Financial Inclusion and Its Implications for Inclusive Growth in Pakistan

• Author: KALSOOM ZULFIQAR, MUHAMMAD ASLAM CHAUDHARY AND ARIBAH ASLAM

Abstract. Financial Inclusion is considered an important means to realize the goal of inclusive economic growth. Present study examines the state of financial inclusion and its significance for inclusive growth in Pakistan. Empirical analysis suggests that Pakistan lags behind other countries vis-à-vis financial inclusion. The study utilizes probit estimation technique to find out the determinants of financial inclusion in Pakistan. It also investigates the relationship between perceived barriers to financial inclusion and individual characteristics. Determinants of various sources of borrowing are also investigated. Education level, income and gender discrimination are found to be important determining factors of financial inclusion. The results suggest that lack of money and requisite formalities are significant barriers to access financial services.

It emphasizes comprehensive and easy financial access to all segments of society to promote and enhance sustainable inclusive economic growth to benefit all.

Keywords: Financial Access, Financial Institutions, Financial inclusion, Inclusive growth, Inequality, Probit estimation

1. INTRODUCTION

   Inclusive growth has become an important policy goal in most of the countries, particularly in developing Asia where remarkable economic growth is eclipsed by associated inequalities. It is focused on participation of individuals in growth process and emphasizes equitable access to various economic opportunities. There is growing evidence that financial inclusion leads to reduction in poverty and inequality and hence is vital for inclusive economic growth (see Beck et al.; 2004, Clarke et al. 2003). Clámara and Tuesta, (2014; pp.6) defined financial inclusion “as the process by which access to and the use of formal financial services are maximized, whilst minimizing unintended barriers, perceived as such by those individuals who do not take part in the formal financial system”. International Monetary Fund (IMF) defined Financial Inclusion as the organized efforts aiming at the availability of financial services for everyone particularly for poor and deprived.

   Financial Inclusion primarily focuses on extending financial services to the poor and underprivileged and has recently gained tremendous attention due to its relevance for Inclusive growth which emphasizes equitable access to opportunities. In the words of Park and Mylenco (2015; pp. 1) “One key ingredient of inclusive growth is an inclusive financial system that expands access to financial services to poor households. Access to finance enables the poor to protect themselves against adverse shocks and to balance their consumption and thus improve their welfare”.

   Financial inclusion enables individuals to participate in the growth process by enhancing their access to economic opportunities and broadening their choices, which ultimately makes them more productive and efficient economic agents. It can lead to poverty reduction in two possible ways. Firstly, increased availability of financial resources enhances access to education, increased self-employment and human development which helps towards poverty alleviation. (see Banerjee and Newman, 1993; Galor and Zeira, 1993; Aghion and Bolton, 1997). Secondly broad based access to financial products and services leads to efficient resource allocation, thus providing better financial leverage to the underprivileged for poverty reduction. Lack of financial resources not only discourages economic growth but also leads to income inequalities.

   Kakwani and Pernia (2000) found that improved access to finances can lead to significant reduction in poverty and income disparity. Beck et al. (2004, p. 18) observed that “In countries with developed financial intermediaries, the incomes of the poorest quintile grow faster than average GDP per capita, income inequality falls more rapidly, infant mortality reductions are larger and child enrolment in primary schools increase”. Moreover, income inequalities are more prevalent in economies where larger segment of population is denied access to financial services. Beck et al. (2004) concluded that if demand for financial services is not met through formal financial system it is automatically shifted to more expensive informal sources. The poor and deprived are forced to borrow at much higher costs that deplete their income and thus they continue to be denied the accrued benefits.

   An inclusive financial system helps socially omitted individuals to assimilate into the economy by creating opportunities for everyone (World Bank; 2008) and, thus, results in more equitable dispersal of growth benefits. Economic growth cannot be considered inclusive in a country if majority of the population is financially excluded having limited access to credit and other facilities. Chakraborty (2010) resolved that it is not possible to attain the goal of inclusive economic growth without active involvement of the excluded and marginalized. Thorat (2008, pp. 2) emphasized the role, financial inclusion can play in reducing poverty and inequality and in generation of productive employment in a country. It is stated that “Financial inclusion means making financial services available to poor, giving them credit facilities that suit their needs and generate self-employment opportunities for them.

