FINANCIAL SECTOR PERFORMANCE AND ECONOMIC GROWTH IN PAKISTAN

Abstract

Banking sector enjoys loin share in financial sector of Pakistan and plays pivotal role in financial intermediation. Considering the dominant share of banks in financial sector, we analyzed the association between bank-based financial development and economic growth in Pakistan. Banking deregulations have been implementing in Pakistan banking sector since 1991 in order to improve the performance of the banking sector with the realization that more efficient banking sector is beneficial to channelize the financial resources optimally. During recent past, numerous banking reforms have been implemented in this sector. Considering these facts, this study examined banking efficiency and productivity during recent banking deregulations era. Moreover, this study also evaluated the determinants of banking efficiency particularly the contagion effect of global financial crisis on banking efficiency. To find out financial intermediation/development and economic growth nexus in Pakistan, this study used annual data from 1973 to 2009. Three different measures of financial development namely; ratios of M2/GDP, assets of banks/assets of banks plus SBP and banking sector private credit/GDP are selected. Considering the nature of the data, time series econometric techniques are exercised. Autoregressive Distributed Lag (ARDL) approach to cointegration is used to assess long run and short run relationship. The empirical findings highlight that bank-based financial development exerts positive on economic growth in long run when one out of three indicators of financial development – ratio of schedule banks’ assets to assets of scheduled banks plus assets of SBP, is used as an explanatory variable. There is no constructive role of financial development for economic growth of this country in the short run. This shows that there is weak supply-leading role of financial development in Pakistan in the long run. Furthermore economic growth positively contributes to economic growth in the long run when M2/GDP is used as a measure of financial development, out of three measures. Hence, there is also weak support for demand following hypothesis regarding finance – growth nexus for Pakistan in the long run. This study also examined technical, pure technical and scale efficiency of Pakistan banking sector during the period 2004–2009 by using non-parametric technique – DEA. It is found that technical efficiency of this banking sector reduced during the middle period i.e. in the years 2006 and 2007 but increasing trend prevailed in the subsequent years. Scale inefficiency is the major reason for decreasing trend in technical efficiency during 2006 and 2007 whereas pure technical efficiency remained ahead and almost perpetuated throughout the analysis period. It can be concluded that in post reforms periods, technical efficiency fluctuated in the middle period and once again acquired increasing trend. This study also found that banking efficiency is sensitive to the existing domestic macro-economic situation. The empirical analysis shows that banking industry of this country remained safe from negative contagion effect of recent global financial crisis. Moreover, diversification in banking income, market share with respect to deposits and issuance of loans are positively associated with banking efficiency. In addition to that, we evaluated productivity change in Pakistan banking sector during the period 2004 – 2009 by using Malmquist productivity change indices. Empirical results highlighted progressive trend in banking productivity during the analysis period and efficiency change played constructive role in banking productivity change.