The past outbreak of global financial crises summarizes the importance of foreign capital inflow. As these global crisis makes the financial sector unstructured and disfigured. The evidence of negative impact of the malfunctioned financial system observed globally. At that point of time, foreign flows act as an incarnation for the affected economy by injecting the money flows. This outcome catching the eyes of the researchers and policymakers because financial flows can modify the financial sector, which leads to higher economic growth in long-run.
However, foreign capital inflows constantly play a necessary role for developing countries. According to Siddiqui, (2014), foreign capital inflows provide the capital needed for investment and growth, which ultimately enhance the performance of the overall economy of any country. It also widening and strengthening the financial markets, accelerate the transfer of technology and management expertise, and enhance liquidity, which expands the new job opportunities and boosts overall economic growth (Ajayi, 2006).
Some researchers also find adverse effects of foreign capital inflows like Baharumshah & Thanoon, (2006); Berument & Dinçer, (2004). They concluded that foreign capital inflows increase inflationary pressures, prompt monetary diversification, current account deficits, and exposure to external shocks and restrict the advantages of domestic policy instruments, etc. Ultimately these factors can badly impact the overall financial system. As we know, malfunctioning financial systems can directly or indirectly affect the economy by misusing resources, reducing savings, and enhancing speculation. As a repercussion, reduction of investment, a misallocation of scarce resources take place. These adverse effects of the financial system lead to the economy's deterioration by rising unemployment and poverty. The 2008 global financial crisis has also clarified the impact of malfunctioning financial systems on the affected economy. Since the breakout of the global crisis, an adverse impact on the rest of the world has been noticed. Highlighting the advantages of appropriate policy measures and introduces the different factors for financial development leads to minimization of the negative impact of the unstructured financial system. Therefore, we need to concentrate on financial development factors, which combined can maximize the utility of financial development.
As we observe from the couple of empirical studies that economic growth and financial development are interrelated with each other (Akisik, 2013; Ang, 2008; Beck et al., 2003; Demetriades & Law, 2006; Djalilov & Piesse, 2011; Fung, 2009; Hsueh et al., 2013; Law, 2008; Levine, 2003; Liu & Hsu, 2006; Zhang & Wu, 2012). Alternatively, several empirical studies (Burnside & Dollar, 2000; Chenery & Strout, 1966; Pradhan et al., 2008) find evidence that foreign flows have a positive growth impact, while some (Chami et al., 2005; Griffin & McKinley, 1994; Mah, 2010) suggests adverse effect or no effect at all on economic growth. Therefore, these literatures summarized that economic growth could directly impact financial development, but foreign financial flows can indirectly affect it by influencing economic growth. Also, the globalization-financial development nexus highlights the attention of researchers and policymakers. In such a scenario, Mishkin, (2009) appeared with a new strand in empirical research on applied finance and macroeconomics. According to him, a new ingredient of empirical research has come out. He added that globalization could bring financial development by stimulating institutional qualities in developing countries. Institutions with strong property rights, effective legal systems, and sound financial regulations, can rapidly upgrade the financial development in developing economies.
As per World Bank, 2014, remittance became the fastest mode of money transferring throughout the world. The remittances flow in low and middle-income countries become $343 billion in 2010; it again enhances to $449 billion in 2015 and in 2016 it become $442 billion. It again rose by $528 billion in 2018 and in 2019 it became $551 billion. But remittance flows to low and middle-income countries in 2020, declines by 20%, i.e., $540 billion, because of the economic crisis happens during the Covid-19 Pandemic situation. At that time, most of the migrants lost their job which raises the unemployment and poverty (World Bank, 2021). But the decline rate of remittance in 2020 (1.6%) is lesser than the 2009 global financial crisis (4.8%). Remittance also reduces the flow of foreign direct investment and overseas development assistance in 2020. As per the study of Peres et al. (2018), FDI received more by the developed countries rather than developing countries before the global financial crisis in 2008, but time has changed the graph, after the crisis it enhances by 35% in the developing countries.
However, this study is interested in research on the impact of foreign flows on financial development because of the consequences of financial flows in overall nations. The empirical studies discussed above, all have one thing in common: each study examines the impact of these external factors and ignores the impact of combined foreign flows, i.e., globalization. It is also surprising to note that there is no empirical evidence on the remittance and FDI-financial development nexus in region-based developing economies. In an attempt to fill the research gap in the current literature, this study empirically analyses the impact of remittance and FDI on financial development dynamics. As remittance and FDI is a part of economic globalization, we will also try to check the impact of economic globalization on financial development dynamics for these two regions.
