Financial Development —Economic Growth Nexus: A Case Study of Bangladesh

Author(s): Md Habibur Rahman

Source: The Bangladesh Development Studies, Vol. 30, No. 3/4 (September-December 2004), pp.
113-128
Published by: Bangladesh Institute of Development Studies
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Notes
TheBangladeshDevelopmentStudies
Vol. XXX, June-September
2004,Nos.3 & 4

FinancialDevelopment-EconomicGrowth
Nexus:A Case StudyofBangladesh
by
Md Habibur Rahman*

I. INTRODUCTION
The existenceof correlationbetweenfinancialdevelopmentand economic
growthis well establishedby the theoretical as well as empiricalevidence.The
presenceof correlationbetweenfinancialdevelopmentand economicgrowthis
initiallyarticulatedby Gurley-Shaw(1955) followed by Goldsmith(1969),
McKinnon (1973) and Shaw (1973). Gurley-Shaw(1955) providedconvincing
evidenceof co-evolution of therealand thefinancialsectorswithoutattributing any
specific direction of causationwhich is again confirmedby Bencivenga-Smith
(1998). Goldsmith (1969) also findsevidenceof strongcorrelation betweenfinancial
development and economicgrowth in hiscross-country study.McKinnon(1973) and
Shaw (1973) advocatefinancialliberalisation based on thebeliefthatit willincrease
savings as well as real credit supply which will in turninducea highervolumeof
investment and fastereconomicgrowth(Dixon 1997, p.752). Evidenceof strong
correlationbetweenfinancialdevelopment and economicgrowthin these studies
convincingly establisheda hypothesis thata well-developedand betterfunctioning
financialsystemsupports fastereconomicgrowth.
To examinethe predictionof the hypothesisthatin the long-runfinancial
development resultshigherinvestment and outputgrowth, thisstudyinvestigatesthe
finance-growth nexus in Bangladeshduring 1976-2005 based on a long-run structural
vectorautoregressions (SVARs) modelspecifiedby Blanchard-Quah (1989). Under
thelong-runSVARs model,it is assumedthatfinancialdevelopment has long-run
impacton investment and incomeper capita.When an economystartsto growit
createsimmediateadditionaldemandforfinancialservicesand helpsgrowa better
financialsystem.At thisstagethepositiveimpactof financialsystemon economic
growthcould be modest.As development proceeds,a betterand well functioning
financialsystemis established. A welldevelopedfinancialsystemcan contribute at a
*
Theauthor
is SeniorResearch
Economist, Unit(PAU),Bangladesh
PolicyAnalysis Bank.

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114 Studies
TheBangladeshDevelopment

