMF Global Financial Development Report, The World Bank, 2014

•  The Role Of Financial Institutions And The Economic Growth: A Literature Review, European Journal Of Business And Management, Muhammad Saqib Khan, 2015

Thank You