Measuring Islamic Financial Inclusion and Its Role in Promoting Economic Growth: The Case of Malaysia

Research Question: What is the dynamic relationship between Islamic financial inclusion, trade openness, foreign direct investment (FDI), inflation, and economic growth in Malaysia? Motivation: This study is motivated by the growing importance of inclusive and ethical financial systems in supporting sustainable economic growth in Islamic emerging economies, particularly Malaysia, where empirical evidence on the macroeconomic role of Islamic financial inclusion remains limited. Idea: The study develops a composite index of Islamic financial inclusion and examines its dynamic relationship with economic growth alongside trade openness, FDI, and inflation, capturing both long-run equilibrium relationships and short-run adjustment dynamics, including the impact of the COVID-19 shock. Data: The analysis uses annual Malaysian data covering the period 2013–2022. Method/Tools: The Augmented Autoregressive Distributed Lag (ARDL) bounds testing approach is employed, with Augmented Dickey–Fuller (ADF) tests confirming a mixed order of integration and justifying the ARDL framework. Findings: The augmented bounds test provides strong evidence of a long-run cointegrating relationship among the variables; long-run estimates reveal that Islamic financial inclusion has a positive and statistically significant effect on economic growth, while trade openness also promotes long-term growth, whereas FDI exhibits a negative long-run impact and inflation is insignificant. In the short run, the error correction term is negative and significant, indicating rapid adjustment toward equilibrium; Islamic financial inclusion continues to exert a strong positive contemporaneous effect, trade openness shows a negative short-run impact likely reflecting adjustment costs, FDI contributes positively to growth, and the COVID-19 dummy variable confirms a significant contractionary effect on GDP. Furthermore, robustness checks using the Toda-Yamamoto causality test confirm a distinct unidirectional causal flow running from Islamic financial inclusion to economic growth. Contributions: This study contributes to the literature by constructing a composite Islamic financial inclusion index and providing robust empirical evidence on its pivotal role in enhancing macroeconomic stability and growth in Malaysia, while offering nuanced insights into short-run and long-run trade-offs associated with external openness and capital flows, with important policy implications for designing resilient, inclusive, and sustainable growth strategies in Islamic emerging economies.