Financial Development and Economic Growth in Nepal: New intuitions from a Time Series Causality Method

Abstract

Generalized empirical evidences about impact and direction of causality between financial development and economic growth ignoring the differences of structure and other factors seem less effective to understand the contributions of financial as well as real sector development to economic growth by country specific factors in Nepal. This paper has established the short run or long run relationship and the direction of causality between financial and real sector development with economic growth. For the study purpose, time-series data covering the period of 1975 to 2015 were used considering whole financial system in Nepal as population and financial intermediation as sample for the study. E-Views 9 was used to obtain the results of Unit root test, Engle-Granger co-integration test, Error correction model and Granger causality test. Results conclude that although finance-led growth yields positive consequences, real sectors indicator like consumer price index (CPI) has more impact on real gross domestic product (GDP), a proxy of economic growth, than financial development indicators (M2Y, CPY) in Nepal. This study also predicts negative co-integrating relationship between trade openness and GDP.Bidirectional causality between broad money to GDP ratio and real GDP, and unidirectional causality of PIY and CPI with positive role upon GDP suggesting urgent need of contractionary fiscal and monetary policies to induce private sector investment in GDP.