Research Center on International Cooperation of the University of Bergamo

FINANCIAL LIBERALIZATION, FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH:

EVIDENCE FROM BANGLADESH
Author(s): Sarkar Humayun Kabir and Hafiz Al Asad Bin Hoque
Source: Savings and Development, Vol. 31, No. 4 (2007), pp. 431-448
Published by: Research Center on International Cooperation of the University of Bergamo
Stable URL: http://www.jstor.org/stable/41406463 .
Accessed: 06/02/2015 00:37
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp

.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.

Research Center on International Cooperation of the University of Bergamo is collaborating with JSTOR to
digitize, preserve and extend access to Savings and Development.

http://www.jstor.org

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

FINANCIAL LIBERALIZATION, FINANCIAL DEVELOPMENT

ECONOMIC
GROWTH: EVIDENCE FROM BANGLADESH

AND

Sarkar HumayunKabir*& HafizAl Asad Bin Hoque**

Abstract
started
theprocess
liberalization
sincethelate1980's.LikemanyothBangladesh
offinancial
erunderdeveloped
countries
theconsequences
liberalization
inBangladesh
areduoffinancial
bious.Previous
studiesdonein within
thecontext
totheperofBangladesh
mostly
pertain
andfinancial
institutions.
Thisstudyisfocused
ontheimpact
formance
ofeconomy
offinancialliberalization
economic
three
, considering
upon
growth
ofBangladesh
proxies
offinancial
suchas realinterest
andefficiency
rate,volume
development
ofintermediation,
ofintermediation.Theanalysisshowsthatdespite
theextensive
in thepost-reform
financial
development
andmonetary
variables
arenotfullycontributing
togrowth.
period,
financial
Keywords:FinancialLiberalization,FinancialDevelopment,EconomicGrowth,
Bangladesh.
: E44,Oil.
JELClassification

1. INTRODUCTION
Marketorientedeconomic policies and the growthorientedfinancialsystem can prudentlymanage the savings mobilizationand efficientallocation
of resourcesin productivesectorsto earn thebest possible rateof return.Fully liberalizedfinancialsystemsfeaturedby least or no governmentcontrolin
ThispaperispartoftheMaster
thesis
ofMr.Sarkar
KabirattheSchoolof
degree
Humayun
PublicPolicyandManagement,
KoreaDevelopment
Institute
(KDI),Seoul,Koreain2002session.Specialthanks
toProfessor
HAHMSang-Moon,
Professor
ofFinance
andEconomics,
KDI
SchoolofPublicPolicy
andManagement,
forhiskindsupervision.
*
-2,Dhaka.
Member
Institute
ofBankManagement
Bangladesh
(BIBM)Mirpur
**Faculty
Lecturer
ofFinance
& Banking,
of
Dhaka.
Dhaka,
Department
University
431

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
DEVELOPMENT
SAVINGS

the creditmarket,freeentryand exit of financialinstitutions,

bank autonowithdrawal
of
shares
from
financial
interest
institutions,
my,
government
rate flexibility,
free internationalcapital movement-contribute
most to the
resources mobilization and allocation process in the economy (Williamson
and Mahar, 1998). Conversely,financialrepressionis featuredby controlled
interestrate in the face of high and unstable inflation,controlledand directed creditto governmentfavoredsectors,and littleor no competitionin the
financialmarkets.McKinnon (1973) and Shaw (1973), with theirworks and
effortsin financialsector reforms,are pioneers who illuminatedthe financially impounded economies and got the economic units to be valorous
enough to break the chains of repression.Afterwards,many developed, developing, and least developed economies in the world, underwent the
process of financial reformsand eventually gained kaleidoscopic experiences. Many countriesfosteredtheireconomic growthand efficiency;
at the
same time,many othersgot frustrating
resultsby facinga financialcrisisand
halted economic growth.
The analysis of a vast volume of theoreticalliteraturehas revealed the
scope of liberalized financialintermediationas a significantdeterminantof
economic growthrate. Earlier literaturesby many scholars such as Patrick
(1966), Cameron (1967), Goldsmith (1969), McKinnon (1973) and Shaw
(1973), insistedon and explained the role of financialinstitutionsin the credit supply process in the economy.Their explanation was buttressedby the
strongpositive relationshipbetween theextentof financialdevelopmentand
economic growth.Goldsmithpointed out how efficiency
of investmentcontributesto financialdevelopment;Mckinnonand Shaw instead,asserted the
role of contributionand functioningof financialpost-reformsin achieving
savings and investmentgrowth.Jappelli and Pagano (1992), Roubini and
Sala-I-Martin (1992), De Gregorio and Guidotti (1992) stated that the
achievement of high rates of economic growth in developing economies
financialsectors.Accordingto
mainlydepends on thefunctioningof efficient
the World Bank (1989), allocation of resourcesto the highestyieldingactivities is the most crucial functionof an efficientfinancialintermediationsystem. Greenwood and Jovanovic(1989) and Bencivengaand Smith(1991) argued in theirstudies thatfinancialintermediariesreshape theirsavings composition for greater capital accumulation, therebynourishing and raising
economic growth.Effectsof financialvariables such as real interestrate and
othermonetaryaggregateson economic growthwas exploredby some other
studies using differentmodels by Agarwala (1983), Anderson (1987),
Khatekhate(1988), Gelb (1989),Gallagher (1991),Odedokun (1992), and Sundararajan (1985, 1987). Most of these studies triedto detectthe contribution
432