   Empirical evidence confirms that countries with a large proportion of their population excluded from financial system also show high poverty ratios and high inequality.” Many empirical studies have established the link between financial sector development, economic growth and reduction in poverty and inequality. Demirgue-Kunt et al. (2008), Johnston and Jonathen (2008) and Hanning and Jansen (2010) concluded that financial sector development promotes pro-poor and equitable economic growth.

   Financial system in developed countries is more inclusive as compared to less developed countries. Kendall et al. (2010) found that 81% of adults living in developed countries have formal bank accounts as compared to only 28% in less developed countries. Empirical evidence suggests that half of the world’s adult population is unbanked (see Chaia, et al. ;2009). This exclusion is more prominent in least developed countries of the world. The percentage of population having an account at a formal institution, savings at a formal institution, and borrowing from a formal institution are the three key indicators to assess the level of financial inclusion in any country. Demirgüç-Kunt. and Klapper (2013) concluded that seven countries namely India, China, Pakistan, Indonesia, Bangladesh, Vietnam and Philippines comprise almost 92% of the 1.5 billion unbanked people in Developing Asia.

   South Asian economies though have a relatively higher saving rate (32%) but most individuals living in these countries save at informal sources. Overall in Asia, only 21% of adults save in financial institutions and about 300 million Asian adults keep their savings outside financial institutions representing approximately half of the total world population that does so. The percentage of adults borrowing from a formal financial institution is the third important dimension of financial inclusion. A major amount of borrowing being done from informal sources indicates that the formal banking system is unable to meet the demand for credit services due to several reasons. In Asia, the adults availing credit facilities from formal financial institutions are only 38% as compared to 83% in high income countries. The level of borrowing1 also varies among different countries due to different set of needs arising from diverse socio-economic conditions.

   Pakistan has a very low level of financial Inclusion and it is one of the least financially inclusive countries in the world. A larger proportion of population is unbanked having no access to formal or informal financial services. Almost 53% of the population have no access and out of the remaining 47% only 23% are formally served and the remaining 24% depend on informal financial services2.There are only 13% adults (ages 15+ years) who have an account at a formal financial institution as compared to 35% in India and 40% in Bangladesh3. Other indicators of financial inclusion also show a dismal picture.

   In empirical literature, there are several studies which investigated the role of financial development in promoting economic growth, poverty alleviation and reducing income disparities in Pakistan. (see Shahbaz andIslam;2011, Shahbaz; 2010, Rahman et al.2008 Kashif andKhalil 2012). Raza et al. (2016) provided an overview of Financial Inclusion in Pakistan. However, none of these studies has focused the determinants of financial inclusion and perceived barriers to financial inclusion and their implications for inclusive growth in Pakistan. It is in this background that present study intends to make a comprehensive analysis of various extents of financial inclusion in relation to inclusive growth in Pakistan and filling the existing gaps in literature.

   The specific objectives of the study are given below:

   • To provide a comparative analysis of the state of financial inclusion in Pakistan.

   • Exploring the determinants of the level of financial inclusion in Pakistan.

   • Investigating the determinants of perceived barriers to financial Inclusion in Pakistan.

   • Investigating the borrowers’ behavior regarding choice of sources of borrowing and factors determining these choices.

   • Exploring the linkages between financial inclusion and inclusive growth in Pakistan.

2. AN OVERVIEW OF FINANCIAL INCLUSION IN PAKISTAN

   Pakistan has a very low level of financial inclusion where only 13% of adult population has access to formal bank accounts4. As per Honohan (2008) financial inclusion index5(FII), Pakistan had a very low index score of just 12% as compared to 32% for Bangladesh, 48% for India, 42% for China and 59% for Sri Lanka. Table 1 summarizes financial inclusion indicators...