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Borsa Istanbul Review 19-3 (2019) 197e206
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Full Length Article

Oil price volatility, Islamic financial development and economic growth in

Gulf Cooperation Council (GCC) countries
Kaouthar Gazdar a,b, M. Kabir Hassan c,*, M. Faisal Safa d, Rihab Grassa e,f
a
College of Islamic Economics and Finance, University Umm-AL Quraa (KSA), Saudi Arabia
b
LEFA (IHEC Carthage), Tunisia
c
Department of Economics and Finance, University of New Orleans, New Orleans, LA, 70148, USA
d
School of Business, McKendree University, 701 College Road, Lebanon, IL, 62254, USA
e
ISCAE, University of Manouba, Tunisia
f
UMS University, Dubai, United Arab Emirates
Received 26 December 2017; revised 7 July 2018; accepted 10 July 2018
Available online 10 August 2018

Abstract

This paper investigates the relationship between oil terms of trade growth volatility and economic growth in the GCC countries. Further it
explores the possible effect of Islamic financial development on such relationship. By analyzing a sample of five GCC countries over the period
of 1996e2016, we find empirical evidence of a significant positive relationship between oil terms of trade growth volatility and economic
growth. Our results also indicate that the effect of oil terms of trade growth volatility on growth is reinforced by the development of Islamic
financial system.
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Copyright © 2018, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-
ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

JEL Classification: G20; O13; O40

Keywords: Islamic financial development; Oil volatility; Growth volatility

1. Introduction and Ramey (1995), Aghion, Bacchetta, Ranciere, and

Macroeconomic literature, for long, has been exploring
the relationship between volatility of various economic var-
iables and economic growth. Two major focuses in literature
have been how the volatilities of various economic variables
effect economic growth and how such effect can be managed.
Findings of different research in literature provide incon-
clusive views on these issues. While Mirman (1971),
Kormendi and Meguire (1985) and Blackburn (1999) find
positive relationship between volatility and growth; Ramey
* Corresponding author.
E-mail addresses: kaouthar.gazdar@gmail.com (K. Gazdar),
KabirHassan63@gmail.com, mhassan@uno.edu (M.K. Hassan), mfsafa@
mckendree.edu (M.F. Safa), rihab_grassa@hotmail.fr (R. Grassa).
_
Peer review under responsibility of Borsa Istanbul Anonim Şirketi.
Rogoff (2009), and Brüeckner and Carneiro (2015) find a
negative effect of volatility on economic growth. On the
other hand, Beck, Lundberg, and Majnoni (2006), and Van
der Ploeg and Poelhekke (2009) focuses on the importance
of a developed financial market on accelerating economic
growth.
This paper aims at analyzing the impact of oil terms of
trade growth volatility on the growth of Islamic economies and
whether development of Islamic financial market may
contribute towards managing such impact. By analyzing five
GCC (Gulf Cooperation Council) countries for the period
1996e2016, we find a significant positive effect of oil terms of
trade growth volatility on economic growth. Further we find
that such impact of oil terms of trade growth volatility is
significantly reinforced by Islamic financial development in
GCC countries.