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
AND
DEVELOPMENT
ECONOMIC
GROWTH
FINANCIAL
H.ALA.B.
S.H.KABIR,
LIBERALIZATION,
HOQUE

of financialliberalizationand the relationshipbetween economic variables

and growthby takinginto account the ratioof eithermoneyor creditto GDP
or the real interestrate as the proxy of financialsector development and
hence, economic growth.In reality,financialsectordevelopment is multidimensional and can be influencedby differentvariables in differentways.
Moreover,these studies ignoredthe directrole of multidimensionalfinancial
reformson economic growthand efficiency.
Analyzing the relationshipbetween various economic variables and real sectorgrowthat a complex level
is essentiallyrequired in designing financialsectorreformsto obtain maximum benefitat thelowest cost.
The studies done in the contextof the Bangladesh financialsectorare very
limitedin scope because mostof themfocuson theperformanceof theeconoWhat has been ascertainedis the increasein
my and on financialinstitutions.
financial deepening (Khalily et al, 2001), credit expansion (Hoque, 2002;
Khalily et al, 2001), productivityof the banking sector (Hoque and Khan,
2001) and the structuralchanges in deposit behavior as a resultof financial
liberalization(Hoque and Mamun, 2001). Thereis no studyregardingthe impact of financialliberalizationupon the growthof the Bangladesh financial
system,which is the topic of the currentstudy.The financialsector is assumed to affecteconomicgrowththroughdifferent
channels,which are proxied by the real interestrate (RIR), inflationrate, foreigndirect investment
and so on. To examine the effectsof fi(FDI), the volume of intermediation,
nancial liberalization,analyses in thispaper are conductedin two periods: the
pre-reform
period (1974-1989),and thepost-reform
period (1990-2001).
The rest of the paper is divided into four sections. Section two outlines
Bangladesh externalsectorliberalizationand growth,sectionthreedescribes
the frameworkforempirical analysis of the paper, section four reportsthe
resultsof the econometricanalysis,and the finalsectioncontainspolicy implicationsand concludingremarks.
2. BANGLADESH EXTERNALSECTOR LIBERALIZATION AND GROWTH
For the last two decades Bangladesh has been undertakinga number of
measures to integratetheexternalsectorwith therestof theworld to achieve
fastereconomic growth.Externalsectorreformmeasures were introducedto
induce higher investments,promote exports,reduce trade deficitbalance,
and to make the domesticcurrencystronger.Apparently,identifyingthe impact of externalsector reformmeasures is not easy, particularlyin an environmentwhere the process of reformsstartedabout two decades ago. How433

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
DEVELOPMENT
SAVINGS

economic indicatorssuggest that macroeconomicchanges in

ever, different
the post-reform
period are making a differencecompared to the pre-reform
trend.It can also be examined whetherthe situationsin termsof the above
mentionedobjectiveshave been improved or not, afterundertakingthe externalsectorfinancialliberalizationmeasures.
There has been a notable change in the level of GDP growthrate in the
period. The annual average
post-reform
period compared to the pre-reform
level of real GDP increasedfrom3.47 percentin the 1980s to about 5 percent
duringthe 1990s.The per capita annual average GDP growthratewas 3 percent in the 1990s as compared to 1.6 percentin the 1980s. Domestic savings
rateis low in Bangladesh,but improvedin thepost-reform
period. The annual average savings rate (as a percentof GDP) increasedto around 7 percentin
the 1990s fromaround only2.3 percentin the 1980s.Domesticsavings growth
rate,in both absolute and percentageterms,have increasedduringthe postreformperiod. Long-termdomestic investment,like domestic savings, increased in the post-reformperiod. The annual average ratio of gross fixed
capital formationto GDP increasedof more than 14 percentduringthe postreformperiod, from10.48 percentin the 1980s. The absolute level of longterm investment(deflated series of gross fixed capital formation)also increased by about 35 percentin the 1990s as compared to the 1980s. However,
theannual average percentagegrowthrateof grossfixedcapital formationreduced marginallyfrom9.71 percentto 7 percentin thepost-reform
period.
The average returnon investment(GDP to long-terminvestment)decreased to 7.19 percentin the 1990s from9.85 percentin the pre-reform
period. The annual average growthrate of the ratioremainednegative throughout 1999-80in both absolute and percentageterms.Therewas a positive correlationbetween privatecapital flows to GDP and M2 to GDP in Bangladesh
during the 1990s. M2 to GDP experienced considerable absolute average
growthin the post-reform
period. Level of M2 to GDP reached to about 38.5
in
the
percent
post-reform
period from28 percentin thethe 1980s.
Reformstowards externalsectorliberalizationare expected to have positiveimpacton domesticcredit.During thepost-reform
period the annual average level of privatecreditto GDP, a measure of financialdevelopment,increased to about 26 percentfromonly 17 percentin the 1980s.Capital market
in Bangladesh is still at a initial stage despite many reformmeasures have
been takensince the 1996 debacle.1The marketcapitalizationto GDP ratioof
Bangladesh was only 2.5 percentin the year 2000, against 130 percentfor
1 There
inBangladesh
in1996where
Stock
Market
theDSEshare
wasanirrational
behavior
to3567on14/11/96.
from
832on01/01/96
priceindexjumped
434

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
H.ALA.B.
AND
S.H.KABIR,
FINANCIAL
DEVELOPMENT
ECONOMIC
GROWTH
LIBERALIZATION,
HOQUE

