An Empirical Investigation of Relationship between Financial Sector Development and Domestic Private Investment in Pakistan

Headnote

Abstract

This work explores empirically the relationship between the domestic private investment and financial development in Pakistan over the period of 1973-2011. The objective here is to see the impact of bank based financial sector development on domestic private investment. Here, prime alternative proxies as indicators of financial development are used in the model and the method used to find out this relationship is OLS. Autoregressive logarithmic model is used. The logarithmic form of regression variables allows interpretation of the estimated coefficients as elasticity directly. The result indicates that financial sector development has positive effect on domestic private investment in Pakistan. Credit to private sector and liquid liabilities as indicators of financial development have been seen to be the most significant factor to affect domestic private investment positively. It means that financial development facilitates domestic private investment in a way to increase the supply of funds to investors. The impact of terms of trade (TOT) is negative and highly significant. It means domestic private investment is highly sensitive to external shocks in Pakistan.

Keywords

Financial Development, Domestic Private Investment, Financial Intermediaries, Credit to Private Sector, External Shocks.

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1. Introduction

The strength in fiscal terms is reflected by the economy's financial construction. It is understood that a smooth and fully built financial sector is significant for the advancement of the country's economy. The potential investors are provided with assistance through the defined sector when it comes to find sources of funding in order to meet their requirements. It performs many important functions comprising of activities such as resource allocation on effective lines and making opportunities available to use the idle funds for better productivity. It is true in case that if there is a financial sector which is not developed, then there are chances that enough mediums for the mobilization of savings and their use for productive purposes in form of investments will be impossible.

Private sector is an important aspect for the growth of economy and at the same time it is also accepted that in comparison of public investment, private investment is crucial in the measurement and determination of the growth and prosperity of a country's economy. This is very much true in developing countries including Pakistan.

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