Financial development across Asian economies? Evidence from the club convergence approach and the ordered Logit and Probit models

Abstract

Purpose This study examines the pattern and determinants of financial development (FD hereafter) convergence across 45 Asian economies from 1997 to 2021. Design/methodology/approach Philips and Sul's (2007, 2009) procedure is used to analyse club convergence. Moreover, to identify the underlying determinants of club formation, ordered Logit and Probit models are also estimated. Data on the IMF's financial development (FD) index, a comprehensive measure capturing the multidimensional nature of financial systems along fundamental dimensions such as depth, access and efficiency, are used to estimate possible relationships. Findings The null hypothesis of convergence in financial development for the whole sample is rejected, suggesting that the examined economies may follow distinct, individual transition paths. Initially, the club clustering algorithm identified five homogenous clusters. However, the merging procedure identified three final clubs with 17 (club 1), 20 (club 2) and 7 (club 3) member countries, classified into relatively highly financially developed, moderately or partially financially developed and least financially developed clubs, respectively. Regarding the main drivers of club convergence, ordered Logit and Probit model results indicate that the coefficients for income, institutional quality, openness, inflation and human capital formation are positive and statistically significant. It indicates that countries experiencing higher economic growth, better institutional quality, greater openness, moderate inflation and greater human capital formation are more likely to belong to the club of higher financial development. Likewise, a negative, statistically significant coefficient for the current account deficit suggests that countries with poor macroeconomic stability belong to the club of low financial development. The results are robust to alternative models. Practical implications The club-convergence findings reported in this study recommend tailored policy interventions to address the convergence gap and facilitate lagging economies toward higher levels of financial development. The club coordination through the trade and movement of human and capital resources should be promoted to boost the positive spillovers from clubs 1 to 2 and 3, for rapid convergence towards high steady-state equilibria. The results of ordered Logit and Probit models suggest that for high financial development convergence, countries should promote sustained economic growth, strong institutions, calibrated openness, macroeconomic stability, moderate inflation and human capital formation. Productivity-enhancing growth strategies, strengthening the legal and regulatory framework, and strong macroeconomic foundations are crucial to avoid convergence into low-financial-development traps. Originality/value Being first of its kind, this study provides fresh evidence on the convergence of financial development across Asian economies – an economically vibrant and institutionally diverse region, given only peripheral attention. Second, most prior studies examining FD convergence have primarily used single-dimensional proxies for FD, such as private credit or market capitalization. This limitation is addressed in this study by incorporating data on a multidimensional measure of financial development that captures depth, access and efficiency of FD (Figure 1). Third, the twin methodology approach, like Philips and Sul's (2007, 2009) club convergence framework and Ordered Logit and Probit estimation, not only helps to identify the existence of club convergence but also explores why one group of countries advances more rapidly in financial development than others, an aspect not explored in the case of Asian economies.