Constructing a Financial Conditions Index for Emerging and Developing Countries: A Static Panel Data Approach

Abstract

This study employs the basic panel data framework to develop a financial conditions index for six emerging and developing countries and estimate its impact on both economic growth and inflationary trend. The countries are Brazil, Malaysia, Mexico, Nigeria, Pakistan and South Africa, while the selected financial variables are treasury bills rate, real effective interest rate, interest rate spread, credit to private sector ratio to nominal GDP and market capitalization ratio to nominal GDP. Using annual data from 2010 to 2010, our findings indicate that real effective exchange rate is the most significant variable in the constructed financial conditions index, followed by credit to private sector, while treasury bills rate, interest rate spread and market capitalization play an insignificant role in the index. Our evidence also indicates that the constructed financial conditions index has a highly significant explanatory power for economic growth, while it contains little information for future inflationary trend. We, therefore, argue that adopting policies that focuses more on exchange rate and financial deepening would accelerate economic growth process in emerging and developing countries.