The Role of Islamic Finance in Achieving Economic Growth: An Econometric Analysis of Pakistan

Abstract

Islamic finance supports sustainable development goals (SDGs) recommended by the United Nations (UN) as a new global development agenda. A chain of research papers about the dynamics of financial development and growth of an economy is found. Yet, the same research agenda is less explored from the perspective of the impact of Islamic finance on economic growth for the countries with concentration of Islamic finance. Moreover, Islamic finance is the best source of financial inclusion for the interest-sensitive people due to divine instructions. The financial capital has productive role when it delivers to economic agents, facing shortage or excess of funds. Therefore, this study explores the linkages among Islamic financial arrangements and economic growth in Pakistan, by using time series data of Pakistan over 2005–2015. Islamic banks’ financing is used as a proxy of Islamic financing, gross fixed capital formation (GFCF), labor force (LF), broad money (M), gross domestic product (GDP), and trade openness (TO) to present the real sector of an economy. For the exploration, the unit root test, ordinary least square (OLS) method, and Granger causality test are applied. The results validate a substantial causal relationship between Islamic financing and economic growth, but the antipodal is not more valid, which is consistent with the supply-leading view of Schumpeter. The results indicate that Islamic finance contributed toward economic growth that is one of the 17 objectives of SDGs. We recommend policy interventions to unlock the potential of Islamic finance for sustainable growth and development in countries where people are interest sensitive.