Malaysia, 86 percent for Chile, 69 percent for Philippines, 38 percent for

Brazil, 33 percentfor South Korea, and 32 percentfor India (World Bank,
2001, Global Development Finance,WashingtonD.C.). During the 1990s,the
countryhas experienced a significantgrowthof merchandiseexports.The
average real growthof totalexportswas 5.19 percentduringthe 1987-89period. This figurejumped to 16.22 percent during the 1992-94 period. This
growth reached a 37.1 percent during 1994-95,declined to 11.8 percentin
1995-96 and slightlyrecovered again in 1996-97.Both the Asian crisis and
September11 affectedexportvolume adversely and a significantslowdown
caused negativeexportgrowth,particularlyafterthe Twin Tower tragedyon
September11, 2001. Compared to the exportsector,performanceof the import sectorwas slow except forthe period 1995-96.Bangladesh experienced
a favorabletrade duringthe 1990-94period. The termsof trade improvedby
2.3 percentin 1990-91,1.4 percentin 1991-92,3.5 percentin 1992-93and 2.4
percentin 1993-94.However, it deterioratedin 1994-95due to an increase in
importprice index.
3. A FRAMEWORK FOR EMPIRICAL ANALYSIS
A financialsectorreformtypicallyinvolves a set of measures such as (1)
withdrawingceilings on deposit and lending rates (2) no restrictionson the
quantityof credit(3) reducingreserverequirementson deposit (4) no restrictionson the entryintobankingand encouragingprivateownershipof banks
and (5) no restrictionson capital transactionswith foreigners.Although the
above measures are not exhaustive,theyinclude the major dimensionsof reformmeasures thathave been adopted by policy makers or governmentsof
various countries to allow marketforces to determinethe optimum price
and quantityof credit,in order to achieve highereconomic growth.At the
same time, liberalizationhas been characterizedby a greaterscope being
grantedto marketforcesin determininginterestratesand in allocatingcredit
(Caprio, Atiyas and Hanson, 1994). The measures of financialliberalization
have theireffecton economic growththrougha numberof channels,including the cost of capital, the volume of savings and investmentfunds,the distributionof funds and projectselection.Cross-countryevidence on the impact of financialliberalizationon growthis not same because financialliberalization is a multidimensionaland sequential process, which largely depends on the policy and institutionalframeworkof the particularcountry.
The policies adopted fora particulareconomymay not be suitable foranother economy,because of differencesin the financial structure,institutional
435

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
DEVELOPMENT
SAVINGS

in internationalconnections.As Bangladesh has been an

base and differences
hesitantreformer,
the channels throughwhich financialliberalizationaffect
have not been addressed by others.In thispaper these
growthand efficiency,
issues are analyzed.
The channels throughwhich the financialsector affectsgrowthare not
readilyobservable,and hence,it is necessaryto relyon a numberofproxiesor
indicatorsof financialdevelopment.This paper concentratedon theimpactof
threeproxies of financialdevelopment:(1) The level of real interestrate (2)
and (3) The efficiency
ofintermediation,
followThe volume ofintermediation
reform
and
The
above
mentioned
financial
Johnston
(1995).
ing
Pazarbasioglu
measures are likelyto affectthesethreeproxiesof financialdevelopment.For
and thus interestrate
example,real interestrateshould reflectcapital scarcity,
allocation
as well as thequality
should
reduce
the
of
ceilings
efficiency capital
of investment.By reducingthe scope forriskpremium,loan rateceilingsdisA large proportionof potentially
by financialinstitutions.
courage risk-taking
out of the market.Interestrate
investments
are
rationed
high-yielding
being
liberalizationcould therefore
affectthe real interestrate,the volume of credit
and the efficiency
Bivariateanalysismay produce
of financialintermediaries.
results
due
to
omitted
variable
bias
(Lutkepohl,1982). So, by enmisleading
all
three
into
the
tering
proxies simultaneously
equations for economic
it
be
to
the
could
differentiate
growth,
possible
importanceof the different
channels. Financial reformsmay affecteconomic growth through certain
in themodel may measure financial
channels.First,volume of intermediation
real
interest
rate
indicate
theprice of scarcecapital in the
depth.Second,
may
market.Finally,spread in themodel may expresstheefficiency
of financialintermediation.The consequencesof thefinancialsectorreformcan be observed
partlythroughthemovementsin theproxies.Financialsectorreformis also a
process,whichnecessarilystimulatesstructuraland institutional
changesover
time. Though some of the reformmeasures have startedfrommid-eighties,
the fullextentof liberalizationmeasures startedin 1990. Under this scenario
we splitthe totalsample intotwo halves - one is thepre-reform
period,from
to
and
the
other
the
from
is
1974:Q1 1989:Q4
1990:Q1 to
post-reform
period,
2001:Q1. This approach allows us to study the impact of different
channels
which
the
financial
sector
affects
the
of
real
under
the
sector,
through
growth
conditionsoffinancialrepressionand duringthepost-reform
period.
3.1 TheModel
An equation has been constructedto examine the impact of financialliberalization on economic growthfor Bangladesh, where the growthrate of
GDP (GRGDP) is a dependent variable. The relationshipof growth with
436