https://doi.org/10.1016/j.bir.2018.07.005
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2214-8450/Copyright © 2018, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND
license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
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K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206
Understanding growth-volatility relationship from the
perspective of the Islamic financial development is important.
Islamic banking experienced rapid growth over time and has
been moving into conventional financial systems (Sole, 2008).
Islamic banks exist in major parts of the world and viewed as a
viable alternative financial intermediary (Hassan, 2017;
Hassan and Lewis, 2014; Sufian and Noor, 2009). Despite such
rapid growth in Islamic financial system, no research so far has
emphasized on Islamic financial development to explore
volatility-growth relationship. This paper contributes to the
existing literature by examining the effect of Islamic finance
development on the volatilityegrowth relationship.
GCC countries are at the center of Islamic economies. In
order to compete with the conventional banks in their domestic
market, these countries incorporate comprehensive retail and
investment banking, insurance, fund management, and
Shariah-compliant securities (Wilson, 2013). Each GCC
country has set up comprehensive Islamic financial in-
frastructures. Islamic banks accounts for 49% of the total
banking sector in Saudi Arabia, 39% in Kuwait and 26% in
Qatar (Islamic Financial Services Board, 2016). Also high
dependency on hydrocarbons is a common feature of GCC
countries. Hydrocarbon exports in these countries represents
about 70% of total export for the period 2011e2014. Fiscal
dependence on hydrocarbon revenues in the same period is
over 80% of total fiscal revenues (Khandelwal et al., 2016).
Therefore, all GCC countries are exposed to any movement in
oil price that causes more volatility in their economic activities
and subsequently uncertainty in economic growth (Al-Khouri
& Dhade, 2014). Thus, high uncertainty in oil price movement
and oil revenues induce GCC countries to emphasize on
necessary measures to protect against oil price volatility and
maintain a sustainable economic development.
The remaining paper presents a brief background of Islamic
finance in GCC countries in section 2, literature review and
hypotheses in section 3, econometric methods in section 4, and
empirical results in section 5. Section 6 concludes the paper.
2. Islamic Finance in GCC countries
Islamic finance has been developing in GCC region for
long. The first bank to incorporate Islamic principles in this
region is Dubai Islamic Bank, which was established in
September 1975. This bank is a private entity with major
shareholdings by its private investors. Two year later in 1977,
the Kuwait Finance House was established in Kuwait with two
major investors - the Ministry of Awqaf and Islamic affairs,
and the Ministry of Justice and Finance. In 1979 the Bahraini
Islamic Bank was established followed by Abu Dhabi Islamic
banks in the same year. From this point in time, Islamic
banking has seen sharp growth in this region, and thus Islamic
banks in GCC countries became a key component of the
financial system in the region (Chowdhury & Rasid, 2016). By
the end of 2016, the total assets of Islamic finance assets in
GCC exceed 801.1 billion dollars, more than 42.3% Shari'a-
compliant assets globally (Islamic Financial Services Board,
2017). During the period 2007e2016, on average, Gulf
_
Islamic banks' assets represents 34% of the total banking as-
sets with an average growth rate of 17.82%, while the growth
rate of the assets of global banking system in GCC is 19%.
Table 1 summarizes some data for each GCC countries.
On the other hand, the number of Islamic bank in GCC
countries increased significantly during the last decade to
more than 50 Islamic banks. This trend reflects also the rapid
growth of Islamic assets in GCC regions over the same time
period.
3. Review of literature and hypothesis development
There is a comprehensive literature, both theoretical and
empirical, on the relationship between volatility and economic
growth. Such literature dates back to Long and Plosser (1983)
who suggest that sectoral shocks may account for GDP fluc-
tuations. Such shocks, integrated with stochastic growth
model, can explain a set of business cycle phenomena. King
et al. (1988) used real business cycle model to test growth
where factor productivity follows random walk with drift. By
incorporating endogenous growth in real business cycle
model, the authors show that temporary shocks can perma-
nently affect output.
Acemoglu, Johnson, Robinson, and Thaicharoen (2003)
examine the relationship between institutions and volatility
for the period 1970e1997. Their findings indicate that major
differences in cross-country differences in volatility are insti-
tutional and macroeconomic factors are not significant to lead
such institutional causes to economic instability. Mirman
(1971) suggests a positive relation between output volatility
and growth resulting from precautionary savings because of
higher volatility. Kormendi and Meguire (1985) analyze post-
war data for 47 countries and find a positive relation between
growth and growth volatility. Blackburn (1999) suggests that
relative increases in the volatility of shocks increase knowl-
edge accumulation pace, resulting in growth. Blackburn and
Pelloni (2004) suggest that real shocks produce positive cor-
relation between output volatility and growth while nominal
shocks generate negative correlation.
On the other hand, Ramey and Ramey (1995), in their seminal
paper, present empirical evidence against the standard dichotomy
that suggests that economic growth and business-cycle volatility
are unrelated. Using a panel of 92 countries, as well as a subset of
24 OECD (Organisation for Economic Co-operation and
Table 1
Market share and average annual asset growth of Islamic banks in GCC
countries; 2007e2016.
Islamic Banks' Asset Islamic Banks' Average
share in total banking Annual Asset Growth
assets (% in 2016) Rate (% over 2007e2016)
Saudi Arabia 51.20 20.95
Bahrain 29.30 7.94
Kuwait 45.20 8.12
UAE 21.60 18.85
Qatar 25.80 28.11
GCC average 34.00 17.82
 _
K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206
Development) countries, the authors provide empirical evidence
that countries with higher volatility have lower growth, even after
controlling for time and country fixed effects. Bleaney and
Greenaway (2001) use data from 14 Sub-Saharan African
countries over 1980e1995 and find that growth is negatively
affected by terms of trade instability. Lensink et al. (1999)
examine different measures of uncertainty to calculate volatility
and their effect on per capita GDP growth over a sample of 138
countries for the period 1970e1995. They find significant
negative effect of volatility on economic growth.
Blattman, Hwang, and Williamson (2007) examine the ef-
fect of terms of trade volatility, arising from excessive com-
modity price fluctuations, on growth performance. Using a
sample of 35 countries for the period 1870e1939, they find
that some commodities are more volatile in price than others,
and countries with more volatile commodities grow slower
than other commodity-specialized nations. Afonso and Furceri
(2010) examine the impact of fiscal volatility and government
size on economic growth for 15 European Union (EU) and 13
OECD countries for the period 1970e2004. They find that
both size and volatility of government revenue and expendi-
ture have negative effect on growth. Museru et al. (2014)
examine the impact of aid inflows and public investment
volatility on growth. Analyzing 26 Sub-Saharan African
countries for the period 1992e2011, they conclude, although
foreign aid has a positive effect on growth, the public invest-
ment volatility diminishes the effectiveness of such aid.
A slightly different branch of literature focuses on the
relative degree of the effect of financial development in
volatility-growth relationship. Denizer, Iyigun, and Owen
(2002) analyzes a panel of 70 countries for the period
1956e1998 and find that countries with developed financial
system observe less fluctuation in output, consumption, and
investment growth. Also they specify that such volatility is
significantly reduced by risk management and information
processing provided by financial institutions (e.g., bank).
Easterly, Islam, and Stiglitz (2001) provide evidence that
growth volatility is significantly affected by financial variables
(e.g., firm net worth, cash flows), but such volatility differ
across countries depending on the nature of shock, macro-
economic structure, government policy regime, and trade
openness. Aghion et al. (2009), based on a sample of 83
countries for the period 1960e2000, find that exchange rate
volatility adversely affect long-run growth. Moreover they add
that, such adverse effect varies with the level of financial
development in a country, and critical in developing countries
with poor credit market.
Rodriguez (2014) analyzes the effect of fiscal policies and
credit constraints on volatility-growth relationship. By
extending Aghion, Angeletos, Banerjee, and Manova (2010)
model to account for credit constraints and by analyzing 20
Latin American countries and 19 OECD countries for the
period 1960e2000, the author concludes that counter-cyclical
fiscal policies reduce growth sensitivity to volatility. He also
adds that in less financially developed countries, such fiscal
policies can have positive impact on growth. In a similar study,
Brüeckner and Carneiro (2015) investigate the impact of terms
199
of trade volatility on real gross domestic product per capita
growth. By analyzing a sample of 175 countries over the
period 1980e2010, they find that terms of trade volatility has
an adverse effect on economic growth in countries with a pro-
cyclical fiscal policy.
Beck et al. (2006) build a theoretical model based on
Bacchetta and Caminal (2000) that predicts that the effect of
volatility on growth is dampened by well-developed financial
intermediaries. They also analyze a sample of 63 countries for
the period 1960e1997. Their results show a weak evidence of
such dampening role played by financial intermediaries on
terms of trade volatility. Moreover they find evidence of
magnifying role played by financial intermediaries for infla-
tion volatilities, especially in countries with little or no access
to external finance through capital market. Raddatz (2006)
investigates the effect of financial development on volatility
using a sample of 70 manufacturing industries over 48 coun-
tries for the period 1981e1998. The author concludes that
financial development reduces volatility in sectors with high
liquidity needs through the reduction in output per firm growth
volatility and number of firm volatility. His results also indi-
cate the higher importance of the development of financial
intermediaries than that of equity market to reduce volatility.
Van der Ploeg and Poelhekke (2009) provide cross-country
evidence that growth volatility adversely affects economic
growth, but such effect depends on the level of a country's
financial development. The authors also conclude that resource
curse is less evident in countries with well-developed financial
sectors. Moradbeigi and Law (2016) investigate the impact of
oil terms of trade growth volatility on growth volatility. By
analyzing 63 countries over a period of 2000e2010, they
confirm the adverse effect of oil terms of trade volatility on
growth. They also find evidence that financial development
dampens the effect of oil terms of trade volatility on growth.
Similar to above literature and specifically to Hassan et al.
(2011a, 2011b), Zirek et al. (2016), Yu et al. (2014, 2012), this
paper examines the effect of oil terms of trade growth vola-
tility on economic growth of GCC countries, where Islamic
finance development is pronounced over last two decades.
Based on the prior literature, the first hypothesis of this paper
examines the effect of growth volatility of oil terms of trade on
economic growth.
H1: Oil terms of trade growth volatility significantly affect
economic growth.
Islamic financial development carries much conducive
features for micro- and macro-economic growth. The Islamic
profit sharing system ensures equitable distribution of wealth
and encourages investments (Hassan, 2017; Hassan and Lewis,
2014). It does not allow creating unnecessary new risks to
upsurge profit and thus reduce speculation in financial mar-
kets. Moreover Islamic finance is global and open to in-
struments that are congruent to its fundamentals. Thus the
second hypothesis of this paper examines whether Islamic
financial development adds to the effect of growth volatility on
economic growth.
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K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206
H2: The development of Islamic finance reinforces the effect
of oil terms of trade growth volatility on economic growth.
4. Data and econometric methods
In order to test the impact of oil terms of trade (OTOT)
growth volatility on the growth of Islamic economies, we
include five GCC countries in our sample e Saudi Arab,
Qatar, Kuwait, the United Arab Emirates (UAE), and Bahrain;
over 1996e2016. Because of data unavailability during the
sample period, we could not include Oman, Jordan and
Morocco.
We develop the country-specific measure of the OTOT
index following Spatafora and Tytell (2009)1 as defined in
Eq. (1).

