Relationship between economic growth, domestic credit and nonperforming loans: evidence from emerging economies

This study aims to investigate causal relationships between economic growth, domestic credit and nonperforming loans (NPL) in emerging economies. We use Panel Vector Autoregression (PVAR) and Granger causality to examine the causal relationships among the variables under consideration. Further, in order to investigate the dynamics between the variables, impulse response analysis is performed. We observe four causal relationships among the variables. The study shows unidirectional causal flows from economic growth to domestic credit, and NPL to economic growth. Furthermore, the study observes a bidirectional causal flow between domestic credit and NPL such that innovation in domestic credit leads to a decline in NPL in the short run; on the other hand, innovation in NPL leads to a decline in domestic credit. Findings are robust as the impulse response analysis is performed with different sequential ordering of variables in Cholesky decomposition. The study sheds light on the dynamics of the relationship between these variables and contributes to the literature on the feedback effects of economic growth, domestic credit, and NPL in emerging economies. Based on the findings, the study gives recommendations for monetary and fiscal policy frameworks in emerging economies.