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
AND
ECONOMIC
GROWTH
FINANCIAL
DEVELOPMENT
H.ALA.B.
S.H.KABIR,
LIBERALIZATION,
HOQUE

threeproxies of financialdevelopmenthas been explored: (1) The level of real interestrate (RIR) (2) The volume of intermediation(M2GDP) and (3) The
efficiencyof intermediation(SPREAD). The otherexplanatoryvariables include:
CPSGDP = claims on private sector by deposit money banks divided by
nominal GDP
= sum of exportsand importsdivided by nominal GDP.
EXIM
FDIGDP = foreigndirectinvestmentdivided by GDP.
RMGDP = reservemoneydivided by nominalGDP.
= inflationratecalculated as percentagechange in consumerprice
INF
index.
The generalfunctionalformforgrowthequations can be expressed as:
GRGDP = Q+ faCPSGDP + 2EXIM + 3FDIGDP + 4M2GDP + 5RMGDP
+ 6SPREAD + yRIR+ 8INF + Ej
(1)
Where 0 is constantand 1 tos are estimatedcoefficients.
eis the serialis
on
the
uncorrected
error
term.
Linearity imposed
equations and the exly
E (e) = 0; (b) Varithat
of
error
is
zero
i.e.
assumes
(a) Expectation
pression
ance of erroris a2 i.e.(s) = S2; (c) Errortermsare not correlatedi.e. N (0, a2);
(d) The observationsare independent.
3.2 Relationship Between theProxies ofFinancial Development
and Economic Growth
Real InterestRate
Real interestrate affectsfinancialsector development throughits influence on volume of financialsavings and on the cost of capital (McKinnon,
1973; Shaw, 1973; Fry,1988; Leite and Sundararajan,1990). Existingempirical
evidence suggests that national savings rate may be affectedpositivelyby
the real deposit rate of interest.However, only in countrieswhere the deposit rate is negative,thereis much scope to increase saving by raising the
real deposit interestrate.As the Bangladesh economyhas been represseduntili 1989, real deposit interestrate was negative (Khalily et al, 1987; Srinivasan, 1988). Negative real interestrate could not attractmuch financialsavings, as financial deepening was lower in the repressed regime. There is
greater extent of financial deepening in the financial reformregime in
Bangladesh. Financial liberalization opens the door to productive invest437

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-XXXI
-No.4-2007
AND
DEVELOPMENT
SAVINGS

fundsat competitiverates.From a theomentopportunitiesto get sufficient

reticalpoint of view, higherequilibriumreal interestrates should be associated with more efficientinvestmentsand higherrates of returnon capital,
which in turnpromoteshighereconomicgrowth.
Volume of Intermediation
If financialliberalizationimproves the rate of returnforsavers, then the
volume of intermediationis expected to increasein the long run. Holding of
financialassets and financialdeepening generallyincreasesas due to liberalized interestrates and to the introductionof new financialinstruments.The
financialsectorreformis usually associated with the increaseof financialdevelopment (deposit or currencyin circulationand broad money as percentage of GDP). Recent studies by Balassa (1990), Srinivasan (1993) and Fry
(1995) conclude thatinterestrate has a positive ratherthan negative impact
are generallysmall and ofteninsignificant.
upon savings,but thecoefficients
An increasein financialintermediationshould involve real savings rather
than a positive inflationcomponentto affectpositive and highereconomic
growth.In Bangladesh, the financialsectorhas been liberalized with no restrictionon interestrate and credit.As it happened in Bangladesh, rapid
creditexpansion oftenfollows the liberalizationof controlson the banking
system.In Bangladesh a good numberof privatebanks have emergedin the
post-reformperiod. Deposit and credithave expanded enormouslyin the
liberalized regime in Bangladesh.2 The level of real interestrate and the
proxy forthe efficiencyof the financialsystemshould controlthese factors.
Hence, we anticipate that the volume of intermediationvariable will play
the main role in the financialsystem,by promotingsavings and positively
contributingto growth.
The study uses two alternativeproxies forthe volume of financialintermediation throughthe banking system- the share of creditto the private
sectorsby banks in GDP (denoted as CPSGDP) and Financialdeepening (denoted as M2GDP). These two variables capturethe two main functionsof financial market,one is the deposit mobilizationrole and the otheris thecredit allocation role. CPSGDP is a more appropriateindicatorof the volume of
intermediationthroughthe banking system,than the CREDIT variable as
used by De Gragorio and Guidotti (1992) and King and Levine (1993), because it excludes the creditgrantedto the privatesectorby the centralbank,
which is oftenhigh duringfinancialrepression.
2 Forinstance
in post-reform
rate(adjusted
forinflation)
realdepositgrowth
periodis
rateis8.25%inthesameperiod.
about9%andrealcredit
growth
438

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
AND
DEVELOPMENT
ECONOMIC
GROWTH
H.ALA.B.
FINANCIAL
S.H.KABIR,
LIBERALIZATION,
HOQUE

Efficiencyof Intermediation
Iffinancialreformcannotensure theefficient
allocationof resourcesit can
be detrimentalto the long-runeconomic growth.If liberalizationin the form
of increased competitivenessand efficiencydoes not contributeeither in
termsof financeand creditavailability,or in termsof the reductionof intermediation costs, then it can be said thatliberalizationhas departed fromits

target.
Banking system plays a predominantrole in credit allocation. Banking
in creditallocation is usually reflectedin activitiessuch as
sectorinefficiency
wide lending margins,which in turn reflectincompetitivenessin banking
industry.Bad and classifiedloans in thebankingsectorare anotheraspect of
asset-liabilitymanagementin banks
efficiencyin intermediation.Inefficient
contributes
to plethora of non-earningasinefficient
by
managementbody
variables to represent
sets in banks' portfolio.This paper used two different
the efficiencyof intermediation.The firstone is the spread between lending
and deposit interestrate (denoted as SPREAD) and the second one is the ratio of reservemoney to GDP (denoted as RMGDP). The spread may not be a
robust indicator of efficiencybecause interestrates were administeredbefore reformmeasures, and afterthe reform,it is influencedby numerous
governmentregulations.Reserve money is definedas the currencyin circulation, plus the required and excess reserves in the banking industry.The
variable RMGDP therefore,includes the currencyto GDP ratio,which is a
measure of efficiencyof the overall banking industryin enhancing the volume of GDP.

