THE DETERMINANTS OF GROWTH of INDUSTRIAL SECTOR AND CREDIT TO PRIVATE SECTOR

SUBMITTED TO

MR AQEEL BAIG
SUBMITTED BY

SAMINA WAJEEH

ABSTRACT
THE DETERMINANTS OF GROWTH of INDUSTRIAL SECTOR AND CREDIT TO PRIVATE SECTOR This study investigates the determinants of industrial sector growth and private sector credits for a Pakistan using the annual data from 1999 to 2011. The results from the panel cross-sectional fixed effects procedure suggest that an increase in the public sector credits and central government debt leads to a decrease in private sector credits in create a positive impact on the private sector and industrial sector growth. For this Pakistans, public sector credits, albeit leading to a financial crowding out, are not found to be more efficient but somehow it should be applicable. We investigate the impact on the financial sector development of credit to domestic country lending via literature review. From the literature review countries, private Sector credits are found to increase with public sector credits and financial development and decrease with central government debt. Financial development is affected adversely from inflation and positively from real GDP and public sector credits in high income countries. Then in the growth of industries, the real exchange rates, inflation rates and maximum lending rates credits to public sector affect financial development positively. On the other hand, public sector credits and inflation are correlated positively with industrial development. Keywords: Private Sector Credits, Industrial Development, Public Sector Credits, Inflation

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Table of Contents
INTRODUCTION ............................................................................................................................................. 4 GROUND OF RESEARCH ................................................................................................................................ 7 Hypotheses ............................................................................................................................................... 7 Null Hypotheses ........................................................................................................................................ 7 Literature Review .......................................................................................................................................... 8 The Determinants of Credit to Private Sector .......................................................................................... 8 The Determinants of Industrial Sector Growth by Lending Credit ......................................................... 13 DATA AND METHODOLOGY ........................................................................................................................ 16 Regression Equation ............................................................................................................................... 16 Independent and Dependent Variables .................................................................................................. 17 Exchange Rates to Time Graph ............................................................................................................... 18 Lending Interest Rate to Time Graph ...................................................................................................... 18 Credit to Private Sector & Time Graph ................................................................................................... 19 Credit to Private Sector & Time Graph ................................................................................................... 19 Industry Growth & Time Graph .............................................................................................................. 20 Regression ................................................................................................................................................... 21 Granger Causality Tests........................................................................................................................... 22 Interpretation ......................................................................................................................................... 23 Conclusion ............................................................................................................................................... 23 Term Abbreviation ...................................................................................................................................... 24 References .................................................................................................................................................. 25

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INTRODUCTION

The importance of private sector development and economic growth is part of discussion in the literature. However there are compromises and on the determinants of the industrial sector growth and it is more consider that Credit to private sector is having a great impact on the development on the private sector Growth. This report attempts to contribute the literature over the determinants of the private sector growth, determinant of credit to private sector and so, on the analysis over the Pakistani industry data of last 10 years.

For developing and under developing countries, public sector debt is considered to be as burden, till the early 1990s there is fiscal improvement noticed in the development and underdevelopment countries, but the adjustment of fiscal development countries has been in noticeable manner WEO (2001). Mentioned by IMF (2004), emerging market is detrending the landing pattern to public sector credit. IMF (2004) more contributed that advanced countries debt major part was land to domestically as compared to emerging markets. However, studies show that since 1990, as compare to the internationally-issued share of debt is low as domestically-issued, it is drastically increase over the period.

The development of a country is dependent on the many factors in that one and major factor is the private investment, and Private sector credit is important factor of it. In a country creating employment a vital role played by the domestic banks. Factor that play role are efficiency and productivity.

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In most countries where domestic banks finance public sector, private sector experience problems in finding your loan Investment. Development for the abovementioned actions rarely takes place. In the context of scenario, Caballero and Krishnamurthy (2004), the results of studies show that crowding out systematically larger in emerging countries than in advanced ones. Continuing the pace, Cottarelli et al. Find (2003) that the change is crowding out Economic growth in Central and Eastern Europe and the Balkans prevented Bank loans to the private sector. Literature also shows that the private sector credit household savings flows, financial depth is determined by the private sector owned banks, the law of a country, inflation, interest rate type and regulatory reforms in the financial markets. In this paper we are targeting to study the impact banking private sector credit to growth of the private sector, the effect of the central govt. debt and liabilities, will use as the indicator of financial development on the on the private sector credit. We will investigate the Determinants factors of financial development. Economic investment is facilitated by Financial development is an important indicator for growth to the private sector credit. In this study we focus on the effect of credit to private sector by domestic banks on financial development.

