ABSTRACT

The study analyzes the role of financial development (FD) using financial stability, financial efficiency, financial depth, financial access, and mobile financial services (MFS) on the size of the informal economy (INF) of Pakistan. For data analysis, annual time-series data over the period of 1990-2020 has been used and the study employed the auto-regressive distributive lag (ARDL) model to investigate the short-run and long-run relationship between the variables. In the short run and long run, FD has a negative relationship with the size of the informal economy. Two dimensions of FD, financial access and financial efficiency have a negative and positive impact on the size of the informal economy, respectively. Whereas, financial depth and financial stability have no significant relationship with the informal economy. MFS, on the other hand, has an inverse relationship with the informal economy in the short run. Policymakers can use financial development as an effective tool for reducing the level of informal activity in Pakistan. Increased access to financial services through bank expansion and mobile applications could encourage economic agents towards formality and reduce tax evasion. However, financial policies are required to accelerate access to financial services and resolve the demand side and supply side issues of private sector credit.