Impact of Financial Development on Output Volatility: A Case Study of South Asian Region

Abstract

The primary aim of the current investigation is to develop a more integrated and in- depth insight of the association amongst the fluctuations observed in output volatility and the financial development. To achieve this objective, a panel dataset encompassing eight South-Asian economies (Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka) is utilized, spanning a time period of 50 years from 1973 to 2022. The empirical analysis employs various statistical techniques such as pooled OLS, fixed effect estimation (FE), and random effect estimation (RE) to examine the data. In this study, the independent variable is financial development, which is quantified by assessing the domestic credit extended to the private sector. Similarly, the volatility of economic output is measured by calculating the three-year moving average of the standard deviation. Through the utilization of a panel dataset, the study determined that financial development has a significant positive impact on output volatility, highlighting that fluctuations in the financial sector can disrupt economic output. Furthermore, the research indicated that inflation and trade openness also contribute to the volatility observed in economic growth. The study revealed that a well-developed real sector has the potential to alleviate output volatility, while inflation tends to exacerbate it. Overall, the findings suggest that financial growth plays a role in reducing the output volatility. The study additionally presents policy implications, underscoring the importance of government actions in improving the management of financial instability. This can be accomplished by strengthening the capabilities of the financial system through the implementation of effective fiscal and monetary policies, ultimately fostering economic growth.