Does financial development cause economic growth: a case study of Nepal

A large number of studies have been conducted to investigate the association between financial development and economic growth. However, whilst these studies have found substantial evidence to support the notion that financial development has a positive impact on growth; a remarkable knowledge gap reamins - on casual direction, and on the ways in which country specific policies and institutions influence the findings. Into this milieu, we conduct this study to investigate whether financial development is important for real growth in Nepal. We employ a Granger non-causality test developed by Toda and Yamamoto (1995), and analyse the impact of the indicators of financial development (financial depth and private credit) on real growth. Our empirical analysis reveals that financial development causes economic growth significantly. Furthermore, our results show a highly significant impact of trade, gross capital formation and government credit on output growth. Hence, we suggest that economic policy should be aimed at reforming and improving the efficiency of the financial sector, as well as real sector reforms simultaneously to accelerate the economic growth rate of Nepal. Using newly assembled data and hitherto unapplied methodologies, we believe that, this study imparts valuable insight on the role of financial sector development on the economic growth of Nepal.