Studies show that the in developing countries if there is an efficient debt management is stable, Debt giving by the banks then it facilitates the financial intermediations (Kumhof and Tanner, 2005) and private sector credit has a positive role in developing private sectors. Whereas another studies Hauner (2006), define that public sector credit should be at optimal level, in the credit only few portion used in the financial sector development,

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more of the portion is disastrous mainly in the low level of income carrying countries, studies also reflect that financial development is also impacted from income level, inflation, legal and institutional infrastructures, enforcement of legal rules, endowments, open trade policies and financial openness.

The distribution of this study is as follows: next chapter presents a literature review about the determinants of private sector credits and industrial development. Chapter next to it then investigates the determinants of private sector credits by domestic banks and financial development empirically. Then we will define the methodology and regression test and summarizes the main findings and concludes.

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GROUND OF RESEARCH

Hypotheses

1. Bank lending does not have any significant impact on the output of the Industrial sector in Pakistan. 2. There is no significant relationship between economic growth and industrial output in Pakistan.

Null Hypotheses
There is significant relationship in between the economic growth and industrial output in Pakistan.

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Literature Review
The Determinants of Credit to Private Sector
Investment and how to do money invest is a crucial factor of economic growth. Especially investment by the private sector has an important part of total investment in many of the market economies. The element of investment is a base element in the supply of private credit to private sector, without which it is generally testing for the firms or economic agents to understand it. So, it is reasonable to ask that private sector credit play a positive role or what make it positive. Caballero and Krishnamurthy (2004) have determined that why expansionary policies to use by advanced countries, the accumulated debt during the recession faces by the economy. At the same time, countries like Argentina cannot be the same way in facing the crisis. They argue that that is not the same level of financial deepening. The way national financial deepening in emerging market countries, lack of prevents Keynesian fiscal policy recommendation, because it is expected in general. The results of the analysis showed, exclusion system mostly emerging countries than advanced extreme Crowding coefficient than in emerging markets during the financial crisis in economic growth. In the other way coefficient that uses to show the effect of fiscal private expansion of credit, is more negative than state showing in the emerging countries. In addition, private credit financial expansion in normal period and in crisis period, response is different, more negative as in countries of emerging market than in advanced countries.

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Cottarelli et al. (2003) study the increase in the bank credit to the private sector, in transition economies (CEB), after the mid of 1990s in increase on employing create a random effect on GLS estimation procedure. Reason that Cottarelli et al. (2003) extract was that after the mid of 1990s was the bank credit to private sectors (BCPS) has extensively increased and especially in CEB economy. Cottarelli et al. (2003) divide the CEB countries in classifying in three groups for determine the factors of recent trends of BCPSs in CEB that classes are Early Birds o o o o o o o Bulgaria Croatia Estonia Hungary Latvia Poland Slovenia

Late Risers o Bosnia and Herzegovina o Lithuania o Serbia o Montenegro

Sleeping Beauties o Albania o The Czech Republic

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o The Former Yugoslav Republic of Macedonia o Romania o The Slovak Republic NOTE: This classification is based on the timing of the rise in BCPS. Factors that are considered as determinants of BCPS ratios are such as indexes of financial liberalization, public debt-to-GDP (Indicator of the level of crowding out), inflation, per capita GDP (Indicator of overall economic Development), bank entry requirements and quality of accounting standards, the legal origin of the country. The results obtained by the Cottarelli et al. (2003) indicate, the intermediation level of bank average BCPS ratio was very low for early birds as compare to sleeping beauties, and most significant as any level, anyway it goes continued to rise above the sleeping beauties rather than just follow it only. Capability of Early birds attracts the fianc from the abroad but it is not play a significant role in the contribution of growth of BCPS. The point that he clear here was the saving from the domestic flow increase in the BCPS in countries of CEB, bank deposit to GDP ratio in CEB countries increased, also have increasing impact on the financial depth that caused the raise in BCPS. As compare to early birds, in sleeping beauties deposit to GDP ratio had an up pattern but BCPS was not have increasing pattern. Cottarelli et al. defined that not only the financial deepening alone significant for BCPS growth, crowding out effect stops the BCPS. We can narrate it as if there is increase in the BCPS ratio of a country it must be have credit to public sector would be low. Other major factor in the raise of BCPS is structural reforms. In the early stages of the countries wont have industrial sector developed that why growth observed slow. Whereas early birds that have a higher index of transition observed the revert pattern as compare to sleeping