4. ESTIMATION RESULTS
EstimationresultsfromOLS regressionsappear in Appendix 1, 2 and 3.
Initially,therewas serial correlationproblem in the resultsas evidenced in
low D.W. statistic.We have made a correctionforserial correlationby using
Cochrane-Orcuttiterativeprocedure.The analysis of the data show thatdifferentMacroeconomicvariables influencedeconomic growthof Bangladesh
in different
ways, during pre-reformand post-reformperiods. Financial intermediationvariables share creditto the private sectorsby banks in GDP
(measured by CPSGDP), and financialdeepening (measured by M2GDP) influencedeconomic growthalmost in the same way. CPSGDP has a insignificant negative effecton growthin both the pre-reform
and post-reform
periof the private sectorsin using resources
ods, wich indicates the inefficiency
439

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-XXXI
-No.4-2007
AND
DEVELOPMENT
SAVINGS

obtained as loans frombanks. It happened because of a faultyand prolonged

entreprivatizationprocess that caused the creationof fake and inefficient
variable
banks.
Also
the
from
the
who
could
not
highestreap
get
preneurs
M2GDP has had a negative effecton economic growth,particularlyin the
post-reform
period. This implies a weakness of the banking sectorin mobilizing savings thatmismatchedthevolume of loans.
The efficiencyof financial intermediationproxied by RMGDP and
SPREAD has both positive as well as an insignificanteffecton growthin
period. RMGDP bears significantpositive impact and SPREAD
post-reform
bears insignificantpositive impact on growthin pre-reform
period. This result indicates the detrimentaleffectof liberalizationin post-reformperiod.
Untimelyand inappropriatebankingsectorliberalization,as previouslystated, worsen the crisesof thebankingsectorin Bangladesh,which was caused
by a huge volume of non performingloan, labor union activities,adverse selection,politicalinfluenceto directcreditetc.
Trade liberalizationproxied by EXIM, the sum of exports and imports
over GDP has significantnegativeinfluenceon growthin pre-reform
period,
and significantpositive influenceon growthin post-reform
period. This result means thattrade is beneficialto economic growth.Aftera decade of financial liberalization,thereis evidence of integrationwithgoods marketand
exchange market (Hoque and Kabir, 2002), which is necessary to benefit
fromthe openig of trade.
Looking at the entireperiod, FDIGDP, the ratio of foreigndirectinvestment to GDP has a positive effecton growthbut the same variable has inperiod. However, in
significantnegative effecton growthin the pre-reform
the Post-reformperiod, FDIGDP has a positive effectthough it is insignificant. As a matterof fact,the inflowof FDI in Bangladesh is relativelylower
as compared to otherSouth Asian countries,probably due to lack of better
administrativecorruption,narrow market,
socio economic infrastructures,
and sees
therecentsituationis different
and politicalunrest.On thecontrary,
favorableconditionsforthe FDI inflowin Bangladesh, which is expected to
have a positiveeffecton theeconomic growth.
RIR (Real InterestRate) has a significantpositive influenceon growth
during the entirepre-reformand post-reformperiods. Real interestrate increased eitherbecause of increased deposit rate or because of decreased inflationrate. Bangladesh captured the positive impact of RIR on economic
growth.Inflationrate (INF) has negative and significanteffecton economic
and post-reform
periods. This negativeeffect
growthin both pre-post-reform
a
of
economic
fact
that
inflation
is
setback
the
growth.
implies

440

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
H.ALA.B.
AND
S.H.KABIR,
FINANCIAL
DEVELOPMENT
ECONOMIC
GROWTH
LIBERALIZATION,
HOQUE

5. POLICY IMPLICATION AND CONCLUDING

REMARKS

The financialsectorin Bangladesh has experiencedreformprograms,but

the resultof these financialreformsis dubious. The well-documentedeffect
of liberalizationis that it increases financial deepening, foreigntrade improvement,creditexpansion and so on. However, the goal of financialliberof the financialsystem,
alization,which is to improve growthand efficiency
is not addressed in the literatureconcerningBangladesh. The econometric
analysis done in this paper improves our understandingof whetherliberalization did help improvingthe growthof theeconomy,or not.
The negative impact of inflationupon growthimplies the factthatinflation distortsgrowthand resourceallocation,otherthan the impact of financial variables. Bangladesh governmentdevalued its currencymore than 19
times and currencydevaluation is inflationaryin the contextof Bangladesh
(Hoque and Kabir,2002). Though currencydevaluation may increase export
competitiveness,this device cannot achieve its targetin an economy like
Bangladesh where exportdepends on large volume of imports,particularly
in the clothingsector.That ultimateeffectin economic growththroughinflationis thereforedetrimental.
Trade liberalization,as proxied by the sum of exportsand importsover
GDP (EXIM) has positive sign during the post-reform
period, implyingthat
trade-liberalization
is generallybeneficialto economic growthand efficiency.
Tariffreductionsfromabout 25% to 16% in 1996,permissionof 100% foreign
ownership in most economic activities is encouraging in this direction
(Bangladesh Bank, 1997). The variable CPSGDP, the share of creditto theprivate sectorsby banks in GDP, has an insignificant
negative effecton growth
in both pre-reform
and post-reform
periods. The resultssuggest inefficiency
of the banking sectorand weak privatizationprocess. The role of the public
sector should be reduced in economic activities.A privatizationboard has
been created to de-nationalize public sector firms.Meanwhile 600 public
firmssold off(CPD, 1996). Though some initiativeshave been taken,we suggest all public sectorcompanies should be handed over to theprivatesector.
Real interestrate (RIR) has a significantpositiveimpacton growthboth in
and post-reform
pre-reform
period. Interestrates were gradually liberalized
and some sectorslike agriculture,exportsand cottageindustriesenjoyeda 3%
subsidy in the post-reform
period. As the interestrateshave not been liberalized to thefullestextent,theanalysisdoes not show cleareffectson growth.
The volume of financialintermediation(representedby M2GDP) has insignificantnegativeeffecton growthin the post-reform
period. This resultis
consistentforBangladesh,with the structuralweaknesses of thebankingsec441

