Islamic Finance and Economic Growth Nexus: An Econometric Analysis

Transcription

1. Review of Education , Administration and Law, Vol. 2, (1) 2019, 11-22 Islamic Finance and Economic Growth Nexus: An Econometric Analysis Kashif Raza a, Rashid Ahmad b, Muhammad Abdul Rehman Shah c, Muhammad Umar d a Lecturer, Department of Economics, The Islamia University of Bahawalpur, Pakistan, Bahawalnagar Campus, kashif.raza@iub.edu.pk b Assistant professor, School of Economics, Bahaudin Zakariya University, Multan, Pakistan: Rashidahmad@bzu.edu.pk c University of Engineering and Technology, Taxila, Pakistan d MPhil Scholar, School of Economics, Bahaudin Zakariya University, Multan: mailumarramzan@gmail.com Corresponding author’s email address: Rashidahmad@bzu.edu.pk ARTICLE DETAILS History: Accepted 15 April 2019 Available online 30 June 2019 Keywords: Islamic banking financing, Labor force, Gross fixed capital formation, Economic Growth JEL Classification: G21, O40, R22, R53 DOI: 10.47067/real.v2i1.7 ABSTRACT Researchers have written chain of research papers about the dynamics of financial development and economic growth. The financial capital plays a productive role when it delivers to economic agents who are facing shortage or excess of funds. This study explores the linkages among Islamic financing and economic growth for Pakistan, by using annual time series data from 2005-2018. Islamic banks’ financing funds used as a proxy of Islamic financing, Gross Domestic Product (GDP), Gross Fixed Capital Formation (GFCF), labor force (LF),Broad money(M) and Trade openness (TO) to presents real sector of an economy. For the exploration, the unit root test, Ordinary least square technique and Granger causality test are applied. The results validate a substantial causal relationship of Islamic financing and GDP, which supports the Schumpeter’s supply-leading view. The results indicate that Islamic finance contributed towards economic growth. © 2019 The authors. Published by SPCRD Ltd. This is an open access article under the Creative Commons Attribution-NonCommercial 4.0 1. Introduction The impact In the literature of development economics, economists have written chain of research papers about the dynamics of financial development and economic growth. The financial institutions play important l role if it is able to provide finance to economic agents who are facing shortage or excess of funds. When the financial sector is more advanced, more physical capital can be accumulated and distributed which can accelerate economic growth with optimal level. Nalan(2018) has shown much attention to Islamic financing and its impact on economic growth. Its research concluded that Islamic banking funds along with innovation clearly effect on economic growth. Stolbov (2012) conducts an empirical study to examine the effect of Islamic financing system on 11
2. Review of Education , Administration and Law, Vol. 2, (1) 2019, 11-22 economic growth and determines that at the same moment the influence of finances on economic growth doesn’t capture any uniformity in trend behavior but meanwhile its depends on the level of growth of an economic system, structure of financial methods, legal system and the overall quality of organizations, So many imminent issues and promising boulevards for upcoming research. Global markets faced confusion in a stir of the credit crunch and ensuing crisis in banking sector, it is the time to observe the evidences of marginal banking model which assumes different approaches about risk and finance, which is based on the philosophies of Sharia as alternate banking. Islamic banking developed extensively in a last few years due to the recent financial shocks and instability, which will run a good prospect in this regard. Islamic banking and finance is the transparent growing sector in the world for development. Young’s World Islamic Banking Competitiveness Report 2013, more than 400 Islamic financing institutions working in more than 80 countries. (Tabash & Dhankar, 2014). The development and stability of Islamic financial industry will benefit Muslim countries particularly and the rest of world generally, I n terms of economic development, poverty reduction, business opportunities, trade balances, capital formation, financial inclusion, and circulation of conservative wealth. Mohieden, Iqbal, Rostom, and Fu (2011) examine that Islamic banks contribution towards real economic growth. Nations of Muslim communities that reject to pledge their capital in Non-Islamic banks would indulge in declining rate in, scarcity of loanable funds for investment purpose. Empirical researches show that the less proportion of Muslims community used conventional relatively non-Muslims, although it is hard to judge the percentage of responsiveness to spoil