Does Deficit Financing Improve Financial Sector Development in Pakistan? Empirical Evidence

The core objective of this study is to show how fiscal deficit financing influences the financial infrastructure (e.g., credit to the private sector) of Pakistan. The investigation is carried out to determine whether private sector investment in Pakistan is crowded out, or crowded in by government budget deficit financing. The investigations mentioned above are carried out in a non-linear framework, i.e., Non Linear Autoregressive Distributed Lag (NARDL). The NARDL can capture the long run dynamic equilibrium relationship between the variables. This research suggests a non-linear association between financial sector development and fiscal deficit financing. In the short-run fiscal balance, domestic debt, government expenditure, and other independent variables significantly and asymmetrically affect financial sector development in Pakistan. The study did not find the crowding-in or crowding out effect of an increase in domestic debt on the amount of credit available to the private sector in the long run. However, financing budget deficit through increased government spending crowd out private investment in the long run. The findings, in general, suggest that the role of fiscal deficit financing on financial sector development in the country is non-linear, indicating regime-specific fiscal deficit financing's effect on the financial sector development of the country. Moreover, the crowding out of private investment because of increased domestic debt is not valid in the long run, while it is true in the case of increased government spending.