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beauties. In the transition process banks privatization is also a major role playing indicator , Cottarelli et al. share early birds privatized their banks and sleeping beauty still invest in the public sector (over 41 percent) in 1999. It is resulting that increase in the bank credit was the impact due to the privatization. The studies indicate that the legislation of country is also a Growth determinant of BCPS. In sum, Cottarelli et al. argue that privatization, public sector reduction of expenditure, is in sum up progress towards market institutions and quality of legislation play a critical indicator of BCPS ratios. Impact of the domestic credit to private sector was investigated by the Back and Zumer (2005), he investigate the increasing pattern on the MS and EU countries. Back and Zumer investigate that growth of the private sector credit was higher in the Hungry and the Baltic Countries rather than in the EU countries. Baltic countries have high growth rate in the credit to private sector rather than the inflation,Back and Zumer (2005) identified that the combination of the macroeconomic and microeconomic factors are the reason of high growth in lending to private sector and it is affected positively that create a influence on the demand and supply side respectively. Factors that are included o o o o banking sector reforms financial liberalization and integration privatization and restructuring of the banking sector environment of moderate or low inflation with a build-up of confidence in policy frameworks o o o decline in interest rates following low inflation, regulatory reforms of financial markets developing confidence macroeconomic stabilization

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Fostering domestic private sector credits.

Back and Zumer (2005) public sector credit to GDP ratios were stable (increasing slightly) and therefore not crowded in by private sector credits. Credit to private non bank sector and economic growth relation investigated by Hofmann (2001), he used the quarterly data between 1980 and 1998, he uses real interest rates and property prices sample of 16 industrialized countries. He concluded that in the industrialized countries there were a boom and bust cycle in credit markets concede with economy and the prices of the property market. Hofmann (2001) investigates the impact on the supply and demand channels by the affect of the credit on the property prices and the interest rate. Long run development credit is not only be explained by the standard credit and interest rate, it is also included the prices of property stated by Hofmann(2001) , he linked real credit negatively with the real interest rates, where as the real credit and real property prices linked positively in the long run. Hofmann investigate that real GDP increase the effects on the credit lending and positively raise in the property prices, it promote the prices of the property output as growth. Studies conclude the ve effect on lending and real GDP, and prices of the property and he identified the two ways relationship b/w property prices and credit. Another study defines the performance of macroeconomics, and studied by Cecchetti and Krause (2001), they finds that macroeconomic performance in developed and emergence countries are improved in last two decades. Studies identified that real growth & inflation is most stable in current era as compared to 1980s. Central banks become independents and govt. role got drastically changed. Cecchetti and Krause examine by using the data of 23 countries, relation of the connection between reductions in inflations and output

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volatility, and their combination in reduction in ownership assets in the commercial banks. Relation identified those countries in that higher the ownership of the govt. showing the overall level of credit is low supply to private sectors. Another result showed that less centralized banking countries would it is also found that the countries with a less centralized banking shares showing the higher shares loans to private sector. He also concluded that monetary policy effectiveness, it is goes up with private ownership of banks. Calza et al. (2001) examine the loans determinants to private sector, in the area of euro and find positive relation with real GDP and negatively with long-term and short-term interest rates in the long run.

The Determinants of Industrial Sector Growth by Lending Credit

We will review the impact of landing to emphasize on the manufacturing sector and credit relationship, this will done by the literature review. Libanio (2006) using laws of Kaldors Manufacturing industry is the engine of growth. The Kaldor law explained by the following regression qi = ai + bimi

q = growth of total output & m= manufacturing output respectively. Libanio (2006) defines from Kaldorian perspective, he defines the association of manufacturing output growth and economic performance, and he stated that there is a vigorous relationship among the growth and manufacturing industry and GDP. He investigate the Nigeria market, and realized that in although relationship is industry and GDP is positive but here were pattern was mixed up and down. Industrial sector like man in

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Nigeria has been constrained due to insufficient funding, either due to the inefficient capital market or the culture. Banks of Nigeria finance mostly short term investment. In country the long term funds are not in reach easily so strict and restrict credit guideline was as output. Gerschenkron (1962) advice that in under developing and moderated developed countries like Nigeria, there should be especial institutions that supply funds to industries in long run, since there is no substantial profit back enterprise so the industry size was assumed to be large, consider the banking on the level of major source for capital and private enterprise for the type of industrialization, indicating a kind of supply-leading tendency. Gerschenkron analysis, implications is that external finance contribution in the economic growth is considered critical for the manufacturing sector, this implied that the financial sector contribution should be well developed and it should be function speedily and efficiently, it should be cheaply mobilize the wanted funds for productive investment, while earning reasonable returns for the financial institutions.

