The inventive role of Goldsmith (1969), Mckinnon (1973) and Shaw (1973) concerning the relationship between financial development and economic growth has persisted an important issue of debate in developing economies like Pakistan. The theoretical logic for relating financial development to growth is that a well-developed financial system accomplishes different critical functions to boost the effectiveness of intermediation by reducing information, transaction, and nursing costs.
A contemporary financial system encourage investment by classifying and backing good business opportunities, mobilizes savings, supervising the performance of managers, enables the trading, hedging, and diversification of risk, and facilitates the exchange of goods and services. These task result in a more efficient allocation of resources, in a more rapid accretion of physical and human capital, and in faster technological progress, which in turn feed economic growth Creane, et al. (2004).
Most of the poetry has mainly absorbed on the role of macroeconomic stability, inequality, income and wealth, institutional development, cultural and religious range and financial market imperfections. Among these factors the role of financial markets in the growth process has received significant attentiveness. In this framework, financial development is measured by many economists to be of vital significant for output growth. Predominantly, government restrictions on the banking system such as, interest rate ceiling, high reserve requirements and directed credit programmes hamper financial development and decrease output growth Mckinnon (1973) and Shaw (1973). The initial involvement due to Mckinnon (1973) and Shaw (1973) hypothesize that the government interference in the pricing and allocation of loanable funds hinder financial domination mainly discouraging real interest rates. Governments are confronted with only limited choice such as inflationary financing, thus even further diminishing the real interest rate. McKinnon underline that the order and suitable sequencing of financial improvements in the financial sector would be much more operative once price stabilization has taken place. In fact, financial development is not isolated a function of liberalizing monetary mechanism but “reliable macroeconomic policy package including a variety of policies, comprising temporary financial market management in order to display credit dullness of borrowers and to avoid misrepresentation such as moral threat and opposing selection. The endogenous growth fiction pressures the predisposed of financial markets on economic growth.
Benhabib and Spiegel (2000) dispute that a positive relationship is accepted between financial development and total factor productivity growth and investment. However, their results are very sensitive to model specification. Furthermore, Beck, et al. (2000) find that financial development has a huge and positive impact on total factor productivity, which suckle through to overall GDP growth Neusser and Kugler (1998).
A number of economists have stressed the role of financial development in well classifying investment opportunities, reducing investment in liquid but unproductive assets, mobilizing savings, improving technological innovation, and improving risk taking. The problem is that a positive relationship between financial development and output growth can exist for different reasons. As output increases the demand for financial services increases too, this in turn has a positive effect on financial development.
Robinson (1952) explores that “Of the liberalization procedure of the economy introduced in early 1990. The major module of the financial sector improvement related to the deregulation of the commercial bank’s lending rates, lowering of their reserve requirements and the introduction of prudential regulations and standards broadly along with the lines recommended by the Basle Committee on Banking Supervisions.
The rest of the paper is organized as follows. Section II defined overview the financial sector reforms in Pakistan. In Section III Model specification and data issues are presented. Econometric methodology
and empirical findings are given in Section IV, while some concluding remarks are given in the final section
The major objective of every government is to achieve the rapid economic growth and thus the sustainable development of the economy. For this purpose governments take many economic decision.
Real gross domestic product (GDP) growth rate represent the portray of a country to evaluate the overall economic performance and the economic health of any country. It helps all economic agents like planer, police maker, and other investors etc. to assess and take the all economic resulted decision including investment and financial decisions. The theories of economic growth and empirical literature identify the main drivers and potential sources of economic growth. The literature such as (Ibrahim, 2013); (Khan ; Qayyum, 2007) and (Levine, 1997) suggested that the financial development is a powerful engine and one of the determinant behind economic growth that plays a huge role that determines the economic development of a country. According to the Levine (1997) financial development increase the economic efficiency through the capital accumulation, facilitate the trading, minimize the risk, mobilize savings and ultimately increase the economic growth of the country. It promote endorses economic growth through productivity growth and capital accumulation. The capital accumulation in term and saving .By increase the per capita income, pooling, and mobilizing the savings accompanied by a treatment investment opportunity, encourages the local and foreign direct investment.
The Financial sector can be explained the as a set of institutions, markets, instruments, legal and regulatory framework that arise the ameliorate the effects of information, execution, and transactions costs. An efficient and powerful financial system can explain the lead to diversification as well as the effective resource allocation. A well-developed financial system increase the technical and economic efficiency of the economy which lead to the greater mobilization of saving and investment, the efficient allocation lead to excessive turnover ratio of the projects (Levine and G. King, 1993). In the early 20th century, the financial market of world had made steady progress and experienced enormous modification. Financial sector development finally resulted in Financial Openness and privatization. The well organized and efficient financial system play a key role for the development of the economy, and trigger to the economic growth of the country. The countries with efficient and dynamic stock markets can established better banking sector compared to the countries that had lagged financial sector (Levine, 1997).