greaterextentto incomegrowthby reducingmarketfrictions (includinginformation

and transactioncosts),poolingrisks,easing tradeand contracts(Levine 1997, p.
691). With a view to examiningthe impact of the Financial Sector Reform
Programme(FSRP), whichwas launchedin 1990, on the causal link amongthe
variables,theSVARs techniquehas been appliedon threesamples:(i) fullsample
period1976-2005;(ii) pre-FSRPperiod1976-1990;and(iii) post-FSRPperiod1991-
2005.
The restof thepaperis organisedas follows:SectionII outlinesan overviewof
thefinancialdevelopment in Bangladeshand sectionIII discussesthemethodology
of the study.SectionsIV and V respectively analysetheidentification restrictions
and containdata analysis.SectionVI discussesempiricalresultswhilesectionVII
containsconcluding remarks ofthestudy.
II. AN OVERVIEW OF FINANCIAL DEVELOPMENT IN BANGLADESH
Financialintermediaries essentiallyinvolvein transferring fundsin exchangeof
goods, services,or promisesof futurereturn.Developmentin the financialsector
raisestheoverallefficiency of thefinancialinstitutions. As arguedby Ross Levine
(1997) that a developed financial system reduces transaction costs, information
asymmetries, market frictions and pools risk.A well-developed financial systemhas
in
been widely understoodas a stimulant accelerating economic growthby
mobilisingsavingsand facilitating investment in an efficient manner.As "financial
development"lacks any precise definitions, followingthe practiceof existing
literature[King-Levine(1993a and 1993b),Levine (1997 and 1999), Levine-Zervos
(1998), Beck-Levine-Loayza(2000a and 2000b)] some indicatorsof financial
developmentmay be used for effectivepolicy formulation, implementation and
evaluation.Accordingly, threealternative indicators of financialdevelopment, such
as domesticcreditto theprivatesectorby banksto GDP ratio,totaldepositsto GDP
ratioandbroadmoney(M2) to GDP ratioforBangladesheconomyhavebeenused.
Domesticcreditto theprivatesectoras a percentof GDP (denotedby cr_y)is
one of the popularindicatorsof financialdevelopment. It includesall the credit
issued to the privatesectorby all financialinstitutions whichgives the degreeof
financialintermediation and measuresthefinancialresourcesprovidedto theprivate
sectorthroughloans and advances,purchaseof non-equitysecurities,and trade
credits.The secondindicator of financialdevelopment is totaldeposits(demandplus
time) as a per centof GDP (denotedby dep_y) which is relativelybroadermeasure
offinancialdevelopment as itincludesall the liquid liabilitiesof thefinancialsystem
excludingcurrency in circulation. A thirdindicator, broadmoneyas a per centof
GDP (denotedby m2_y),is basicallytheliquidliabilitiesof thefinancialsystemin

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 Economic
FinancialDevelopment-
Rahman: Nexus
Growth 115

Bangladeshthatincludescurrencyplus demandand interest-bearing liabilitiesof

financialintermediaries. Thisis thebroadestmeasureoffinancialdevelopment andis
consideredtobe a typicalmeasureoffinancial"depth."It also indicatesthedegreeof
monétisation withrespectto therealeconomy.
The processof financialdevelopment in Bangladeshgotit's momentum through
the financialsector reformstartedin the early 1980s. The bankingarena of
Bangladeshwas in a stateof disarray, particularly sinceitsindependence in 1971 as
sequel to bad lendingpractices, which resulted in an accumulation of huge non-
performing loans. The internal weakness of thesystem was not easilyrecognizable
due to deceptiveandartful accounting jugglery.Interest earningswereenteredintoin
the books of accounton an accruedbasis, provisionsfor bad debt were highly
inadequate.In the process,the capitalbase of the nationalisedcommercialbanks
(NCBs) was silentlyeatenup,posingthreatto thestability to thefinancialsystemas
a whole. To infuse competitionin the financial system two banks were
denationalised in 1984 and a numberof newbankswerepermitted to operatein the
private sector in 1986. At thesame time, a National Commission on Money,Banking
and Creditwas constituted by the Government to identifyproblemsand suggest
remediesof theproblemsin thebankingsector.The reformin thefinancialsector
was neededto ensuresafety, soundnessandefficiency in thebankingsector.Largely
basedon theexperts'suggestions, Government adopteda numberofinstitutional and
policy reform/liberalisation measures since 1989-90. These were aimed at
liberalisation of depositsand lendingratesand makethemflexibleto meet market
needswitha view to improving allocationof resources,replacement of directcredit
controlwithindirect monetary instruments, of
strengtheningprudential guidelinesfor
bank supervisionby the CentralBank, establishment of appropriateaccounting
policiesincludingloan classification and provisioning,improvement in capitalbase
of banksand strengthening thelegal framework of debtrecoveryand regulations
affecting financialinstitutions by improvingregulatory power of the Bangladesh
Bank,good governance ofthepublicfinancialinstitutions, andefficiency ofthelegal
framework.
Witha view to investigating thehistoricaloverviewof theabove indicatorsof
thefinancialdevelopment anditsassociationwithinvestment activities(measuredby
fixedcapitalformation as a per centof GDP denotedby i_y)as well as per capita
income(denotedby y_pcap),annualdata during1976-2005are used. The data as
presented in Figure1 as well as in Table 1 showthatall threeindicators of financial
development displaysteadyincreasingtrendduring1976-2005,indictingwidening
anddeepeningofthefinancialsystemin Bangladeshovertime witha structural break
in 1991.NotethattheFSRP was launchedin 1990to shiftthepolicystancegradually
towardsindirectcontrol.Priorto 1990,thepolicywas based on directcontrolover

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116 Studies
TheBangladeshDevelopment

variousinstruments, such as the volumeand directionof creditand interestrates.