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The reviewed literature, the development in the manufacture industries have on the theoretical background provided in Nigeria, that works as empirical investigations provided an adequate information the lending by bank effects on economic growth on industrial output in Nigeria. (World Banks)Credit to the private sector in the money transmission credit played always a vital role, credit finance the o Production o consumption o Capital formation These all factors affects on activities of economy. The data on domestic credit to the private sector are taken from the banking survey of the International Monetary Funds (IMF) International Financial Statistics or, when unavailable, from its monetary survey. This survey includes the all authorities of monetary (like central bank), banks money in deposit, and other banking institutions. It is also included finance companies, development banks, and savings and institutions for loans. Credit to the private sector may sometimes include credit to state-owned or partially state-owned enterprises.

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DATA AND METHODOLOGY

For the study time series data is from 2001 to 2011 has been used, The data is obtained from the world bank website. From the literature, some of the variables that have been tested to have an effect on production of the Industrial sectors were included in the model. Based on the hypothetical reasoning, the model use by the approach is

Regression Equation
IG =0 + 1 DCPVS + 2 IR + 3 ER + 4 MLR + t (Equation 4.1) Where IG= IR = Industrial Growth Inflation rate

DCPVS = Domestic credit private sector ER= Exchange Rate

MLR= Maximum landing Rate ET = Error Term

For the study we used the regression equation as mentioned in the 4.1. Index of industrial growth on the credit to private sectors, we use factors on that Industrial growth, independent variable domestic credit to private sector, exchange rate, maximum landing rate, error term. Finally, is the term refers to as error term. Which is identically and independently normally distributed with mean zero and constant variance, and 1, 2 , 3, 4 are parameters to be estimated.

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Here 1>0, coefficient of domestic credit to private sector, should be positive to have a positive impact.

2<0, Inflation rate, also have the inverse relation if the inflation rate would be low it will increase the growth would be defined, inflation rate low indicate that there is low poverty level in the industry. 3<0, Exchange rate, also have the inverse relation if the exchange rate would be low it will increase the growth would be defined, the cost of the export would be low, the cost on the machinery that is more have excise duty would be low, and enhance the growth of the field. 4<0, Maximum lending rate, also have the inverse relation if the lending rate would be low it will increase the growth would be defined; people will borrow more they have to pay return on the borrowing.

Independent and Dependent Variables

IG= IR = Industrial Growth (Dependent Variable) Inflation rate (Independent Variable)

DCPVS = Domestic credit private sector (Independent Variable) ER= Exchange Rate (Independent Variable)

MLR= Maximum landing Rate (Independent Variable)

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Exchange Rates to Time Graph

100 90 80 70 60 50 40 30 20 10 0

Exchange Rate

Time
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Lending Interest Rate to Time Graph

16 14 12 10 8 6 4 2 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Lending Interest Rate

Time

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Credit to Private Sector & Time Graph

35 30 25 20 15 10 5

Credit To Private Sector

Time
0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Credit to Private Sector & Time Graph

25

Inflation
20

15

10

Time

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

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Industry Growth & Time Graph

28

Industry Growth
27 26 25 24 23

Time
22 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

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Regression

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Granger Causality Tests

Pairwise Granger Causality Tests Date: 01/04/13 Time: 00:13 Sample: 2001 2011 Lags: 2 Null Hypothesis: ER does not Granger Cause IG IG does not Granger Cause ER DCPVS does not Granger Cause IG IG does not Granger Cause DCPVS MLR does not Granger Cause IG IG does not Granger Cause MLR RESID does not Granger Cause IG IG does not Granger Cause RESID IR does not Granger Cause IG IG does not Granger Cause IR DCPVS does not Granger Cause ER ER does not Granger Cause DCPVS MLR does not Granger Cause ER ER does not Granger Cause MLR RESID does not Granger Cause ER ER does not Granger Cause RESID IR does not Granger Cause ER ER does not Granger Cause IR MLR does not Granger Cause DCPVS DCPVS does not Granger Cause MLR RESID does not Granger Cause DCPVS DCPVS does not Granger Cause RESID IR does not Granger Cause DCPVS DCPVS does not Granger Cause IR RESID does not Granger Cause MLR MLR does not Granger Cause RESID IR does not Granger Cause MLR MLR does not Granger Cause IR IR does not Granger Cause RESID RESID does not Granger Cause IR Obs 9 F-Statistic 0.61512 0.31155 0.55559 0.87420 0.43824 0.09722 0.12386 0.51329 1.80269 0.35211 1.09049 9.70482 0.95045 0.09222 0.79454 0.09568 0.67578 0.16949 1.92986 0.78779 2.55889 0.26519 47.9421 0.86878 0.29432 0.51249 0.10132 1.16937 2.35415 0.41660 Prob. 0.5849 0.7486 0.6125 0.4842 0.6728 0.9094 0.8868 0.6332 0.2766 0.7230 0.4188 0.0292 0.4595 0.9138 0.5122 0.9108 0.5587 0.8499 0.2590 0.5147 0.1925 0.7796 0.0016 0.4860 0.7599 0.6337 0.9059 0.3982 0.2110 0.6849