of investment. However, the democratic objectives of Islam not realized now a days due to fund transfer to poor people. For instance, see Furqani & Mulyany (2009), Majid& Kassim (2010), Abduh & Omar (2012), Manap, Abduhb & Omar (2012), Kusuma & Muqorobin (2014), and Tabash & Dhankar (2014). To fill gap in research, this study will try to study the link between Islamic finance and GDP growth, and their causal path crosswise the nations. Figure 01: Growth in Islamic Banking (2005-2018) (Source: SBP Islamic Banking Bulletin, Various Issues) Figure 01 displays the trend of returns in Islamic banking from 2005 to 2018, trend lines shows, equity, assets and return on deposits respectively. Initially it seems that few banks took time to stable. 12
3. Review of Education , Administration and Law, Vol. 2, (1) 2019, 11-22 This study intends to discover the connection between Islamic funding and economic growth. It will develop confidence of investors and policy makers to support Islamic finance for sustained growth in Pakistan. It will appear as trend setter paper for researchers to consume their efforts in this avenue. Table 01: Data Trend in Variables GDP GFCF Broad Million Million Money Years Rs. Rs. Million Rs. 2005 7738134 1215075 3182515 2006 8216160 1456889 4631578 2007 8613232 1491796 5439249 2008 8759778 1560186 5794143 2009 9007825 1482823 6814495 2010 9152553 1374205 7807082 2011 9404102 1268315 8790979 2012 9733907 1299089 10306617 2013 10159011 1332648 11676558 2014 10640381 1388839 13028161 2015 11229656 1503731 14637380 2016 11682893 1548606 15998152 2017 12179755 1615617.7 17432541 2018 12676616 1682629.4 18866930 Source: World Development Indicators (WDI)&SBP Trade openness Ratio 0.32932 0.35681 0.33403 0.33368 0.28855 0.30983 0.30451 0.26934 0.27542 0.26139 0.24326 0.239285 0.230058 0.220831 Labor force Million Rs. 46.82 50.5 50.78 52.23 55.76 57.22 58.41 59.33 60.35 60.09 63.06 63.44 64.533 65.626 IB financing Million Rs. 81,463 114,965 177,475 269,087 299,295 356,545 404,758 450,634 676,570 881,228 1,181,853 1,397,150 1,636,982 1,876,813 The above table 01 describes the past trend of all macroeconomics variables and their relationship of GDP, especially core variable, with Islamic banks’ financing, means in last decade it is clearly observed the increasing trend in both variables. And graphically also be observed as: Figure 02: Trend in Islamic Banking (2005-2018) IB Financing Million Rs. 2,000,000 1,500,000 1,000,000 IB Financing Million Rs. 500,000 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 0 This empirical research will investigate the following hypothesis: H1: Islamic bank’s financing has significant influence on economic growth. H2: Gross fixed capital formation has positive associated to economic growth. 13
4. Review of Education , Administration and Law, Vol. 2, (1) 2019, 11-22 H3: Labor force has positive impact on economic growth. H4: Trade openness has substantial effect on economic growth. H5: Money supply devours substantial effect on economic growth. 2. Literature Review Financial stability and economic growth nexus goes back to 19th and 20th centuries where Bagehot (1873) and Hicks (1969) claimed that financial system observed industrialization in England and more capital accumulation due to “massive works.” Schumpeter (1912) stressed the significance of the banking system in economic growth and highlighted the same directional effect of financial capital on economic growth and its mechanism underlying the long run association between finance and GDP growth by identification of productive investment of funds. McKinnon (1973) and Shaw (1973), explore that expansion of financial explorer leads to increase in output . The other fact has substantiated, for instance, King and Levine (1993) using panel data of 80 countries, document strong and positive link among financial development and per capita output. Xu (2000) further illustrates that there is strong indication that financial institution strikes increase in economic growth in short run as well as long run. th, the causality directional approach is equipped to finally fall into three categories, namely (1) financial development affects economic growth (2) economic growth affects financial sector, and (3) bi-directional causality between financial development and economic growth “feedback”. The former argues that the existence of financial sector would provide effectual allocation of resources to fuel the other economic sector in their growth process. Schumpeter (1912), Demetriades & Hussein (1996), Levine (1997) and Ahmad & Ansari (1998), Fase & Abma (2003) have argued that this approach is considered as the significant method in promoting economic development. The latter hypothesizes that a high economic growth may create demand for certain