Investment as a percentofGDP andpercapitaincome(in current USD) also display
a similarpatternand move broadlytogether reflectinga close associationamong
financialdevelopment, investmentandpercapitaincomeduringtheperiod.1

Figure1
Trendsin SomeIndicatorsofFinancial
Investment
Development, andEconomicGrowth

It has been observedfromTable I thatthe averagecredit,depositand broad

moneyto GDP ratiosincreasesubstantially from6.6 percent,14.9 percentand 19.0
percent respectivelyin 1976-1980to 28.8 percent35.01 percentand 40.0 percent
respectively 2001-2005, reflecting overtimesteady growthin financial
in an
deepeningor financialdevelopment in Bangladesh.Atthesametimetheinvestment-
GDP ratioas well as incomepercapitaalso sharesthesimilarup-wardtrendduring
thatperiod.

1This
implyanycausal linkamongthem.
apparentgraphicalassociationdoes notnecessarily
In view ofjustifying econometric
thisassociation,however,a sophisticated technique(long-
runSVARs model)has been used in sectionVII and foundtheevidenceof long-run causal
linkamongfinancialdevelopment, investmentandpercapitaincome.

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Rahman:FinancialDevelopment-
EconomicGrowth
Nexus 117

TABLE I
TRENDS IN SOME INDICATORS OF FINANCIAL
DEVELOPMENT, INVESTMENT AND INCOME

Period lr cr_y Dep_y m2_y i_y y_pcap

1976-1980 11.09 6.59 14.86 19.03 10.44 160.0
1981-1985 13.68 13.67 20.23 24.54 10.51 192.0
1986-1990 14.71 19.08 24.75 28.67 13.87 242.0
1991-1995 13.90 16.58 23.07 26.68 17.93 283.0
1996-2000 13.83 23.17 26.70 31.01 21.51 353.0
2001-2005 12.33 28.83 35.08 40.02 22.63 395.0
Notes: 1. lr= Weightedaverageannualinterest rateon lendingbybanks.
2. cr_y= Domesticcreditto theprivatesectoras a percentofGDP.
3. dep_y= Totaldepositsas a percentofGDP.
4. m2_y= Broadmoneyas a percentofGDP.
5. Ly = Grossfixedcapitalformation(grossinvestment) as a percentofGDP.
6. y_pcap= GDP percapitaatcurrent US dollar.
Sources: 1. On-lineversionofInternational (IFS), IMF.
FinancialStatistics
2. WorldDevelopment Indicator
CD ROM 2003,WorldBank.
3. AnnualReportandEconomicTrends(variousissues),BangladeshBankand
4. Authors'estimates.
The scatter-plotsfor the various indicators of financial development vs.
investment-GDPratioand income per capita have shown in Figures 2 through4. The
scatter-plotsof the threeindicatorsof financialdevelopmentvis-à-vis investmentas
well as per capita income stronglysupportthe existence of co-movementbetween
financial developmentand economic activity(Figures 2 and 3). Besides, almost a
linear relationshipis observed in anotherscatter-plotsdiagram between investment-
GDP ratioand per capita income (Figure 4).

