Effect of interest rate on economic performance: Evidences from Islamic and Non-Islamic Economies

Saving and investment are most important tools for economic growth and interest rate is the most important determinant of saving and investment according to classical, neo-classical and contemporary economists however in Islam riba or interest is considered forbidden, so the aim of this study is to know the effect of religious factor on financial decision of country’s population and its impact on economic growth. As interest rate is forbidden in Islam so country with majority Muslim population should not consider interest rate while saving and investing. We used Panel least square and fixed effect model separately for 57 non-Islamic and 17 Islamic countries from 2005 to 2013. Results suggested that in Islamic countries, people don’t care about interest rate while saving however growth in GDP per capita income seems to effect positively to the saving decision. However for non-Islamic economies GDP per capita growth as well as interest rate both has positive impact on saving. However in the case of investment, interest rate affects negatively while growth in GDP per capita affects positively for both Islamic and non-Islamic countries. Hence there seems to be a need of different policies for Muslim countries in order to increase economic growth as religious factor has effects on financial decisions.