Finance-growth nexus: Islamic finance development in Indonesia

Abstract

Purpose There are many studies related to finance-growth nexus, but existing empirical evidences still have not provided conclusive result of the nature and direction of this relationship. Moreover, there are only few studies about finance-growth nexus seen from Islamic finance perspective, especially in Indonesia. Therefore, this study aims to examine the nature of causal relationship between Islamic finance development and economic growth in Indonesia seen from the development of Islamic banking, sukuk market and Islamic stock market. Design/methodology/approach By using quarterly data from 2002Q3 to 2017Q4, this study uses vector autoregressive (VAR) model, then uses granger causality and impulse response function to analyze the causal relationship between Islamic finance development and economic growth and also among three main sub-sectors of Islamic finance. Findings This study found that Islamic banking development and Islamic stock market development support neutrality hypotheses view, while sukuk market development supports supply-leading hypotheses view. Moreover, this study also found that there are unidirectional causalities from sukuk market development to Islamic banking development and from sukuk market development to Islamic stock market development. Research limitations/implications This study focuses only on the development of Islamic finance viewed from a macro perspective and only looks at how the three main sub-sectors in Islamic finance develop. In addition, the results of research related to finance-growth nexus are also sensitive to the object of research, the method and the proxies of variables used. Originality/value To the best of the authors’ knowledge, there is no study that examines the causal relationship between Islamic finance development and economic growth in Indonesia based on its three main sub-sectors simultaneously. So, this study gives empirical evidence to contribute on finance-growth nexus discussion based on three main sub-sectors of Islamic finance development in Indonesia.