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Interpretation

Interpretation of the data is suggested that coefficient of the Credit supply to private sector is not having an important impact on the Industrial growth and exchange rate is impacting in the negative impact on the Industrial growth. In the same time we can conclude that the Inflation rate is impacting positively means growth is increasing as the rate is decreasing. The maximum lending rate is also beneficial for the Industrial sector growth. The model significance is more than 4%, thats why model is accepted as the reliable. Durbin Watson is in the acceptable range 1.5-2.5, thats means in the data there is no correlation is exists. But individual relation of the data is showing that credit to private sector and exchange rate and inflation rate t statistics data is looking insignificant to some extent. R2 is showing that variability in the data is due to independent variables.

Conclusion
Although credit to private sector is a major impacting variable in the industrial growth, but we can see that clearly that the impact of in Pakistan is minimum that credit is supply to private sector but it is not playing any vital role in the growth of industry thats mean we need to check the patterns of allocation the credit and where it is consuming. Hence our assuming hypotheses are accepted and null hypothesis is rejected.

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Term Abbreviation
CEB- Albania, Bosnia and Herzegovina (BiH), Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, the Former Yugoslav Republic of Macedonia, Poland, Romania, Serbia and Montenegro (SM), the Slovak Republic, and Slovenia.

World Economic Outlook New Member States (MS) of the European European Union (EU)

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References

Back, P. and Zumer, T. (2005), Developments in Credit to the Private Sector in Central and Eastern European EU Member States: Emerging from Financial Repression - A Comparative Overview Focus 2/05. Vienna: Oesterreichische National bank. 83-109.

Levine, R. (1997), Financial Development and Economic Growth: Views and Agenda, Journal of Economic Literature Vol. XXXV (June 1997), pp. 688726.

Levine, R., Loazya, N. and Beck, T. (2000), Financial Intermediation and Growth: Causality and Causes, Journal of Monetary Economics Vol. 46 (August 2000), pp. 31-77.

Rajan, R. G. and Zingales, L. (2001), The Great Reversals: The Politics of Financial Development in the 20th Century, NBER Working Papers, w8178.

Baltagi B., Demitriades, P. and Law, S. H. (2007), Financial Development, Openness and Institutions: Evidence from Panel Data, Paper presented atthe Conference on New Perspectives on Financial Globalization, Research Department. Washington, DC-April 26 27, 2007. Beck, T., Demirguc-Kunt, A. and Levine, R. (2002), Law, Endowments, and Finance, NBER Working Papers, w9089.

Boyd, J. H., Levine, R. and Smith, B. D. (2001), The Impact of Inflation on

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Financial Sector Performance, Journal of Monetary Economics 47 (2001) 221-248.

Caballero, R. and Krishnamurthy, A. (2004), Fiscal Policy and Financial Depth, NBER Working Papers, w10532.

Calza, A., Gartner, C. and Sousa, J. (2001), Modelling the Demand for Loans to the Private Sector in the Euro Area, ECB Working Paper No. 55. Frankfurt: European Central Bank.

Cecchetti, S. G. and Krause, S. (2001), Financial Structure, Macroeconomic Stability and Monetary Policy NBER Working Papers, w8354. Hauner, D. (2006), Fiscal Policy and Financial Development, IMF Working Papers, WP/06/26. Washington D.C.: International Monetary Fund.

Hauner, D. (2007), Credit to Government and Banking Sector Performance, Journal of Banking& Finance), doi: 10.1016/j.jbankfin.2007.07.012.

Hofmann, B. (2001), The determinants of private sector credit in industrialized countries: do property prices matter? BIS Working Papers No 108. Basel: Bank for International Settlements.

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