The financial development is not a single magic bullet that only explains the economic development, there is not a single theory which explains the finance sector development boosts productivity growth and investment everywhere. But a solid and powerful engine behind economic growth that plays a huge role that determines the economic development of a country. It endorses economic growth through productivity growth and capital accumulation by increasing the savings, pooling, and mobilizing the savings rate, producing information about investment decisions, encouraging the inflows of foreign capital in the form of foreign direct investment.
MEASUREMENT OF FINANCIAL DEVELOPMENT
The relationship between financial sector development, productivity growth, and investment is complex phenomena due to vast concept, there are several dimensions of the
financial development (?ihák, Demirgüç-Kunt, Feyen, and Levine, 2012). Most of the Empirical literature suggested that financial development can distinguish between four standard quantitative dimensions:
FIG 1: FINANCAIL DEVELOPMENT DIMENSIONS
Financial depth can be explained through the size of the financial sector, the ratio of the financial sector relative to the total economy of country. It is the size of banks, financial institutions, and financial markets in the economy. Financial efficiency can measure the financial depth turnover ratio, related to the efficiency of the banks, financial institutions, and financial markets. Financial stability is the ability of the financial system that facilitates the smooth flow of funds, enhance productivity growth, lower the risks, and absorb shocks. Financial openness is the willingness of a country to adopt liberalized policies that upsurge the size of the financial depth of the economic as well as the efficiency encouraged the of private sector interests to boost the finance.
The effects of the financial development dimensions depend upon the country characteristics and financial depth, vary over time, financial openness boosts the productivity growth in the low-income countries, vanishes in developed countries.
FINANCIAL DEVELOPMENT INDICATORS
There are wide ranges of financial development indicators that capture the four dimensions of financial development.
Financial Institutions Financial Markets
Depth Private Sector Credit to GDP Stock market capitalization and outstanding domestic private debt securities to GDP
Financial Institutions’ asset to GDP Private Debt securities to GDP
M2 to GDP Public Debt Securities to GDP
Deposits to GDP International Debt Securities to GDP
Gross value added of the financial sector to GDP Stock Market Capitalization to GDP
Stocks traded to GDP
Access Accounts per thousand adults(commercial banks) Percent of market capitalization outside of top 10 largest companies
Branches per 100,000 adults (commercial banks) Percent of value traded outside of top 10 traded companies
% of people with a bank account (from user survey) Government bond yields (3 month and 10 years)
% of firms with line of credit (all firms) Ratio of domestic to total debt securities
% of firms with line of credit (small firms) Ratio of private to total debt securities (domestic)
Efficiency Net interest margin Turnover ratio for stock market
Lending-deposits spread Price synchronicity (co-movement)
Non-interest income to total income Private information trading
Overhead costs (% of total assets) Price impact
Profitability (return on assets, return on equity) Liquidity/transaction costs
Boone indicator (or Herfindahl or H-statistics) Quoted bid-ask spread for government bonds
Turnover of bonds (private, public) on securities exchange
Stability Z-score Volatility (standard deviation / average) of stock price index, sovereign bond index
Capital adequacy ratios Skewness of the index (stock price, sovereign bond)
Asset quality ratios Vulnerability to earnings manipulation
Liquidity ratios Price/earnings ratio
Others (net foreign exchange position to capital etc.) Duration
Ratio of short-term to total bonds (domestic, int’l)
Correlation with major bond returns
Financial sector development plays important role for the determination of the economic growth of the Pakistan economy. The empirical association between economic growth and financial sector development has been a wide-ranging subject of debate in empirical research. The practical evidence suggested that there is a significant, positive relationship between financial development and economic growth. However, these findings do not establish the effect political factors on the economic growth with financial develop.
Significance of Study
The development of financial sector in developing countries and initial markets is part of the private sector development strategy to encourage the economic growth and reduce the poverty. During the last years Pakistan has seen remarkable financial sector development which has positive impact on economic growth of Pakistan. The character of financial issue in economic growth of Pakistan is not well researched. The present study will present the historical profile of the financial development and will forecast the financial development and economic growth. Present study fills the gap and empirically estimate the to the relationship between Financial development, economic growth and determinates of financial development with political and social determinants in Pakistan, by using the time series data.
Numerous literature has been carried out regarding the relationship between financial development and economic growth. Most of the studies forced only the short run and long run relationship of financial development and economic growth by using the deferent proxies of the financial development (Zaman, et al., 2010).
Objectives of the Study
The specific objectives of the study are as follows;
? To estimate past and future forecast of major indicators of financial development in Pakistan.
? To find the impact of financial development and other determinates on economic growth in Pakistan.
? To make Policy recommendation based on the find