The Role of Macroeconomic Factors in Shaping Financial Development: Evidence from Pakistan

Abstract

This study aims to empirically examine the relationship between key macroeconomic factors—financial development, inflation, interest rate, trade openness, and exchange rate—and their influence on FD in Pakistan. By analyzing the period from 1993 to 2023, the research seeks to provide a comprehensive understanding of how these variables interact and impact financial development in the country. The study utilizes secondary time series data gathered annually in Pakistan between 1993 and 2023. The data for all variables was sourced from the World Bank. An Ordinary Least Squares (OLS) analysis was employed due to its optimistic and holistic perspective, which is critical for this investigation. The study examines the correlation and regression analyses to determine the relationships between financial development and the selected macroeconomic variables. The correlation analysis revealed a moderate positive correlation (0.523) between FD and the selected macroeconomic variables. The regression analysis provided that inflation and TO have a positive effect on FD. On the other hand, EXCR and INTR have a negative effect on FD. Furthermore, the study identified a unidirectional causal relationship between inflation rate, TO, and FD, whereas a bidirectional causal relationship was observed between INTRs, EXCRs, and FD. The findings of this study have significant implications for policymakers in Pakistan. Understanding the positive impacts of inflation and TO, as well as the negative impacts of INTRs and EXCRs, can help in formulating strategies to foster FD. Policymakers can use these insights to create a more conducive environment for financial growth by adjusting macroeconomic policies accordingly. This study contributes to the existing literature by providing empirical evidence on the role of macroeconomic factors in shaping FD in Pakistan over a span of three decades. It highlights the importance of considering multiple economic indicators and their interrelationships to understand FD comprehensively. This research also lays the groundwork for future studies to explore these dynamics in other developing and emerging economies.