Measuring the Threshold Level of Financial Deepening to Achieve Inclusive Growth in Pakistan

Abstract

This study empirically investigates the relationship between financial development and inclusive growth in Pakistan with threshold analysis over the period of 1987-2020. The study measured inclusive growth as the measure hinged on two factors; growth in per capita GDP and income inequality this ensures the growth adjusted to inequalities which is close definition to pro-poor growth or inclusive growth. The econometric technique of quantile regression is used to obtain threshold estimates over the different quaintiles.  The results of are given as a threshold level on the basis on quantile (0.10, 0.25, 0.50, 0.75, 0.85 and 0.90). The study found that the impact of financial development on inclusive growth depends on the measure of the former up to the threshold level and not beyond. The results indicates that financial development indicators; domestic credit, broad money M2, and gross fixed capital formation are significant in 10^th and 90^th quantile, which means finical development is important in inclusive growth former to this threshold not beyond. Through a granger causality test, the direction of causality is through the inclusive growth rather than through financial development; through the financial deepening measure. While the study found that either a low level or high level of openness on trade and capital investment are desirable for inclusive growth in Pakistan, the results also reveal that policy variables in the workings of the Pakistan economy and financial openness are sensitive to the pattern of financial development. With financial deepening, both are negatively related to inclusive growth but positively related to inclusive growth when financial widening is considered. This suggests that government intervention in the activities of the private sector is detrimental when the latter are to drive financial development process. However, the involvement of government in ensuring the appropriate level of financial widening, through the central bank operations, produces a positive impact on growth.