Abstract

This study aims to check the impact of domestic debt on financial development by using three dimensions of financial development: depth, stability, and efficiency. The proxy variable for measuring the depth dimension of the financial development is Liquid liabilities to GDP in percentage. For the stability dimension of the financial development, the proxy variable is bank capital relative to total assets (%). Bank deposits to GDP (%) are a proxy variable for measuring other dimensions of financial development. Time series data of Pakistan is analyzed from 1972 to 2022 using the ARDL Model. Some variables are stationary at the level and first difference through ADF. CUSUM, LM, Jarque Bera, and Ramsey RESET show that the model is error-free. Domestic debt positively and significantly impacts financial development's depth and stability dimension. However, it harms the efficiency dimension of financial development and supports the lazy bank hypothesis. It means that the crowding-out effect is present in Pakistan’s financial markets. Conclusively, domestic debt positively impacts the efficiency dimension of financial development and supports the safe asset hypothesis in the case of Pakistan. Currently, the government is borrowing 56% of its GDP domestically. Therefore, it is creating a positive impact on the financial development as a whole, and the financial sector is risk-averse and holds only government securities. The bulk of the finance can be generated through external means, particularly from external debt when the domestic debt market is not fully developed.

Keywords: Domestic Debt, Financial Development, ARDL Model, Financial Markets and institutions