Finance–Growth Nexus in Nepal: An Application of the ARDL Approach in the Presence of Structural Breaks

Abstract

Executive Summary A healthy financial system is important for the growth process of an economy. It affects growth by influencing the saving, investment and technological innovations. In fact, researchers argue that low-income countries like Nepal need a much more robust and active financial system when compared to the developed world. Therefore, this study examines the relationship between financial development and economic growth using annual time series data for Nepal during the period 1984–2014. Because Nepal has a bank-based economy, the study used credit issued by banking and financial institutions to the private sector as the proxy for financial development. The economic growth has been measured using real gross domestic product (GDP) growth and real GDP per capita growth (constant 2005 US$). The autoregressive distributed lag (ARDL) bounds testing approach is used to investigate the cointegration among variables in the presence of structural breaks. The study used Zivot and Andrews’ (ZA) unit root test in order to find the structural breaks in the variables. The study finds that the structural change in private credit took place in 2007 when the government of Nepal and Maoists (the then rebels) signed a Comprehensive Peace Agreement and the Maoist rebels joined the interim government, which formally ended the 10 years long civil war in Nepal. Similarly, the study observes break points in real GDP growth and per capita growth in 2001 when the Royal Massacre and a state of emergency took place in Nepal. After allowing for structural breaks, the study finds evidence of a cointegration relationship between financial development and economic growth when economic growth is used as the dependent variable. Thus, it can be argued that the long-run causality is unidirectional from financial development to economic growth in Nepal. The estimates of the ARDL approach suggest that financial development has a significant positive impact on economic growth in both long run and short run. However, the estimates show that gross domestic saving, a control variable, has a negative impact on economic growth in Nepal. It clearly indicates that Nepal has long not been able to utilize the savings in the productive sector. The political instability, poor investment policies and securities and hence the lack of foreign investment and lack of technological innovations could be the causes for Nepal not benefiting from the country’s savings. It is also found that trade openness has a negative relationship with economic growth in the long run: possibly the cause of the persistent trade deficit of Nepal with the rest of the world. However, in the short run, the result shows a positive relationship between trade openness and growth. In fact, it is found that the magnitude of the positive impact of trade openness in the short run is higher than the magnitude of its negative impact in the long run. Thus, the policymakers should give more emphasis on trade and investment policies that could reduce the prolonged trade deficit and help the nation in getting long-term benefits from international trade.

Population growth, income growth and savings in Ghana

“…However, the direction of the effect of the savings on economic growth have empirically be proven to depend on whether the economy is advanced or developing. Thus, the findings from this study is consistent with that of the studies conducted by Sahoo et al (2001) and Bist and Bista (2018) who found negative relationship between savings and economy growth. With regards to Ghana's case, underlying the expansion of the Ghanaian economy is growth in the financial sector with a rise in access to credit and other financial services.…”

Savings, investment, and growth in Nepal: an empirical analysis

“…Moreover, a decade-long Civil War, from 1996 to 2006, the political turmoil in the subsequent years until 2018, corruption, weak regulatory and legal policies, poor information systems, and poor technological innovations have been major barriers to the development of Nepal's financial sector (Bist and Bista 2018). Thus, the poor and urban-based financial sector is another hurdle in channeling savings into the productive sectors in the country.…”

Relationship between Trade Openness, Financial Development and Economic Growth of Nepal: Evidence from a Developing Country

“…The trade openness hasn't been able to cause value addition in the GDP of Nepal despite the high trade-GDP ratio. Bista & Bista (2018) also showed that trade openness doesn't cause positive growth in Nepal. A major share of trade of Nepal consists of imports which are not found to be further used for production or value addition but consumption.…”

“…Hence, the study was not able to explain the relationship between FDI and economic growth of Nepal adequately without the presence of autocorrelation. Bista & Bista (2018) examined the relationship between economic growth, trade openness and financial development. Growth proxies like real GDP growth and real GDP per capita growth were taken as dependent variables.…”