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Impact of Financial Development on Trade Balance: An ARDL Cointegration and Causality Approach for Pakistan

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  • Ahad, Muhammad

Abstract

This paper aim to examine the relationship between financial development, trade balance, exchange rate and inflation by using time series data from 1972 to 2014 for Pakistan. We have tested the unit root properties of variables by using Augmented Dickey-Fuller, Phillips-Perron and Breakpoint unit root tests. The ARDL approach is applied to examine the cointegration between variables due to mixed orders of integration between series I(0)/I(1). The ARDL findings suggested that long run relationship exists between financial development, trade balance, exchange rate and inflation. Error Correction Mechanism (ECM) is applied to analyze short run relationship. The lagged value of the Error Correction Term (ECMt-1) is negative and significant at 1% level of significance. The value of ECMt-1 is -0.91 which states that digression from the short run towards long run is corrected by almost 91 percent by every year. Financial development, exchange rate and inflation have significant impact on trade balance in the long run. But in the short run, only exchange rate and inflation have statistically significant impact on trade balance. Diagnostic statistics have confirmed the characteristics of model in the short run as well as in the long run. The causal relationship between variables are examined by VECM Granger causality and robustness of causal analysis is tested by Variance Decomposition Approach (VDA). The results of VECM have predicted that unidirectional causality from financial development to trade balance exist in the long run. The results of Variance Decomposition Approach explained that 19 percent of trade balance is explained by shocks stimulating in financial development. Government should enhance financial development by managing lending interest rates to improve trade balance.

Suggested Citation

  • Ahad, Muhammad, 2015. "Impact of Financial Development on Trade Balance: An ARDL Cointegration and Causality Approach for Pakistan," MPRA Paper 68545, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:68545
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    Cited by:

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    2. Ghulam Mustafa, 2023. "The Dynamic Relationship Between Financial Development, Economic Growth, Foreign Direct Investment and Trade Openness: Evidence from South Asian Countries," Millennial Asia, , vol. 14(3), pages 406-433, September.
    3. A. O Olohunlana & R. O. S Dauda, 2019. "Implications of financial development on poverty and inequality: Evidence from Nigeria," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 22(71), pages 42-59, March.
    4. Çetin, Murat & Sarıgül, Sevgi Sümerli & Işık, Cem & Avcı, Pınar & Ahmad, Munir & Alvarado, Rafael, 2023. "The impact of natural resources, economic growth, savings, and current account balance on financial sector development: Theory and empirical evidence," Resources Policy, Elsevier, vol. 81(C).
    5. Muzammil, Muhammad, 2020. "A Comparison of Agricultural, Industrial and Services Sector Impact on Trade Balance: A Case Study of Pakistan," MPRA Paper 95750, University Library of Munich, Germany.

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    More about this item

    Keywords

    Financial Development; Trade Balance; ARDL Cointegration; Causality; Pakistan;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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