Does financial development cause environmental pollution? Empirical evidence from South Asia

This study explores the influence of financial development (FD) on CO₂ emissions in five South Asian economies including energy consumption (ENC) and per capita income (PCI) as control variables. Using annual panel data for the period 1980-2018, this study applies the second-generation unit root and cointegration tests, panel pooled generalized least square (GLS) estimate, pooled mean group (PMG) estimation, and Dumitrescu-Hurlin panel causality test to accomplish the study. Westerlund cointegration test confirms a long-run relationship among the variables. The GLS estimation results reveal that FD, ENC, and PCI have significant impacts on environmental pollution. The relationship between FD and CO₂ emissions is linear, and thus, FD causes environmental pollution positively; an increasing level of FD does not reduce the latter. PCI and ENC affect environmental quality negatively. However, the existence of the EKC hypothesis is validated, as, at a rising level of PCI, pollution starts declining, taking an inverse U-shape. The PMG estimators also provide similar outcomes and validate the robustness of the panel GLS estimation. The D-H causality test supports the GSL findings and further reveals a feedback relationship between PCI and CO₂ emissions, ENC causes CO₂ emissions, bidirectional causality exists between FD and ENC, PCI causes both ENC and FD, and CO₂ emissions cause FD. The outcomes have implications for the policymakers to encourage firms and stakeholders to invest in renewable energy projects, and the financial intermediaries to the extent and subsidize loans for such investment projects. This is likely to induce investments in renewable energy sources, which will boost the energy portfolios, reduce CO₂ emissions, and produce a moderately cleaner environment.