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118 Studies
TheBangladeshDevelopment

Figure2
FinancialDevelopment
and Investment
Relationship

30.00 -i

25.00
I ' QT£^e
20'00
|8 15.00
- Üfr^^0*0^
^J***^*^*
1 -
10.00 ^
■
^Stt*****
I 5.00
~c
0.00 -I 1 1 « 1 1 « 1
0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00
CreditGDP Ratio |

30 i
TrendLine

■'
5-
|
■ 1 <
0 -I 1 1 1 1 1

10 15 20 25 30 35 40 45
DepositGDP Ratio

1 TrendLine

5-
|
0 -I r^ 1 ■ ■
10 20 30 40 50
BroadMoneyGDP Ratio

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 Nexus
EconomicGrowth
Rahman:FinancialDevelopment- 119

Figure3
FinancialDevelopment
and Per Capita GDP Relationship

500 Trend Line

S îoo - **¿*t^+
¿ o' , , , , , , ,
O 5 10 15 20 25 30 35
CreditGDP Ratio

soo -i Trend Line

S îoo - *^*O

o -I- , , , ,
5 15 25 35 45
I Total DepositGDP Ratio

soo -i Trend Line

■
| 200 ^á^^O
- -<*O
' loo
o -I , , , ,
10 20 30 40 50
Broad MoneyGDP Ratio

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120 TheBangladeshDevelopment
Studies

Figure4
Investment
and Per CapitaGDP Relationship

500 -i Trend Line

I200"
^ä^^
* oJ , , , , ,
5 10 15 20 25 30
Investment
GDP Ratio

III. METHODOLOGY
Structuralmacroeconometric models,such as the Klein interwarmodel,the
Brookingmodel,theBEA model,theSt. Louis modeland theTaylormodelthatare
based on hundreds of equations,are replacedby thevectorautoregressions (VARs).
The problemof identification and endogeneity is associatedwiththesestructural
macroeconometric modelswhichcan easily be overcomeby the VARs approach.
Sims's (1980) seminalworkintroducesVARs thatallows feedbackand dynamic
interrelationshipacross all the variablesin the systemand appearsto be highly
competitive withthelarge-scalemacroeconometric modelsin forecasting and policy
analysis.The unrestricted VARs modelassumesthateach and everyvariablein the
system endogenous does notimposeanya priorirestrictions.
is and Because it does
not imposeany a priorirestrictions and is based on reducedformequations,it is
difficultto reconcileVARs witheconomictheoryand to provideany meaningful
interpretationsoftheestimated parameters.
In orderto overcometheabovedifficulties withthestandard unrestricted VARs,
somestudies,such as Bernanke (1986) and Blanchard- Watson (1986), come up with
a structuralVARs (SVARs) model that allows contemporaneous structural
restrictions.
Shapiro-Watson (1988) and Blanchard-Quah (1989), on theotherhand,
develop an alternativeSVARs model thatallows long-run structural restrictions.
the
Nonetheless, long-run structuralmodels do not impose any contemporaneous

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Rahman:
FinancialDevelopment-
Economic Nexus
Growth 121

theyallow to determine
restrictions, short-rundynamicsin thedatathroughimpulse
responsefunctions (IRFs) and variance (VDCs). As theobjectiveof
decompositions
thispaperis to investigatelong-run betweenfinancialdevelopment
relationship and
economic growthin Bangladesh,a Blanchard-Quah(1989) type of long-run
structural
modelis estimated.
IV. IDENTIFICATION RESTRICTIONS
In orderto investigatethe long-runrelationship
amongfinancialdevelopment
and investmentand percapitaincome,a systemof equationsbased on thelong-run
SVARs model is specifiedwherea set of economicallymeaningful identification
restrictions
on thedatais required.
Considerthefollowing
productionfunction:
Y=f(K,AL) (1)
Here,Y = Real output,K = Capital,L = Labourand A = Technology.Dividing
equation (1) by effectivelabour (AL), we get the followingintensiveform
productionfunction:
y=f(k)
We know thatchangein capitalis nothingbut investment whereper capita
incomeis an increasingfunction ofinvestmentorcapitalformation.Therefore,
jfc= / = sy * y = f(I) (2)
WhereT and V areinvestment andrateofsavingrespectively.
Assumingthatinvestment (/) is an increasingfunctionfinancialdevelopment(F),
equation(2) can be written
as
¿ = /= /(F) (3)