ðX M Þ
POILt i i
OTOTi;t ¼ ð1Þ
MUVt
In Eq. (1), POILt is the annual oil price for the sample
period (1996e2016), MUVt is a manufacturing unit value
index that is used as a deflator, and Xi is the average annual
share of export, and Mi is the average annual share of import in
country i in year t to its GDP ratio. The annual averaging of
export and import allows the OTOT to reflect only changes in
the oil prices, depending on the composition of each country's
oil net export basket.
The annual growth rate of the OTOT index (gOTOTi;t ) is
defined in Eq. (2).
gOTOTi;t ¼ lnOTOTi;t  lnOTOTi;t1
Eq. (2) reflects the real oil price change in each country
scaled by the importance of oil in the net export of the country
(Moradbeigi and Law, 2016). The volatility of the oil terms of
trade growth [SD (OTOT)i,t] is defined in Eq. (3).
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi

2ffi
1X s 1 Xs
SDðOTOTÞit;tþS ¼ gOTOTitþS 
S s¼0 S þ 1 s¼0
In Eq. (3), S takes the value of four as we calculate the
standard deviation over a five non-overlapping year period of
time.
We use two indicators to measure Islamic Financial
Development (IFD); Islamic financial depth (IFD1), and Is-
lamic financial concentration (IFD2). Islamic financial depth is
the most commonly used variable in recent literature (Law and
Singh, 2014; Moradbeigi and Law, 2016; Naceur et al., 2007)
as an indicator of financial sector development. For each
country, annual Islamic financial depth is defined as the ratio
of financial intermediation credit to the private sector to Gross
Domestic Product (GDP). Again, for each country, annual
1
Moradbeigi and Law (2016) developed OTOT index for their sample
countries following same approach.
_
Islamic financial concentration is defined as the ratio of Is-
lamic banking assets to total banking assets.
To test the two hypotheses in this paper, we estimate the
following model:
GROWTHit ¼b0 SDðOTOTÞit þ b1 IFDit
þ b2 IFDit  SDðOTOTÞit þ a Zit þ εi þ qt þ mit
ð4Þ
In Eq. (4), GROWTHit is measured as the growth rate of
real GDP per capita, SDðOTOTÞit is the five-year non-over-
lapping standard deviation of oil terms of trade growth,
IFDit is the measure of Islamic Finance development, ðIFDit *
SDðOTOTÞit Þ is an interaction variable between Islamic
Finance Development and oil terms of trade growth volatility,
and Zit is a set of control variables. We include a constant term
in Eq. (4) and several control variables based on recent
literature.
One control variable is the initial level of development
(IIC ) measured as the logarithm of initial real GDP per capita
at the beginning of sample period, the year of 1996 (Gylfason
& Zoega, 2006; King and Levine, 1993). Gylfason and Zoega
(2006) argue that countries with high proportion of initial in-
come in natural resources converge quickly to a steady state.
We also include trade openness (TO), measured as the ratio
of combined export and import to GDP. Literature on empir-
ical growth identifies openness towards international trade as
an important determinant of economic growth (Harrison,
1996; Menyah et al., 2014; Yanikkaya, 2003). Another con-
trol variable we use in our analysis is government consumption
ð2Þ (GC ), which is measured as the ratio of government expen-
diture to GDP. Loizides and Vamvoukas (2005) argue that
government consumption causes short-term and long-term
growth in national income. Devarajan, Swaroop, and Zou
(1996) conclude that productive government expenditure
lead to a higher steady-state growth rate.
We also use inflation (INF) as a control variable measured
as the logarithm of annual inflation rate. Recent economic
gOTOTitþS
literature (Barro, 2013; Orphanides, 2004; Svensson, 1997)
ð3Þ broadly identifies inflation as an indicator for macroeconomic
stability. Another control variable we use is interest rate spread
(INTER) that is measured the difference between lending rate
and LIBOR. Dotsey (1998) presents evidence that interest rate
spread is an important indicator of economic growth. By
analyzing emerging markets like Argentina, Brazil, Mexico,
Korea, and Philippine, Neumeyer and Perri (2005) also
conclude that interest rates are useful factors to analyze
emerging market business cycle.
Allen, Qian, and Qian (2005) analyze the private sector of
China and conclude that the institutional governance and
regulation plays a significant role in the growth of private
sector. Again Djankov, McLiesh, and Ramalho (2006)
analyze 135 countries and conclude that governmental regu-
lation has significant positive effect on economic growth. For
this, we include institutional regulation by government
(REGULATION ) measured as a variable rescaled to assume
values between zero and one. Larger values of this variable
 _
K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206 201

