The Impact of Introduction of Islamic Finance in Pakistan on Inclusive Growth

Abstract

Purpose: This paper examines the impact of Islamic finance on inclusive growth in Pakistan. While financial development is widely recognized as a driver of economic growth, through efficient capital allocation, investment promotion, and expanded credit access, conventional financial systems have often been associated with rising inequality and financial instability. Islamic finance, grounded in principles of risk-sharing, ethical investment, and asset-backed transactions, presents a potentially more inclusive and stable alternative that aligns financial intermediation with real economic activity.

Design/Methodology/Approach: The study employs the Autoregressive Distributed Lag (ARDL) model to analyze both short- and long-term relationships among financial development, Islamic finance, and inclusive growth over the period 1990–2021. An Inclusive Growth Index and four Financial Development Indices are constructed using Principal Component Analysis (PCA), guided by frameworks from the IMF, World Bank, and ADB. To capture the unique effects of Islamic finance, the model incorporates an Islamic finance dummy variable alongside key control variables. Individual financial indicators are also analyzed to uncover dimensions potentially obscured by composite indices. Findings: The results reveal that financial development significantly enhances inclusive growth, and the integration of Islamic finance has a positive and statistically significant effect. These findings underscore the role of Islamic finance in promoting a more equitable and resilient financial system.