financial instrument and arrangements. Robinson (1952) and Romer (1990) explained that well-built financial system could ratify high economic extension through technological changes, along with innovations and it will attract higher demand on the financial instrument. Since financial system is actively responsive on such development, a higher economic performance could be attained. Several evidences had taken place through occurrences of economic disasters such as Mexican crisis, Indonesian crisis, and current global financial crisis in USA, which describe a potential disequilibrium to real economy. Therefore, the role of financial activity cannot be excluded in developing an economic growth of a nation. This is because financial sector has a function as financial intermediaries that accumulate capital from household sector or savers to business sector, in which the capital will be used to generating real sector which will absorb available labor in a market, and also realize profit. Stolbov (2012) debates on systems of banks and markets appear to be equally imperative: Both sectors of the financial system are positive associated with the dynamics of an economy. Islamic funding is one of the most developing zones of the industry and has risen to distinction due to its unique features. In the context of Islamic banks which tie to closely associate with financial intermediaries, particularly into the real economy. Furqani &Mulyany (2009),Abduh& Omar (2012), and Tabash & Dhankar (2014) have explored the link among Islamic banks’ financing and economic growth with a limited scope in this area. 14
5. Review of Education , Administration and Law, Vol. 2, (1) 2019, 11-22 Quarterly data study of Indonesia for duration of 2003 to 2012, Abduh& Omar (2012) utilize an autoregressive distributed lag (ARDL) framework and to identify the causality analysis. Therefore, the government should design the all policies in regard of Islamic in order to support the economic development. Furqani & Mulyany (2009) estimated econometric regression models by using the quarterly data from 1997 to 2005 and concluded that the relationship between Islamic financial capital and economic growth. Which clearlyencourage Islamic financing through banks. On the other hand,Majid &Kassim (2010) is in errand of the supply-leading opinion. Kusuma & Muqorobin (2014) observe the rapid progress of the Islamic banks in Indonesia and assess the stability of these banks in order to prove that they positively contribute towards the country’s economic growth using the Vector Auto Regression (VAR) analysis. Tabash &Dhankar (2014) discovers linkages in the region of Middle East about Islamic finance and economic growth nexus especially for Qatar, Bahrain, and United Arab Emirates(UAE) and appears to be a bi-directional correlation for Bahrain and Qatar using Granger causality test. The results obtained for UAE directs that a causal relationship transpires unique direction, which cares Schumpeter’s supply-leading theory. The literature highlighted a large prospective for Sharia financial goods to play an energetic role in growth in future perspective. Infrastructure development is a key to stimulus economic development. Al-Rajhi (1999) describes many opportunities with the help of Islamic banks to finance development projects in private as well as public sector with economic organizations in a world. 3. Data and Methodology The question arises over here according to recent literature that what drives changes in economic growth? Is it only Islamic banks’ financing? Obviously no, physical capital and others factors also play vital role in economic growth. As standard Cobb-Douglas production function “Yt = ALα Kβ “, that is significant to economic growth. “A” is generally considered as total factor productivity, “L” is the quantity of labor and Gross fixed capital formation (GFCF) represents the Quantity of Capital. 3.1 Econometric Methodology This study used Granger causality test to investigate correlation between Islamic banks’ financing and economic growth and ordinary least square method for regression analysis. But checking the stationary of the data series of relevant macro-economic factors is the first step before regression analysis. 3.2 Unit Root Test This test is used to check the stationary of the data. If probability distribution of data remains unchanged as time go on then data can considered as stationary. 3.3 Granger causality Technique The aim here is to probe the effect of Islamic financing’ on the process of Economic growth in Pakistan. For this purpose general methodology is written as: The granger causality test for variables, involves as initially estimate the following VAR model as: 15
6. Review of Education, Administration and Law, Vol. 2, (1) 2019, 11-22