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
SAVINGS
DEVELOPMENT

tor in savings mobilization.Though the Bangladesh banking systemsuffers

froma lot of problems- huge loan defaults,adverse selection,politicalinfluence to directcredit- expansionsstillappeared as positiveforgrowth.The efficiencyof intermediationas proxied by spread has an interestingeffecton
and
growth. The effectis insignificantly
positive in both pre-post-reform
As
there
is
a
in
amount
of
loan
the
post-reform
periods.
huge
non-performing
in
sector
the
Bangladeshbanking
post-reform
period,itmay affectresults.
Bangladesh embarked on financialliberalizationas part of its development strategy to secure sustainable economic development (Ariffand
Khalid, 2000). The main concern was to increase savings and mobilize resources efficiently,
which should lead to higherefficiencyand ultimatelyto
Our
higher growth.
analysis shows that though there is a considerable
amount of financialdevelopment in the post-reformperiod, financialand
monetaryvariables are not contributingfullyto growth.The sequence of financial sectorliberalizationhas been foundto be crucialto the success of liberalization.In Bangladesh, the domesticsectorhas not been fullyliberalized
beforethe trade sectorliberalization.It hampered the abilityof domesticindustries to compete with the world market.Similarly,trade and capital account liberalizationneed to be done carefully.More specifically,McKinnon
(1982) suggested that trade liberalizationshould be done afterfiscal deficit
has been eliminated.Policy makersneed to take intoaccount all thesefactors
to take appropriatesteps to ensurerobusteconomic growth.

References
and Growthin DevelopingCountries",
World
AgarwalaR.K.,1983,'TriceDistortions
BankWorking
WorldBank.
PaperNo.575,Washington,
AndersonD., 1987,"EconomicGrowthand theReturnsto Investment",
WorldBank
Discussion
No.
World
Bank.
12,
Paper,
Washington,
Ariff
M. and A.M. Khalid,2000,"Bangladesh:Restructuring
and Liberalization
did
Growth
andtheAsianFinancial
: Lessons
Crisis
help"in Liberalization,
forDeveloping
andTransitional
Economies
inAsia,EdwardElgarPublishing
Limited.
Balassa ., 1990,"TheEffects
ofInterest
Rateson Savingsin DevelopingCountries"
BancaNazionale
delLavoroQuarterly
Review,
172,pp. 101-118.
Annual
Bank.
BangladeshBank,1997,
Report
ofBangladesh
V.and B. Smith,
Intermediation
andEndogenous
1991,"Financial
Growth",
Bencivenga
TheReview
Economic
Vol.
No.
195-209.
Studies,
58,
2,
of
pp.
442

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
AND
ECONOMIC
GROWTH
H.ALA.B.
FINANCIAL
DEVELOPMENT
S.H.KABIR,
LIBERALIZATION,
HOQUE

in theEarlyStagesofIndustrialization
CameronR., 1967,Banking
, New York:Oxford
Press.
University
: Theory
andEvidence,
I. Atiyasand J.Hanson,1994,Financial
Post-reform
CaprioG. Jr.,
Press.
Cambridge:
CambridgeUniversity
orStagnation
CentreForPolicyDialogue,1996,Growth
?, Dhaka,Bangladesh:UniverPress.
sity
and EconomicGrowth",
De Gregorio
1992,"FinancialDevelopment
J.and P.Guidotti,
Fund.
International
IMF Working
92/101,
DC,
Monetary
Paper
Washington
2nd
andBanking
in Economic
Interest
Development, edition,BaltiFryM.J.,1995,Money,
Press.
moreand London:JohnsHopkinsUniversity
in Economic
Baltimoreand
and Banking
Development,
FryM.J.,1988,Money,Interest
Press.
London:JohnsHopkinsUniversity
in Africa,
and Economic
Growth
Boulder,Colorado:
GallagherM., 1991,Rent-seeking
Westview
Press.
Growth
andEfficiency,
WorldBank,
GelbAlanH., 1989,Financial
Policies,
Washington:
June.
andDevelopment,
Structure
New Haven:YaleUniversity
Goldsmith
R.,1969,Financial
Press.
and DistriGreenwoodJ.,and B. Jovanovic,
Growth,
1989,"FinancialDevelopment,
Political
Vol.
No.
1076-107.
butionofIncome",Journal
98,
4,
of
Economy,
pp.
of NCBs, SBs, FCBs,
Hoque Hafiz Al Asad Bin,2002,"ComparativePerformance
PCBs and IBs FinancialPost-reform
Journal
ofInstitute
Regime- An Evaluation",
of
Bankers,
Bangladesh.
ErrorCorrecHoque HafizAl Asad Binand SarkarH. Kabir,2002,"Conintegration,
tionand TestsofPurchasing
PowerParityDoctrine:EvidenceFromBangladesh",
SavingsandDevelopment.
ofBanks:A
Hoque HafizAl Asad Binand A.R. Khan,2001,"FinancialPerformance
Statistical
of
Journal
Analysis",DhakaUniversity
ofBusinessStudies,University
Dhaka,Vol.22,No. 1,June2001,pp. 27-49.
Hoque Hafiz Al Asad Bin and AshrafAl Mamun,2001, "Deposit Behaviorin
Shiftin Deposit"MimeoBangladesh- An Econometric
Analysisof Structural
graphed.
and Liquidityconstraints",
CEPR
JappelliT. and M. Pagano,1992,"Saving,Growth,
Discussion
No.
London:
Center
for
Economic
662,
Research,
Paper,
Policy
May.
"
R.B.and C. Pazarbasioglu,
Fi1995, LinkagesBetweenFinancialVariables,
Johnston
nancialSectorPost-reform,
and EconomicGrowthand Efficiency",
IMF Working
95/103.
Paper,
M.A
Khalily
Baqui, R.L. Meyerand L.J.Hushak,1987,"Deposit Mobilizationin
forRuralFinancialInstitutions
and FinancialPolicies",
Bangladesh:Implication
TheBangladesh
Vol.
No.
December
Studies,
XV,
4,
1987,(85-117).
Development
443