indicate better institutional regulation. We expected a positive vGROWTH

relationship between growth, Islamic finance development
and regulation quality.
In order to control for the effect of non-Islamic conven-
tional banks, we use two indicators to measure Conventional
Financial Development e Conventional financial depth
(CFD1), and Conventional banks deposits to GDP (CFD2).
Moreover, given the high level of oil related industry
engagement in the GCC economies, we also control for the
non-oil related industry GDP that is impacted by oil terms of
trade shocks. For this we include non-oil related industry
growth (NON_OIL GDP GROWTH ) in our analysis.
GCC countries are pegged to the US Dollar, except Kuwait
(quasi-pegged with US Dollar). Therefore these countries have
not been able to develop any clear monetary policy. To control for
this issue, we use a shock absorbing tool as a control variable - the
central bank reserves (RESERVES). εi in Eq. (4) is a country
fixed effect that should capture the systematic differences in the
financial environment across five GCC countries, qt is the time
fixed effect to capture the year specific impacts on economic
growth of each country, and mit is the disturbance term.
Eq. (4) allows us to assess whether oil terms of trade
volatility has a different influence on growth in countries with
varying degrees of Islamic financial development. In this
specification, the responsiveness of the steady state level of
economic growth to oil terms of trade growth volatility is the
growth rate function of economic growth with respect to oil
terms of trade growth volatility as defined in Eq. (5), which is
the first derivative of Eq. (4) with respect to SD(OTOT).
¼ b0 þ b2  IFDi;t ð5Þ
vSDðOTOTÞ
The implication of our hypothesis centers around the co-
efficients b0 and b2 . A positive sign of b0 ðb0 > 0Þ would
imply that an increase in oil terms of trade growth volatility
contributes towards economic growth. A positive sign of
b2 ðb2 > 0Þ would imply that Islamic Financial development
reinforces the effect of oil terms of trade growth volatility on
economic growth. The list of the variables used in the analysis
is presented in Table 2 with corresponding data sources.
Table 3 presents the Summary statistics of all variables
used in this analysis. Oil terms of trade growth volatility
ranges between 0.00 and 2.27 with an average and standard
deviation of 0.13 and 0.51 respectively. Islamic financial depth
ranges between 1.59 and 73.20 with average and standard
deviation of 25.11 and 20.60 respectively. Again Islamic
financial concentration ranges between 5.52 and 107.07 with
average and standard deviation of 46.41 and 34.26
respectively.
Table 4 presents the correlation matrix among the variables
in this analysis. It is important to note that there is a low
correlation between two indicators of Islamic financial
development. The correlations of these two variables with oil
terms of trade growth volatility are low as well.
5. Empirical results
To estimate Eq. (4) we follow panel data random effect
method. The results of Hausman test do not accept the null

Table 2
Definitions and data sources of variables used in this paper.
Variable Definition Source
Real GDP per capita Ratio of real GDP to population. World Development Indicators (2016), The World Bank
GDP Growth Real GDP per capita growth. World Development Indicators (2016), The World Bank
NON_OIL GDP GROWTH Non-oil industry GDP growth. World Development Indicators (2016), The World Bank
Islamic Financial Development 1. Islamic Financial Depth: Authors' calculation based on Bank reports
Financial intermediary credit to the private sector
to GDP ratio.
2. Islamic Financial Concentration:
Islamic banking assets to total banking assets ratio.
Oil Terms of Trade Growth Standard deviation of oil terms of trade growth Authors' calculation based on Spatafora and Tytell (2009)
volatility in five-year interval.
Initial level of development ln (Initial real GDP per capita) at the beginning of Authors' calculation based on King and Levine (1993).
sample period (1996).
Trade Openness Combined exports and imports to GDP ratio. World Development Indicators (2016), The World Bank
Government Government expenditure to GDP ratio. World Development Indicators (2016), The World Bank
Consumption
Inflation ln (1 þ Inflation rate). World Development Indicators (2016), The World Bank
Conventional Finance Development 1. Conventional Finance Depth: Financial intermediary Authors' calculation based on Bank reports
credit to the private sector to GDP ratio.
2. Conventional Finance Concentration: conventional
banking deposits to GDP ratio.
Reserves Ln (central banks reserves) World Development Indicators (2016), The World Bank
Interest Spread Interest rate spread (lending rate minus LIBOR). World Development Indicators (2016), The World Bank
Regulation The ability of the government to provide sound Worldwide Governance Indicators (WGI) Database
policies and regulations that enables and promotes
private sector development.
These variables have been rescaled to assume
values between zero and one.
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K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206

