Islamic financial development & economic growth: the emergence of Islamic financial market in Pakistan

PurposeThe impact of Islamic finance on economic growth is an ongoing debate. The purpose of this study is to empirically evaluate how the development of Islamic finance affects the long- and short-run economic growth of Pakistan. Design/methodology/approachThe institutional variables, Islamic banking development (IBD), Islamic bond market development (IBM) and Islamic stock market development (ISM), are considered as measures of Islamic financial development, and real gross domestic product (GDP) is taken as measurement proxy of economic growth. The quarter time series data from Q1:2006 to Q4:2021 is analyzed through Autoregressive distributed lag model, Bounds test, ECM and Pairwise granger causality test. FindingsThe findings of this study indicate that in the long run, there is a significant and positive correlation between IBD and ISM with the real GDP, though ISM negatively cointegrated with real GDP in the short run. In contrast, IBM and real GDP did not find cointegrated in the long run, though the relationship is significant but negative in the short run. Practical implicationsThe findings highlight Islamic financial development in Pakistan can contribute to the country's economic development, and this can be achieved by improving the infrastructure, increasing skilled professionals, creating a favorable legal environment and ensuring financial sector stability. Investors can diversify their investments and mitigate risk by adding Islamic financial instruments to their portfolios. Originality/valueThis pioneering study simultaneously measures the cause and effect relationship between Islamic financial development indicators (Islamic banking, Islamic bond and Islamic stock) and economic growth in Pakistan.