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
DEVELOPMENT
SAVINGS

Banking
KhalilyM.A.Baqui,M. Islamand S.A. Khan,2001,"FinancialLiberalization,
in DCSectorand Industrial
Finance:Stagnancy
orDynamism?",
Paperpresented
CI Seminar,
Dhaka,Bangladesh.
Khatekhate
Ratesin Less Developed
D.R., 1988,"AssessingtheImpactof Interest
World
Countries",
, Vol.16,No. 5 pp. 577-88.
Development
mightbe Right"
KingR.G. and R. Levine,1993,"Financeand Growth:Schumpeter
108:717-37.
Journal
ofEconomics,
Quarterly
RateManagement
and LiberLeiteS.R and V.Sundararajan,
1990,"Issuesin Interest
Vol.37,pp. 735-52,
International
Fund.
alization",Staff
Papers,
Monetary
due to OmittedVariables",
Journal
ofEconometLutkepohlH., 1982,"Non-causality
rics,Vol.19,pp. 367-378.
McKinnonR.I.,1973,Moneyand Capitalin EconomicDevelopment,
DC:
Washington
Institution.
Brookings
McKinnonR.I.,1982,"The orderofeconomicliberalization:
lessonsfromChileand
in K. Brunnerand A. Metzler(eds), Economic
Policyin a Worldof
Argentina",
Series
on
Public
Vol.
Change:Carnegie-Rochester
Conference
Policy, 17,Amsterdam:
NorthHolland.
OdedokunM.,1992,"Multi-Country
Evidenceon theeffects
ofMacroeconomic,
Finanin theDeveloping
cial and TradePolicieson Efficiencies
of ResourceUtilization
IMF Working
Fund.
International
Countries",
paper92/53,Washington:
Monetary
PatrickH.T.,1966,"FinancialDevelopmentand EconomicGrowthin Under-DevelEconomic
andCultural
Vol.14,pp. 174-89.
oped Countries",
Development
Change,
RoubiniN. and X.Sala-I-Martin,
and
"Financial
1992,
Repression EconomicGrowth",
Vol.
5-30.
Economics,
39,
Journal
ofDevelopment
pp.
"
inEconomic
New York:OxfordUniShaw,L., 1973, Financial
Deepening
Development",
Press.
versity
SrinivasanA., 1988, "A MultiproductCost Study of Rural Bank Branchesin
Ph.D.Dissertation,
OhioStateUniversity.
Bangladesh",
Unpublished
SrinivasanT.N.,1993,"Savingin theDevelopmentProcess"in J.H.Gapaniski,ed.,
TheEconomics
Kluwer.
ofSaving,Dordrecht:
ratios
ofFirmsand Interest
RatePolicy:MacroV.,
1985,
Sundararajan
"Debt-Equity
economiceffects
ofhighleveragein DevelopingCountries",
Papers,Vol.32,
Staff
Fund.
September,
pp. 533-44,International
Monetary
RatiosofFirmsandtheEffectiveness
ofInterest
V.,1987,"TheDebt-Equity
Sundararajan
RatePolicy:AnalysisWitha DynamicModelofSavings,Investment,
in
andGrowth
Vol.34,June,
International
Fund.
Korea",Staff
Papers,
pp.260-310,
Monetary
Williamson
liberalization',
J.and M.A. Mahar,1998,"A survey
offinancial
EssaysinInternational
No. 211,Princeton
New Jersey,
USA.
Finance,
Princeton,
University,
WorldBank,1989,World
New York:OxfordUniversity
Press.
Development
Report,
WorldBank,2001,GlobalDevelopment
D.C.
Finance,
Washington
444

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
DEVELOPMENT
AND
ECONOMIC
GROWTH
FINANCIAL
H.ALA.B.
S.H.KABIR,
LIBERALIZATION,
HOQUE

>.ONt^ONOOOONON
^oqvqoqoNOsONoqoq

CA

#o
^

S i
'
1S ri
U O
S
3 s
x * ^
S s i
.2 Dn

,
li .M
, s
w tu

<.

en
_u
CA
X2
I
It((CNTje
^oot^oooooooooooo
1
^ooooo

m
CA
"S
*
*
*
*
rT
'o
LTT
^
OJ
<=*
IN.