equation(3) into(2), we get

Inserting
y = /(/,*•) (4)
The above functional relationshipamongper capita income, investment and
financialdevelopmentcan be expressed as F (financialdevelopment)+ I
(investment)"^ y (incomeper capita) meaningto say thatfinancialdevelopment
generatesinvestment and investment higherpercapitaincome.This chain
generates
ofcausalitycan be expressedas:
/ = / (F ) (5>
y = / ( /, F ) (6)
Based on the functionalrelationshipspecifiedin equations(5) and (6) and
a
incorporatingpolicyvariable,theshort-term reallendingrate(r/r),we can specify

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122 Studies
TheBangladeshDevelopment

the followinglong-runfunctionalrelationshipamong lending rate, financial

investment
development, andGDP percapita.

<lr = eu (?)
eFt= A2le?r+ e 2, (8)
e/=A31<Zr+A32^+f3, (9)
e> = A41<"-+ A42ef+ A43e't+ e 4, (10)

Here €t is theestimated residualofithequationfromstandard VAR model,Ayis

thelong-run responseof ithvariablesto jthstructuralshocksand eitis thestructural
shocksfromtheithvariablein thesystem.The restrictions statedin equations7-10
have some interestingimplicationsregardingfinancialdevelopment-economic
growthrelationship in thatit assertsfinancialdevelopmenthas long-run effecton
investmentandpercapitaincome.Incomepercapita,on theotherhand,has no long-
runeffecton financialdevelopment. Blanchard-Qüah's (1989) techniqueof SVARs
is employedto estimate thelong-run response matrix.

V. DATAANALYSIS
In linewiththestandard practiceofthefinance-growth annualdataon
literature,
financialdevelopment as proxiedby thedomesticcreditto theprivatesectoras a per
centof GDP2,grossfixedcapitalformation as a percentof GDP, percapitaGDP at
current USD and,a policyvariable,reallendingratesduring1976-2005are used to
estimatethe model. As Blanchard-Quah's(1989) techniqueof long-runSVARs
a seriesofunitroottests,suchas Dickey-Fuller
requiresall variablestobe stationary,
(DF 1981), Phillips-Perron (PP 1988), and Kwiatkowski-Phillips-Schmidt-Shin
(KPSS, 1992) are employed determine
to theorderof integration foreach of the
variablesused in the study.The resultsof unitroottestsare reportedin Table II,
indicatingonly the real lendingrate is 1(1) or non-stationary while restof the
variablesare trendstationary. Because 1(1) variableis inappropriate forBlanchard-
Quah's SVARs estimation,thelending rateis used in itsfirst formandis
differenced
foundto be stationary.

2Twoother as a percentofGDP andbroadmoney

suchas totaldeposits
variables, (M2) as a
percentofGDP arealsousedforpossiblealternativeindicators
offinancial
development.

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 EconomicGrowth
Rahman:FinancialDevelopment- Nexus 123

TABLE II
RESULTS OF UNIT-ROOT TESTS
" ~ "
.. . . . 1 withouttrend 1 withtrend ! Decisi
Variables(in naturallog) on
| ^ pp| Kpsg | ApF| pp | Kps^j
Rate
NominaUendingrate(lr)9 1(1) 1(1) 1(0) 1(1) 1(1) 1(1) 1(1)
(dir)9
Lendingrateat 1stdifference 1(0) 1(0) 1(0) 1(0) 1(0) 1(0) 1(0)
Real lendingrate(rir)* 1(0) 1(0) 1(0) 1(0) 1(0) 1(0) 1(0)
Financialdevelopment
Domesticcreditto theprivate
sectoras a percentofGDP (Icy) 1(0) 1(0) 1(1) 1(0) 1(0) 1(0) 1(0)
Totaldepositas a percentofGDP (ldy) 1(0) 1(0) 1(1) 1(0) 1(0) 1(0) 1(0)
Broadmoneyas a percentofGDP (lmy) 1(1) 1(1) 1(1) 1(0) 1(0) 1(0) 1(0)
Investment
Grossfixedcapitalformation
as a percentofGDP (liy) 1(1) 1(0) 1(1) 1(1) 1(0) 1(0) 1(0)
Income
PercapitaGDP at current USD (lypcap) 1(1) 1(1) 1(1) 1(1) 1(0) 1(0) 1(0)
Notes: 1. (p= without log,1(1) = unit-root
and1(0) = stationary.
2. Lag lengthforADF testsis decidedbasedon Akaike'sinformation criterion
(AIC),
3. MaximumBandwidthforPP and KPSS testis decided based on Newey-West
(1994).
4. All thetestsareperformed on thebasisof5% significancelevel.