Table 3

This table presents the pairwise correlations between the variables for the period 1996e2016. Y is the annual real GDP per capita growth; IIC is the initial level of development at the beginning of the sample
period; NON_OIL GDP GROWTH is non-oil GDP Growth; GOVEX is the annual Government expenditure to GDP ratio; INF is the logarithm of annual inflation rate; TO is trade openness measured as the annual

Islamic financial concentration measured as the ratio of Islamic banking assets and total banking assets; CFD1 is Conventional finance depth measured as Conventional financial intermediary credit to the private
export and import to GDP ratio; SD(OTOT) is the oil terms of trade growth volatility; IFD1 is Islamic financial depth measured as Islamic financial intermediary credit to the private sector to GDP ratio; IFD2 is
REGULATION

sector to GDP ratio; CFD2 is conventional finance concentration measured as the ratio of conventional banking deposits to GDP; INTER is interest rate spread; RESERVES is Ln (central banks reserves);
Summary statistics, 1996e2016.
Variable Mean St.Dev. Min Max
Y 0.18 3.01 9.45 4.97

0.62 (0.01) 1
IIC 4.41 0.23 4.08 4.79
GOVEX 17.89 6.09 7.21 27.93
INF 0.63 0.32 0.11 1.16

INTER
TO 101.4 23.87 63.15 143.76

REGULATION is the ability of the government to provide sound policies and regulations that enables and promotes private sector development. P-value are reported in parentheses.
0.61 (0.00) 1
SD(OTOT) 0.13 0.51 0 2.27
IFD1 25.11 20.6 1.59 73.2

RESERVES

0.48 (0.00) 0.31 (0.01)

IFD2 46.41 34.26 5.52 107.07
CFD1 118.64 72.15 25.73 331.96
CFD2 31.42 19.96 2.84 83.03

0.32 (0.03) 1
RESERVES 23.84 1.62 20.48 27.34

0.65 (0.01)
INTER 3.68 1.77 1.35 6.62
REGULATION 0.55 0.23 0.21 0.99

CFD2
This table presents the summary statistics for the variables used in our

1
analysis for the period 1996e2016. Y is the annual real GDP per capita

0.31 (0.05)

0.69 (0.01)
0.35 (0.01)

0.56 (0.00)
growth; IIC is the initial level of development at the beginning of the sample
period; NON_OIL GDP GROWTH: non-oil GDP Growth, GOVEX is the

CFD1
annual Government expenditure to GDP ratio; INF is the logarithm of annual

1
inflation rate; TO is trade openness measured as the annual export and import

0.03 (0.83)

0.10 (0.61)
to GDP ratio; SD(OTOT) is the oil terms of trade growth volatility; IFD1 is

0.21 (0.13)

0.59 (0.01)

0.28 (0.02)
Islamic financial depth measured as Islamic financial intermediary credit to
IFD2
the private sector to GDP ratio; IFD2 is Islamic financial concentration

1
measured as the ratio of Islamic banking assets and total banking assets.

0.18 (0.23)

0.52 (0.01)
CFD1 is Conventional finance depth measured as Conventional financial

0.65 (0.01)
0.37 (0.01)

0.31 (0.01)
0.81 (0.0)
intermediary credit to the private sector to GDP ratio; CFD2 is conventional
finance concentration measured as the ratio of conventional banking deposits
IFD1

to GDP; INTER is interest rate spread (lending rate minus LIBOR); RE-

1
SERVES is Ln (central banks reserves); REGULATION is the ability of the

0.61 (0.01)
0.11 (0.01)
0.36 (0.01)

0.56 (0.00)

0.49 (0.00)
SD (OTOT)

0.51 (0.01)

0.37 (0.02)
government to provide sound policies and regulations that enables and pro-
motes private sector development.
1

hypothesis that the coefficients estimated by the efficient

0.44 (0.01)

0.08 (0.57)

0.61 (0.01)
0.01 (0.93)
0.01 (0.82)
0.56 (0.01)

0.14 (0.21)

0.59 (0.00)
random effects estimator are the same as the coefficients
estimated by the consistent fixed effect estimator (results
TO

presented in Table 5, Table 6, and Table 7).

1
0.15 (0.27)
0.06 (0.67)
0.04 (0.97)
0.11 (0.46)
0.35 (0.03)

Table 5 presents the estimates of Eq. (4) for our sample of

0.01 (0.92)
0.01 (0.91)
0.09 (0.49)
0.14 (0.25

five GCC countries for the period 1996e2016. The first

model (Model 1) presents the estimates of Eq. (4) without the
INF

Islamic financial development indicators and their interaction

0.27 (0.02)

0.51 (0.01)

0.12 (0.29)

0.67 (0.00)
0.71 (0.0)

variables with oil terms of trade growth volatility. Model 2

0.34 (0.01)
0.23 (0.05)
0.08 (0.52)

0.52 (0.01)

0.63 (0.00)
GOVEX

presents estimates of the same equation using Islamic

financial depth (IFD1) as Islamic financial development in-
1

dicator and its interaction variable with oil terms of trade

NON_OIL GDP

growth volatility [SD(OTOT)*IFD1] as explanatory variables.

