Sami, SAF; (2016) Impact of Financial Integration on Growth in Developing, Transition, and Emerging Market Economies: Quest for Threshold Analysis. (UCL Centre for Comparative Studies of Emerging Economies Working Paper Series 2016/5). UCL School of Slavonic and East European Studies (SSEES): London, UK.

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Abstract

This research paper assesses the impact of financial integration proxied by de-facto measures, namely, various forms of capital flows, and de- jure measures, namely, capital account openness, on economic growth. Threshold regression (TAR) and logistic smooth transition regression (LSTR) methods are deployed to find the threshold estimates for each of these proxy variables for international financial integration. These nonlinear growth regressions are carried out for 185 countries over the period 1961-2015. The prime focus of this research paper is the threshold determination of the de jure measure of financial integration. The de jure measure of capital account openness issued for threshold analysis is the (1) Chinn-Ito Index (KAOPEN). We also employ the proxy variables for the de facto measures of financial integration and this includes the following: (2) Net Inflows of Foreign Direct Investment (FDI as % of GDP), (3) Equity Foreign Portfolio Inflow (EFPI as % of GDP), (4) Cross-Border Lending e.g. Loans from Non-Resident Banks (CBL or NRBL as % of GDP), and (5) Net Financial Account (NFA as % of GDP). However, these results should be interpreted with caution given the problem of endogeneity due to reverse causality between de facto measures of financial integration and growth. The obtained results acquired for these IFI proxy variables are not uniform across all measures of financial integration utilized in this research, and country groups we focus here, to suggest that the effect of financial integration on growth is positive. There are distinctive thresholds for different income groups, some that are very interesting for policymaking purposes. The results that are of notable importance are related to the de jure measure of capital account openness. These results indicate that transition economies have the lowest threshold, followed by emerging economies, whereas developing economies have the highest threshold. However, while it is growth retarding above the threshold (growth enhancing below the threshold) for all income groups, for emerging markets, it is growth enhancing both below and above the threshold. The accuracy of these threshold estimates is validated predominantly via the bootstrapping technique and various other robustness checks.

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