Does financial inclusion affect monetary policy in SAARC countries?

Abstract

Alike the role of heart for human body, finance is the focal point of an economy, whereas savings and investment are its tubes and vessels. Hence, a solid financial system is a fundamental character of an enduring economy. The frozen financial system endures longer if its foundation is concrete and subsists in the people of grass-root level. They are those, who live in villages and small towns, earn meager income, work in primary sector, spend more on food, and have lesser social securities. In this setting, the process of bringing these people into the main stream of financial activities is called financial inclusion. This study describes the impact of financial inclusion on monetary policy of South Asian Association for Regional Cooperation (SAARC) countries from 2004–2013. The study uses principal component analysis (PCA) to construct a Financial Inclusion Index that serves as a proxy variable for the accessibility of financial inclusion in the SAARC countries. Adding to it, three different models like FEM, REM, and Panel-corrected standard errors are used for the analysis. In this study, an empirical result of generalized least square(GLS) estimation shows that financial inclusion, exchange rate, and interest rate are negatively associated with inflation in SAARC countries.

Keywords:

• financial inclusion
• monetary policy
• principal component analysis (PCA)
• panel-corrected standard errors (PCSEs)

JEL classifications:

• E44
• E51
• E52
• F36

Public Interest Statement

Financial inclusion is an attempt to provide formal banking services to all the people of a society including the poorest of poor people. This paper investigates the impact of financial inclusion on monetary policy for the South Asian Association for Regional Cooperation (SAARC) nations. No study has found relationship between financial inclusion and its effect on monetary policy for the SAARC countries.

In the analysis part, the proxy variables for monetary policy are exchange rate, interest rate, and inflation. In addition, for financial inclusion are geographical penetration, demographic penetration, and banking penetration. The study constructed a Index of Financial Inclusion (IFI) by analyzing the data from 2004 to 2013 by the tool named: principal component analysis (PCA). It is found in the study that financial inclusion, interest rate, and exchange rate are negatively associated with inflation in SAARC countries. Along with this, the financial inclusion also helps in price stabilization and controlling the inflation in an economy which is essential for a sustainable economy.

Acknowledgements

We are indebted to Dr. Ruchi Sharma and Dr. Sujata Kar, who gave us suggestions to complete this study smoothly. We also express our gratitude towards anonymous referees for giving their valuable comments. The authors take all the responsibilities for all the errors and omissions, if there are any. We also thank to our parent organization, the Indian Institute of Technology Indore, India, which facilitated us with all the required resources for this study.

Additional information

Funding

Funding. The study has not received any direct funding from any institution.

Notes on contributors

Sanjaya Kumar Lenka

Sanjaya Kumar Lenka is a doctoral research scholar in the School of Humanities and Social Sciences, Indian Institute of Technology Indore, India. He has specializations in financial economics, monetary economics, and development economics. He is the main and corresponding author of this manuscript. Before joining this institute, he worked at Institute of Economic Growth, New Delhi and National University of Educational Planning and Administration, New Delhi. He did his MPhil from North Orissa University followed by a Master’s degree from Fakir Mohan University. His works have been published as book, book chapters, and articles in various national and international journals.

Arun Kumar Bairwa

Arun Kumar Bairwa is a PhD Scholar in the School of Humanities and Social Sciences, IIT Indore, India. His areas of interests are industrial policy and labor reforms. He completed his master’s from Central University of Kerala. He also worked at IIM Indore as an academic associate.