VI, EMPIRICAL RESULTS

In orderto generatethe long-runresponse matrix,initiallywe need to estimatea
VAR model where the lag lengthis decided based on Akaike
4-variable unrestricted
informationcriterion(AIC) making all the residuals white noise. The estimated
resultsof Blanchard-Quah's SVARs model for the three samples are presentedin
Table III where domesticcredit-GDP ratio alone is used as an indicatorof financial
development.
The estimatedlong-runresponsematrixforthe full sample (top partof theTable
III) indicatesthatfinancialdevelopmenthas statisticallysignificantlong-runpositive
impact on both the investment-GDPratio and on per capita GDP.3 A one per cent
positive shock to financialdevelopment(credit-GDP ratio in this case) will generate

3 Two otherindicators suchas totaldepositsas a percentof GDP

forfinancialdevelopment
and broad money(M2)-GDP ratio are also producesimilarresultsregardingfinancial
development- economicgrowth nexuswhicharenotreported herebutavailableon request.

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124 Studies
TheBangladeshDevelopment

about0.15 percentpositiveimpacton investment-GDP ratioand about0.22 percent

on
positiveimpact per capita income meaning more domestic creditto theprivate
sectorgeneratesmoreinvestment activitiesand hencemorepercapitaincome.The
estimatedresultsalso indicatethatthereis a positiveand significant relationship
betweeninvestment activitiesand percapitaincome.In thelong-run a one percent
positiveshockto investment-GDP ratiowill generateabout0.22 per centpositive
impact on per capita income. The long-runresponseof financialdevelopment,
investment andpercapitaincomewithrespectto reallendingratechanges,however,
does notappearwiththeexpectedsigns.The resultsof thelong-run responsematrix
forthe pre-FSRPperiod(middlepartof the Table III) remainbroadlycounter-
intuitivewherethe long-runresponsesof investment-GDP shareand incomeper
capita are and
insignificant appear with negativesigns. This may be due to
predominant role of nationalised banks during the post-FSRPperiod wherethe
bankingarenaof Bangladeshwas in a stateof disarray,as sequel to bad lending
practices,whichresultedin an accumulation of huge non-performing loans. The
practice of administered interest ratewith the low degreeof monétisation is another
addedphenomenon the
during post-FSRPperiod.
The estimatedparameters of the long-runresponsematrixduringpost-FSRP
period (bottompart of the Table III) appear withthe expectedsigns. There is
statistically significant and negativeimpactof real lendingrate on investment
activity, financialdevelopment andincomepercapita.Domesticprivatesectorcredit
as a ratioofGDP has long-run positiveimpactbothon investment shareofGDP and
on incomepercapita.A one percentincreasein theprivatesectorcreditas a ratioof
GDP will generateabout0.10 percentpositiveimpacton investment-GDP ratioas
well as on incomepercapita.Thisfinding is
during post-FSRPperiod verymuch
the
expected,as theintroduction of theFSRP in 1990 shiftsthepolicystancetowards
indirectcontrolalong withgradualincreasein thecreditshareof privatebanksin
additionto gradualdecreaseof non-performing loans.In general,thefindings of the
long-run response matrix imply the view, as arguedby Ross Levine and others, that
financialdevelopment has long-run directas well as indirectimpacton per capita
incomebyreducing market frictions,poolingrisks,andeasingtradeandcontracts.

