Financial development and environment in South Asia: the role of institutional quality

Abstract

The paper investigates the effect of financial development and institutional quality on the environment in South Asia. Other determinants of environmental quality included are economic growth, energy consumption, FDI, trade openness and institutional quality. For empirical analysis, panel data is used for the period 1984 to 2015. The estimated results indicate that Environmental Kuznet Curve (EKC) hypothesis holds in South Asia, i.e., environment first deteriorates with economic development and then it starts improving. Empirical results reveal that 1% increase in economic growth worsens environment by 1.709%. However, further increase in economic growth improves environment by 0.104%. Energy consumption has deteriorating effect on environment. Financial development has degraded the environment in the region, which indicates that South Asian countries have used financial development for capitalization and not to improve technology. The estimated results show that 1% increase in financial development deteriorates environment by 0.147%. FDI, which is a measure of financial openness, has mitigating effect on pollution. In turn, trade openness has worsened the environmental quality in the region. Institutional quality has significant negative effect on carbon emissions. It also has significant negative moderating effects on carbon emissions. The findings show that 1% improvement in institutional quality will decrease pollution by 0.114%. The study suggests that South Asian countries should focus more on technology effect and not on scale effect of financial development.

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