^
H
HP

NON
Z
OO
Nos
CNJOO
1-1
^
^
N
T-T1
<
#
*
*
*
OO
CA

IcD
* CO
* T-H
* So
C*5 * o
LO
*#

CNON
C'| ON
Cs|ON

S40 (NON
rsCtcndw
rs
.SP
>
e
0
^
_
jsj
"
~
~ ^ ~
~
fe
t3

Cn
CA

OO^-V
LO^ QO'-- ^

U
1
<
3IS3
S32
'
fN

tN^csj^CN
_
43
.1
CA
4-4
s
?
3
|

S
I
CO^ ^
CO^fO^.
'
g
>
5
&H
fi O O^ ^ <ET O co" fe ^ S ^
oT -' OcTfe T -
<
IX,
S5"
LO
5

$ % h & k $ k z b z h $

^ V ^ V tQ V ^
ONV
V
^
g
CA

CA
8
s^
2
g s^ $ s^
CA
^
SC - -, o
*

1
(

I iKSSf^SSsisKSo^g
'"
o
(N -rt V ^ <N
0<^J

"?
^ <N
O
(d

-C

S- iCNCO^LO4Ot^00

cr
w

z
445

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-No.4-2007
-XXXI
AND
SAVINGS
DEVELOPMENT

0LOO>t^t^OO
>-40
^OOONOOOOOOOOONON

*
S
0
^GO
t
2
3
ON
rH

W I
X> rH
1 ^
2 S
S

_, 3/3

s
X t
I
I?

D -M
5
.
s
3*
&
< ''S

CA
In
i
^.fNCNcOfNfNCNT-HTs1
,0000000000000000
^ooo

* 'S
* 4
* rT
* 4

- ^

)
^p ^LO

(N H
Z
OCO
fN^
1-1
fNV,
fN^
H
HT1
d
&
#g
*
* LT?

CA
*LFT
I CT

H^
^ ^
ON
s
-^^
rg ^^
rsi^
2

w
H dd
#
v
)

_
_

^
"S
P
^ *- * ^

"u
)
S"
*
*
*
CLh *

1
fN^
4
v
N
^ ^'
QJJ
I^fNJ
H

Nevi
N
H
S!
^
s
i

LO

LO

* ^ ^ ^
*
.1
CA

5
0
5

^ ^

^
^

^
CD
rJ

i
on
ONW
^
? ,_ 2;,
43
g
>
5-
I ^

^
0

ON
^ON
^ON
^-
n
'-io
Ij ^ ^fN&
Q

^
N

T
rt

0
s
-< fN
I
I
COs-, CO
CO4-,' ON4-,- ON-,
, CN I* 2 ^- On^T- CO

Q
1
1
1
1
1
1
1
,
p_
sP
^
LO
********
-

N
So

T
*
LO

2P
^
^
N rH
,- On,-i

^ O
^
p
LO
X
fN
> ^<N
^ ^tN
S ^I

I OfN
li
I LO
i O
r-t 4~'
T1
i fN
LOfN
Ol ^rsi 00
OI rsj
^
*T
"f
'T
*"?
{
^

(
ib 3

g
sg^g

CA

- S
8 ^ S -r

CA
rt

$:
ON
S
Co
Co
1 C4^
in

^
So
^
gg
CTS
LO
^ 04 NO^J.
S CO
(vj
1
'-I ' S

CN1^
V ^ 1^
^
d.
.
O

_o

"ifNC0^t!LO4Ot^00
3

cr

446

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-FINANCIAL
AND
GROWTH
DEVELOPMENT
ECONOMIC
FINANCIAL
H.ALA.B.
S.H.KABIR,
LIBERALIZATION,
HOQUE

>-^
-(CN-hOt-hO
-

>
QtNtNC4tNrsCNtNCN
rsllDtN^^^CO^
^OOOOOO
.
CJ
H
04

0
g

s2

'

CN
ON

^ ci-
LOci- ^ Cl- CO- CO

O ^ CTn
.- .
Q
-Ht^
>R CO" so
^CO^lT)^
U

sags

^
SgggSSsg^sSgKgSS'
' *-I ^
OO
*-

1-4 ^ ci- rsl

CO

O v ^ 4
M
S

ri
S 2
1
S- 7
W
.
5
^ S
2 S
O d
53

3 *
en J ^
2 *
1
!
^
W 5 2
S
<
Cl
< W &

_
^

_
_
^pt^o^j^oB^
^

8
Q

t^N
^
*
*
-I ^r-
^

^
Le

^ $,

* ^ V
3

* .. s
^'>

*
ON
to
^

t ao

on4

^ ON

ifi CT

1 '

Sd.
CO

^-vt^^v
OOOOOOO
o
^ ^^ 1-H
^ ^

|I?!||li||?iHH

g
J=i
-
fC
3
cr
W

CN

CO

LO

vO

t4^

OO

#u
CA
J3

(d
a
*S

&
G
CA
2
.1
vSh
>
e
'
"
4>
CICA
2

S
s
CA

43
>
JU
5rH
-
s
c
1>

lH

Cn
8
CA
(

jU
1

-
S

o
G

PQ
2
447

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions

-XXXI
-No.4-2007
AND
SAVINGS
DEVELOPMENT

Rsum
financire
Le Bangladesha commencle processusde libralisation
depuisla finde
sontambigus; cette
la dcennie1980-90.Les consquencesde cettelibralisation
surla croissanceconomiqueen
surl'impactde la libralisation
tudese concentre
: le tauxd'intrt
du dveloppement
financier
troisproxies
considrant
rel,le volume
dmontre
de l'intermdiation.
et l'efficacit
des fondsintermdis,
que,
L'analyse
les variables
financier
dans la priodeaprsrforme,
malgrun fortdveloppement
la croissance.
ne contribuent
financires
etmontaires
pas totalement

448

This content downloaded from 119.148.3.126 on Fri, 6 Feb 2015 00:37:56 AM

All use subject to JSTOR Terms and Conditions