0.04 (0.77)

0.25 (0.07)

0.48 (0.01)
0.51 (0.07)
0.45 (0.01)

0.35 (0.01)

0.05 (0.72)
0.21 (0.18)

0.38 (0.01)

0.21 (0.20)

0.35 (0.09)
GROWTH

In the same way, Model 3 presents the estimates of Eq. (4)

using Islamic financial concentration (IFD2) as Islamic
1

financial development indicator and its interaction variable

0.04) (0.79)
0.44 (0.01)
0.31 (0.02)

0.51 (0.00)
0.29 (0.02)

with oil terms of trade growth volatility [SD(OTOT)*IFD2] as

0.52 (0.0)
0.52 (0.01)

0.02 (0.92)
0.13 (0.23)
0.25 (0.03)

0.26 (0.01)

0.37 (0.01)

explanatory variables. Model 4 in Table 6 presents estimates

of the same equation using conventional banking financial
Correlation matrix, 1996e2016.
IIC

depth (CFD1) as financial development indicator of conven-

0.13 (0.23)

0.43 (0.01)
0.09 (0.51)

tional banking in GCC countries and its interaction variable

0.01 (0.97)
0.42 (0.01)

0.15 (0.19)
0.11 (0.41)

0.25 (0.03)
0.04 (0.07)
0.07 (0.06)

0.11 (0.36)
0.02 (0.01)
0.07 (0.51)

with oil terms of trade growth volatility [SD(OTOT)*CFD1]

as explanatory variables. Model 5 presents the estimates of
Y

Eq. (4) using conventional banking financial concentration

REGULATION
GROWTH

(CFD2) as conventional banking financial development in-

RESERVES
SD (OTOT)
NON_OIL
Table 4

GOVEX

dicator and its interaction variable with oil terms of trade

Variable

INTER
CFD1
CFD2
IFD1
IFD2

growth volatility [SD(OTOT)*CFD2] as explanatory

INF
IIC

TO
Y
 _
K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206 203

Table 5 Table 6
Economic Growth, Oil Price Volatility and Islamic Finance development, Economic growth, oil price volatility and conventional finance development,
1996e2016. 1996e2016.
Variables Model 1 Model 2 Model 3 Variables Model 1 Model 4 Model 5
IIC 3.06** (2.42) 2.82*** (2.87) –0.124*** (3.72) IIC 3.06** (2.42) 0.001** (2.26) 1.06 (1.35)
NON_OIL GDP 0.067*** (4.34) 0.05*** (5.24) 0.04*** (4.31) NON_OIL GDP 0.067*** (4.34) 0.004** (2.62) 0.005*** (3.12)
GROWTH GROWTH
GOVEX 1.31*** (3.18) 1.49*** (4.50) 0.9.24** (2.12) GOVEX 1.31*** (3.18) 0.18** (2.62) 0.58 (1.11)
INF 0.097** (2.02) 0.04 (0.10) 0.017 (0.46) INF 0.097** (2.02) 0.011 (0.19) 0.034 (0.99)
TO 0.012 (0.04) 0.17 (0.94) 0.028 (0.14) TO 0.012 (0.04) 0.37* (2.16) 0.031 (0.25)
SD(OTOT) 2.033** (2.18) 0.84* (1.76) 1.26** (2.64) SD(OTOT) 2.033** (2.18) 8.306** (2.33) 1.034 (0.33)
IFD1 0.05 (1.22) CFD1 0.055 (0.08)
IFD2 0.047* (1.98) CFD2 0.044 (0.19)
SD(OTOT)* IFD1 3.32** (2.34) SD(OTOT)* CFD1 3.799 (1.59)
SD(OTOT)*IFD2 1.21* (1.86) SD(OTOT)*CFD2 0.482 (1.10)
RESERVES 0.137* (1.74) 0.058** (2.85) 0.034 (1.18) RESERVES 0.137* (1.74) 0.031*** (3.71) 0.021* (2.00)
INTER 0.008 (0.75) 0.059** (2.85) 0.029*** (3.08) INTER 0.008 (0.75) e e
REGULATION 0.08 (0.53) 0.04 (0.28) 0.045 (0.35) REGULATION 0.08 (0.53) 0.218 (1.34) 0.095 (0.43)
CONSTANT 0.76 (0.67) 0.86 (0.96) 0.81 (1.03) CONSTANT 0.76 (0.67) 1.01* (2.01) 0.34 (0.80)
Hausman test 0.81 0.73 0.69 Hausman test p-values 0.81 0.63 0.59
p-values Adj R-square 0.6074 0.7288 0.5089
Adj R-square 0.6074 0.7778 0.8794 This table presents the panel data random effect estimate of the equation
This table presents the panel data random effect estimate of the equation GROWTHit ¼ b0 SDðOTOTÞit þ b1 IFDit þ b2 IFDit *SDðOTOTÞit þ a Zit þ
GROWTHit ¼ b0 SDðOTOTÞit þ b1 IFDit þ b2 IFDit *SDðOTOTÞit þ a Zit þ εi þ qt þ mit . Model 1 presents the baseline model without Islamic financial
εi þ qt þ mit . Model 1 presents the baseline model without Islamic financial development indicators and their interaction variables with oil terms of trade
development indicators and their interaction variables with oil terms of trade growth volatility. Model 4 presents the estimate of the equation with con-
growth volatility. Model 2 presents the estimate of the equation with Islamic ventional financial depth as conventional financial development indicator and
financial depth as Islamic financial development indicator and its interaction its interaction variable with oil terms of trade growth volatility. Model 5
variable with oil terms of trade growth volatility. Model 3 presents the estimate presents the estimate of the equation with conventional financial concentration
of the equation with Islamic financial concentration as Islamic financial as conventional financial development indicator and its interaction variable
development indicator and its interaction variable with oil terms of trade with oil terms of trade growth volatility. All these estimates are on five GCC
growth volatility. All these estimates are on five GCC countries for the period countries for the period 1996e2016. The dependent variable in all three
1996e2016. The dependent variable in all three models is annual real GDP per models is annual real GDP per capita growth rate (Y ); IIC is the initial level of
capita growth rate (Y ); IIC is the initial level of development at the beginning development at the beginning of the sample period; NON_OIL GDP GROWTH
of the sample period; NON_OIL GDP GROWTH is non-oil GDP Growth, is non-oil GDP Growth, GOVEX is the annual Government expenditure to
GOVEX is the annual Government expenditure to GDP ratio; INF is the log- GDP ratio; INF is the logarithm of annual inflation rate; TO is trade openness
arithm of annual inflation rate; TO is trade openness measured as the annual measured as the annual export and import to GDP ratio; SD(OTOT) is the oil
export and import to GDP ratio; SD(OTOT) is the oil terms of trade growth terms of trade growth volatility; CFD1 is Conventional finance depth measured
volatility; IFD1 is Islamic financial depth measured as Islamic financial as Conventional financial intermediary credit to the private sector to GDP
intermediary credit to the private sector to GDP ratio; IFD2 is Islamic financial ratio; CFD2 is Conventional finance concentration measured as the ratio of
concentration measured as the ratio of Islamic banking assets and total conventional banking deposits to GDP; INTER is interest rate spread (lending
banking assets; INTER is interest rate spread (lending rate minus LIBOR); rate minus LIBOR); RESERVES is Ln (central banks reserves); REGULATION
RESERVES is Ln (central banks reserves); REGULATION is the ability of the is the ability of the government to provide sound policies and regulations that
government to provide sound policies and regulations that enables and pro- enables and promotes private sector development. The Hausman test for the
motes private sector development. The Hausman test for the choice of Fixed choice of Fixed Effects and Random Effects p-values are presented at the
Effects and Random Effects p-values are presented at the bottom of each bottom of each model. t-statistic for each estimate is presented in parentheses.
model. t-statistic for each estimate is presented in parentheses. *, **, and *** *, **, and *** indicate significance at 10%, 5%, and 1% level.
indicate significance at 10%, 5%, and 1% level.

