How Financial Stability Affects Economic Development in South Asia: A Panel data Analysis

Abstract

This study examines the relationships between economic development and financial stability in five South Asian economies, namely Pakistan, India, Bangladesh, Sri Lanka and Nepal over the period of 1980-2012. Human Development Index (HDI) is used to measure economic development calculated using the goalposts based on south Asian data. While financial stability is measured by constructing an aggregate financial stability index (AFSI) that combines various indicators relating to financial sector development, vulnerability and banking soundness. We employ Pedroni panel cointegration technique to examine long-run relationship between variables. Empirical evidence confirms the long-run relationship between selected variables. Results estimated by employing Fully Modified OLS (FMOLS) show that financial stability is an essential factor for improving the process of economic development in South Asian countries. Causality analysis indicates that economic development Granger cause financial stability in South Asia.