Macroeconomic Environment and Financial Sector’s Performance: Econometric Evidence from Three Traditional Approaches

Abstract

Stable macroeconomic condition is the prerequisite for sound and healthy performance of the financial sector in the country. The study explores the impact of macroeconomic environment on financial sector’s performance in Pakistan. In doing so, it employs the Fully Modified Ordinary Least Square (FMOLS) approach for cointegration (long-run association) and error correction method for short-run relation. Also Ng-Perron test is used to find out the integrating order of the running variables. The present paper reveals that previous policies of financial institutions and economic growth have improved the level of financial development. Increases in both government spending as well as foreign remittances push the performance of the financial sector upwards. Contrarily, the efficiency of financial markets deteriorates on account of rising inflation due to its damaging impact, while literacy rate has a negative influence on the banking sector in Pakistan. Trade openness along with improved capital inflows open new directions to improve the development of financial markets in the country. Further, performance of the financial sector is attached to qualified institutions. The high savings rate declines the efficiency of banking sector and political instability retards the performance of financial markets.