is used as an indicator of financial development, oil terms of

variables. Model 6 and 7 in Table 7 presents robustness tests of
Eq. (4) by including both conventional and Islamic financial
development indicators.
Results of Model 1 estimation show that the oil terms of
trade growth volatility has a positive effect on real GDP
growth rate in our sample five GCC countries. This estimate is
significant at 5% level. In Model 2, when Islamic financial
depth is used as an indicator of financial development and
included in the analysis along with its interaction variable with
oil terms of trade growth volatility, the coefficient of oil terms
of trade growth volatility is positive and significant at 10%
level, although the Islamic financial depth (IFD1) variables is
insignificant, but the interaction variable is significant at 5%
level. In model 3, when Islamic financial concentration (IFD2)
trade growth volatility is again positive and significant at 5%
level. Also the Islamic financial concentration is positive and
significant at 10% level and its interaction variable with the oil
terms of trade volatility is positive and significant at 10%
level. These results are consistent with both hypothesis 1 and
2, implying that oil terms of trade growth volatility has a
positive and significant effect on growth and such positive
effect is enhanced when Islamic financial concentration is used
as an indicator of Islamic financial development. These find-
ings are consistent with the findings of Kormendi and Meguire
(1985) and Blackburn (1999) that countries with higher growth
volatility experience higher growth. This also implies that
Islamic banking assets to total banking assets ratio appear to
be an important factor affecting economic growth, where
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K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206