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 Nexus
Growth
Rahman:FinancialDevelopment-Economic 125

TABLE III
ESTIMATES FOR THE LONG-RUN RESPONSES TO ONE S.D.
STRUCTURAL SHOCKS
I. Full sampleperiod1976-2005

<r-'=0.93***</r(8a)
(5.42)

e'-y= 0.95***<"
(6.98)
+ 0.15*** ec;-y
(3.44)
' (9a)
? + "
ey Pcap = Q 84 * * * erlr + Q 22 * * * ^- 0>22 * * * *'- (10a)
(6.60) <429> <6fS9>
II. Pre-FSRP period1976-1990

= 0.63***<"
ec,r-y (g,,)
(3.73)
= 0.23*** <'r - 0.03 ec;-ym
<?;-y <4-53> (-1.15)

ey.Pcap
=026***e:lr-0.03eïr-y +0.11***e;-y (1Ob)
(4-.ll) <-°-89> i3-50)
III. Post-FSRP period1991-2005

<r-'=-0.39***</r (ge)
(-4.52)
e1-'= - 0,14* ** efr+ 0.10*** <r-y
' (9c)
(-3.64) (4.48)

ey-pcaP
=_o.35***^ +0.10***^ +O.Ol***e;-y(ioc)
(-5.08) <5-42) <3-74)

Notes: 1. Figuresin parentheses arez-statistic

(t-value).
2. The resultsin theabove tableare estimated whendomesticcreditto theprivate
sectoras a percentofGDP is usedas an indicatorof thefinancialdevelopment.
Resultsforthe othertwo indicatorsof financialdevelopment, such as total
as a
deposits per centof GDP and broad money(M2)-GDP ratio, foundtobe
are
similarwhicharenotreported herebutavailableon request.
3 *** _ significantat 1 percentlevel.

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126 Studies
TheBangladeshDevelopment

VII. SUMMARY AND CONCLUSION

The intentionof this paper is to investigatethe long-runrelationshipbetween
financial development and economic growth,particularlythe long-runimpact of
financialdevelopmenton investmentand per capita income. Accordingly,a system
of equations based on some theoreticalpredictionsis specified and estimatedusing
Blanchard-Quah's (1989) techniqueof SVARs. A series of scatterdata plots is also
used to substantiatethe existence of co-movementbetween financial development
and per capita income showing steady increasing trend in all the indicators of
financial development,investment-GDPratio and income per capita with a clear
indication of a close association among them during the period 1976-2005. This
apparentassociation does not necessarilyimply any causal link between financial
developmentand per capita income. The overtimetrendsin all the indicatorsof the
financial developmentwitness a structuralbreak in 1991, the year following the
introductionof FSRP. The estimatedparametersof the long-runresponse matrix,
particularlyin post-FSRP period, stronglycomplement the apparent association
betweenthevarious indicatorsof financialdevelopmentand income per capita.
Althoughthe resultsof the long-runresponse matrixduringpre-FSRP period
remain broadly misleading, the overall finding of the estimated SVARs model
indicate that financial development has a long-run positive impact both on
investment-GDPratio and income on per capita. The results also confirmthat
investment'sshare of GDP has long-runimpacton per capita income as well. Thus,
financialdevelopmenthas directas well as indirect(via investment)long-runimpact
on per capita income. These results,therefore,supportthe main hypothesisof the
studythatfinancialdevelopmenthas long-runimpact on income per capita. As the
resultsforthepre and post-FSRP period differsignificantly,therole of a competitive
environmentin thefinancialsectoris veryimportantin Bangladesh. The introduction
of the FSRP in 1990 plays a key role in creatinga competitiveenvironmentby
increasingtherelativecreditshare of privatecommercialbanks (PCBs) thanthose of
nationalisedcommercialbanks (NCBs).

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Rahman;FinancialDevelopment-Economic Nexus
Growth 127

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