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Therefore, this study only takes remittance and FDI because they are the top two foreign financial flows. In this perspective, Figure 1 states that an up-sloping trend of remittance and FDI flows leads to a reappearance of it and gaining more importance day by day in the Research field. As we know that international financial flows are coming to developing countries through firms, financial institutions and markets, and government sources. Concerning the current scenario, Remittances is the top financial flows of developing countries followed by FDI, official development Assistance and portfolio equity (Figure 1). So, remittance shows an increasing trend which is impressive in nature. However, in modern times most devastating financial crises are the Asian crisis of 1997 and the financial crisis of 2007-08. The Asian crisis of 1997 originated from Thailand and spread over East Asia later. According to the World Development Indicator, during the 1997 crisis growth rate of remittance was higher than the net FDI inflows growth rate. In 1997, remittance was higher than the rest of the year, but FDI was lesser than remittance. In the year 2007-08, another crisis happened in the United States because of severe contraction of liquidity in the global financial market, as an effect, U.S. Housing Market collapsed. According to the dataset collected from World Development Indicator, FDI is regularly decreasing, but remittances increase at a constant rate for 2007-09. Besides this, remittances have increased significantly from 2015-2019, But in between 2019-2020, the data are dropping because of the pandemic crisis that happens in this duration. Most of the migrants came home during that period which automatically leads to degradation of the remittance amount. However, in spite of the ups and downs of the financial flows, we are choosing the top two financial flows i.e., remittance and FDI for our analysis.
Moreover, according to the World Bank data from its latest version of "Migration and Development Brief", Region-wise, Europe and Central Asia (ECA) have the highest amount received from remittance and FDI, and Sub-Saharan Africa (SSA) has the lowest remittance and FDI receiving region. The report also added that remittance inflows increase in Latin America and the Caribbean (6.5 percent), South Asia (5.2 percent), and the Middle East and North Africa (2.3 percent). However, it reduces in East Asia and the Pacific (7.9 percent), Europe and Central Asia (9.7 percent), and Sub-Saharan Africa (12.5 percent). Therefore, a dropping rate of remittance in Europe and Central Asia and Sub-Saharan Africa also highlights the importance to check the loopholes of this regions. These are the reasons finds ECA and SSA region as a top and bottom Remittance and FDI receiving region for this study. Whereas figure 2 and figure 3 are showing the proof of choosing these two regions as top and bottom in both the cases of Remittance and FDI receiving region. Therefore, it will be interesting to take these regions as our sample area for our analysis.
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However, this comparative analysis between the ECA and SSA region, based on the impacts of remittance and FDI on the pattern of financial development, has not been analysed before. Against this backdrop, we aim to study the impacts of Remittance, FDI, and economic globalization on financial development by considering other critical macroeconomic factors, including institutional quality, Economic growth, domestic investment, and inflation, using annual data over 1984-2020. Therefore, we are trying to see the behaviour of the top Remittance and FDI receiving region and bottom Remittance and FDI region on financial development dynamics, which will help in policy implication in the near future.
Therefore, our study adds value to the existing literature for several reasons. As per my knowledge, this region-based study is the first study that considers the various dimensions of financial development, like financial institutions and financial markets (access, depth, and efficiency). On this reason, it becomes productive in case of financial development that ensures every aspects of the financial sector at the same time. The financial development dataset is constructed by Svirydzenka, (2016), a recently published financial development index in the International monetary fund. As Remittance and FDI are part of globalization, that is the reason our study not only considers Remittance and FDI as our primary independent variable but also it observes the impact of economic globalization for robustness. This study considers the globalization index by Gygli et al., (2019), a newly published KOF globalization index dataset in the International monetary fund for testing this hypothesis. Overall, this study gives a broader sense of identifying the impact of remittance, FDI, and economic globalization on financial development, which can add value to the research field by providing new policy measures for future endeavours.
The structure of the paper is as follows: Section 2 is all about the review of the related literature. Section 3 is related to the Theoretical framework. Section 4 describes the data sources used in this study, and Sections 5 and 6 describe the Methodology followed by Results and discussion of this study. Finally, the conclusion, Policy implications, and possible directions for future research are described in Section 7.