Table 7 significant at 1% level and its interaction with oil terms of

Economic growth, oil price volatility, conventional and Islamic finance trade growth volatility is significant at 5% level. Again, the
development, 1996e2016.
Islamic financial concentration variable is significant at 1%
Variables Model 6 Model 7 level and its interaction with oil terms of trade growth vola-
IIC 0.001** (2.52) 0.09 (0.5) tility is also significant at 5% level. On the other hand, in
NON_OIL GDP GROWTH 0.06** (2.74) 1.11*** (3.91) Model 7, when conventional banking development indicators
GOVEX 2.07** (2.56) 1.108 (1.18)
INF 0.045 (0.87) 0.051 (1.13)
are used, conventional banking depth is significant at 10%
TO 1.09*** (4.03) 1.249*** (3.51) level but its interaction with oil terms of trade growth volatility
SD(OTOT) 11.901** (2.59) 14.69*** (2.44) is not significant at al. The conventional banking concentration
IFD1 0.43*** (3.34) variable is again significant at 10% level and its interaction
IFD2 0.85*** (3.21) with oil terms of trade growth volatility is also significant at
CFD1 0.28* (2.26)
CFD2 0.65* (2.21)
10% level.
SD(OTOT)* IFD1 43.08** (2.48) In summary, these findings imply that an increase in the oil
SD(OTOT)*IFD2 9.34** (2.63) terms of trade growth volatility contributes towards the eco-
SD(OTOT)* CFD1 0.15 (1.41) nomic growth in GCC countries; and such positive effect is
SD(OTOT)*CFD2 0.47* (2.08) enhanced with the development of the Islamic financial sys-
RESERVES 0.026*** (3.65) 0.023** (2.42)
CONSTANT 1.28* (2.07) 0.136 (0.18)
tem. Conventional banking system turns out to be a significant
Hausman test p-values 0.63 0.73 factor as well for the development of GCC economies,
Adj R-square 0.8157 0.6640 although such effect is present at a lower magnitude. There-
This table presents the panel data random effect estimate of the equation fore, a more developed Islamic financial system is likely to
GROWTHit ¼ b0 SDðOTOTÞit þ b1 IFDit þ b2 IFDit *SDðOTOTÞit þ a Zit þ help countries to deal better with oil terms of trade growth
εi þ qt þ mit . Model 6 presents the equation estimate with both Islamic volatility.
financial depth and Islamic financial concentration as Islamic financial Among the control variables, coefficients of the initial level
development indicator and their interaction variable with oil terms of trade
growth volatility. Model 7 presents the equation estimate with both conven-
of development (IIC ) are negative in six of the seven models
tional financial depth and conventional financial concentration as Islamic and significant in five models. These results support the
financial development indicator and their interaction variable with oil terms of proposition of Barro (1991) that poor countries tend to grow
trade growth volatility. All these estimates are on five GCC countries for the more rapidly than rich countries; and also consistent with the
period 1996e2016. The dependent variable in all three models is annual real findings of Gylfason and Zoega (2006) that economic growth
GDP per capita growth rate (Y ); IIC is the initial level of development at the
beginning of the sample period; NON_OIL GDP GROWTH is non-oil GDP
is inversely related initial income. Coefficient of the non-oil
Growth, GOVEX is the annual Government expenditure to GDP ratio; INF is GDP growth (NON_OIL GDP GROWTH ) appears positive
the logarithm of annual inflation rate; TO is trade openness measured as the and significant at in each model. This implies that non-oil
annual export and import to GDP ratio; SD(OTOT) is the oil terms of trade based industry growth also significantly contribute towards
growth volatility; IFD1 is Islamic financial depth measured as Islamic financial the development of GCC economies, although such industry
intermediary credit to the private sector to GDP ratio; IFD2 is Islamic financial
concentration measured as the ratio of Islamic banking assets and total
can be assimilated to a shock absorbing tool.
banking assets; CFD1 is Conventional finance depth measured as Conventional Government consumption appears negative and significant
financial intermediary credit to the private sector to GDP ratio; CFD2 is in five of seven models. Although literature on government
Conventional finance concentration measured as the ratio of conventional consumption and economic growth provide evidence for both
banking deposits to GDP; RESERVES is Ln (central banks reserves). The positive and negative effect of government consumption on
Hausman test for the choice of Fixed Effects and Random Effects p-values are
presented at the bottom of each model. t-statistic for each estimate is presented
growth, our results are consistent with the findings of
in parentheses. *, **, and *** indicate significance at 10%, 5%, and 1% level. Henrekson (1993) who find no supporting evidence that gov-
ernment consumption causes positive economic growth. These
findings also support the findings of Barro (1990) that un-
credit to private sector does not appear as an important productive government spending reduces economic growth.
determinant for growth in our sample of five GCC countries. Halicioglu (2003) also finds no causal relation between gov-
Model 4 and Model 5 in Table 6 presents Eq. (4) with ernment spending and GDP growth.
conventional Islamic financial development indicators. Both Inflation in this analysis appears to be negative but insig-
indicators are insignificant although oil terms of trade growth nificant in most of our models (except Model 1). This is
volatility is significant at 5% level in Model 2. This implies consistent with the findings of Fischer (1993) who finds
that conventional banking development is yet not a significant negative relation between inflation and growth. Also Johnson
factor of growth in GCC countries. But in Table 7 both Model (1967) finds no positive or negative relation between infla-
6 and Model 7 presents a slightly different picture when all tion and economic growth. Barro (2013) also suggest that only
financial development indicators are included in Eq. (4). Both in case of high inflation rate, inflation seems to be a statisti-
Model 6 and 7 indicate that oil terms of trade growth volatility cally significant factor for growth.
is significant at 5% and 1% level respectively. In Model 6, Trade openness is negative and significant in only three of
when both Islamic financial depth and Islamic financial con- the seven models. This implies an insignificant relation be-
centration is used as indicators of Islamic financial develop- tween trade openness and economic growth. This result is
ment, the results indicate that Islamic financial depth is consistent with the findings of Menyah et al. (2014) that found
 _
K. Gazdar et al. / Borsa Istanbul Review 19-3 (2019) 197e206
limited causal relation financial development and trade
openness.
Inflation in this analysis appears to be negative but insig-
nificant in most of our models (except Model 1). Higher in-
terest rate weakens economic growth. Our finding is consistent
with those of Woodford (2003), Horowitz (1996).
Regulatory quality does not have a significant effect on
economic growth although it carries a positive sign in all the
models. This result is consistent with the finding of Grassa and
Gazdar (2014) that found limited causal relation between
institutional quality and financial and economic development.
The results also show that central banks reserve (RESERVES)
has a positive and significant effect on economic growth.
6. Conclusion
We analyze the effect of oil terms of trade growth volatility
on economic growth and further examine whether a developed
Islamic financial system can reinforce such effect. We analyze
a sample of five GCC countries over the period of 1996e2016
and use two indicators to measure Islamic financial develop-
ment; Islamic Financial Depth (financial intermediary credit to
the private sector to GDP ratio) and Islamic Financial Con-
centration (Islamic banking assets to total banking assets
ratio). The results provide evidence that the oil terms of trade
growth volatility has a significant positive effect on economic
growth. Such effect is significantly reinforced by the devel-
opment of Islamic financial system. Both effects of oil terms
of trade growth volatility and Islamic financial development
on economic growth are more pronounced when the Islamic
financial concentration is used as an indicator of Islamic
financial development.
These findings present important policy implications for
GCC economies. A sound financial system reduces the uncer-
tainty among households and firms, increases government
credibility and thus enhances the positive effects of oil resources
on growth by channeling their revenues in more productive ac-
tivities (Moradbeigi and Law, 2016). In similar way, GCC
economies can ensure sustainable economic growth by sys-
tematic development of Islamic financial systems. Also being
majorly oil exporting countries, they are vulnerable to rapid
decline in oil prices. Our results indicate that these countries
should put significant effort to diversify and focus on non-oil
related industry growth as suggested by Gill, Izvorski, Van
Eeghen, and De Rosa (2014) and Cherif and Hasanov (2014).
Conflict of interest
None.
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